IMPORTANT NOTICE THIS OFFERING IS AVAILABLE ONLY TO ELIGIBLE INVESTORS WHO ARE EITHER (1) QIBs (AS DEFINED BELOW) IN THE UNITED STATES OR (2) PERSONS OUTSIDE OF THE UNITED STATES IN RELIANCE ON REGULATION S (AS DEFINED BELOW)
IMPORTANT: You must read the following before continuing. The following applies to the attached Prospectus, and you are therefore advised to read this carefully before reading, accessing or making any other use of the Prospectus. In accessing the Prospectus, you agree to be bound by the following terms and conditions, including any modifications to them any time you receive any information from us as a result of such access. You acknowledge that this electronic transmission and the delivery of the attached Prospectus is intended for you only and you agree you will not forward this electronic transmission or the attached Prospectus to any other person. NOTHING IN THIS ELECTRONIC TRANSMISSION CONSTITUTES AN OFFER OF SECURITIES FOR SALE IN ANY JURISDICTION WHERE IT IS UNLAWFUL TO DO SO. THE SECURITIES HAVE NOT BEEN, AND WILL NOT BE, REGISTERED UNDER THE U.S. SECURITIES ACT OF 1933, AS AMENDED (THE “SECURITIES ACT”), OR THE SECURITIES LAWS OF ANY STATE OF THE U.S. OR OTHER JURISDICTION AND THE SECURITIES MAY NOT BE OFFERED OR SOLD WITHIN THE U.S., EXCEPT PURSUANT TO AN EXEMPTION FROM, OR IN A TRANSACTION NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND APPLICABLE STATE OR LOCAL SECURITIES LAWS. THE ATTACHED PROSPECTUS MAY NOT BE FORWARDED OR DISTRIBUTED TO ANY OTHER PERSON AND MAY NOT BE REPRODUCED IN ANY MANNER WHATSOEVER. ANY FORWARDING, DISTRIBUTION OR REPRODUCTION OF THIS DOCUMENT IN WHOLE OR IN PART IS UNAUTHORIZED. FAILURE TO COMPLY WITH THIS DIRECTIVE MAY RESULT IN A VIOLATION OF THE SECURITIES ACT OR THE APPLICABLE LAWS OF OTHER JURISDICTIONS. IF YOU HAVE GAINED ACCESS TO THIS TRANSMISSION CONTRARY TO ANY OF THE FOREGOING RESTRICTIONS, YOU ARE NOT AUTHORIZED AND WILL NOT BE ABLE TO PURCHASE ANY OF THE SECURITIES DESCRIBED THEREIN. Confirmation of your Representation: In order to be eligible to view the Prospectus or make an investment decision with respect to the securities, investors must be either (1) Qualified Institutional Buyers (“QIBs”) (within the meaning of Rule 144A under the Securities Act) or (2) “qualified investors” (“Qualified Investors”) within the meaning of the relevant implementation of Article 2(1)(e) of the Directive of the European Parliament and of the Council 2003/71/EC (the “Prospectus Directive”) in each relevant jurisdiction located outside of the U.S. in accordance with Regulation S under the Securities Act (“Regulation S”). By accepting the e-mail and accessing the Prospectus, you shall be deemed to have represented to us that (1) you and any customers you represent are either (a) QIBs, or (b) Qualified Investors outside of the U.S. and the electronic mail address that you gave us and to which this e-mail has been delivered is not located in the U.S. and (2) you consent to delivery of such Prospectus by electronic transmission. Any investor will be deemed to have represented and agreed that any securities acquired by it in the offer have not been acquired on behalf of persons in the EEA other than Qualified Investors for whom the investor has authority to make decisions on a wholly discretionary basis, nor have the securities been acquired with a view to their offer or resale in the EEA to persons where this would result in a requirement for publication by the issuer, Citigroup Global Markets Limited, Goldman Sachs International or Alfa Capital Markets, on behalf of themselves and the other managers (collectively, the “Managers”) of a prospectus pursuant to Article 3 of the Prospectus Directive. The issuers, the Managers and their respective affiliates will rely upon the truth and accuracy of the foregoing representations and agreements. This communication is only being distributed to and is only directed at (i) persons who are outside the United Kingdom or (ii) investment professionals falling within Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (the “Order”) or (iii) high net worth companies, and other persons to whom it may lawfully be communicated, falling within Article 49(2)(a) to (d) of the Order (all such persons together being referred to as “relevant persons”). The securities are only available to, and any invitation, offer or agreement to subscribe, purchase or otherwise acquire such securities will be engaged in only with, relevant persons. Any person who is not a relevant person should not act or rely on this document or any of its contents. You are reminded that the Prospectus has been delivered to you on the basis that you are a person into whose possession the Prospectus may be lawfully delivered in accordance with the laws of the jurisdiction in which you are located and you may not, nor are you authorized to, deliver or disclose the contents of the Prospectus to any other person. The materials relating to the offering do not constitute, and may not be used in connection with, an offer or solicitation in any place where offers or solicitations are not permitted by law. If a jurisdiction requires that the offering be made by a licensed broker or dealer and the Managers or any affiliate of the Managers is a licensed broker or dealer in that jurisdiction, the offering shall be deemed to be made by the Managers or such affiliate on behalf of the issuers in such jurisdiction. The Prospectus has been sent to you in an electronic form. You are reminded that documents transmitted via this medium may be altered or changed during the process of electronic transmission and consequently, none of the issuers, the Managers nor any of their affiliates accepts any liability or responsibility whatsoever in respect of any difference between the Prospectus distributed to you in electronic format and the hard copy version available to you on request. You are responsible for protecting against viruses and other destructive items. Your use of this e-mail is at your own risk and it is your responsibility to take precautions to ensure that it is free from viruses and other items of a destructive nature. Offering of 48,106,700 New Global Depositary Receipts representing 12,026,675 New Ordinary Shares to Existing Holders of Global Depositary Receipts Subscription Price: US$21.37
The Offering X5 Retail Group N.V. (the “Company” and together with its consolidated subsidiaries, unless the context requires otherwise, “X5”) is the largest food retailer by revenue in the Russian Federation. X5 was formerly known as Pyaterochka Holding N.V. This is an offering (the “New GDR Offering”) of 48,106,700 global depositary receipts (“New GDRs”, and together with all currently existing global depositary receipts, the “GDRs”), each representing one-quarter of an ordinary share, with a nominal value of €1.00 per share (the “New Shares” and together with X5’s existing ordinary shares, the “Shares”), to holders of GDRs at the close of business on 18 April 2008 (the “Record Date”). GDR holders who have certified (“Eligible Investors”) that they are either (i) “qualified institutional buyers” (“QIBs”) as such term is defined by Rule 144A (“Rule 144A”) under the U.S. Securities Act of 1933, as amended (the “Securities Act”), or (ii) “qualified investors” (“Qualified Investors”) within the meaning of the relevant implementation of Article 2(1)(e) of the Directive of the European Parliament and of the Council 2003/71/EC (the “Prospectus Directive”) in each relevant jurisdiction located outside the United States will be entitled to subscribe for New GDRs under the New GDR Offering. Other certifications may be required for residents in certain jurisdictions. If you are not an Eligible Investor, you may not participate in the New GDR Offering. In order to participate in the New GDRs Offering, Eligible Investors must duly complete, and return on time, the subscription card (the “Subscription Card”) that Eligible Investors are receiving from The Bank of New York, as depositary (the “Depositary”), to the Depositary in accordance with the instructions set forth therein, during a period beginning on or about 9:00 am London time on 23 April 2008 for holders of Regulation S GDRs (as defined below) and on or about 9:00 am New York time on 23 April 2008 for holders of Rule 144A GDRs (the “First GDR Subscription Day”) and ending on or about 5:00 pm London time on 2 May 2008 for holders of Regulation S GDRs and 12:00 noon New York time on 2 May 2008 for holders of Rule 144A GDRs (the “Last GDR Subscription Day” and the period between the First GDR Subscription Day and Last GDR Subscription Day inclusive, the “GDR Subscription Period”). Two New GDRs will be offered for every nine GDRs held by Eligible Investors on the Record Date (their “Regular Entitlement”). CTF Holdings Limited (“CTF”) has agreed to procure that (i) its subsidiaries, Cesaro Holdings Limited and Luckyworth Limited (together, the “Alfa Entities”), which together own 43.05% of the Company’s outstanding GDRs as at the date hereof, participate in the New GDR Offering to the full extent of their respective Regular Entitlements; and (ii) the Royal Bank of Scotland plc (“RBS”), which owns 5.36% of the Company’s outstanding GDRs as at the date hereof pursuant to a repurchase transaction with Luckyworth Limited, participates to the full extent of its Regular Entitlement. Certain members of the Management Board and senior employees of the Company have also agreed to participate in the New GDR Offering to the full extent of their Regular Entitlements. The GDRs that are subject to the foregoing commitments to participate in the New GDR Offering are referred to as “Committed GDRs”. To the extent that any holders of GDRs as of the Record Date do not subscribe for any New GDRs in the New GDR Offering (the “Non-Subscribing Holders”) or subscribe for less than their Regular Entitlement (“Partially-Subscribing Holders”), the number of New GDRs that would have been issued in respect of such GDRs (excluding the Committed GDRs, the “Excess GDRs”) will be offered for sale by Citigroup Global Markets Limited, Goldman Sachs International and Alfa Capital Markets (together, the “Joint Bookrunners” and together with BNP Paribas, Commerzbank Aktiengesellschaft N.V., ING Bank N.V. and Raiffeisen Centrobank AG, (the “Co-Lead Managers”), the “Managers”) subject to the terms and conditions of the underwriting agreement between X5 and the Managers dated 23 April 2008 (the “Underwriting Agreement”). The offering and sale of the Excess GDRs is referred to as the “Rump Offering”. Subject to the terms and conditions of the Underwriting Agreement, the Joint Bookrunners have agreed to purchase the Excess GDRs for resale as described below. X5 may also sell up to 3,769,113 GDRs, currently held by a subsidiary (the “Treasury Stock” and together with the New GDRs, the “Offer GDRs”), in connection with any Rump Offering. Offers and sales of Offer GDRs in the Rump Offering will be made only (i) in the United States to QIBs pursuant to Rule 144A and (ii) outside the United State to Qualified Investors pursuant to Regulation S (“Regulation S”) under the Securities Act. See “The Offering,” “Subscription and Sale” and “Selling and Transfer Restrictions” for more details. Upon the completion of the Rump Offering, if the aggregate proceeds for the Excess GDRs offered and sold in the Rump Offering, after deduction of any expenses related to the Rump Offering (including any applicable taxes), exceed the aggregate Subscription Price for such Excess GDRs (such amount, the “Excess Amount”), each Non-Subscribing Holder and Partially Subscribing Holder will be entitled to receive, except in certain circumstances, a part of the Excess Amount (the “Excess Proceeds”) in cash from the Joint Bookrunners through the financial institution through which such holder holds GDRs, on a pro-rata basis calculated on the basis of Excess GDRs held. The New GDR Offering is being conducted concurrently with the Company’s granting to the Depositary, who is the sole registered holder of the Company’s Shares (the “Share Offering”), the right to subscribe for up to 12,026,675 New Shares (the “Share Rights”). The New GDR Offering, Share Offering and Rump Offering (including offers and sales of the Treasury Stock) are, together, referred to as the “Offering”. References herein to the GDRs include the Excess GDRs (except where specified or where the context requires otherwise). Listing and Trading Applications have been made (i) to the U.K. Financial Services Authority (the “UKLA”), in its capacity as competent authority under the Financial Services and Markets Act 2000 (the “FSMA”), to admit 48,106,700 New GDRs to the official list of the UKLA (the “Official List”), and (ii) to the London Stock Exchange plc (the “London Stock Exchange”) for such New GDRs to be admitted to trading on the London Stock Exchange’s Regulated Market (as defined in the Markets in Financial Instruments Directive, Directive 2004/39/EC) (the “Regulated Market”). Admission of the New GDRs issued in the New GDR Offering to the Official List and to trading on the Regulated Market is expected to take place on 7 May 2008, following closing and settlement therefor on or around 7 May, 2008 (the “New GDR Offering Closing Date”) and with respect to the New GDRs issued in the Rump Offering, is expected to take place on 9 May 2008, following closing and settlement therefor on or about 9 May 2008 (the “Rump Offering Closing Date”). No application is currently intended to be made for the New GDRs to be admitted to listing or dealt with on any other exchange. The Company’s GDRs are listed on the London Stock Exchange (the “LSE”) under the symbol “FIVE”. The closing price on 21 April 2008 of the Company’s GDRs on the LSE was US$32.5. Neither this Prospectus nor any other document relating to the Offering has been filed with or approved by The Netherlands Authority for the Financial Markets (Autoriteit Financiële Markten). The Rule 144A GDRs have been designated as eligible for trading on PORTAL. Rights to Subscribe for New GDRs (“GDR Rights”) are not transferable and will not be listed by the Company on any stock exchange. Risk Factors For a discussion of certain risk factors that should be considered in connection with an investment in the GDRs, see “Risk Factors” beginning on page 10. Delivery and Settlement The New GDRs which are sold to Qualified Investors outside the United States (the “Regulation S GDRs”) will be issued in global form and will be evidencedbyaMaster Regulation S GDR (“Master Regulation S GDR”) registered in the name of The Bank of New York Depository (Nominees) Limited, as nominee for The Bank of New York, London Branch, as common depositary for Euroclear Bank SA/NV as operator of the Euroclear System (“Euroclear”) and Clearstream Banking, société anonyme (“Clearstream”). The New GDRs which are sold to QIBs in the United States (the “Rule 144A GDRs”) will be evidenced by a Master Rule 144A GDR (“Master Rule 144A GDR” and, together with the Master Regulation S GDR, the “Master GDRs”), registered in the name of Cede & Co as nominee for The Depository Trust Company (“DTC”). It is expected that delivery of the New GDRs will be made against payment therefor in U.S. dollars in same day funds through the facilities of Euroclear, Clearstream and DTC on or about the New GDR Offering Closing Date or Rump Offering Closing Date, as applicable. Alfa Capital Markets is the UK branch of Alfa Capital Holdings (Cyprus) Limited, a company incorporated in Cyprus, which is based in and focused on Cyprus and the UK and is not affiliated with U.S. based Alfa Insurance. Joint Global Co-ordinators Citi Goldman Sachs International Joint Bookrunners Alfa Capital Markets Citi Goldman Sachs International Co-Lead Managers BNP Paribas Commerzbank Corporate & Markets ING Raiffeisen Centrobank Dated 23 April 2008 IMPORTANT INFORMATION ABOUT THIS PROSPECTUS This Prospectus is based on information provided by X5 and other sources that X5 believes to be reliable. The Managers and their affiliates, and any person acting on behalf of the Managers or their affiliates, are not responsible for, and are not making any representation or warranty, express or implied, to any prospective investor concerning X5’s future performance or the accuracy or completeness of this Prospectus. This Prospectus comprises a prospectus for the purposes of the Offering under Article 5(3) of the Prospectus Directive and for the purpose of giving information with regard to X5 and its subsidiaries to enable investors to make an informed assessment of the assets and liabilities, financial position, profit and losses and prospects of X5. In making an investment decision regarding the Offer GDRs offered hereby, each prospective investor must rely on its own examination of X5 and the terms of the Offering, including the merits and risks involved. Each prospective investor should rely only on the information contained in this Prospectus. None of X5 or any of the Managers have authorised any other person to provide any prospective investor with different information. If anyone provides any prospective investor with different or inconsistent information, such prospective investor should not rely on it. Each prospective investor should assume that the information appearing in this Prospectus is accurate as of the date on the front cover of this Prospectus only. The business, financial condition and results of operations of X5 and the information set forth in this Prospectus may have changed since that date. No prospective investor should consider any information in this Prospectus to be investment, legal or tax advice. Each prospective investor should consult its own counsel, accountant and other advisors for legal, tax, business, financial and related advice regarding the Offering and purchasing of the Offer GDRs. None of X5 or any of the Managers makes any representation to any offeree or purchaser of the Offer GDRs regarding the legality of an investment in the GDRs by such offeree or purchaser under appropriate investment or similar laws. The Managers are acting exclusively for X5 and no one else in connection with the Offering and will not be responsible to any other person for providing the protections afforded to its clients or for providing advice in relation to the Offering. X5 accepts responsibility for the information contained in this Prospectus, and, having taken all reasonable care to ensure that such is the case, X5 declares that the information contained in this Prospectus is, to the best of X5’s knowledge, in accordance with the facts and contains no omission likely to affect its import. X5 obtained the market data used in this Prospectus under the captions “Prospectus Summary”, “Risk Factors”, “Operating and Financial Review” and “Business” from internal surveys, industry sources and currently available information. In particular, market data has been sourced from reports published by, among others, the Federal State Statistics Service (“Rosstat”), the World Bank, Economist Intelligence Unit and Business Analytica. X5 accepts responsibility for having correctly reproduced information obtained from industry publications or public sources, and, so far as X5 is aware and has been able to ascertain from information published by those industry publications or public sources, no facts have been omitted which would render the reproduced information inaccurate or misleading. However, each prospective investor should keep in mind that X5 has not independently verified information that it has obtained from industry and government sources nor has there been any investigation of the validity of the methodology of or the basis used by the third parties in producing such data or making estimates and forecasts. This Prospectus also contains information from other third parties, including AC Nielsen and Formata Holding B.V. (“Formata”). Information relating to Formata and its operations, including the Formata Consolidated Financial Statements, has been drawn from Formata’s website or from other public sources. Accordingly, X5 accepts responsibility only for accurately reproducing such information. As far as X5 is aware and is able to ascertain from the information published by a third party, no facts have been omitted from such information that would render it inaccurate or misleading. X5 has also included its own estimates, assessments, adjustments and judgements in preparing some market information, which has not been verified by an independent third party. Market information included herein is, therefore, unless otherwise attributed exclusively to a third party source, to a certain degree subjective. While X5 believes that its own estimates, assessments, adjustments and judgements are reasonable and that the market information prepared by X5 appropriately reflects the industry and the markets in which it operates, there is no assurance that X5’s own estimates, assessments, adjustments and judgements are the most appropriate for making determinations relating to market information or that market information prepared by other sources will not differ materially from the market information included herein. No content of any of X5’s websites forms any part of this Prospectus.
i X5 and the Joint Bookrunners reserve the right to reject any offer to purchase the New GDRs in whole or in part and to sell to any prospective investor less than the full amount of the New GDRs sought by such investor.
In connection with the Offering, each of the Managers and any affiliate acting as an investor for its own account may take up the Offer GDRs and, in that capacity, may retain, purchase or sell for its own account such securities and any of X5’s securities or related investments and may offer or sell such securities or other investments otherwise than in connection with the Offering. Accordingly, references in this Prospectus to the Offer GDRs being offered should be read as including any offering of securities to the Managers and any affiliate acting in such capacity. The Managers do not intend to disclose the extent of any such investment or transactions otherwise than in accordance with any legal or regulatory obligation to do so.
The Managers and the Depositary (and/or their respective affiliates) have, from time to time, engaged, and may in the future engage, in commercial banking, investment banking and financial advisory and ancillary transactions in the course of their business with X5 or any parties related to X5. As a result of these transactions, those parties may have interests that may not be aligned, or could potentially conflict with, the interests of X5 and any potential investors.
The distribution of this Prospectus and the offer and sale of the Offer GDRs may be restricted by law in certain jurisdictions. Each prospective investor must inform itself about, and observe, any such restrictions. See “Terms and Conditions of the Global Depositary Receipts” and “Subscription and Sale” elsewhere in this Prospectus. Each prospective investor must comply with all applicable laws and regulations in force in any jurisdiction in which such prospective investor purchases, offers or sells the Offer GDRs, or possesses or distributes this Prospectus, and each prospective investor must obtain any consent, approval or permission required for its purchase, offer or sale of the Offer GDRs under the laws and regulations in force in any jurisdiction to which such prospective investor is subject or in which such prospective investor makes such purchases, offers or sales. Neither X5 nor any Manager is making an offer to sell the Offer GDRs, or a solicitation of an offer to buy any of the Offer GDRs, to any person in any jurisdiction except where such an offer or solicitation is permitted.
NOTICE TO UNITED STATES INVESTORS
The Offering of the Offer GDRs has not been, and will not be, registered under the Securities Act. The Offer GDRs may not be offered or sold (i) in the United States except to QIBs in transactions that are exempt from registration under the Securities Act or (ii) outside the United States in offshore transactions in reliance on Regulation S.
Prospective investors are hereby notified that, in the Rump Offering, the Joint Bookrunners may be relying on the exemption from the registration requirements of Section 5 of the Securities Act provided by Rule 144A.
THE OFFER GDRS OFFERED HEREBY HAVE NOT BEEN REGISTERED WITH, OR APPROVED OR DISAPPROVED BY, THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION (“SEC”) OR ANY STATE SECURITIES COMMISSION IN THE UNITED STATES OR ANY OTHER U.S. REGULATORY AUTHORITY. FURTHERMORE, THE FOREGOING AUTHORITIES HAVE NOT PASSED ON OR ENDORSED THE MERITS OF THIS OFFERING OR THE ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENCE IN THE UNITED STATES.
NOTICE TO NEW HAMPSHIRE RESIDENTS
Neither the fact that a registration statement or an application for a license has been filed under Chapter 421-B of the New Hampshire revised statutes (“RSA 421-B”) with the State of New Hampshire nor the fact that a security is effectively registered or a person is licensed in the State of New Hampshire constitutes a finding by the Secretary of State of New Hampshire that any document filed under RSA 421-B is true, complete and not misleading. Neither any such fact nor the fact that an exemption or exception is available for a security or a transaction means that the Secretary of State has passed in any way upon the merits or qualifications of, or recommended or given approval to, any person, security or transaction. It is unlawful to make, or cause to be made, to any prospective purchaser, customer or client any representation inconsistent with the provisions of this paragraph.
ii NOTICE TO EUROPEAN ECONOMIC AREA INVESTORS
In any European Economic Area (the “EEA”) Member State that has implemented the Prospectus Directive, this communication is only addressed to and is only directed at qualified investors in that Member State within the meaning of the Prospectus Directive.
This Prospectus has been prepared on the basis that any offer of GDRs in any Member State of the EEA which has implemented the Prospectus Directive (2003/71/EC) (each, a “Relevant Member State”) will be made pursuant to an exemption under the Prospectus Directive, as implemented in that Relevant Member State, from the requirement to publish a prospectus for offers of GDRs. Accordingly, any person making or intending to make any offer within the EEA of Offer GDRs which are the subject of the Offering contemplated in this Prospectus may only do so in circumstances in which no obligation arises for X5 or any of the Managers to publish a prospectus pursuant to Article 3 of the Prospectus Directive or supplement a prospectus pursuant to Article 16 of the Prospectus Directive, in each case, in relation to such offer. Neither X5 nor the Managers have authorised, nor do they authorise, the making of any offer (other than Permitted Public Offers) of Offer GDRs in circumstances in which an obligation arises for X5 or the Managers to publish or supplement a prospectus for such offer.
Each person in a Relevant Member State who receives any communication in respect of, or who acquires any Offer GDRs under, the offers contemplated in this Prospectus will be deemed to have represented, warranted and agreed to and with each Manager and the Issuer that: (a) it is a qualified investor within the meaning of the law in that Relevant Member State implementing Article 2(1)(e) of the Prospectus Directive; and (b) in the case of any Offer GDRs acquired by it as a financial intermediary, as that term is used in Article 3(2) of the Prospectus Directive, (i) the Offer GDRs acquired by it in the offer have not been acquired on behalf of, nor have they been acquired with a view to their offer or resale to, persons in any Relevant Member State other than qualified investors, as that term is defined in the Prospectus Directive, or in circumstances in which the prior consent of the Joint Global Co-ordinators has been given to the offer or resale; or (ii) where Offer GDRs have been acquired by it on behalf of persons in any Relevant Member State other than qualified investors, the offer of those New GDRs to it is not treated under the Prospectus Directive as having been made to such persons.
For the purposes of this representation, the expression an “offer” in relation to any Offer GDRs in any Relevant Member State means the communication in any form and by any means of sufficient information on the terms of the offer and any Offer GDRs to be offered so as to enable an investor to decide to purchase or subscribe for the Offer GDRs, as the same may be varied in that Relevant Member State by any measure implementing the Prospectus Directive in that Relevant Member State.
NOTICE TO UNITED KINGDOM INVESTORS
This communication is only being distributed to and is only directed at (i) persons who are outside the United Kingdom or (ii) investment professionals falling within Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (the “Order”) or (iii) high net worth entities or other persons to whom it may lawfully be communicated, falling within Article 49(2)(a) to (d) of the Order (all such persons together being referred to as “relevant persons”). The Offer GDRs are only available to, and any invitation, offer or agreement to subscribe, purchase or otherwise acquire such Offer GDRs will be engaged in only with, relevant persons. Any person who is not a relevant person should not act or rely on this document or any of its contents.
NOTICE TO RUSSIAN INVESTORS
This Prospectus is not a public offer or advertisement of GDRs in the Russian Federation, and is not an offer, or an invitation to make offers, to purchase, sell, exchange or transfer any GDRs in the Russian Federation or to or for the benefit of any Russian person or entity. The Offer GDRs have not been and will not be registered with the Federal Service for the Financial Markets of the Russian Federation and are not intended for “placement” or “circulation” in the Russian Federation.
iii PRESENTATION OF FINANCIAL AND OTHER INFORMATION
Presentation of Financial Information
X5’s audited consolidated financial statements for the years ended 31 December 2007 and 2006 (together or separately, the “X5 Consolidated Financial Statements”) have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as adopted by the European Union. The audited consolidated financial statements of Perekrestok Holdings Limited for the year ended 31 December 2005 (the “2005 Perekrestok Consolidated Financial Statements”) have been prepared in accordance with IFRS as issued by the International Accounting Standards Board (“IASB”). The audited consolidated financial statements of Pyaterochka Holding N.V. for the year ended 31 December 2005 (the “2005 Pyaterochka Consolidated Financial Statements”) have been prepared in accordance with IFRS as issued by the IASB. The audited consolidated financial statements of Formata Holding B.V. for the year ended 31 December 2007 (the “Formata Consolidated Financial Statements”) have been prepared in accordance with IFRS as issued by the IASB. See “Independent Auditors” below.
The X5 Consolidated Financial Statements for the year ended 31 December 2006 and thereafter have been affected by a significant business combination. On 18 May 2006, Pyaterochka Holding N.V. (renamed X5 Retail Group N.V. after the combination) acquired 100% of the voting shares in Perekrestok Holdings Limited. However, because on completion of the transaction, shareholders and other related parties of Perekrestok Holdings Limited obtained control over 56% of the shares of Pyaterochka Holding N.V., the transaction was accounted for as a reverse acquisition of Pyaterochka Holding N.V. by Perekrestok Holdings Limited. Accordingly, the X5 Consolidated Financial Statements for the years ended 31 December 2007 and 2006 are prepared as a continuation of the consolidated financial statements of Perekrestok Holdings Limited following the reverse acquisition, and the reverse acquisition is accounted for as a purchase by Perekrestok Holdings Limited of Pyaterochka Holding N.V. on 18 May 2006 (see note 8 in the X5 Consolidated Financial Statements for the year ended 31 December 2006).
In this Prospectus, references to “X5” are to X5 Retail Group N.V. and, unless the context requires otherwise, its consolidated subsidiaries. References to “Pyaterochka” are to Pyaterochka Holding N.V. and unless the context requires otherwise, its subsidiaries, as such entities existed prior to the reverse acquisition of Pyaterochka Holding N.V. by Perekrestok Holdings Limited on 18 May 2006. References to “Perekrestok” are to Perekrestok Holdings Limited and unless the context requires otherwise, its subsidiaries, as such entities existed prior to the reverse acquisition of Pyaterochka Holding N.V. References to “Formata” are to Formata Holding B.V. and references to “Formata Group” are to Formata and its consolidated subsidiaries. References to “CTF” are to CTF Holdings Limited. References to the “Alfa Group Consortium” are to CTF and its direct and indirect subsidiaries.
X5’s Consolidated Financial Statements for the years ended 31 December 2007 and 2006 are included in this Prospectus. The 2005 Perekrestok Consolidated Financial Statements and the 2005 Pyaterochka Consolidated Financial Statements are incorporated by reference from the prospectus dated 18 May 2006 issued by Pyaterochka Holding N.V. relating to the offering of 15,813,253 shares in the form of 63,253,012 GDRs in connection with the acquisition of Perekrestok Holdings Limited (the “2006 Prospectus”) and form part of this document. The 2005 Perekrestok Consolidated Financial Statements and the X5 Consolidated Financial Statements are, together, referred to herein as the “Consolidated Financial Statements”.
Reclassifications
As discussed in note 2 to the X5 Consolidated Financial Statements for the year ended 31 December 2007, certain balances in the comparative 2006 financial information reflected in the X5 Consolidated Financial Statements for the year ended 31 December 2007 have been reclassified to conform to the 2007 presentation. Investment property in the amount of US$40.0 million was reclassified from property, plant and equipment and disclosed separately, and costs of US$34.2 million incurred in bringing the inventories to the location and condition ready for sale were reclassified from selling, general and administrative expenses to cost of sales. For purposes of presentation in this prospectus, similar reclassifications have been made to the consolidated financial information for the year ended 31 December 2005 to reflect the reclassifications that were effective in 2007. Investment property in the amount of US$11.7 million was reclassified from property, plant and equipment and disclosed separately, and costs of US$9.2 million incurred in bringing the inventories to the location and condition ready for sale were reclassified from selling, general and administrative expenses to cost of sales.
iv Additionally, certain balances in the comparative 2005 financial information reflected in the X5 Consolidated Financial Statements for the year ended 31 December 2006 have been reclassified to conform to the 2006 presentation. In particular, inventory shrinkage costs of US$11.5 million were reclassified from operating expenses to cost of goods sold.
The X5 Consolidated Financial Statements for the year ended 31 December 2006 included in this Prospectus and the 2005 Perekrestok Consolidated Financial Statements incorporated by reference have not been adjusted to take into account the changes described above that were effective in later years. Accordingly, these financial statements are not comparable in all respects to the presentation of the 2006 and 2005 consolidated financial information contained in this Prospectus.
Non-IFRS Measures EBITDA This Prospectus contains non-IFRS measures and ratios, including EBITDA for both X5 and Formata (see “Selected Consolidated Historical Financial Information – Non-IFRS measures and ratios – EBITDA” and “Business – X5 Operations and Stores – Karusel Hypermarkets”). EBITDA, for any relevant period, represents profit for the year before income tax expense, finance cost net of finance income, net foreign exchange gains/ losses, depreciation and amortisation and other non-operating gains/losses. X5 presents EBITDA because it considers EBITDA to be an important supplemental measure of its operating performance and believes the EBITDA measure is frequently used by securities analysts, investors and other interested parties in the evaluation of companies in the food retail industry. EBITDA has limitations as an analytical tool and it should not be considered in isolation, or as a substitute for analysis of X5’s operating results as reported under IFRS. Some of these limitations are: (i) EBITDA does not reflect the impact of finance costs, which are significant and could further increase if X5 incurs more debt, on its operating performance; (ii) EBITDA does not reflect the impact of income taxes on its operating performance; and (iii) EBITDA does not reflect the impact of depreciation and amortisation on X5’s operating performance. Although depreciation and amortisation are non-cash charges, the assets being depreciated and amortised will often have to be replaced in the future, and EBITDA does not reflect any cash requirements for such replacements. In addition, other companies in the food retail industry may calculate EBITDA differently or may use it for different purposes than X5 does, limiting its usefulness as a comparative measure. X5 compensates for these limitations by relying primarily on its IFRS operating results and using EBITDA only supplementally. EBITDA is a measure of X5’s operating performance that is not required by, or presented in accordance with, IFRS. EBITDA is not a measurement of X5’s operating performance under IFRS and should not be considered as an alternative to profit for the year, operating profit or any other performance measure derived in accordance with IFRS or as an alternative to cash flow from operating activities, or as a measure of X5’s liquidity. In particular, EBITDA should not be considered as measures of discretionary cash available to X5 to use in the growth of its business.
Like-for-Like Retail Sales Like-for-like comparisons of retail sales between two periods are comparisons of retail sales in local currency (including VAT) generated by the relevant stores. The stores that are included in like-for-like comparisons are those that have operated for at least twelve full months preceding the beginning of the last month of the reporting period. Their sales are included in like-for-like calculation starting from the first day of the month following the month of the store opening. The like-for-like comparison for each store takes into account retail sales generated by that store during the same months it was in operation in both the reporting period and the period of comparison. The retail sales of all the relevant stores in the relevant months are then aggregated and compared. Like-for-like sales are calculated on the basis of traffic and basket amounts of relevant stores in the period under review. For example, the like-for-like comparison of retail sales between 2007 and 2006 would include sales of a store that was opened or acquired on 15 October 2006, and the retail sales to be compared would be the aggregate retail sales generated by that store in November and December of 2007 and 2006. As the Pyaterochka acquisition was completed on 18 May 2006, X5 includes stores acquired in the Pyaterochka acquisition only for the months of June to December in each of 2006 and 2007 for the purposes of like-for-like retail sales calculation in this Prospectus. X5 has previously publicly reported like-for-like retail sales on a pro-forma basis, calculated by including acquired Pyaterochka stores for the full year in each of 2006 and 2007. Those figures differ from the like-for-like retail sales presented in this Prospectus.
“Retail sales” is the revenue derived from sales of goods from X5 stores (net of sales of goods to wholesale purchasers from distribution centres), and unless otherwise stated, is inclusive of VAT.
v Other Measures “Average basket size” is the average amount spent by customers on each purchase in the relevant stores for the period under review.
“Net selling space” is the area owned or leased by X5 to sell its products, less any area leased or sub-leased to third parties or used for administrative functions.
“Sales per square metre of net selling space” is calculated by dividing the total retail sales for each format for the period under review by the aggregate weighted net selling space. The weighted net selling space per store is calculated by multiplying the net selling space for that store at the end of the period under review by the number of days the store was operational during the period under review and dividing this number by 365. The weighted net selling space per store format is then aggregated for all stores of that format to provide the “aggregate weighted net selling space”.
“Traffic” is the number of customer visits in the relevant stores for the period under review.
References to “net” in this Prospectus with respect to financial data are to figures that do not include Value Added Tax (“VAT”). Unless otherwise stated, all financial data presented in this Prospectus are given inclusive of VAT.
All percentages in relation to the number or proportion of GDRs held by GDR holders are calculated including the GDRs held by Perekrestok Holdings Limited, a wholly owned subsidiary of X5. At the date of this Prospectus, Perekrestok Holdings Limited holds 3,769,113 GDRs, representing 1.74% of X5’s issued GDRs. The GDRs held by Perekrestok Holdings Limited are referred to in this Prospectus as the “Treasury Stock”.
References to the Moscow region or where data is presented by region in this Prospectus, other than as set out in the “Food Retail Industry” section, include the following areas: Moscow, Moscow region, Ryazan region and Yaroslavl. References to the St. Petersburg region or where data is presented by region in this Prospectus, other than as set out in the “Food Retail Industry” section, include the following areas: St. Petersburg, Leningrad region and Pskov region. References to the Yekaterinburg region or where data is presented by region in this Prospectus, other than as set out in the “Food Retail Industry” section, include the following areas: Yekaterinburg and Sverdlovsk region. References to the Nizhniy Novgorod region or where data is presented by region in this Prospectus, other than as set out in the “Food Retail Industry” section, include the following areas: Nizhniy Novgorod region, Vladimir region, Penza region, Republic of Chuvash and Republic of Marij El. References to the Chelyabinsk region or where data is presented by region in this Prospectus, other than as set out in the “Food Retail Industry” section, refer only to the Chelyabinsk region. References to the Samara region or where data is presented by region in this Prospectus, other than as set out in the “Food Retail Industry” section, refer only to the Samara region. References to the Southern Russia region or where data is presented by region in this Prospectus, other than as set out in the “Food Retail Industry” section, include the following areas: Volgograd region, Rostov region and Krasnodar region. References to “Other” regions or where data is presented by region in this Prospectus, other than as set out in the “Food Retail Industry” section, include the following areas: Tyumen region, Lipetsk region, Voronezh region, Kursk region and Republic of Tatarstan.
Independent Auditors The consolidated financial statements of X5 Retail Group N.V. for the years ended 31 December 2007 and 2006, included in this Prospectus, have been audited by ZAO PricewaterhouseCoopers Audit, independent auditors, as stated in their reports, appearing herein.
The consolidated financial statements of Perekrestok Holdings Limited for the year ended 31 December 2005, incorporated by reference into this Prospectus from pages 121-173 of the 2006 Prospectus, have been audited by ZAO PricewaterhouseCoopers Audit, independent auditors, as stated in their report, incorporated by reference in this Prospectus.
The consolidated financial statements of Pyaterochka Holding N.V. for the year ended 31 December 2005 have been audited by ZAO Deloitte & Touche CIS, independent auditors, as stated in their report. These consolidated financial statements, together with the audit report, have been incorporated by reference into this Prospectus from pages 73-105 of the 2006 Prospectus.
The consolidated financial statements of Formata Holding B.V. for the year ended 31 December 2007, included in this Prospectus, have been audited by ZAO Deloitte & Touche CIS, independent auditors, as stated in their report. These consolidated financial statements, together with the audit report, have been extracted from Formata’s website and included in the Annexure to this Prospectus.
vi Neither Formata nor ZAO Deloitte & Touche CIS have read, prior to publication, or otherwise been involved in the preparation of this Prospectus. ZAO Deloitte & Touche CIS has not been requested to provide, and has not provided, its consent to the inclusion or incorporation herein of their audit reports.
ZAO PricewaterhouseCoopers Audit and ZAO Deloitte & Touche CIS are corporate members of the Institute of Professional Accountants of Russia (Institut Professionalnykh Bukhgalterov Rossii) and members of the Russian Chamber of Auditors (Auditorskaya Palata Rossii).
Important Notice As Required By Dutch Law In Respect Of the Consolidated Financial Statements of X5 Retail Group N.V. and Pyaterochka Holding N.V. as Included In This Prospectus The consolidated financial statements of Pyaterochka Holding N.V. for the year ended 31 December 2005 form a part of the statutory annual financial statements (jaarrekening) for the year ended 31 December 2005, as required by Dutch law (the “2005 Pyaterochka Statutory Annual Financial Statements”). Therefore, only a part of financial statements similar, but not necessarily identical, to the 2005 Pyaterochka Statutory Annual Financial Statements are incorporated by reference in this Prospectus. The 2005 Pyaterochka Statutory Annual Financial Statements have been audited by R.M.A. Zuiverloon R.A.¸ an auditor (registeraccountant) within the meaning of Article 2:393, paragraph 1, of the Dutch Civil Code, of Deloitte Accountants B.V., who issued an unqualified audit report, within the meaning of Article 2:393, paragraph 5, of the Dutch Civil Code, in respect of such statements on 24 May 2006. The 2005 Pyaterochka Statutory Annual Financial Statements were adopted by the general meeting of shareholders of Pyaterochka Holding N.V. and filed with the commercial register of the Chamber of Commerce and Industry for Amsterdam, The Netherlands. The audit report issued by ZAO Deloitte & Touche CIS in respect of the 2005 Pyaterochka Consolidated Financial Statements is not an audit report within the meaning of Article 2:393, paragraph 5, of the Dutch Civil Code.
The consolidated financial statements of X5 Retail Group N.V. for the year ended 31 December 2006 form a part of the statutory annual financial statements (jaarrekening) for the year ended 31 December 2006, as required by Dutch law (the “2006 X5 Statutory Annual Financial Statements”). Therefore, only a part of financial statements similar, but not necessarily identical, to the 2006 X5 Statutory Annual Financial Statements are included in this Prospectus. The 2006 X5 Statutory Annual Financial Statements have been audited by P.C. Dams R.A., an auditor (registeraccountant) within the meaning of Article 2:393, paragraph 1, of the Dutch Civil Code, of PricewaterhouseCoopers Accountants N.V., whose registered address is at Thomas R. Malthusstraat 5, 1066, JR Amsterdam, The Netherlands, who issued an unqualified audit report¸ within the meaning of Article 2:393, paragraph 5, of the Dutch Civil Code, in respect of such statements on 15 May 2007. The 2006 X5 Statutory Annual Financial Statements were adopted by the general meeting of shareholders of X5 Retail Group N.V. and filed with the commercial register of the Chamber of Commerce and Industry for Amsterdam, The Netherlands. The audit report issued by ZAO PricewaterhouseCoopers Audit in respect of the consolidated financial statements of the X5 Consolidated Financial Statements for the year ended 31 December 2006 is not an audit report within the meaning of Article 2:393, paragraph 5, of the Dutch Civil Code.
Neither the 2005 Pyaterochka Statutory Annual Financial Statements nor the 2006 X5 Statutory Annual Financial Statements are included or incorporated by reference in this Prospectus.
The statutory annual financial statements (jaarrekening) of X5 Retail Group N.V. for the year ended 31 December 2007 (the “2007 X5 Annual Financial Statements”), as required by Dutch law, have not yet been audited by an auditor (registeraccountant) within the meaning of Article 2:393, paragraph 1, of the Dutch Civil Code and have not yet been adopted by the general meeting of shareholders of X5. The 2007 X5 Annual Financial Statements will also contain consolidated financial statements of X5 for the year ended 31 December 2007. X5 must publish the 2007 X5 Annual Financial Statements, together with the report of the auditor within the meaning of Article 2:393, paragraph 1, of the Dutch Civil Code in accordance with applicable Dutch law requirements. At the annual meeting of the general meeting of shareholders of X5, which is scheduled to be held on 16 June 2008, the general meeting of shareholders will be requested to adopt the 2007 X5 Annual Financial Statements. Upon adoption of the 2007 X5 Annual Financial Statements, such statements must be filed with the commercial register of the Chamber of Commerce and Industry for Amsterdam, The Netherlands. The audit report issued by ZAO PricewaterhouseCoopers Audit in respect of the X5 Consolidated Financial Statements for the year ended 31 December 2007 is not an audit report within the meaning of Article 2:393, paragraph 5, of the Dutch Civil Code. As the 2007 X5 Statutory Annual Financial Statements will be prepared and audited on dates different than the dates on which the X5 Consolidated Financial Statements for the year ended 31 December 2007, included in this Prospectus, have been prepared and audited, there may be differences in the numbers
vii contained in, or the notes to, the consolidated financial statements contained in the 2007 X5 Statutory Annual Financial Statements and the consolidated financial statements of X5 included in the X5 Consolidated Financial Statements for the year ended 31 December 2007.
Other Information References to “U.S.” or the “United States” are to the United States of America. References to “U.K.” or the “United Kingdom” are to the United Kingdom of Great Britain and Northern Ireland. References to “Russia” are to the Russian Federation.
Certain amounts that appear in this Prospectus have been subject to rounding adjustments; accordingly, figures shown as totals in certain tables may not be an arithmetic aggregation of the figures that precede them.
CURRENCIES AND EXCHANGE RATES
In this Prospectus, references to “U.S. dollars” or “$” are to the currency of the United States, all references to “roubles” or “RR” are to the currency of the Russian Federation and all references to “€” and “Euro” are to the lawful currency of the member states of the European Union that adopted that single currency in accordance with the Treaty Establishing the European Community, as amended by the Treaty on European Union.
The following tables show, for the periods indicated, certain information regarding the exchange rate between the rouble and the U.S. dollar, based on the official exchange rate quoted by the Central Bank of Russia (“CBR”). These rates may differ from the actual rates used in the preparation of X5’s financial statements and other financial information appearing in this Prospectus.
Roubles per U.S. dollar For each year from 2003 to 2007 Period and for the three months ended 31 March 2008 High Low Average(1) end 2003 ...... 31.88 29.25 30.69 29.45 2004 ...... 29.45 27.75 28.81 27.75 2005 ...... 29.00 27.46 28.32 28.78 2006 ...... 28.48 26.18 27.19 26.33 2007 ...... 26.58 24.26 25.58 24.55 Three months ended 31 March 2008 ...... 24.89 23.51 24.25 23.52
(1) The average of the exchange rates on each day of each full month during the relevant period.
Roubles per U.S. dollar Period For each month from November 2007 to March 2008 High Low end November 2007 ...... 24.68 24.26 24.35 December 2007 ...... 24.75 24.42 24.55 January 2008 ...... 24.89 24.29 24.48 February 2008 ...... 24.78 24.12 24.12 March 2008 ...... 24.05 23.51 23.52
The exchange rate between the rouble and the U.S. dollar on 18 April 2008 was RR23.37 per $1.00.
No representation is made that the rouble or U.S. dollar amounts in this Prospectus could have been converted into U.S. dollars or roubles, as the case may be, at any particular rate or at all. A market exists within Russia for the conversion of roubles into other currencies, but the limited availability of other currencies may tend to inflate their values relative to the rouble.
LIMITATION ON ENFORCEMENT OF CIVIL LIABILITIES
Judgements rendered by a court in any jurisdiction outside the Russian Federation will generally be recognised by courts in the Russian Federation only if an international treaty providing for recognition and enforcement of judgements in civil cases exists between the Russian Federation and the country where the judgement is rendered and/or a federal law is adopted in Russia providing for the recognition and enforcement of foreign court judgements. There is no treaty between the United Kingdom and the Russian Federation or The
viii Netherlands and the Russian Federation providing for reciprocal recognition and enforcement of foreign court judgements in civil and commercial matters, and no relevant federal law on enforcement of foreign court judgements has been adopted in the Russian Federation.
The Deed Poll (as defined below) in respect of the GDRs provides for actions brought against X5 by any holder of GDRs to be settled by arbitration in London, England, in accordance with the rules of the London Court of International Arbitration. The Russian Federation is a party to the United Nations (New York) Convention on the Recognition and Enforcement of Foreign Arbitral Awards. However, it may be difficult to enforce arbitral awards in the Russian Federation due to a number of factors, including: (a) the inexperience of Russian courts in international commercial transactions; (b) official and unofficial political resistance to enforcement of awards against Russian companies in favour of foreign investors; (c) Russian courts’ inability or unwillingness to enforce such orders; and (d) legal grounds (for example, the concept of “public order”) and/or technical grounds (for example, the lack of capacity of the parties or the invalidity of an arbitration clause).
The majority of the members of X5’s Management Board and Supervisory Board and members of X5’s senior management named in this Prospectus reside outside the United Kingdom, the United States and The Netherlands. The majority of their and X5’s assets are located outside the United Kingdom, the United States and The Netherlands, principally in the Russian Federation. As a result, it may not be possible for holders of Shares or GDRs to: (a) effect service of process within the United Kingdom, the United States or The Netherlands upon any members of X5’s Management Board and Supervisory Board and members of X5’s senior management named in this Prospectus; or (b) enforce, in the Russian Federation, court judgements obtained in courts of the United Kingdom, the United States or The Netherlands, as the case may be, against X5 or any of its directors and members of its senior management named in this Prospectus in any action.
For a further description of the risks relating to the ability of holders of Shares or GDRs to enforce court judgements against X5 or any of the members of its Management Board or Supervisory Board and senior management, see “Risk Factors – Risks Relating to the Shares, the GDRs and the Trading Market – Recourse against X5 and its directors and senior management may be limited because X5 generally conducts its operations outside The Netherlands and the United Kingdom and the majority of X5’s current directors and senior management reside outside The Netherlands and the United Kingdom”.
FORWARD-LOOKING STATEMENTS
This Prospectus includes statements that are, or may be deemed to be, “forward-looking statements”. These forward-looking statements can be identified by the use of forward-looking terminology, including the words “targets”, “estimates”, “believes”, “expects”, “aims”, “intends”, “will”, “may”, “anticipates”, “would”, “could” or “should” or similar expressions or, in each case their negative or other variations or by discussion of strategies, plans, objectives, goals, future events or intentions. These forward-looking statements all include matters that are not historical facts. They appear in a number of places throughout this Prospectus and include statements regarding X5’s intentions, beliefs or current expectations concerning, among other things, X5’s results of operations, financial condition, liquidity, prospects, growth, strategy and dividend policy and those of the industry in which X5 operates. By their nature, such forward-looking statements involve known and unknown risks, uncertainties and other important factors beyond X5’s control that could cause X5’s actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Such forward-looking statements are based on numerous assumptions regarding X5’s present and future business strategies and the environment in which X5 will operate in the future. Forward-looking statements are not guarantees of future performance. The important factors that could cause X5’s actual results, performance or achievements to differ materially from those expressed in such forward-looking statements include, among others: • changes in consumer demand or consumer preference for products that X5 sells; • the effects of competition in the geographic and business areas in which X5 operates;
ix • the effect of changes in, or enforcement of, laws, regulations, taxation or accounting standards or practices; • the risks relating to X5’s planned acquisition of Formata; • the effects of, and changes in, the policy of Russian government; • technology and systems utilised by X5; • the ability of X5 to acquire and retain real estate on favourable terms; • X5’s ability to implement and finance X5’s expansion programme in its current and, potentially new, markets; and • other factors set out under “Risk Factors”.
This list of important factors is not exhaustive. When relying on forward-looking statements, investors should carefully consider the foregoing factors and other uncertainties and events, especially in light of the political, economic, social and legal environment in which X5 operates. These forward-looking statements speak only as of the date of this Prospectus. X5 expressly disclaims any obligation or undertaking to publish any updates or revisions to any forward-looking statements contained herein to reflect any change in X5’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statements are based.
x TABLE OF CONTENTS
PROSPECTUS SUMMARY ...... 1 SUMMARY OF THE OFFERING ...... 6 RISK FACTORS ...... 10 USE OF PROCEEDS ...... 30 CAPITALISATION ...... 32 DILUTION ...... 33 SELECTED CONSOLIDATED HISTORICAL FINANCIAL INFORMATION ...... 34 OPERATING AND FINANCIAL REVIEW ...... 39 FOOD RETAIL INDUSTRY ...... 62 BUSINESS ...... 68 MANAGEMENT AND CORPORATE GOVERNANCE ...... 86 PRINCIPAL SHAREHOLDINGS ...... 96 MATERIAL CONTRACTS ...... 97 TRANSACTIONS WITH RELATED PARTIES ...... 98 DESCRIPTION OF SHARE CAPITAL AND ARTICLES OF ASSOCIATION ...... 100 TERMS AND CONDITIONS OF THE GLOBAL DEPOSITARY RECEIPTS ...... 110 SUMMARY OF PROVISIONS RELATING TO THE GDRS WHILE IN MASTER FORM ...... 127 TAXATION ...... 129 THE OFFERING ...... 136 SUBSCRIPTION AND SALE ...... 138 SELLING AND TRANSFER RESTRICTIONS ...... 140 SETTLEMENT AND DELIVERY ...... 143 INFORMATION RELATING TO THE DEPOSITARY ...... 146 LEGAL MATTERS ...... 146 INCORPORATION BY REFERENCE ...... 146 LISTING AND GENERAL INFORMATION ...... 147 INDEX TO FINANCIAL STATEMENTS ...... F-1 ANNEXURE—INDEX TO FORMATA CONSOLIDATED FINANCIAL STATEMENTS ...... A-1
xi PROSPECTUS SUMMARY
This summary highlights certain aspects of X5’s business and the Offering and must be read as an introduction to this Prospectus. Any decision to invest in the New GDRs should be based on a consideration of the Prospectus as a whole, including the risk factors. Following the implementation of the relevant provisions of the Prospectus Directive in each member state of the EEA, no civil liability will attach to X5 in any such member state solely on the basis of this summary, including any translation thereof, unless it is misleading, inaccurate or inconsistent when read together with the other parts of this Prospectus. Where a claim relating to the information contained in this Prospectus is brought before a court in a member state of the EEA, the plaintiff may, under the national legislation of the member state where the claim is brought, be required to bear the costs of translating the prospectus before the legal proceedings are initiated.
X5’s Business X5 is Russia’s largest food retailer in terms of revenue and the country’s leading multi-format food retailer, currently operating three store formats: soft discount stores, supermarkets and hypermarkets. X5 has grown from one supermarket in Moscow in 1995 to 868 stores in 2007, including 674 soft discount stores, 179 supermarkets and 15 hypermarkets. X5 currently operates its soft discount stores under the brand name “Pyaterochka” and its supermarkets and hypermarkets under the brand name “Perekrestok”. X5 intends to begin operating hypermarkets under the brand name “Mercado Supercenter” from June 2008 and to launch a new supermarket concept under the “Green Perekrestok” brand in July 2008. In addition, at 31 December 2007, X5’s franchisees operated 680 stores across Russia and in Kazakhstan under the “Pyaterochka” brands and 8 stores under the “Perekrestok” brand in the Moscow region.
X5 currently owns approximately 47% of its net selling space and leases the remainder primarily through leases with initial terms typically of five years or more.
X5’s main subsidiaries are organised under the laws of the Russian Federation.
Competitive Strengths and Strategy X5 believes that its competitive strengths include its market leadership in an attractive market, its multi- format operations, brand recognition of the “Perekrestok” and “Pyaterochka” brands amongst consumers, its extensive portfolio of owned real estate and its experienced management team.
Its strategy is to maintain and enhance its market leadership through focusing on multi-format development, expanding via organic growth and acquisitions, developing infrastructure to support growth and enhancing efficiency and further improving operational performance.
Management Team and Employees The Supervisory Board is responsible for advising and supervising the Management Board and the general course of affairs in X5 and its business. The Supervisory Board of X5 currently consists of six members, being Mr. Hervé Defforey, Mr. Mikhail Fridman, Mr. Alexander Savin, Mr. David Gould, Mr. Vladimir Ashurkov, and Mr. Carlos Criado-Pérez Trefault. The Management Board of X5 currently consists of three members, being Mr. Lev Khasis, Mr. Evgeny Kornilov and Mr. Frank Lhoëst. In 2007, the then serving members of the Supervisory Board and Management Board received total compensation of US$8.2 million, in addition to share based payments of US$33.1 million.
In 2007, the shareholders of X5 approved the granting of 100,000 options to acquire GDRs to Mr. Defforey and 60,000 options to acquire GDRs to Mr. Criado-Pérez Trefault. Certain members of the Supervisory Board, including Mr. Fridman and Mr. Gould also hold beneficial interests in X5’s GDRs.
As at 31 December 2007, 2006 and 2005 X5 employed 44,092, 34,941 and 13,871 employees, respectively. These employees may now, or in the future, hold GDRs, either through purchases on the market or through the exercise of options granted under the employee stock option plan adopted by the General Meeting of Shareholders on 15 June 2007.
1 Major Shareholders and Related Party Transactions All X5 Shares are held by its sole shareholder, the Depositary. The Depositary has issued GDRs in respect of all issued Shares. Certain members of the Supervisory Board hold beneficial interests in X5’s GDRs. Mr. Fridman holds beneficial interests in X5’s GDRs through Cesaro Holdings Limited and Luckyworth Limited, who, together, own 43.05% of X5’s issued GDRs. Mrs. Franus (who recently resigned from X5’s Supervisory Board with effect from 23 April 2008) and Mr. Rogachev (who recently resigned from X5’s Supervisory Board with effect from 21 April 2008) hold beneficial interests in X5’s GDRs through Marie-Carla Corporation N.V. and Tayleforth N.V., who together hold 21.06% of X5’s issued GDRs. Mr. Khasis holds beneficial interests in X5’s GDRs through Seaton Consultants Limited, which holds 1.88% of X5’s issued GDRs. Mr. Gould holds beneficial interests in X5’s GDRs through Talkoviy Enterprises Limited, which holds 0.03% of X5’s issued GDRs. X5 has engaged in certain related party transactions with members of the Alfa Group Consortium, including OJSC Alfa-Bank (“Alfa-Bank”), and with other entities that are controlled by members of the Supervisory Board. The Managers (and/or their respective affiliates) have, from time to time, engaged, and may in the future engage, in commercial banking, investment banking and financial advisory and ancillary transactions in the course of their business with X5 or any parties related to X5. As a result of these transactions, those parties may have interests that may not be aligned, or could potentially conflict with, the interests of X5 and any potential investors. Dividend Policy X5 does not, at present, intend to pay dividends on its shares in respect of its financial years ending 31 December 2007 and 31 December 2008 and for the foreseeable future. Auditors The consolidated financial statements of X5 Retail Group N.V. for the years ended 31 December 2007 and 2006 included in this Prospectus and the consolidated financial statements of Perekrestok Holdings Limited for the year ended 31 December 2005 have been audited by ZAO PricewaterhouseCoopers Audit, independent auditors, as stated in their reports. The consolidated financial statements of Pyaterochka Holding N.V. for the year ended 31 December 2005 incorporated by reference in this Prospectus and the consolidated financial statements of Formata Holding B.V. included in this Prospectus for the year ended 31 December 2007, have been audited by ZAO Deloitte & Touche CIS, independent auditors, as stated in their reports. Summary Consolidated Historical Financial Information The following table sets out selected data from the income statement contained in the Consolidated Financial Statements included in this Prospectus for the years ended 31 December 2007 and 2006 and incorporated by reference for the year ended 31 December 2005: Years ended 31 December 2007 2006 2005 (in millions of US$) Revenue ...... 5,320.4 2,803.4 1,014.8 Cost of sales(1) ...... (3,916.5) (2,041.7) (758.4) Gross profit ...... 1,403.9 761.6 256.4 Selling, general and administrative expenses(1) ...... (1,135.0) (630.8) (215.1) Lease/sublease and other income ...... 68.0 36.9 15.6 Operating profit ...... 336.9 167.7 56.9 Finance costs ...... (133.0) (63.0) (14.6) Finance income ...... 7.2 1.4 0.2 Net foreign exchange gain / (loss) ...... 31.5 14.1 (4.4) Profit before tax ...... 242.7 120.3 38.1 Income tax expense ...... (98.9) (36.1) (9.1) Profit for the period ...... 143.7 84.2 29.0 Attributable to: Equity holders of the parent ...... 143.7 84.2 29.1 Minority interest ...... – – (0.1) Profit for the period ...... 143.7 84.2 29.0
(1) Includes amounts reclassified to conform to the presentation adopted in the X5 Consolidated Financial Statements for a subsequent year or years. See “Presentation of Financial and Other Information – Reclassifications”.
2 The following table sets out selected data from the consolidated balance sheet contained in the Consolidated Financial Statements included in this Prospectus as at 31 December 2007, 2006 and incorporated by reference as at 31 December 2005:
At 31 December 2007 2006 2005 (in millions of US$) Current assets ...... 861.5 632.0 182.3 Non-current assets ...... 5,660.9 4,460.5 377.2 Total assets ...... 6,522.4 5,092.5 559.5 Current liabilities ...... 1,552.3 1,068.5 216.6 Non-current liabilities ...... 1,726.4 1,133.9 160.9 Total liabilities ...... 3,278.7 2,202.4 377.5 Total equity ...... 3,243.7 2,890.0 182.0 Total equity and liabilities ...... 6,522.4 5,092.5 559.5
Operating and Financial Review and Prospects In the year ended 31 December 2007, revenue for X5 was US$5,320.4 million and EBITDA was US$479.3 million. The main factors that have affected X5’s results of operations during the three years ended 31 December 2007 and that can be expected to affect its results of operations in the future, are the increases in the number of stores and net selling space, macroeconomic trends, the shift in the Russian food retail market structures, X5’s purchasing policies, increases in the sale of X5’s private label goods, improvement of X5’s warehousing and distribution, maintaining the proportion of X5’s owned to leased real estate and the effect of Russian tax legislation on X5’s operations.
X5’s liquidity needs arise principally from the need to finance existing operations, as well as the opening, construction and acquisition of new stores. In order to be able to finance planned capital expenditure in 2008, X5 may need to incur further borrowings. If X5 is unable to secure further loans or alternative sources of funding, it may need to reduce its planned capital expenditure for 2008.
Risk Factors The risks identified in this Prospectus include risks relating to X5’s business and industry, risks relating to X5’s expansion strategy, risks relating to X5’s acquisition of Formata, risks relating to X5’s real estate, risks relating to Russia (including political, economic, social and legislative and legal risks) and risks relating to X5’s Shares, the GDRs and their trading markets. The risks identified there may not be the only ones facing X5. Additional risks not currently known to X5 or that X5 currently deems immaterial may also impair its business operations. The business, financial condition or results of operations of X5 could be adversely affected by these risks. The trading price of the GDRs could also decline due to these risks, and investors could realise losses on their investment.
Material Contracts On 11 April 2006, X5 entered into a call option agreement with Overture Corporation N.V. and Puritani Corporation N.V. (the “Call Option Agreement”) pursuant to which it acquired an option to acquire Formata, the holding company for the Karusel hypermarkets (the “Karusel Option”). This option was exercised in January 2008.
On 18 December 2007, X5 entered into a three year facility agreement with a consortium of international banks for a principal amount of US$1,100.0 million, divided into two term loan facilities. The loans bear an initial interest rate of LIBOR plus 2.25% per annum plus any mandatory costs of compliance by certain financing parties with certain regulatory requirements (the “Syndicated Term Loan”).
Taxation Holders of GDRs who subscribe for New GDRs may be subject to taxation under Dutch taxation laws.
3 The Offering This is an offering of 48,106,700 New GDRs to GDR holders on the Record Date. The right to subscribe for New GDRs is granted at no cost to all GDR holders, but only Eligible Investors may subscribe. Eligible Investors may instruct the Depositary regarding the issuance of New GDRs at the Subscription Price of US$21.37, consisting of a subscription price of US$21.32 per New GDR and the Depositary’s issuance fee of US$0.05 per New GDR. The Alfa Entities own 43.05% of X5’s outstanding GDRs as at the date hereof and CTF has agreed to procure that the Alfa Entities, and RBS, which owns 5.36% of X5’s outstanding GDRs at the date hereof (subject to a repurchase transaction with an Alfa Entity) , participate in the New GDR Offering to the full extent of their Regular Entitlements. Certain members of the Management Board and senior employees of X5 who, together, own 1.89% of X5’s outstanding GDRs at the date hereof, have also agreed to participate in the New GDR Offering to the full extent of their Regular Entitlements.
The Joint Bookrunners have agreed to purchase any Excess GDRs, subject to the terms and conditions of the Underwriting Agreement, at the Subscription Price, less commissions and fees.
X5 is concurrently granting the right to the Depositary, its sole existing shareholder of record, to subscribe for up to 12,026,675 New Shares at US$85.28 per New Share (the “Share Subscription Price”). The Share Offering is being conducted on the basis that statutory pre-emptive rights have been disapplied by resolution of the Supervisory Board on 21 April 2008. The Depositary will participate in the Share Offering only to the extent required to acquire a sufficient number of underlying New Shares to fulfil the allocation of New GDRs in the New GDR Offering.
Applications have been made (i) to the UKLA to admit 48,106,700 New GDRs to the Official List; and (ii) to the London Stock Exchange plc for such New GDRs to be admitted to trading on the Regulated Market. Admission of the New GDRs issued in the New GDR Offering and in the Rump Offering to the Official List and to trading on the Regulated Market is expected to take place on the New GDR Offering Closing Date and the Rump Offering Date, respectively.
The GDR Rights are not transferable and will not be listed by the Company on any stock exchange.
Timetable The timetable below lists certain important dates relating to the Offering. All time references are to London time.
Record Date for the New GDR Offering ...... 18April 2008 Announcement of the New GDR Offering ...... 23April 2008 First GDR Subscription Day ...... 23April 2008 Ex-rights Date on the London Stock Exchange ...... 23April 2008 Last GDR Subscription Day ...... 2May2008 Offer of Excess GDRs and possibly, Treasury Stock, under Rump Offering ...... 6May2008 Listing of, and start of trading in, New GDRs on the London Stock Exchange ...... 7May2008 Delivery of New GDRs issued in the New GDR Offering(1) . . . 7 May 2008 Delivery of New GDRs issued in the Rump Offering(1) ...... 9May2008 Payment of Excess Proceeds(1) ...... 9May2008
(1) No assurance can be given that the issue and delivery of the New GDRs or payment of the Excess Payment will not be delayed.
X5 may adjust the dates, times and periods given in this timetable and throughout this Prospectus. If X5 should decide to so adjust dates, times or periods, it will notify the London Stock Exchange and make an announcement through a Regulatory Information Service.
Reasons For the Offer and Use of Proceeds The proceeds to X5 from the Offering, net of commissions, fees and expenses (which are estimated to amount to US$29.5 million), are expected to be approximately US$996.1 million. X5 expects to use the majority of the net proceeds of the Offering to fund the cash consideration payable for the acquisition of Formata and the rebranding, restyling and integration of the Karusel hypermarkets. Any remaining amounts from the net proceeds will be used for general corporate purposes.
4 Additional Information As at the date of this Prospectus, X5 had issued 54,120,038 ordinary shares in registered form, each with a nominal value of €1.00 each, for which 216,480,152 GDRs have been issued by the Depositary. Certain documents, including this Prospectus, the X5 Consolidated Financial Statements for the years ended 31 December 2007 and 2006, the 2005 Perekrestok Consolidated Financial Statements, the 2005 Pyaterochka Consolidated Financial Statements and the articles of association of X5, are available for inspection at the registered office of X5. This Prospectus is also available at http://www.londonstockexchange.co.uk/rns.
5 SUMMARY OF THE OFFERING
New GDRs offered in the New GDR Offering ...... Upto 48,106,700 New GDRs are being offered to holders of X5’s GDRs on the Record Date. Each New GDR will represent one-quarter of a New Share. The New GDRs will be delivered by the Depositary pursuant to a Deposit Agreement by and between X5 and the Depositary dated 11 May 2005 (the “Deposit Agreement”).
Eligible Investors can subscribe for their Regular Entitlement, being two New GDRs for every nine GDRs held by Eligible Investors on the Record Date.
Eligible Investors may make application for a lower whole number than their Regular Entitlement, but will not be entitled to make application for a greater number of New GDRs than their Regular Entitlement.
The Regulation S GDRs will be evidenced initially by a Master Regulation S GDR and the Rule 144A GDRs will be evidenced initially by a Master Rule 144A GDR, each of which have been issued by the Depositary pursuant to the Deposit Agreement. Pursuant to the Deposit Agreement, the Shares represented by the new GDRs will be held by ING Securities Service as custodian (the “Custodian”), for the benefit of the Depositary.
Except in the limited circumstances described herein, definitive GDR certificates will not be issued to holders in exchange for interests in the GDRs represented by the Master GDRs. Subject to the terms of the Deposit Agreement, interests in New GDRs which will be represented by the Master Regulation S GDR may be exchanged for interests in the corresponding number of New GDRs represented by the Master Rule 144A GDR, and vice versa.
Eligible Investors ...... Existing GDR holders who have certified that they are (i) QIBs or (ii) Qualified Investors who are outside the United States. Other certifications may be required as a condition to subscribe for New GDRs in certain jurisdictions. Offers and sales of New GDRs in the New GDR Offering will be made (i) within the United States to QIBs in transactions that are exempt from the registration requirements of the Securities Act and (ii) outside the United States to Qualified Investors in reliance on Regulation S.
Only Eligible Investors who are holders of record of X5’s existing GDRs as of the Record Date may subscribe for New GDRs.
Subscription Price ...... US$21.37 per New GDR.
For each New GDR that an Eligible Investor makes an application to subscribe for, such Eligible Investor will be required to remit funds to the Depositary prior to the Last GDR Subscription Day in an amount equal to the Subscription Price multiplied by the number of New GDRs that the Eligible Investor subscribes for.
Purchase Price for New GDRs ...... ThePurchase Price for New GDRs will be equal to the Subscription Price multiplied by the number of New GDRs that an Eligible Investor subscribes for.
6 Method of Exercise for New GDRs .... Eligible Investors can subscribe for New GDRs by completing the Subscription Card they are receiving from the Depositary. The Subscription Card should be returned to the Depositary prior to the end of the GDR Subscription Period, by facsimile at the facsimile number or by e-mail in PDF format at the e-mail address specified in the Subscription Card. The Purchase Price must be paid by wire transfer to the Depositary at the account specified in the Subscription Card prior to the Last GDR Subscription Day. Any Eligible Investor who holds GDRs through a financial intermediary wishing to subscribe for New GDRs should instruct the financial intermediary through which it holds its GDRs in accordance with the instructions received from it. Once an Eligible Investor has returned its Subscription Card to the Depositary, it cannot revoke or modify that exercise. An Eligible Investor who has not validly subscribed for New GDRs by the end of the GDR Subscription Period will not be able to subscribe for New GDRs under the New GDR Offering. GDR Subscription Period ...... Theperiod beginning on or about 9:00 am London time on 23 April 2008 for holders of Regulation S GDRs and on or about 9:00 am New York time on 23 April 2008 for holders of Rule 144A GDRs and ending on or about 5:00 pm London time on 2 May 2008 for holders of Regulation S GDRs and 12:00 noon New York time on 2 May 2008 for holders of Rule 144A GDRs. The Depositary ...... TheBank of New York. Record Date for New GDR Offering . . . 18 April 2008. Rump Offering ...... After the GDR Subscription Period has ended, the Joint Bookrunners may, subject to the terms and conditions of the Underwriting Agreement, commence the Rump Offering, in which they will offer for sale any Excess GDRs. X5 may also offer for sale all, or part, of its Treasury Stock, being 3,769,113 GDRs, in the Rump Offering. Underwriting ...... Subject to the terms and conditions of the Underwriting Agreement, the Joint Bookrunners have severally agreed to purchase any Excess GDRs (up to a maximum of 23,908,684 GDRs) at the Subscription Price, to be offered for resale in the Rump Offering. The Offer GDRs will be offered and sold in the Rump Offering (i) in the United States to QIBs pursuant to Rule 144A and (ii) outside the United States to Qualified Investors pursuant to Regulation S. The Co-Lead Managers have no obligation to underwrite any GDRs. The Joint Bookrunners do not have any obligation to purchase any New GDRs for which CTF, RBS, and certain members of the Management Board and senior employees have agreed to subscribe or procure subscription for. Excess Proceeds ...... Excess Proceeds are the proportionate amounts paid to Non- Subscribing Holders and Partially-Subscribing Holders where the aggregate proceeds for the Excess GDRs offered and sold in the Rump Offering, after deduction of any expenses related to the Rump Offering (including any applicable taxes), exceed the aggregate Subscription Price for the Excess GDRs. Upon the completion of the Rump Offering, each Non-Subscribing Holder and each Partially- Subscribing Holder will be entitled to, except as noted below, Excess Proceeds on a pro rata basis, calculated on the basis of Excess GDRs.
7 If any Excess Amount divided by the total number of Excess GDRs is less than US$0.01 per Excess GDR, no Excess Proceeds will be paid to the Non-Subscribing Holders or Partially-Subscribing Holders and, instead, any Excess Amount will be for the benefit of the Joint Bookrunners. X5 will not be entitled to receive any Excess Proceeds, although its subsidiary, Perekrestok Holding Limited, will be entitled to any Excess Proceeds paid in respect of the Treasury Stock in case Perekrestok Holding Limited qualifies as a Non-Subscribing Holder. The Excess Proceeds, if any, will be paid to the Non-Subscribing Holders and the Partially-Subscribing Holders as soon as practicable after the Rump Offering Closing Date and will be credited to those holders through the facilities of Euroclear, Clearstream and DTC. Payments will be made in U.S. dollars only, without interest and after the withholding of any applicable taxes. Total GDRs outstanding after the New GDR Offering ...... 264,586,852 GDRs, each representing one-quarter of a New Share. See “Capitalisation”. Closing Date ...... NewGDRs issued in the New GDR Offering will be delivered to the brokerage accounts of participating Eligible Investors through DTC, Euroclear or Clearstream on or about the New GDR Offering Closing Date, New GDRs issued in the Rump Offering (and any Treasury Stock) will be delivered to the brokerage accounts of participating Eligible Investors through DTC, Euroclear or Clearstream on or about the Rump Offering Closing Date. No assurance can be given that such delivery will not be delayed. Lock-up ...... TheCompany, CTF and certain members of the Supervisory Board and Management Board together with certain other senior employees of X5 and CTF have agreed to certain limitations regarding the issue, sale and other transactions in respect of GDRs for 180 days following the Rump Offering Closing Date, as described in “Subscription and Sale – Lock up Arrangements”. There is an exception from these limitations (except with respect the Company, for pledges of GDRs in connection with financing arrangements intended to provide funding for subscription of New GDRs. There are also exceptions from these limitations applicable to X5, including, among other exceptions, for the issuance of up to 1,837,000 Shares in connection with the acquisition of Formata under the Call Option Agreement (assuming a purchase price of approximately US$970.0 million). Marie-Carla Corporation N.V. and Tayleforth N.V. (entities associated with certain current and former Supervisory Board members), who together, hold 45,579,604 GDRs (representing a 21.06% interest in X5) have not entered into any lock-up arrangement. Share Offering ...... Concurrently with the New GDR Offering, X5 is granting to its sole existing shareholder, the Depositary, a right to subscribe for up to 12,026,675 New Shares in accordance with its Share Rights. The Share Offering is being conducted on the basis that statutory pre-emptive rights have been disapplied by resolution of the Supervisory Board on 21 April 2008. The Exercise Price for the Share Rights is US$85.28 per New Share, which is equivalent to the Subscription Price less the Depositary’s issuance fee multiplied by four (being the number of GDRs corresponding to each Share). The Depositary will participate in the Share Offering only to the extent required to acquire a sufficient number of underlying New Shares to fulfil the allocation of New GDRs in the New GDR Offering.
8 Share capital after the Share Offering . . . 66,146,713 ordinary shares in registered form, each with a nominal value of €1.00 each, for which 264,586,852 GDRs have been issued by the Depositary.
In addition, X5 may issue up to 1,837,000 Shares in connection with the acquisition of Formata under the Call Option Agreement (assuming a purchase price of approximately US$970.0 million).
Voting Rights of the GDRs ...... The Shares are subject to applicable provisions of Dutch corporate law and the articles of association of X5 (the “Articles”). Pursuant to the Deposit Agreement, the Depositary will endeavour to exercise on behalf of holders of all GDRs, at any meeting of holders of the Shares of which the Depositary receives timely notice, the voting rights relating to the Shares underlying the GDRs in accordance with instructions it receives from holders of GDRs, but only if X5 notifies the Depositary of the resolution to be voted upon. Otherwise, the Depositary will not exercise the voting rights attaching to the deposited Shares.
Taxation ...... Foradiscussion of certain tax consequences in The Netherlands, the United Kingdom and the United States of purchasing and holding the New GDRs, see “Taxation”.
Listing and Trading of New GDRs ..... Subject to the transfer restrictions specified in “Selling and Transfer Restrictions”, the New GDRs will be fungible with existing GDRs and will be eligible for trading on the London Stock Exchange and settlement through the facilities of DTC, Euroclear, or Clearstream, as the case may be.
Admission of the New GDRs to the Official List and to trading on the Regulated Market is expected to take place on 7 May 2008.
Security Identification Numbers ...... The Master Regulation S GDR has been accepted for clearance through Euroclear and Clearstream and the Master Rule 144A GDR has been accepted for settlement through DTC.
The New GDRs issued under Regulation S will be fungible with the existing Regulation S GDRs, and their security identification numbers will be as follows: Regulation S GDRs ISIN: US98387E1064 Regulation S GDRs CUSIP Number: 98387E205
The New GDRs issued under Rule 144A to QIBs located in the United States will be fungible with the existing Rule 144A GDRs and have the following security identification numbers:
Rule 144A GDRs ISIN: US98387E2054 Rule 144A GDRs CUSIP Number: 98387E106
Risk Factors ...... Before making any investment decision in respect of the Offer GDRs, prospective investors should consider carefully the factors and risks attached to an investment in the Offer GDRs, including the information set forth under “Risk Factors”.
Selling Restrictions ...... TheOffer GDRs are being offered and sold in the New GDR Offering and the Rump Offering subject to certain selling restrictions. See “Selling and Transfer Restrictions”.
9 RISK FACTORS
Prospective investors should carefully consider the following information about these risks, together with the information contained in this Prospectus, before deciding to buy GDRs. If any of the following risks actually occurs, X5’s business, prospects, financial condition or results of operations could be materially adversely affected. In that case, there could be an adverse effect on the trading prices of the GDRs.
The risks and uncertainties discussed below are those that X5 believes are material, but these risks and uncertainties may not be the only ones that X5 faces. Additional risks and uncertainties, including those that X5’s management is not currently aware of or deem immaterial, may also result in decreased revenues, increased expenses or other events that could result in a decline in the value of the GDRs.
Risks Relating to X5’s Business and Industry
A change in consumer preference or decline in consumer demand in the markets in which X5 operates could adversely affect X5’s revenue and profitability. Consumer demand in the markets in which X5 operates depends upon a range of factors outside X5’s control, including demographic factors, consumer preferences and discretionary consumer spending (which is in turn influenced by factors such as general economic conditions, the availability of disposable income and general levels of consumer confidence). A decline in consumer demand or change in consumer preference in the markets in which X5 operates could substantially reduce X5’s revenue and profitability. X5’s business is greatly influenced by the growth of the gross domestic product (“GDP”) of Russia, which has resulted in increased disposable incomes and consumer spending nationwide. X5 management believes that this, in turn, benefits X5’s business by causing shoppers to move from traditional retail formats to modern retail formats and by ultimately increasing sales and revenues of modern retail stores such as the ones operated by X5. In contrast, customers tend to reduce spending in periods of economic uncertainty. A downturn in general economic conditions and a decrease in disposable incomes could have an adverse effect on X5’s business, financial condition and operating results, turnover and profitability. Further, consumer demand for X5 store formats and product assortment is directly affected by changes in consumer preferences. For example, if consumer preferences in the markets in which X5 operates cease to favour X5 store formats and/or the products offered by X5 and X5 management is unable to identify and adapt to such changes in consumer preferences, consumer demand would decline, decreasing revenue and profitability, which would have an adverse effect on X5’s business, financial condition and operating results. In addition, the seasonality of consumer demand could cause significant fluctuations in X5’s performance from period to period.
X5 faces significant competition that could lead to a reduction of market share and a decline in profitability. The grocery retail industry in Russia is competitive in some of the regions, in particular, Moscow and St. Petersburg. In recent years, the growth in consumer demand in Russia has attracted new market participants and has produced an increasingly competitive environment. While intensity of competition varies from region to region, St. Petersburg is the most competitive market, where penetration of modern format retail food market is close to 80%, compared to approximately 40% in Moscow and 33.3% on average in Russian cities where the population exceeds 100,000 people.
As the market continues to develop, grocery retail chains will compete more intensively on the basis of location, quality of products, service, price, product variety and store condition. Some of X5’s current competitors or potential new entrants, particularly large international discount store chains, may have greater financial, distribution, purchasing and marketing resources, any of which could give them a competitive advantage. There can be no assurance that X5 will be able to compete successfully against current competitors or future new entrants. Any loss of market share by X5 could be permanent. Competitive pressures may have a material adverse effect on its business, financial condition and operating results.
In addition, Russia’s retail market is highly fragmented which poses challenges in increasing market share for X5. In particular, industry consolidation may lead to a loss of market share for X5 or an increased level of competitive activity.
Reduction in supplier discounts, rebates and bonuses could affect X5’s financial condition and operating results. As per standard international practice in modern grocery retailing, X5 is able to obtain discounts, rebates and bonuses from suppliers (see “Business – Suppliers and Logistics – Suppliers”). The level of discounts,
10 rebates and bonuses from X5’s suppliers increased in the year ended 31 December 2007, primarily due to the increased volume of goods purchased from the suppliers and a greater number of products delivered by the suppliers to X5’s distribution centres, rather than directly to retail stores. However, X5 may not be able to maintain the same level of supplier discounts, rebates and bonuses in the future (including those received as a result of suppliers delivering products directly to distribution centres). If X5 is unable to maintain a level of supplier discounts, rebates and/or bonuses equal to or greater than its competitors, this could have a material adverse effect on X5’s business, financial condition and operating results.
The sale of food products exposes X5 to the risk of product liability claims and adverse publicity. The packaging, marketing, distribution and sale of food products entail an inherent risk of contamination or deterioration, which could potentially lead to product liability, product recall and resultant adverse publicity. Such products may contain contaminants that could, in certain cases, cause illness, injury or death to consumers. Even an inadvertent shipment of contaminated products may lead to an increased risk of exposure to product liability claims. For example, an outbreak of hepatitis traced to an X5 soft discount store several years ago caused several soft discount stores to be closed for a number of days by the authorities. Product liability claims may be asserted against X5 in the future or X5 may be obligated to undertake significant product recalls. This risk is increased as X5 sells its own private label products. If a material product liability claim is successful, X5’s insurance may not be adequate to cover all liabilities it may incur, and X5 may not be able to continue to maintain such insurance, or obtain comparable insurance at a reasonable cost, if at all. If X5 does not have adequate insurance or contractual indemnification available, product liability claims relating to defective products could have a material adverse effect on X5’s ability to market successfully its products and on its business, financial condition and operating results.
Even if a product liability claim is not successful, is not fully pursued or is fully covered by insurance, the negative publicity surrounding any alleged contamination could result in a decreased in the products sold by X5, which could have a material adverse effect on X5’s goodwill, brand and operating results.
Salary increases in Russia may reduce our profit margins. Salaries in Russia have historically been significantly lower than salaries in the more economically developed countries of North America and Europe for similarly skilled employees, although they have increased significantly in recent years. If salaries continue to increase, or increase more rapidly than X5’s like-for-like sales growth, X5’s margins could be reduced. X5 may also need to increase the levels of its employee compensation more rapidly than in the past to remain competitive. Unless X5 is able to continue to increase the efficiency and productivity of its employees, salary increases could have a material adverse effect on its business, financial condition and operating results.
X5’s competitive position and future prospects depend on its senior management’s experience and expertise and X5’s ability to recruit and retain qualified personnel. X5’s ability to maintain its competitive position and to implement its business strategy is dependent, to a large extent, on the services of its directors and senior management. There can be no assurance that such key personnel will remain with X5. The loss of or diminution in the services of one or more of X5’s senior management team or its inability to attract, retain and maintain additional senior management personnel could have a material adverse effect on X5’s business, financial condition and operating results. X5 is not insured against damage that may be incurred in case of loss or dismissal of its key specialists or managers.
X5’s future success will depend, in part, on its ability to continue to attract, retain and motivate qualified personnel. Competition in Russia for personnel with relevant expertise is intense due to the small number of qualified individuals. A failure by X5 to successfully manage its personnel needs could have a material adverse effect on its business, financial condition and operating results.
X5’s insurance policies may be insufficient to cover losses arising as a result of business interruption, damage to its property or third-party liabilities. X5’s insurance policies cover most of its supermarket and hypermarket operations and part of its soft discount store operations. X5’s insurance policies may not be sufficient to cover losses arising as a result of a business interruption or damage to X5’s property as a result of fire, explosion, flood or other circumstances. In addition, while X5 maintains third-party liability insurance to the extent required by Russian law, there can be no assurance that if X5 suffers material losses or incurs a significant liability X5’s insurance policies will be sufficient to cover such losses or liability. If X5’s insurance policies are insufficient to cover such losses or liability, this may materially and adversely affect X5’s business, financial condition and operating results.
11 X5’s exposure to several tax jurisdictions may have an adverse effect on X5. Although most of X5’s operations are located in Russia, X5 is subject to the tax laws of several jurisdictions, including The Netherlands, Russia, Cyprus, Ukraine and Gibraltar, and the Company and/or any of its subsidiaries may be treated as being resident for tax purposes and/or otherwise subject to tax in jurisdictions other than their places of incorporation. The combined effect of the application to X5 of the tax laws, including the application or disapplication of tax treaties concluded by the relevant countries, of more than one of these jurisdictions and/or their interpretation by the relevant tax authorities could, under certain circumstances, produce contradictory results and related tax liabilities for X5, and may materially and adversely affect X5’s business, financial condition and operating results.
Challenges to X5’s tax position by the Russian tax authorities could have a material adverse effect. In recent years the tax authorities in the Russian Federation have taken a more assertive approach in their enforcement of tax legislation, and it is possible that transactions and activities that have not been challenged in the past may now be challenged. As a result, significant additional taxes, penalties and interest could well be assessed. Fiscal periods remain open to review by the authorities in respect of taxes for three calendar years preceding the year of review. Under certain circumstances, including for example if a court determines that a taxpayer has obstructed or hindered a tax inspector, reviews may cover longer periods.
X5 has claimed tax benefits from certain arrangements that could be challenged as not having been in compliance with Russian tax laws applicable at the relevant times. As the Russian tax enforcement environment has evolved, X5’s provisioning policy has tightened and its reliance on tax reduction measures has reduced. At 31 December 2007, X5’s balance sheet reflects additional liabilities and provisions relating to Russian tax, and related penalties and interest, in the amount of US$75.7 million, covering the period since the beginning of 2005 (the period ordinarily open to review by the authorities as described above). Of this amount, US$40.0 million was recorded in respect of certain acquisitions, including Pyaterochka, in 2006, and a further US$15.6 million in respect of acquisitions in 2007, representing management’s risk-weighted estimate of the potential cash outflows from a range of tax-related contingencies. See also note 35 to the X5 Consolidated Financial Statements for the year ended 31 December 2007. A portion of these acquisition-related provisions, and of the remaining US$19.9 million out of the total US$75.7 million, related to additional liabilities for income taxes and provisions for taxes other than income taxes that were payable but not declared in the tax accounts of X5 companies, together with certain related penalties and interest. For a discussion of the impact on X5’s income statement of the accrual of additional liabilities and provisions in each year, see “Operating and Financial Review – Significant Factors Affecting Results of Operations – Tax Contingencies”. In addition, as it did when it acquired other Russian food retailers, such as Pyaterochka and Mercado, X5 will consider recording, and will likely record, additional liabilities and provisions relating to tax contingencies when it acquires the Formata Group. The amount of any such liabilities and provisions could be significant, as the Formata Group has recorded only minimal liabilities and provisions as reflected in the Formata Consolidated Financial Statements (see note 24 of the Formata Consolidated Financial Statements) and as was the case when X5 acquired Pyaterochka and Mercado. Any such liabilities and provisions will be reflected on X5’s balance sheet but will not affect its income statement in the year of the acquisition.
In addition to reflecting the US$75.7 million of additional accrued liabilities and provisions in X5’s balance sheet at 31 December 2007, management also considered the extent of possible exposures in relation to Russian tax matters that are technically more than remote, but not probable and, accordingly, are not required to be accrued under IFRS. Management estimates that, at 31 December 2007, there are possible exposures in relation to profit tax and other tax risks that are more than remote, but for which no liability is required to be recognised under IFRS, that could be several times the additional accrued liabilities and provisions reflected on the balance sheet at that date (and potentially in excess of X5’s profit before tax for the year). There is also a prospect of additional cash outflows in relation to other tax contingencies that under IFRS are required neither to be accrued nor disclosed, including with respect to arrangements of the kind mentioned in the preceding paragraph entered into in periods prior to 2005. To date, X5 has not experienced significant cash outflows arising from possible or contingent risks.
Claims in respect of Russian taxes could have a material adverse effect on X5’s liquidity and financial condition, and, to the extent not covered by the accrued additional liabilities and provisions, on X5’s future profits. In addition, legal prosecutions relating to these matters could have an adverse effect on X5’s reputation. Accordingly, the value of X5’s GDRs could fall.
12 The Pyaterochka and Perekrestok brand names and related intellectual property are critical to X5’s business and substantial erosion in the value of the brand names due to product recalls, customer complaints, adverse publicity, legal action or other factors could have a material adverse effect on X5’s business, financial condition and operating results. As X5’s success depends to a significant extent upon brand recognition and the goodwill associated with it, the Pyaterochka brand name and trademark and the Perekrestok brand name and trademark are key assets of X5’s business. Maintaining the reputation of X5’s brand names and trademarks is critical to X5’s success. Substantial erosion in the value of X5’s brand names due to product recalls, customer complaints, adverse publicity, legal action or other factors could have a material adverse effect on X5’s business, financial condition and operating results. There can be no assurance that X5’s strategy and its implementation will maintain the value of these brands.
Russia and the other countries in which X5 operates generally offer a lower level of intellectual property rights enforcement than countries in Western Europe and North America. X5 believes it has taken appropriate steps to protect its trademarks and other intellectual property rights but cannot be certain that such steps will be sufficient or that third parties will not infringe or challenge such rights. If X5 is unable to protect its intellectual rights against infringement, it could have a material adverse effect on its business, financial conditions and operating results. Delays in registration of trademarks and defects in agreements pursuant to which trademarks were assigned to X5 may also increase the risk of infringement of X5’s intellectual rights and have a material adverse effect on X5’s business, financial condition and operating results.
A decline in consumer confidence or consumer preference in Moscow or St. Petersburg could materially adversely affect X5’s revenue and profitability. A significant proportion of X5’s revenues and profit is generated from its operations in the Moscow and St. Petersburg regions. In 2007, 84% of X5’s net retail sales was derived from sales in these areas. If consumer confidence or consumer preference for other food retail formats in these areas is/were to be adversely affected, this could have a material adverse effect on X5’s business, financial condition and operating results.
Systems failures and delays could harm X5’s business. X5 manages its inventory and logistical operations through a variety of electronic media, including an intranet, networked personal computers and automated inventory management systems. These operations are heavily dependent on the integrity of the electronic systems supporting them. X5’s systems and operations are vulnerable to damage or interruption from human error, data inconsistency, natural disasters, power loss, computer viruses, intentional acts of vandalism, breach of security and similar events. X5 has contingency plans in place to deal with such events; however, X5’s systems could suffer failures or delays in the future causing significant losses to its business. Equipment breakdowns may result in significant productivity losses and potentially complete inoperability of the stores trading software for significant periods of time (with the exception of cash registers). Significant systems failures and delays could cause unanticipated disruptions in service, decreased customer service and customer satisfaction and harm to X5’s reputation, which could result in loss of customers, loss of revenues and increased operating expenses.
Notwithstanding the above, X5 believes that its financial systems are sufficient to ensure compliance with the requirements of the UKLA’s Disclosure and Transparency Rules as a listed entity.
Risks Relating to X5’s Expansion Strategy The failure of X5’s strategy to open new stores could hamper its growth and profitability. At present, the stores operating under Pyaterochka’s brand are located in the Moscow region, St. Petersburg, seven other regions of the European part of Russia and the Urals. Stores operating under the Perekrestok brand are located in the Moscow region, St. Petersburg and 15 other regions of the European part of Russia and in Ukraine. As part of its strategy, X5 plans to increase substantially the number of stores operating under its brands in the European part of Russia (including in Moscow and St. Petersburg), the Urals and Ukraine.
The successful implementation of X5’s expansion strategy depends on its ability to locate and acquire appropriate sites on commercially reasonable terms, open new stores in a timely manner, employ, train and retain additional store and supervisory personnel and integrate the new stores into X5’s existing operations on a profitable basis. To maintain its leadership position, X5 must also expand at a rate that equals or exceeds that of its competitors. If X5 is not able to match or exceed the growth of its competitors, recognition of X5’s brands
13 may diminish, its number of customers may fall and it may lose the benefits it currently enjoys because of economies of scale, which could adversely affect its business, financial condition and operating results.
There can be no assurance that X5 will achieve its growth plans, that it will grow equal to or faster than its competitors or that new stores will operate profitably. See also “Risks Relating to X5’s Real Estate – Failure to acquire rights to appropriate real estate on commercially acceptable terms, protect X5’s real property rights or build and develop new stores on newly acquired sites could have a material adverse effect on X5’s business, financial condition and operating results”.
Expansion through acquisition entails certain risks, which may have a material adverse effect on X5’s business, financial condition and operating results. X5 has in the past and may in the future expand its business through acquisitions (see “Business – History and Development”). The pursuit of an acquisition strategy entails certain risks, including failing to identify suitable acquisition targets and/or failing to conduct appropriate due diligence on their operations and/or financial condition; overvaluing and paying a consideration greater than the market value of acquisition targets; incurring significantly higher than anticipated financing-related risks and operating expenses; discovering larger or previously undisclosed liabilities or contingent liabilities; failing to assimilate and integrate the operations and personnel of acquired businesses; failing to install and integrate all necessary systems and controls; losing customers; entering markets in which X5 has no or limited experience and/or where there may be limited access to requisite logistics and distribution facilities and arrangements; and experiencing the disruption of ongoing business and the strain of X5’s management resources. If any such risks occur, this could have a material adverse effect on the business, financial condition and operating results of X5.
In addition, X5 may acquire companies or groups of companies, which have minority shareholders who remain as shareholders after the acquisition. Minority shareholders have certain rights under Russian law, such as the ability to block resolutions of X5’s general shareholder meeting where such resolution requires unanimous or qualified majority voting. Minority shareholders may also be required to approve resolutions relating to interested-party transactions as uninterested shareholders. Minority shareholders may not approve transactions that X5 wishes to conduct, which could have a material adverse effect on the business, financial condition and operating results of X5.
Failure to generate or raise sufficient capital would hamper X5’s expansion strategy. Implementation of X5’s growth strategy and current expansion commitments requires significant capital expenditure. Cashflow from X5’s operations and/or borrowings from financial institutions or funding from capital markets sources may not be sufficient to fund its planned capital expenditures. Borrowings from financial institutions at favourable terms may also become increasingly difficult in light of the recent volatility in the international credit markets. Covenants in X5’s existing financing arrangements may restrict X5’s ability to raise additional debt funding. If X5 is not successful in generating sufficient cashflow or obtaining sufficient capital to fund its planned expenditure, it may need to curtail or discontinue its expansion, which could have a material adverse effect on X5’s future development. In addition, X5 has been required on a number of occasions to obtain waivers of covenants contained in financing arrangements to avoid breach of those covenants. Any failure to obtain waivers when required could lead to the acceleration of X5’s indebtedness, which would have a material adverse effect on X5’s business, financial condition and operating results.
Rapid growth and expansion may strain X5’s managerial, financial and operational resources, restricting its ability to expand its operations successfully. X5’s businesses have been expanding rapidly and X5 intends to continue this growth for the foreseeable future. Management of such growth increases the operating complexity of X5’s business and may place a significant strain on its managerial, financial and operational resources. To ensure operating efficiency during such growth will require, among other things, continued development of financial, operational and management systems, increased marketing activities and hiring and training of new personnel (including management personnel). X5 will also need to maintain close co-ordination among its logistical, technical, accounting, finance, marketing and sales personnel. If it is unable to achieve any of these objectives, X5’s business, financial condition and operating results could be materially adversely affected.
In addition, X5 may encounter difficulties in the ongoing process of implementing and enhancing its management information system to support its strategic growth. If X5 is unable to maintain an adequate management information system, financial reporting function and system of internal controls, its business, financial condition and operating results may be adversely affected.
14 Notwithstanding the above, X5 believes that its systems are sufficient to ensure compliance with the requirements of the UKLA’s Disclosure and Transparency Rules as a listed entity.
Risks Relating to X5’s Acquisition of Formata Integration of the Karusel hypermarkets entails certain risks. In January 2008, X5 exercised an option to acquire the Karusel chain of hypermarkets (see “Business – History and Development – Recent Acquisitions and Proposed Acquisition of Formata”). If X5 acquires the Karusel hypermarkets, it will face certain risks arising directly from such acquisition. For example, the IT systems run by the Karusel hypermarkets differ from those at X5. To successfully integrate Karusel hypermarkets, X5 will need to close each Karusel store for a certain period of time to allow for integration of IT systems and to convert the store layout to match X5’s other hypermarkets. This will require X5 to incur capital expenditure, while being unable to generate revenue from these hypermarkets during the integration and refurbishment period. X5 expects to spend approximately US$150 million in 2008 and 2009 to fully rebrand and integrate the Karusel stores.
The planned acquisition of the Karusel hypermarkets is subject to a number of conditions precedent, which, if not fulfilled, may prevent its closing; if the acquisition of the Karusel hypermarkets is not completed, X5 may not be able to achieve its stated objectives and X5 would not be able to use the net proceeds of the Offering as anticipated. X5 has exercised an option to acquire Formata, the holding company of the Karusel hypermarkets; however, completion of the acquisition is subject to the completion of due diligence satisfactory to X5 and the receipt of approvals from the Federal Antimonopoly Service (“FAS”). Completion of the acquisition will not occur until after completion of the Offering. If the acquisition is not completed, X5 may be unable to achieve its strategic objective of rapid expansion in the hypermarket sector, which could have a material adverse effect on the value of its GDRs. If X5 does not complete the acquisition of Formata, it will use the proceeds of the Offering for general corporate purposes and other acquisitions.
Potential problem areas identified during our due diligence, as well as potential liabilities that have not been discovered during due diligence, may result in write-downs of assets or charges or other expenses that are higher than expected. X5 is able to conduct only limited due diligence in connection with the acquisition of Formata, pursuant to the terms of the Call Option Agreement, and has had only limited access to Formata’s books and records. There may be problem areas of which it is unaware that may cause Formata to experience significant future losses or expenses or expose Formata and X5 to future write-downs or other charges. Because X5’s due diligence was limited, its assessment of the risks presented by the acquisition of Formata may not be accurate and there may be risks and problem areas of which it is not aware. In particular, X5 has limited knowledge of the conduct of Formata’s business since 31 December 2007 (the date of the most recent audited accounts). Since 31 December 2007, Formata may have incurred significant liabilities, sold significant assets or entered into transactions with related parties on terms that are unfavourable to members of the Formata Group or that will be unfavourable to X5 upon completion of the acquisition of Formata, including guarantees of any liabilities of related parties (see “The Formata Group has entered into development contracts with related parties which may not be in line with arm’s length, market terms” below). Should circumstances arise that it did not identify, anticipate or correctly evaluate in the course of its due diligence investigation, or that arise after due diligence work is completed, any necessary provisions, write-downs, charges or other expenses could be significant, and could lead to significant losses which could have a material adverse effect on its business, financial condition and operating results.
In X5’s experience, there are risks commonly associated with the food retailing business and companies with large real estate portfolios generally, which could well be applicable to Formata. These risks generally include: (i) the adequacy of title to land and buildings; (ii) the validity and completeness of construction permits; (iii) a high proportion of leased as compared to owned property; (iv) if there is a high proportion of leased property, the reliance on short term rather than long term leases; (v) the use of property to secure large borrowings; (vi) the use of intellectual property by related parties and (vii) many of the risk factors included in “Risks Relating to X5’s Business and Industry” and “Risks Relating to X5’s Real Estate”. Some of these risks are referred to in the notes to the Formata Consolidated Financial Statements such as, notes 19, 21 and 26. For a discussion of potential liabilities and provisions in relation to tax contingencies in Formata and its subsidiaries (see “Risks Relating to Business and Industry – Challenges to X5’s tax position by the Russian tax authorities could have a material adverse effect” above).
15 The Formata Group has entered into development contracts with related parties which may not be in line with arm’s length, market terms. In the first quarter of 2008, the Formata Group entered into agreements with certain Russian subsidiaries of Donson B.V. (the “Donson Subsidiaries”). Donson B.V. and the Donson Subsidiaries are controlled by, amongst others, Mr. Andrei Rogachev and Mrs. Tatiana Franus. Mr. Rogachev recently resigned from the X5 Supervisory Board with effect from 21 April 2008. Mrs. Franus recently resigned from the X5 Supervisory Board with effect from 23 April 2008. These agreements (the “Donson Construction Agreements”) provide for certain Donson Subsidiaries to construct hypermarkets for the Formata Group, including acquiring plots, obtaining permits and performing related activities. The costs for constructing hypermarkets under these agreements amount to US$223 million, which, in X5’s experience, is significantly higher than the market rate for comparable services for similar stores.
The Formata Group also entered into an agreement with certain Donson Subsidiaries (the “Donson Framework Agreement”) in the first quarter of 2008, which provides that those Donson Subsidiaires will source sites and build new hypermarkets for the Formata Group. Certain Donson Subsidiaries currently have an agreement with the Formata Group to construct 15 hypermarkets under the Donson Framework Agreement; however, the Formata Group may be obligated to enter into further agreements with Donson B.V. or one or more of the Donson Subsidiaries to proceed with development of further hypermarkets to be sourced and constructed by Donson Subsidiaries. The amounts payable under the Donson Framework Agreement and any other agreement between the Formata Group and Donson Subsidiaries may, similarly to the Donson Construction Agreements, be significantly above what X5 considers to be market rates and may contain other onerous terms, such as prepayment of amounts payable under the contracts.
If X5 is obliged to perform the obligations of the Formata Group under the Donson Construction Agreements, Donson Framework Agreement or any other agreement entered into with Donson B.V. or the Donson Subsidiaries, X5 will pay a significantly higher rate for services provided under these agreements than the market rate for comparable services. The formula used to calculate the exercise price of the Karusel Option does not allow for an adjustment to account for any amounts that have been, or may be, paid by the Formata Group to Donson B.V. or the Donson Subsidiaries after 31 December 2007 and prior to completion of the acquisition of the Formata Group by X5. Any commitments or payments made by the Formata Group to Donson and the Donson Subsidiaries that are significantly higher than the market rate for comparable services may have a material adverse effect on X5’s business, financial condition and operating results.
Risks Relating to X5’s Real Estate Failure to acquire rights to appropriate real estate on commercially acceptable terms, protect X5’s real property rights or build and develop new stores on newly acquired sites could have a material adverse effect on X5’s business, financial condition and operating results. X5’s ability to open new stores is heavily dependent on identifying and leasing and/or purchasing properties that are suitable for its needs on commercially reasonable terms. The market for property in large metropolitan areas in Russia is highly competitive and, when economic conditions are favourable, competition for, and therefore the cost of, high-quality sites may increase, as they have done in the past. If X5 fails to identify and secure sites on a timely basis for any reason, including competition from other food retailers seeking similar sites, its growth may be adversely affected. Even if X5 procures the rights to suitable sites, it may experience difficulty or delay in obtaining approvals from the various regional authorities required to undertake construction and to secure X5’s rights to the use of stores or to refit or refurbish those stores. Consequently, X5 may not be able to successfully identify, lease and/or purchase suitable properties on acceptable terms when required, which could have a material adverse effect on its business, financial condition and operating results.
Failure to renew store leases on commercially reasonable terms or at all as they expire may have a material adverse effect on X5’s business, financial condition and operating results. Approximately 53% of the total net selling space of X5’s stores are leased. X5 may not continue to be able to renew its store leases on favourable terms, or at all, as they expire. If X5 is unable to renew the leases for its store locations as they expire, or lease other favourable locations on acceptable terms, or if X5’s existing leases are terminated for any reason (including in connection with a landlord’s loss of its ownership rights to such sites), or if their terms are revised to X5’s detriment, such failures could have a material adverse effect on X5’s business, financial condition and operating results.
16 Successful challenges to X5’s ownership interests or lease rights in land or delays or cancellation of X5’s construction projects could have a material adverse effect on X5’s business, financial condition and operating results. X5 owns or leases buildings in which its businesses are located. X5’s business includes the acquisition of ownership or lease interests in land plots and buildings with a view to further development or re-development. Russian land and construction legislation is complicated and often ambiguous and/or contradictory at the federal and regional levels. In particular, it is not always clear which state bodies are authorised to enter into land leases with respect to particular land plots, construction approval procedures are complicated and prone to challenge or reversal, and construction and environmental rules often contain requirements that are impossible to comply with fully in practice. As a result, X5’s ownership of and/or lease rights to land and buildings may be challenged by government authorities or third parties, and its construction projects may be delayed or cancelled.
Under Russian law, transactions involving real estate may be challenged on many grounds, including where the seller or assignor of rights to real estate acting fraudulently or otherwise did not have the right to dispose of such real estate, breach of internal corporate approval requirements by a counterparty and failure to register the transfer of title in the Unified State Register of Rights to Real Estate and Transactions therewith (the “Real Estate Register”). As a result, defects in transactions with respect to real estate may lead to the invalidation of such transactions with respect to the particular real estate, which may affect X5’s title or lease rights to such real estate.
Further, under Russian law, certain encumbrances over real estate (including leases of less than one year and free of charge use agreements) do not need to be registered in the Real Estate Register in order to encumber validly the property. There is, therefore, a risk that third parties may successfully register or claim existence of encumbrances (of which X5 had no prior knowledge) over real estate owned or leased by X5 at any point in time.
Moreover, in the markets in which X5 currently operates and its target markets, there is a shortage of skilled contractors able to build new stores on time and in compliance with its standardised requirements. Unskilled contractors may have difficulty in obtaining the requisite construction permits to build new stores on time. As a result, X5 may not be able to meet its target expansion plans, and this could have a material adverse effect on its business, financial condition and operating results.
The value of real property X5 owns may decrease. X5 acquires premises for a large number of new stores every year. The prices of these properties may decrease for various reasons, including: • changes in the competitive environment; • changes in the attractiveness of real property as an investment asset either in Russia as a whole or in certain regional markets in which our real property is located due to changes in country-related or region-related risks; and • fluctuations in demand for commercial real property.
As a result of any unfavourable changes in the real property market, the value of X5’s real property may decrease, which could have a negative impact on the total value of its assets.
Risks Relating to Russia Political Risks Political and governmental instability in Russia could adversely affect X5’s business, financial condition and operating results. Since 1991, Russia has sought to transform itself from a one-party state with a centrally planned economy to a market-oriented economy. The Russian political system remains vulnerable to popular dissatisfaction, including dissatisfaction with the results of privatisation in the 1990s, as well as to demands for autonomy from particular regional and ethnic groups. The course of political, economic and other reforms has, in some respects, been uneven and the composition of the Russian government – the Prime Minister and the other heads of federal ministries – has, at times, been unstable. For example, six different Prime Ministers have led governments between March 1998 and May 2000. Mr. Putin became acting President of Russia on 31 December 1999 and was elected President in March 2000. Since that time, Russia has generally experienced a significantly higher degree of governmental stability. In addition, the elections to the State Duma in December 2003 resulted in a substantial majority for parties supportive of Mr. Putin.
17 In February 2004, just prior to his election to a second term as President, Mr. Putin dismissed his cabinet, including the Prime Minister. He subsequently appointed a new Prime Minister and issued a presidential decree that significantly reduced the number of federal ministries, redistributed certain functions amongst various agencies of the government and announced plans for a major overhaul of the federal administrative system. Many of these changes have since been implemented. In addition, a new law was adopted pursuant to which the executives of sub-federal political units (e.g., governors) are nominated by the President of Russia and confirmed by the legislature of the sub-federal political unit. Moreover, pursuant to legislation that came into force on 7 December 2006, single-member-district elections for the State Duma were eliminated and all votes are now cast on a party-list basis. On 12 September 2007, Mr. Putin dismissed the Russian government and subsequently appointed a new government. The most recent State Duma elections held on 2 December 2007 resulted in further increase in the share of the aggregate vote received by United Russia and other political parties allied with the President, bringing that percentage to more than two thirds. On 2 March 2008, the presidential elections were held, resulting in Mr. Putin’s successor, Dmitry Medvedev, being elected as president. Although the new President has publicly announced that he will continue the former President’s policies, there can be no assurance that significant changes in economic and political environment will not occur. The potential instability during the transition period and shifts in governmental policy and regulation in Russia, which are less predictable than in many Western countries, could negatively affect the economic and political environment in the near term. Similar or possible other future changes in the government, possible major policy shifts or a possible lack of consensus between the President, the government, Russia’s parliament and powerful economic groups could lead to political instability, which could have a material adverse effect on the value of investments in Russia generally and on X5 in particular.
Substantially all of X5’s operations are in Russia, and changes in the economic policies in Russia could adversely affect its business. In recent years, the political and economic situation in Russia has generally become more stable and conducive to investment. However, major policy shifts, government reshuffles and a lack of consensus among key political groups could hinder or reverse political, economic and regulatory reforms. Reform may also suffer if key government officials engage in private business while in office, particularly when these business interests are in the industry that such officials regulate. Any such deterioration of Russia’s investment climate might constrain X5’s financing ability in the international capital markets, limit sales in Russia, and otherwise harm its business. In addition, the use of governmental power against particular companies or persons, for example, through the tax, environmental or prosecutorial authorities, could adversely affect the Russian economic climate and, if directed against X5, its senior management, major shareholders or its beneficial owners, X5’s business, financial condition and results of operations could suffer a material adverse effect. Russian authorities have recently challenged some Russian companies and prosecuted their executive officers and shareholders on tax evasion and related charges. In some cases, the results of such prosecutions and challenges have been significant claims against companies for unpaid taxes and the imposition of prison sentences on individuals. There has been speculation that in certain cases these challenges and prosecutions were intended to punish, and deter, opposition to the government or the pursuit of disfavoured political or economic agendas. There has also been speculation that certain environmental challenges brought recently by Russian authorities in the oil and gas sector have been targeted at specific Russian businesses under non-Russian control, with a view to bringing them under state control. More generally, some observers have noted that takeovers in recent years of major private sector companies in the oil and gas, metals and manufacturing sectors by state-controlled companies following tax, environmental and other challenges may reflect a shift in official policy in favour of state control at the expense of individual or private ownership, at least where large and important enterprises are concerned. Moreover, regulatory authorities in Russia have a high degree of discretion and at times appear to exercise their discretion arbitrarily, without hearing or prior notice. Such arbitrary governmental actions have reportedly included denial or withdrawal of licences, sudden and unexpected tax audits, criminal prosecutions and civil actions. Arbitrary government action, if directed at X5 or its major shareholders or beneficial owners, could have a material adverse effect on X5’s business and financial condition and operating results. For example, in 2006, a new excise mark was introduced for alcohol products, which resulted in a practical suspension of all alcohol products other than beer for a period of approximately two months. If Russian authorities were to revoke or deny X5 certain licences for the sale of alcoholic beverages in its stores, this would have a material adverse effect on the business, financial condition and operating results of X5. In the year ended 31 December 2007, alcoholic beverages accounted for approximately 10% of X5’s revenue from sale of goods.
18 Political and other conflicts create an uncertain operating environment that hinders X5’s long-term planning ability and could adversely affect its business and financia1 condition. Russia is a federation of 83 sub-federal political units, consisting of republics, territories, regions, cities of federal importance and autonomous regions and districts. The delineation of authority and jurisdiction among the members of the federation and the federal government is, in many instances, unclear and remains contested. Lack of consensus between the federal government and local or regional authorities often results in the enactment of conflicting legislation at various levels and may lead to further political instability. In particular, in the past conflicting laws have been enacted in the areas of privatisation, securities, corporate legislation, regulation of land use and licensing. Some of these laws and governmental and administrative decisions implementing them, as well as certain transactions consummated pursuant to them, have in the past been challenged in the courts in Russia and such challenges may occur in the future.
Additionally, ethnic, religious, historical and other divisions have, on occasion, given rise to tensions and, in certain cases in Southern Russia, military conflict. As a result, a number of fatal terrorist attacks have been carried out in Moscow and other Russian regions. The further intensification of violence, including terrorist attacks and suicide bombings, or its continued spread, could have significant political consequences, including the imposition of a state of emergency in some or all of Russia. Moreover, any terrorist attacks and the resulting heightened security measures may cause disruptions to domestic commerce and exports from Russia, and could materially adversely affect X5’s business, financial condition and operating results.
Economic Risks Economic instability in Russia could adversely affect X5’s business. The Russian economy has been subject to abrupt downturns. In particular, on 17 August 1998, in the face of a rapidly deteriorating economic situation, the Russian government defaulted on its rouble-denominated securities, the Central Bank stopped its support of the rouble and a temporary moratorium was imposed on certain hard currency payments. These actions resulted in an immediate and severe devaluation of the rouble, a sharp increase in the rate of inflation, a dramatic decline in the prices of Russian debt and equity securities and the inability of Russian issuers to raise funds in the international capital markets. These problems were aggravated by the near collapse of the Russian banking sector after the events of 17 August 1998 as evidenced by the revocation of the banking licences of a number of Russian banks. This further impaired the ability of the banking sector to act as a reliable and consistent source of liquidity to Russian companies, and resulted in the loss of bank deposits in some cases.
Because Russia produces and exports large quantities of oil and natural gas, the Russian economy is vulnerable to fluctuations in the price of oil and natural gas on the world market and a decline in the price of oil and natural gas could significantly slow or disrupt the Russian economy.
Therefore, there can be no assurance that recent trends in the Russian economy, such as the increase in the gross domestic product, a relatively stable rouble and a reduced rate of inflation, will continue in future. Strong fluctuations of the rouble in real terms relative to the U.S. dollar and other currencies, changes in monetary policy, inflation or other factors could adversely affect Russia’s economy and X5’s business in the future. Any such market downturn or economic slowdown could also severely limit X5’s access to capital, also adversely affecting its business and operating results in the future.
The Russian banking system remains underdeveloped and another banking crisis could place severe liquidity constraints on X5’s operations. Russia’s banking and other financial systems are not well developed or regulated, and Russian legislation relating to banks and bank accounts is subject to varying interpretations and inconsistent application. The August 1998 financial crisis resulted in the bankruptcy and liquidation of many Russian banks and almost entirely eliminated the developing market for commercial bank loans at that time. Many Russian banks also do not meet international banking standards, and the transparency of the Russian banking sector in some respects still lags behind international banking standards. Aided by inadequate supervision by the regulators, many banks do not follow existing Central Bank regulations with respect to lending criteria, credit quality, loan loss reserves or diversification of exposure. Further, in Russia, bank deposits made by corporate entities generally are not insured.
Recently, there has been a rapid increase in lending by Russian banks, which many believe has been accompanied by deterioration in the credit quality of the borrowers. In addition, a robust domestic corporate debt
19 market is leading to Russian banks increasingly holding large amounts of Russian corporate rouble bonds in their portfolios, which is further deteriorating the risk profile of Russian bank assets. The serious deficiencies in the Russian banking sector, combined with the deterioration in the credit portfolios of Russian banks, may result in the banking sector being more susceptible to market downturns or economic slowdowns, including due to Russian corporate defaults that may occur during any such market downturn or economic slowdown. In addition, in 2004 the Central Bank revoked the licenses of certain Russian banks, which resulted in market rumours about additional bank closures and many depositors withdrawing their savings. If another banking crisis were to occur, Russian companies would be subject to severe liquidity constraints due to the limited supply of domestic savings and the withdrawal of foreign funding sources that would occur during such a crisis.
There are currently a limited but increasing number of sufficiently capitalised Russian banks. X5 attempts to mitigate this risk by receiving and holding its rouble-denominated funds in a number of Russian banks, including subsidiaries of foreign banks. Nonetheless, X5 holds the bulk of its rouble cash in Russian banks, including subsidiaries of foreign banks, because the rouble is not transferable or convertible outside of Russia. There are few, if any, safe rouble-denominated instruments in which X5 may invest the excess rouble cash of its Russian subsidiaries. A banking crisis or the bankruptcy or insolvency of the banks with which X5 holds funds could result in the loss of its deposits or affect its ability to complete banking transactions in Russia, which could have a material adverse effect on its business, financial condition and operating results.
The poor condition of Russia’s physical infrastructure could disrupt normal business activity. Russia’s physical infrastructure largely dates back to Soviet times and has not been adequately funded and maintained over the past decades. Particularly affected are the rail and road networks, power generation and transmission, communication systems and building stock. Road conditions throughout Russia are poor, with more than half of all roads not meeting minimum requirements for use and safety. X5 relies on the satisfactory condition of roads to allow for movement of its goods by trucks between distribution centres and stores. Any significant problem with the condition of such roads would have a material adverse effect on X5’s operations. The federal government is actively considering plans to reorganise the nation’s rail, electricity and telephone systems. Any such reorganisation may result in increased charges and tariffs while failing to generate the anticipated capital investment needed to repair, maintain and improve these systems. Russia’s poor physical infrastructure disrupts the transportation of goods and supplies and adds costs to doing business in Russia, and further deterioration in the physical infrastructure could have a material adverse effect on X5’s business, financial condition and operating results. In addition, there are a number of nuclear and other dangerous installations in Russia where safety systems to contain ecological risks may not be sufficiently effective. The occurrence of accidents in these installations, as well as the generally unfavourable ecological situation in Russia, may also have a material adverse effect on X5’s business, financial condition and operating results.
Currency and exchange rate fluctuations may adversely affect X5’s business and financial condition and the price and liquidity of the GDRs. Because X5 reports its financial statements in U.S. dollars, a decline in the value of the rouble against the U.S. dollar may result in a decrease in X5’s net profit and shareholders’ equity when expressed in U.S. dollars and an increase in its U.S. dollar costs in rouble terms. The market price and liquidity of the GDRs could be adversely affected by such a decline. See “Currencies and Exchange Rates” above.
Emerging markets such as Russia are subject to greater risks than more developed markets, and financial turmoil in any emerging market could disrupt X5’s business or financial condition. Generally, investment in emerging markets is only suitable for sophisticated investors who fully appreciate the significance of the risks involved in, and are familiar with, investing in emerging markets. Investors should also note that emerging markets such as Russia are subject to rapid change and that the information set out herein may become outdated relatively quickly. Moreover, financial turmoil in any emerging market country tends to adversely affect prices in equity markets of all emerging market countries as investors move their money to more stable, developed markets. As has happened in the past, financial problems or an increase in the perceived risks associated with investing in emerging economies could dampen foreign investment in Russia and adversely affect Russia’s economy. In addition, during such times, emerging market companies can face severe liquidity constraints as foreign funding resources are withdrawn. Thus, even if the economy in Russia remains relatively stable, financial turmoil in any emerging market country could seriously disrupt X5’s business, which would have a material adverse effect on its business, financial condition and operating results.
20 Social Risks Crime and corruption could disrupt X5’s ability to conduct its business and could materially adversely affect its financial condition and operating results. The political and economic changes in Russia since the early 1990s have resulted in significant undermining of authority. The local and international press have reported that significant organised criminal activity has arisen, particularly in large metropolitan centres. Property crime in large cities has increased substantially. In addition, the local and international press have reported high levels of official corruption, including the bribing of officials for the purpose of initiating investigations by government agencies. Additionally, published reports have indicated that a significant number of Russian media outlets regularly publish disparaging articles in return for payment. The depredations of organised or other crime or demands of corrupt officials could in the future disrupt X5’s ability to conduct its business effectively and could thus materially and adversely affect its financial condition and operating results.
Social instability could increase nationalism or violence, materially adversely affecting X5’s ability to conduct its business. The failure of salaries to be paid in full on a regular basis in Russia and the failure of salaries and benefits generally to keep pace with the rapidly increasing cost of living in Russia have led in the past, and could lead in the future, to labour and social unrest. Labour and social unrest may have political, social and economic consequences, such as increased nationalism, restrictions on foreign involvement in the Russian economy and increased violence. Any of these or similar consequences of social unrest could restrict X5’s operations and lead to the loss of revenue, materially adversely affecting its business, financial condition and operating results.
Legislative and Legal risks Certain characteristics of the Russian legal system and Russian legislation could have a material adverse effect on X5’s business, financial condition and operating results. Russia is still developing the legal framework required to support a market economy. Risks associated with the Russian legal system include: (a) inconsistencies between (i) federal laws; (ii) decrees, orders and regulations issued by the president, the government and federal ministries; and (iii) regional and local laws, rules and regulations; (b) a lack of judicial and administrative guidance on interpreting Russian legislation; (c) a lack of judicial independence from political, social and commercial forces; (d) substantial gaps in the regulatory structure due to delay or absence of implementing regulations; (e) the relative inexperience of judges and courts in interpreting new principles of Russian legislation and complex commercial arrangements; (f) a high degree of discretion on the part of government authorities; (g) bankruptcy procedures that are not well developed and are subject to abuse; (h) a lack of binding judicial precedents; and (i) difficulty in enforcing court judgements.
These uncertainties mean that no assurance can be given that X5 will be in full compliance with all applicable laws and regulations in Russia.
While legislation has been enacted to protect private property against expropriation and nationalisation, due to the lack of experience of the courts in Russia in enforcing these provisions and due to potential political changes, these protections may not be enforced in the event of an attempted expropriation or nationalisation. Expropriation or nationalisation of any of X5’s entities, their assets or portions thereof, potentially without adequate compensation, would have a material adverse effect on the business, financial condition and operating results of X5.
Moreover, the regulation and supervision of the securities market, financial intermediaries and issuers are considerably less developed in Russia than in the United States and Western Europe. Securities laws, including those relating to corporate governance, disclosure and reporting requirements, have only recently been adopted, whereas laws relating to anti-fraud safeguards, insider trading restrictions and fiduciary duties are rudimentary.
21 Russian corporate and securities rules and regulations can change rapidly, which may adversely affect X5’s ability to conduct securities-related transactions. While some important areas are subject to virtually no oversight, the regulatory requirements imposed on Russian issuers in certain other areas of corporate and security laws and regulations result in delays in conducting securities offerings and in accessing the capital markets. It is often unclear whether, or how, regulations, decisions and letters issued by the various regulatory authorities apply to X5. As a result, X5 may be subject to fines or other enforcement measures despite its best efforts at compliance.
From time to time, Russian authorities also place particular emphasis on particular industries or segments of the community for policy reasons. For example, Russian tax authorities have recently announced a special interest in retail businesses. To this end, there are a number of ongoing tax claims against major Russian retailers such as Svyaznoy, Eldorado and Arbat Prestizh.
Additionally, several fundamental laws have only recently become effective. The enactment of new legislation in the context of a rapid evolution to a market economy and the lack of consensus about the scope, content and pace of economic and political reforms has resulted in ambiguities and inconsistencies in the overall Russian legal system. Many new laws remain untested. In addition, Russian legislation also often contemplates implementing regulations that have not yet been promulgated, leaving substantial gaps in the regulatory infrastructure. All of these weaknesses could affect X5’s ability to enforce its legal rights, including rights under X5’s contracts, or to defend X5 against claims by others.
Legal and regulatory burdens may adversely affect X5’s financial condition and operating results and its ability to maintain or expand its operations. X5’s operations and properties are subject to regulation by various government entities and agencies, in connection with obtaining and renewing various licenses and permits and with respect to various quality, health and safety, packaging, labelling and distribution standards. Russia is in a state of structural, economic and political transition and the regulatory regimes applicable to X5’s operations are still developing. Many regulations applicable to X5 have only recently been enacted and there is uncertainty regarding their application and enforcement. Regulatory authorities often have little experience in analysing regulatory issues arising from commercial transactions and exercise considerable discretion in matters of enforcement and interpretation of applicable laws, regulations and standards.
Compliance with the requirements imposed by regulatory authorities may be costly and time consuming and may result in delays in the commencement or continuation of operations. Regulatory uncertainty may make it difficult for X5 to plan or conduct its business. Failure to obtain necessary approvals or licences or to comply fully with applicable regulations could delay X5’s expansion plans, require it to incur additional unanticipated expenditures or result in the imposition of sanctions, including civil and administrative penalties applicable to X5 and criminal and administrative penalties applicable to its officers and/or requirements that X5 cease certain of its business activities. No assurance can be given that, in the future, X5 will continue to hold all material licenses necessary for its existing operations or to obtain all necessary approvals and licenses required in connection with its expansion plans. Any failure to obtain such approvals or licenses may have a material adverse effect on X5’s business, financial condition and operating results.
The focus by certain Russian regulatory authorities on the retail industry and large retailers may have a material adverse effect on X5’s business, financial condition and operating results. Certain Russian authorities, including the FAS, have recently focused on the retail industry as a sector that requires greater regulatory oversight. For example, in January 2008, the Tatarstan division of the FAS claimed that a number of retail companies, including X5, entered into cartel-like arrangements with each other and imposed particularly unfavorable conditions on the suppliers of goods and requested that X5 ceases any such practices. If X5 activities are found to be in violation of anti-monopoly laws or regulations, X5 could be subject to penalties, or forced to change its business operations, including changing its standard agreement with suppliers, in a manner that increases costs or reduces revenues.
In 2007, the Russian Ministry of Economic Development and Trade and the FAS expressed concern that retailers who hold a significant share in a local retail market may be reducing competition and imposing unfair terms on third parties.
In late 2007, the State Duma considered a draft federal law “On Retail Trade” (the “Draft Retail Legislation”). The Draft Retail Legislation proposes to grant powers to Russian federal authorities to introduce licensing of trading of certain goods, impose price limits on retail sales of certain goods, require disclosure of profit margins by retailers and determine a maximum volume of foreign food products that may be sold by
22 retailers. Russian regional authorities would be empowered to licence retail sales of alcoholic beverages and establish and run retail personnel training and development programs. These powers may be delegated by the regional authorities to the municipal authorities. Russian municipal authorities would also have powers in their own right to establish rules mandating particular store locations, limit store opening hours for supermarkets and hypermarkets and maintain a trade register of stores containing information such as the total net selling space, main trading equipment, working hours and product assortment of each store owned by a retailer.
The Draft Retail Legislation also proposes to limit the growth of food retailers to prevent retailers from abusing “dominant” positions. Under the Draft Retail Legislation filed with the State Duma in late 2007, a retailer will be considered to have a “dominant” position if it has a market share of 15% or more in the retail food market in any particular municipality. Retailers may also be considered to be “dominant” if they account for more than 3% of the market share in their municipality and, together with two other retailers, account for at least 30% of that market or, together with four other retailers, account for at least 40% of that market. In addition, the Draft Retail Legislation proposes that no retailer will be permitted to gain a market share beyond 35% in any given municipality. Market share will be determined on the basis of a retailer’s share in the total retail sales of food products by all retailers operating in that municipality.
Under the Draft Retail Legislation, if the FAS considers that any retailer has breached the relevant market share thresholds in any municipality, that retailer will be considered to be “dominant” amongst suppliers. That retailer may therefore be required to post an irrevocable offer on its website to buy that product from any supplier. The offending retailer may also be prohibited from obtaining different profit margins on similar products purchased from different suppliers.
The Draft Retail Legislation has not yet been adopted as a federal law by the Russian federal legislative authorities and is expected to undergo industry consultation prior to any such adoption. The State Duma are actively considering the proposed terms of the Draft Retail Legislation and the final provisions may change from the current published draft. However, the adoption of the current version of the Draft Retail Legislation or similar legislation could require retailers in some retail markets, including X5, to take steps to comply with new legislation, which could have a material adverse effect X5’s business, financial condition and operating results.
In addition, there is a risk that federal or regional authorities may impose regulatory constraints on the ability of food retail operators to increase their prices. In October 2007, federal authorities took steps to limit food price inflation by entering into an agreement with around 20 leading food producers and food retailers with respect to fixing maximum trade margins on some food products for the period from 15 October 2007 to 31 January 2008, which period was subsequently extended to 1 May 2008. Certain regional authorities contemplated similar plans. There can be no assurance that federal or regional authorities would not attempt to introduce more comprehensive measures limiting the ability of food retailers to increase prices on products they sell or regulating their profit margins. If any such measures are implemented, they could have a material adverse effect on X5’s business, financial condition and operating results.
One or more of X5’s subsidiaries may be forced into liquidation due to negative net assets or on the basis of other formal non-compliance with certain requirements of Russian law, which could materially adversely affect X5’s business, financial condition and operating results. Certain provisions of Russian law may allow a court to order liquidation of a Russian legal entity on the basis of its formal non-compliance with certain requirements during formation, reorganisation or during its operation. There have been cases in the past in which formal deficiencies in the establishment process of a Russian legal entity or non-compliance with provisions of Russian law have been used by Russian courts as a basis for liquidation of a legal entity. For example, under Russian corporate law, negative net assets calculated on the basis of Russian accounting standards (“RAS”), as at the end of the second or any subsequent year of a company’s operation, can serve as a basis for a court to order the liquidation of the company, upon a claim by governmental authorities. Numerous Russian companies have negative net assets due to very low historical asset values reflected on their RAS balance sheets; however, their solvency, i.e., their ability to pay debts as they come due, is not otherwise adversely affected by such negative net assets. In a highly publicised case a few years ago, a court ordered the liquidation of a company with negative net assets, although it was otherwise solvent. Some Russian courts in deciding whether or not to order the liquidation of a company have looked beyond the fact that the company failed to fully comply with all applicable legal requirements and have taken into account other factors, such as the financial standing of the company and its ability to meet its tax obligations, as well as the economic and social consequences of its liquidation. This judicial approach is supported by a recent decision of the Constitutional Court of the Russian Federation that held that even repeated violations of law may not form a basis for an involuntary liquidation of a company, and instead consideration should be given to whether the
23 liquidation would be an adequate sanction for such violations. Although, as happens from time to time in Russia mostly due to ambiguities and inconsistencies of applicable provisions of Russian law, some of X5’s subsidiaries might have failed, and may continue to fail, from time to time to comply fully with all the applicable legal requirements (for example, unduly executed capital contributions in the course of foundation, formal deficiencies in the reorganisation process, or negative net assets under RAS), the management of X5 believes that none of X5’s subsidiaries should be subject to liquidation on such grounds and none of the possible violations has caused any damage to anyone or has had any other negative consequences. However, weaknesses in the Russian legal system create an uncertain legal environment, which makes the decisions of a Russian court or a governmental authority difficult, if not impossible, to predict. If involuntary liquidation were to occur, X5 would be forced to reorganise the operations it currently conducts through the affected subsidiaries. Any such liquidation could lead to additional costs which could materially adversely affect X5’s business, financial condition and operating results.
Difficulty in ascertaining the validity and enforceability of title to land in Russia and the extent to which it is encumbered may have a material adverse effect on X5’s operations. Until the beginning of the 1990s, all land in Russia was owned by the State. After the Soviet Union ceased to exist, land reform commenced in Russia and real estate legislation changed continuously over the following years – more than one hundred federal laws, presidential decrees and governmental resolutions were issued. Almost all Russian regions passed their own real estate legislation. Until recently, the land legislation in Russia was unsystematic and contradictory. In many instances, there was no certainty regarding which municipal, regional or federal government body, had power to sell, lease or otherwise dispose of land.
In 2001, the Russian Civil Code (the “Civil Code”) was amended and the new Russian Land Code (the “Land Code”) as well as a number of other federal laws regulating land use and ownership were enacted. Nevertheless, the legal framework relating to the ownership and use of land and other real property in Russia is not yet sufficiently developed to support private ownership of land and other real property to the same extent as is common in countries with more developed market economies. Because of Russia’s vast territory and difficulties of being in a transitional phase, the process of surveying and title registration may last for many years. Thus, it is often difficult to ascertain the validity and enforceability of title to land in Russia and the extent to which titles are encumbered. These and other uncertainties related to land ownership may have a material adverse effect on X5’s business, financial condition and operating results.
Non-compliance with governmental and administrative real estate regulations in Russia could materially affect X5’s operations and business prospects. In order to use and develop land in Russia, approvals and consents of various federal, regional or local governmental authorities, such as the various environmental, sanitation and epidemiological control authorities, are required. The approval and consent requirements vary from locality to locality; they are numerous, sometimes contradictory and are subject to change without public notice and are occasionally applied retroactively. The enforcement of such requirements is inconsistent and is often arbitrary and selective. Failure to obtain the required approvals and consents may lead to severe consequences to landowners and leaseholders. No assurance can be given that X5 will be in full compliance with all governmental and administrative real estate regulations in Russia. If any of X5’s existing or prospective store sites is found not to be in compliance with all applicable regulations, X5 may be subject to fines or penalties or its rights to such properties may be affected which could have a material adverse effect on X5’s overall business, financial condition and operating results.
If transactions of X5 and its predecessors-in-interest were to be challenged on the basis of non-compliance with applicable legal requirements, the remedies in the event of any successful challenge could include the invalidation of such transactions or the imposition of liabilities on X5. X5, or its predecessors-in-interest at different times, took a variety of actions involving share acquisitions, charter capital increases, share issues, amendments to charter documents, reorganisations, so called “major transactions” and “interested party transactions”, transactions with state authorities and other transactions and actions that, if successfully challenged by competent state authorities, counterparties in such transactions or shareholders of the relevant companies or their predecessors-in-interest on grounds of non-compliance with applicable legal requirements (including, without limitation, under the terms of the relevant agreements or under applicable legislation and regulations), ineffective execution of agreements, unauthorised actions by members of management and directors or invalid shareholder resolutions, could result in the invalidation of such transactions or the imposition of other liabilities. Because applicable provisions of Russian law are subject to many different interpretations, X5 may not be able to defend successfully any challenge brought against such transactions, and
24 the invalidation of any such transactions or imposition of any such liability may, individually or in the aggregate, have a material adverse effect on X5’s business, financial condition and operating results. See also “Risk Factors – Risks Relating to Russia – Legislative and Legal Risks – Certain characteristics of the Russian legal system and Russian legislation could have a material adverse effect on X5’s business, financial condition and operating results”.
Shareholder liability under Russian legislation could cause X5 to become liable for the obligations of its subsidiaries. Russian law generally provides that shareholders in a Russian joint stock company or a limited liability company are not liable for the obligations of such joint stock company or, as the case may be, limited liability company and bear only the risk of loss of their investment. This may not be the case, however, when one person is capable of determining decisions made by another person. The person capable of determining such decisions is called an “effective parent”. The person whose decisions are capable of being so determined is called an “effective subsidiary”. The effective parent bears joint and several responsibility for transactions concluded by the effective subsidiary in carrying out these decisions if: (a) this decision-making capability is provided for in the charter of the effective subsidiary or in a contract between such persons, and (b) the effective parent gives obligatory directions to the effective subsidiary.
Moreover, an effective parent is secondarily liable for an effective subsidiary’s debts if an effective subsidiary becomes insolvent or bankrupt as a result of the action or inaction of an effective parent. This is the case no matter how the effective parent’s capability to determine decisions of the effective subsidiary arises. For example, this liability could arise through ownership of voting securities or by contract. In these instances, other shareholders of the effective subsidiary may claim compensation for the effective subsidiary’s losses from the effective parent which caused the effective subsidiary to take action or fail to take action knowing that such action or failure to take action would result in losses. Accordingly, in X5’s position as an effective parent, it could be liable in some cases for the debts of its effective subsidiaries in Russia.
X5 may be subject to vaguely drafted Russian transfer pricing rules. Russian transfer pricing rules give Russian tax authorities the right to review, make transfer pricing adjustments and impose additional tax liabilities in respect of transactions between related entities and certain other types of transactions between independent parties (such as foreign trade transactions and transactions that have significant price fluctuations), if the transaction price deviates by more than 20% from the market price. The Russian transfer pricing rules are vaguely drafted, leaving wide scope for interpretation by Russian tax authorities and courts. Due to the uncertainties in interpretation of transfer pricing legislation, the tax authorities may challenge the prices of certain of X5’s inter-group transactions and propose adjustments. If such price adjustments are upheld by Russian courts and implemented, X5’s effective tax rate could increase and future financial results could be adversely affected. In addition, X5 could face significant losses associated with the assessed amount of prior tax underpaid and related interest and penalties, which could have a material adverse effect on its business, financial condition and operating results. See also “Risk Relating to X5’s Business and Industry – Challenges to X5’s tax position by the Russian tax authorities could have a material adverse effect.”.
New Russian thin capitalisation rules could affect X5’s ability to deduct interest on certain borrowings. Russian thin capitalisation rules limit the amount of interest that can be deducted by a Russian company on debts payable to non-resident shareholders. Until 1 January 2006, these rules applied only to loans to a Russian company by a foreign shareholder owning directly or indirectly more than 20% of the share capital of the Russian company. However, new thin capitalisation rules that came into effect on 1 January 2006 extend the rules’ application to loans issued to a Russian company by another Russian company that is affiliated with the foreign shareholder as well as to loans secured by such foreign shareholder or its affiliated Russian company. It is not yet clear how these new rules will be applied in practice by the Russian tax authorities, particularly in relation to guarantees issued with respect to loans impacted by the rules.
The new rules apply if a company receives a loan or is the beneficiary of a loan guarantee from a foreign shareholder owning directly or indirectly over 20% of the company or from a Russian affiliated company of such foreign shareholder. X5 may be affected because of its loans to its Russian subsidiaries. In this event, interest payments made by X5 under such loans may be treated as dividend payments, which are not deductible for corporate income tax purposes and are subject to withholding income tax at the rates applicable to dividends, which may adversely affect X5’s business, financial condition and operating results.
25 Risks Relating to the Shares, the GDRs and the Trading Market X5’s ability to pay dividends and to service its debt obligations depends primarily upon receipt of sufficient funds from its subsidiaries. Because X5 is a holding company, its ability to pay dividends depends primarily upon receipt of sufficient funds from its subsidiaries. Furthermore, the payment of dividends by its subsidiaries and/or the ability of X5 to repatriate such dividends from Russia may, in certain instances, be subject to statutory restrictions, and retained earnings criteria, and is contingent upon the earnings and cash flow of, and committed borrowings by, those subsidiaries. The inability on the part of X5’s subsidiaries to pay dividends would impact the amount of funds available to X5 to pay dividends and service X5’s debt obligations. In addition, X5’s principal source of revenue is generated by its subsidiaries in roubles; the management of X5 intends to convert the net income of X5 into U.S. dollars or other foreign currencies. No assurance may be given that it will succeed in converting such net income, or, if able to do so, that it will be able to convert at favourable exchange rates. X5 does not currently intend to pay dividends to its shareholders in the immediate future (see “Dividend Policy”).
X5 may exclude the applicability of pre-emptive rights in share capital increases. In the event of an increase in X5’s share capital, existing holders of Shares shall, absent limited exceptions pursuant to Dutch law and the Articles, be entitled to pre-emptive rights pursuant to Dutch law and the Articles, unless such rights shall be excluded or limited by, or pursuant to, a resolution of the General Meeting of Shareholders, irrespective of whether the share capital increase is in exchange for contributions in cash or contributions in kind.
In particular, in the event of an increase in X5’s share capital in exchange for a contribution in cash as proposed in the Offering, X5 may, in order to avoid securities registration and/or prospectus publication requirements in one or more jurisdictions, elect to exclude certain existing holders of Shares and/or GDRs, including, but not limited to U.S. holders, or, in the EEA, holders that do not qualify as Qualified Investors, from participating in such rights offering.
The Shares underlying the New GDRs are not listed and may be illiquid. Unlike many other global depositary receipts offerings traded on the London Stock Exchange, the Shares are neither listed nor traded on any stock exchange and X5 does not intend to apply for the listing or admission to trading of the Shares on any stock exchange. As a result, a withdrawal of Shares by a holder of GDRs, whether by election or due to certain events described under “Terms and Conditions of the Global Depositary Receipts”, will result in that holder obtaining securities that are significantly less liquid than the GDRs and the price of those Shares may be discounted as a result of such withdrawal.
Voting rights with respect to the Shares represented by the New GDRs are limited by the terms of the Deposit Agreement and the relevant requirements of Dutch law. GDR holders will have no direct voting rights with respect to the Shares represented by the New GDRs. New GDR holders will be able to exercise voting rights with respect to the Shares represented by New GDRs only in accordance with the applicable provisions of the terms and conditions of the New GDRs and the relevant requirements of Dutch law. Further, there exist practical limitations upon the ability of New GDR holders to exercise their voting rights due to the additional procedural steps involved in communicating with them. For example, X5 is required under its Articles to notify shareholders at least 15 days in advance of any General Meeting of Shareholders. Holders of Shares, whose ownership is directly recorded in X5’s shareholder registry, will receive notice directly from X5 and will be able to exercise their voting rights by either attending the meeting in person or voting by power of attorney. Currently, only the Depositary is a holder of Shares.
GDR holders, by comparison, will not receive notice of a General Meeting of Shareholders directly from X5. Rather, in accordance with the Deposit Agreement, X5 will provide notice to the Depositary. The Depositary has undertaken, in turn, as soon as practicable thereafter to mail to the GDR holders notice of such meeting and a statement as to the manner in which voting instructions may be provided by holders to the Depositary. To exercise their voting rights, GDR holders must then instruct the Depositary how to vote the Shares represented by the GDRs they hold or, those GDR holders who wish to vote in person at such meeting must request a proxy from the Depositary to do so. Because of these additional procedural steps involving the Depositary, the process for exercising voting rights may take longer for GDR holders than for holders of Shares not represented by GDRs, and X5 cannot assure GDR holders that they will receive voting materials or proxy in time to enable them to return voting instructions to the Depositary in a timely manner. GDRs for which the Depositary does not receive timely voting instructions may not be voted.
26 Future sales of X5’s Shares or GDRs may affect the market price of the Shares or GDRs. Following the Offering, new issuances and sales, or the possibility of new issuances and sales, of a substantial number of X5’s Shares, or GDRs, onto the public markets, or a sale of Shares by any significant holders of Shares could have an adverse effect on the trading prices of the GDRs and/or could affect X5’s ability to obtain further capital through an offering of equity securities. Subsequent equity offerings may also reduce the percentage ownership of X5’s existing shareholders. In addition, X5 may issue securities convertible or exchangeable for Shares or GDRs.
The Alfa Group Consortium, through Luckyworth Limited and Cesaro Holdings Limited, owns 43.05% of X5’s GDRs, which are subject to a 180 day lock-up agreement containing certain exceptions (see “Subscription and Sale—Lock-Up Arrangements”). Mr. Andrei Rogachev, a former member of X5’s Supervisory Board and a shareholder in Formata, and his associates, through Marie-Carla Corporation N.V. and Tayleforth N.V., own 21.06% of X5’s GDRs. These GDRs are not subject to any lock-up agreement. Any significant sales of GDRs by significant GDR holders could have a material adverse effect on the trading price of X5’s GDRs.
Certain members of the Management and Supervisory Boards and senior management of X5 are subject to a lock-up agreement in connection with the Offering, but these agreements do not prohibit a pledge of Shares (including in the form of GDRs) in connection with certain funding arrangements. Accordingly, the pledgee bank or banks may undertake certain hedging arrangements (which are not prohibited by the lock-up agreement), and could sell significant amounts of GDRs if there is a default under such funding arrangements.
If certain options as described in a Discussion Paper 08/01 in relation to the admission of GDRs were later implemented as a result of responses to any subsequent consultation paper, the price of our GDRs could be adversely affected. In January 2008, the Financial Services Authority (“FSA”) published a Discussion Paper 08/01 (the “Discussion Paper”) reviewing the structure of the listing regime in the United Kingdom. One of the options for change presented by the FSA in the Discussion Paper (“Option 1”) is to allow companies with global depositary receipts admitted to the Official List to retain their admission only if they comply with the continuing obligations for companies with a primary listing of equity securities, which are significantly more onerous than the obligations applicable to X5 upon its initial UKLA Admission. Any changes would need to undergo a consultation process involving the publication, by the FSA, of one or more consultation papers and thereafter considering responses to such consultation papers before implementing any changes. If the FSA implements Option 1, and X5 chooses to retain its admission to the Official List, it is possible that such a listing would make it more costly for X5 to comply with the more onerous obligations of a primary listing. For example, the requirement for shareholder approvals for certain acquisitions could be a hindrance to the rapid execution of any growth strategy. Such transactions may require shareholder approval if X5 is subject to the obligations of a primary listing. Alternately, if the FSA implements Option 1, and X5 choose to move its listing to the alternative “Directive-Minimum” segment for equity securities described by the FSA, the GDRs would continue to be admitted to trading on the International Order Book (regulated market segment) of the London Stock Exchange, and X5 would be subject to substantially the same continuing obligations as its current position, but the GDRs would cease to be admitted to the Official List. The removal from the Official List might adversely affect the ability of GDR holders to continue to hold the GDRs, for example, because of the terms of the contractual or constitutive investment restrictions that such investors are subject to. Market perception might also be less favorable for an admission to trading without an admission to the Official List, even without a substantive or perceived change in the continuing obligations to which X5 would be subject. Related sales of GDRs or a fall in demand for the GDRs could result in a material adverse effect on the price of our GDRs.
There can be no assurance that other regulatory changes implemented by the FSA, as a result of the Discussion Paper or otherwise, would not have a material adverse effect on X5 or the price of its GDRs. Furthermore, there can be no assurance that X5 will choose to maintain either the admission to the Official List or the admission to trading on the IOB (regulated market segment). In such a case, X5 may seek to obtain a listing for our GDRs elsewhere, but may not be successful in doing so.
Recourse against X5 and its directors and senior management may be limited because X5 generally conducts its operations outside The Netherlands and the United Kingdom and the majority of X5’s current directors and senior management reside outside The Netherlands and the United Kingdom. Although X5 is incorporated under the laws of The Netherlands, X5’s business and assets are substantially located in Russia. Judgements rendered by a court in any jurisdiction outside the Russian Federation will generally be recognised by courts in the Russian Federation only if an international treaty providing for
27 recognition and enforcement of judgements in civil or commercial cases exists between the Russian Federation and the country where the judgement is rendered and/or a federal law is adopted in Russia providing for the recognition and enforcement of foreign court judgements. There is no treaty between the United Kingdom and the Russian Federation or The Netherlands and the Russian Federation providing for reciprocal recognition and enforcement of foreign court judgements in civil and commercial matters, and no relevant federal law on enforcement of foreign court judgements has been adopted in the Russian Federation. These limitations may deprive investors of effective legal recourse for claims related to their investment in the Shares or the GDRs. The Deed Poll in respect of the GDRs provides for actions brought against X5 by any holder of GDRs to be settled by deprive investors of effective legal recourse for claims related to their investment in the Shares or the GDRs. The Deed Poll in respect of the GDRs provides for actions brought against X5 by any holder of GDRs to be settled by arbitration in London, England, in accordance with the rules of the London Court of International Arbitration. The Russian Federation is a party to the United Nations (New York) Convention on the Recognition and Enforcement of Foreign Arbitral Awards, but it may be difficult to enforce arbitral awards in Russia due to a number of factors, including the inexperience of Russian courts in international commercial transactions, official and unofficial political resistance to enforcement of awards against Russian companies in favour of foreign investors, the corruption of Russian courts and Russian courts’ inability to enforce such orders.
In addition, most of X5’s current members of the Management Board and the Supervisory Board and members of its senior management reside outside the United Kingdom, principally in the Russian Federation. All of X5’s assets and the assets of its current members of the Management Board and the Supervisory Board and senior management are located outside the United Kingdom, principally in the Russian Federation. As a result, it may not be possible to effect service of process within the United Kingdom upon X5 or its current members of the Management Board and the Supervisory Board and members of senior management, or to enforce Dutch or U.K. court judgements obtained against X5 or its directors and members of senior management in jurisdictions outside The Netherlands and the United Kingdom. In addition, it may be difficult for holders of Shares or GDRs to enforce, in original actions brought in courts in jurisdictions outside the United Kingdom, liabilities predicated upon English securities laws.
Further X5 Share or GDR issues made as part of X5’s acquisition strategy may result in further dilution to holders of X5 Shares or GDRs. As part of its acquisition strategy X5 may issue additional Shares, GDRs or other securities convertible or exchangeable into Shares or GDRs, as consideration in any relevant acquisitions. Any such issues could result in effective dilution to holders of Shares or GDRs and/or adversely affect the market price of the GDRs. X5 may, in the future, issue Russian Depositary Receipts for further Shares. X5 may also issue up to 1,837,000 Shares (assuming a purchase price of approximately US$970.0 million) to the shareholders of Formata as part of the consideration for the acquisition of the chain of Karusel hypermarkets.
Significant GDR holders in X5 may take actions that are not in line with, or may conflict with, X5’s minority GDR holders’ best interests. Significant GDR holders may be able to influence X5’s business through their ability to control actions which require shareholders’ approval of a certain percentage above a simple majority and through appointment of nominees to X5’s Board of Supervisory Directors and Management Board. Under X5’s Articles of Association, if less than 50% of the issued share capital of X5 is present or represented, certain matters, such as approvals for a merger or demerger or exclusion or limitation of pre-emptive rights or delegation to another corporate body of X5 of the authority to exclude or limit pre-emptive rights, requires a majority of at least two-thirds of the votes cast. In such a case, GDR holders who hold a significant number of voting rights in X5 could approve or block the passing of any resolution, without regard to the best interests of X5 or the best interests of the minority GDR holders.
There are a number of holders of GDRs in X5 with shareholdings above 10%. The Alfa Group Consortium, through Luckyworth Limited and Cesaro Holdings Limited, owns 43.05% of X5’s GDRs. Mr. Andrei Rogachev, a former member of X5’s Supervisory Board and a shareholder in Formata, and his associates, through Marie- Carla Corporation N.V. and Tayleforth N.V., own 21.06% of X5’s GDRs. If the interests of such holders conflict with the other GDR holders, or if significant holders of GDRs choose to cause X5’s business to pursue strategic objectives that conflict with the interests of the other GDR holders, those other GDR holders could be disadvantaged.
28 X5 is subject to potential conflicts of interest relating to the Joint Bookrunners and their Affiliates. X5 is subject to potential conflicts of interest relating to the Joint Bookrunners and their affiliates because, amongst other things: (i) X5 has and may, in the future, enter into transactions for the purchase and sale of securities, loans and other investments, derivative transactions and other transactions (including, without limitation, providing leverage against investments) with certain of the Joint Bookrunners and/or their affiliates; and (ii) Alfa Capital Markets, one of the Joint Bookrunners, is a member of the Alfa Group Consortium, which is an indirect majority shareholder of X5.
X5 has engaged and may continue to engage in transactions with related parties that may present conflicts of interest, potentially resulting in the conclusion of transactions on less favourable terms than could be obtained otherwise. X5 has historically engaged in transactions with related parties. In particular, it has engaged in transactions with companies controlled by and/or related to certain members of the Supervisory Board, including equity purchases and sales, services contracts and financing arrangements. See “Principal Shareholdings” and “Transactions with Related Parties”. For example, in January 2008, X5 exercised the Karusel Option to acquire the entire issued share capital of Formata, a company controlled by Overture Corporation N.V. and Puritani Corporation N.V., companies that are controlled by significant minority shareholders in X5 and related to members of the Board of Supervisory Directors. The acquisition is subject to the completion of due diligence satisfactory to X5 and the receipt of approvals from the FAS. X5 has also, for example, engaged in related party transactions with members of the Alfa Group Consortium (see “Transactions with Related Parties”).
Conflicts of interest may arise between such companies and X5, potentially resulting in the conclusion of transactions on terms not determined by market forces and currently X5’s IT systems may not allow X5 to determine whether its business partners are related parties, as that expression is generally used. Conflicts of interest that may materially and adversely affect X5’s business, financial condition and operating results could deter prospective investors from investing in X5 which could adversely impact X5 and/or the market price of the GDRs.
Any related party transactions which are carried out on a non arm’s length basis may expose X5 to business, financial and accounting risks such as increased competition from related parties, transfer pricing adjustments of VAT and profits tax liabilities and potential taxable benefits for the recipients of low-rate interest of intra-group loans, which could have a material adverse effect on X5’s business, financial condition and operating results.
UK and Dutch law and takeover protection may not be available. The Dutch corporate law aspects of the implementation of the EU Takeover Bids Directive may or may not apply to X5 as it is uncertain whether, under Dutch law, the GDRs will qualify as depositary receipts issued with the co-operation of X5 (certificaten van aandelen uitgegeven met medewerking van de vennootschap). See “Description of Share Capital and Articles of Association – Qualification of GDRs under Dutch Law” for a discussion of the possible qualification under Dutch law of the GDRs as depositary receipts (certificaten van aandelen). In addition, as X5 is not incorporated in England and Wales, the City Code on Takeovers and Mergers will not apply in its entirety to X5. See also “Description of Share Capital and Articles of Association – EU Takeover Bids Directive”.
29 USE OF PROCEEDS
The proceeds to X5 from the Offering, net of commissions, fees and expenses (which are estimated to amount to US$29.5 million), are expected to be approximately US$996.1 million.
X5 expects to use the majority of the net proceeds of the Offering to fund the cash consideration payable for the acquisition of Formata and the rebranding, restyling and integration of the Karusel hypermarkets. X5 estimates that the consideration for the exercise of the Karusel Option will be up to US$970.0 million, of which it has an option to pay 75% in cash and up to 25% in Shares.
Any remaining amounts from the net proceeds will be used for general corporate purposes.
If X5 does not complete its acquisition of Formata, X5 will use the proceeds of the Offering for general corporate purposes and other acquisitions.
30 DIVIDEND POLICY
X5 did not pay dividends for the years ended 31 December 2007 and 2006 and does not currently intend to pay dividends in the foreseeable future. X5 expects to reinvest substantially all of its cash flows from operations into its existing business and new investment opportunities for the foreseeable future.
The payment of dividends or any other distribution is subject to compliance with the Dutch Civil Code and the Articles. Dividends may, in principle, only be paid out of profits as shown in the adopted annual financial statements prepared using IFRS. The profits must first be applied to maintain reserves required by the law and must then be set off against certain financial losses. The General Meeting of Shareholders, on the proposal of X5’s Supervisory Board, may determine which part of the profits shall be added to the reserves (in excess of minimum requirements) and the allocation of the remaining profits. On proposal of the Supervisory Board, the General Meeting of Shareholders may resolve to distribute all or any part of the freely distributable reserves. On proposal of the Supervisory Board, the General Meeting of Shareholders may also resolve in accordance with the provisions of the Dutch Civil Code and the Articles that an interim dividend shall be distributed.
As a holding company, the level of X5’s income and its ability to pay dividends depend primarily upon the receipt of dividends and any other distributions from its subsidiaries. The payment of dividends by its subsidiaries is contingent upon sufficiency of their earnings, cashflows and distributable profits.
X5 did not declare a dividend for the years ended 31 December 2007, 2006 or 2005.
31 CAPITALISATION
The following table sets forth X5’s consolidated cash, short-term borrowings and capitalisation as at 31 December 2007, on a historical basis, as adjusted to give effect to the New GDR Offering of 12,026,675 Shares at the Share Subscription Price of US$85.28 per Share, and as further adjusted for the possible offering of a maximum amount of treasury stock of 942,278 Shares at the Share Subscription Price of US$85.28 per Share. Historical financial information as of 31 December 2007 has been derived from X5’s audited consolidated financial statements for the year ended 31 December 2007 included elsewhere in this Prospectus. The following table has been prepared for illustrative purposes only and because of its nature, addresses a hypothetical situation. The adjusted numbers, therefore, do not represent X5’s actual financial position or results. The following table should be read in conjunction with “Selected Consolidated Historical Financial Information”, “Use of Proceeds”, “Operating and Financial Review”, “Business” and the X5 Consolidated Financial Statements for the year ended 31 December 2007 and the accompanying notes thereto included elsewhere in this Prospectus.
As at 31 December 2007 As Further Adjusted for Offering of a maximum As Adjusted for amount of New GDR Treasury Offering(3) Stock(3)(4) Historical (unaudited) (unaudited) ($ in millions of US$) Cash ...... 179.5 1,205.1 1,285.5 Short-term borrowings ...... 253.7 253.7 253.7 Long-term borrowings ...... 1,464.7 1,464.7 1,464.7 Shareholders’ equity ...... Share capital (historical issued and outstanding 53,177,760 shares as adjusted to reflect the issuance of 12,026,675 ordinary shares and further adjusted to reflect the issuance of 942,248 ordinary shares, each with nominal value of €1.00 per share) ...... 70.9 88.6(2) 90.0 Additional paid in capital ...... 2,896.4 3,904.3 3,983.3 Accumulated other comprehensive income ...... 294.2 294.2 294.2 Retained earnings ...... (18.0) (18.0) (18.0) Minority interests ...... 0.2 0.2 0.2 Total shareholders’ equity ...... 3,243.7 4,269.3 4,349.7 Total capitalisation (unaudited)(1) ...... 4,708.4 5,734.0 5,814.4
(1) Total capitalisation is long-term borrowings plus shareholders’ equity. (2) The U.S. dollar amounts representing the nominal par value of the 12,026,675 ordinary shares was calculated based on the exchange rate of US$1.4721 per €1.00, the official exchange rate established by the European Central Bank on 31 December 2007. (3) The adjustment does not take into account estimated offering expenses payable by X5 in connection with the Offering. (4) The further adjustments in this column assume 942,278 Shares (in the form of GDRs) are offered in the offering of Treasury Stock.
There has been no material change in X5’s long-term debt, net of current portion, since 31 December 2007.
In addition, X5 may issue up to 1,837,000 Shares in connection with the acquisition of Formata under the Call Option Agreement (assuming a purchase price of approximately US$970.0 million for Formata).
32 DILUTION
X5’s consolidated net tangible book value at 31 December 2007 was approximately US$(214.3) million, resulting in consolidated net tangible book value per Share of US$(4.03). Consolidated net tangible book value per Share represents the amount of X5’s total tangible assets (determined as total assets less goodwill and intangible assets) less total liabilities and minority interest, divided by the number of Shares outstanding.
Dilution in net tangible book value per Share represents the difference between the Share Subscription Price and the net tangible book value per Share immediately after the completion of the Offering. After giving effect to the sale by X5 of 48,106,700 GDRs in the New GDR Offering at the Subscription Price (less the Depositary issuance fee of US$0.05 per GDR) of US$21.32 per New GDR (US$85.28 per Share) and after deducting commissions, fees and expenses which are estimated to amount to US$29.5 million. X5’s net tangible book value as at 31 December 2007, as adjusted, would have been US$11.99 per Share. This represents an immediate increase in net tangible book value of US$16.02 per Share to existing GDR holders and an immediate dilution of US$73.29 per Share to new investors purchasing New GDRs in the New GDR offering (based on a ratio of 4 GDRs per Share).
US$ Subscription Price per New Share ...... 85.28 Net tangible book value per Share as at 31 December 2007 ...... (4.03) Increase in net tangible book value per Share attributable to investors in the New GDR Offering .... 16.02 Pro forma net tangible book value per Share immediately after the New GDR Offering ...... 11.99 Dilution per Share to investors in the New GDR Offering ...... 73.29 Notes: 942,278 treasury shares that may be offered as part of the Rump Offering, have been excluded from this calculation.
X5 may issue up to 1,837,000 Shares in connection with the acquisition of Formata under the Call Option Agreement. These treasury shares have not been included in this calculation.
33 SELECTED CONSOLIDATED HISTORICAL FINANCIAL INFORMATION
Historical Consolidated Financial Information of X5 and Perekrestok The consolidated financial data set forth below have been derived from the X5 Consolidated Financial Statements for the years ended 31 December 2007 and 2006 included in this Prospectus and from the 2005 Perekrestok Consolidated Financial Statements incorporated by reference.
As described in “Presentation of Financial Information – Reclassifications”, certain financial information herein relating to the years ended 31 December 2006 and 2005 has been reclassified to conform with the presentation in a subsequent year or years.
The X5 Consolidated Financial Statements for the year ended 31 December 2006 and thereafter have been affected by a significant business combination. On 18 May 2006, Pyaterochka Holding N.V. (renamed X5 Retail Group N.V. after the combination) acquired 100% of the voting shares in Perekrestok Holdings Limited. However, because on completion of the transaction, shareholders and other related parties of Perekrestok Holdings Limited obtained control over 56% of the shares of Pyaterochka Holding N.V., the transaction was accounted for as a reverse acquisition of Pyaterochka Holding N.V. by Perekrestok Holdings Limited. Accordingly, the X5 Consolidated Financial Statements for the years ended 31 December 2007 and 2006 are prepared as a continuation of the consolidated financial statements of Perekrestok Holdings Limited following the reverse acquisition, and the reverse acquisition is accounted for as a purchase by Perekrestok Holdings Limited of Pyaterochka Holding N.V. on 18 May 2006 (see note 8 in the X5 Consolidated Financial Statements for the year ended 31 December 2006).
X5’s functional currencies are the Russian rouble and the Ukranian hryvnia. X5’s presentation currency is the U.S. dollar.
The financial data set forth below should be read in conjunction with the Consolidated Financial Statements and related notes included elsewhere in this Prospectus and the “Operating and Financial Review”.
Selected Consolidated Income Statement Data The following table sets out selected data from the income statement contained in the Consolidated Financial Statements included in this Prospectus for the years ended 31 December 2007, 2006 and incorporated by reference for the year ended 31 December 2005:
Years ended 31 December 2007 2006 2005 (in millions of US$) Revenue ...... 5,320.4 2,803.4 1,014.8 Cost of sales(1) ...... (3,916.5) (2,041.7) (758.4) Gross profit ...... 1,403.9 761.6 256.4 Selling, general and administrative expenses(1) ...... (1,135.0) (630.8) (215.1) Lease/sublease and other income ...... 68.0 36.9 15.6 Operating profit ...... 336.9 167.7 56.9 Finance costs ...... (133.0) (63.0) (14.6) Finance income ...... 7.2 1.4 0.2 Net foreign exchange gain / (loss) ...... 31.5 14.1 (4.4) Profit before tax ...... 242.7 120.3 38.1 Income tax expense ...... (98.9) (36.1) (9.1) Profit for the period ...... 143.7 84.2 29.0 Attributable to: Equity holders of the parent ...... 143.7 84.2 29.1 Minority interest ...... – – (0.1) Profit for the period ...... 143.7 84.2 29.0
(1) Includes amounts reclassified to conform to the presentation adopted in the X5 Consolidated Financial Statements for a subsequent year or years. See “Presentation of Financial and Other Information – Reclassifications”.
34 Selected Consolidated Balance Sheet Data The following table sets out selected data from the consolidated balance sheet contained in the Consolidated Financial Statements included in this Prospectus as at 31 December 2007 and 2006 and incorporated by reference as at 31 December 2005:
At 31 December 2007 2006 2005 (in millions of US$) Current assets ...... 861.5 632.0 182.3 Non-current assets ...... 5,660.9 4,460.5 377.2 Total assets ...... 6,522.4 5,092.5 559.5 Current liabilities ...... 1,552.3 1,068.5 216.6 Non-current liabilities ...... 1,726.4 1,133.9 160.9 Total liabilities ...... 3,278.7 2,202.4 377.5 Total equity ...... 3,243.7 2,890.0 182.0 Total equity and liabilities ...... 6,522.4 5,092.5 559.5
Non-IFRS measures and ratios EBITDA The following table sets out EBITDA and EBITDA margin, which X5 uses in assessing its performance for the years ended 31 December 2007, 2006 and 2005:
Years ended 31 December 2007 2006 2005 (in millions of US$) EBITDA(1) ...... 479.3 246.8 81.0 EBITDA margin(2) ...... 9.0% 8.8% 8.0%
(1) EBITDA, for any relevant period, represents profit for the year before income tax expense, finance costs net of finance income, net foreign exchange gain/loss and depreciation and amortisation.
A reconciliation of EBITDA from profit for the period under review is as follows:
Years ended 31 December 2007 2006 2005 (in millions of US$) Profit for the year ...... 143.7 84.2 29.0 Income tax expense ...... 98.9 36.1 9.1 Finance costs, net of finance income ...... 125.8 61.5 14.4 Net foreign exchange (gain)/loss ...... (31.5) (14.1) 4.4 Depreciation and amortisation ...... 142.4 79.1 24.1 EBITDA ...... 479.3 246.8 81.0
X5 presents EBITDA because its management considers EBITDA to be important supplemental measure of X5’s operating performance. EBITDA is frequently used by securities analysts, investors and other interested parties in the evaluation of companies in X5’s industry. EBITDA has limitations as an analytical tool, and should not be considered in isolation, or as a substitute for analysis of X5’s operating results as reported under IFRS. Some of these limitations are as follows: • EBITDA does not reflect the impact of income taxes on X5’s operating performance; • EBITDA does not reflect the impact of finance costs on X5’s operating performance, which can be significant and could further increase if X5 incurs more debt; • EBITDA does not reflect the impact of net foreign exchange gain/(loss); • EBITDA does not reflect the impact of depreciation and amortisation on X5’s operating performance. Although depreciation and amortisation are non-cash charges, the assets being depreciated and amortised will often have to be replaced in the future, and EBITDA does not reflect any cash requirements for such replacements; and
35 • Other companies in X5’s industry may calculate EBITDA differently or may use them for different purposes than X5 does, limiting the usefulness of EBITDA as a comparative measure. X5 compensates for the above-mentioned limitations by relying primarily on its IFRS operating results and using EBITDA only supplementally. See the X5 consolidated income statement and consolidated statements of cash flows included elsewhere in this Prospectus. EBITDA is a measure of X5’s operating performance that is not required by, or presented in accordance with, IFRS. EBITDA is not a measurement of X5’s operating performance under IFRS and should not be considered as alternatives to profit for the year, operating profit or any other performance measures derived in accordance with IFRS or as an alternative to cash flow from operating activities or as a measure of X5’s liquidity. In particular, EBITDA should not be considered as measures of discretionary cash available to X5 to invest in the growth of its business. (2) EBITDA margin is calculated as EBITDA divided by revenue.
Net Retail Sales The following table sets out net retail sales by region and format for the years ended 31 December 2007, 2006 and 2005:
By Regions Years ended 31 December 2007 2006 2005 (in millions of US$) Moscow ...... 2,934.7 1,583.8 709.5 St. Petersburg ...... 1,506.4 767.4 44.5 Yekaterinburg ...... 68.9 21.3 – Chelyabinsk ...... 93.0 – – Nizhniy Novgorod ...... 223.5 162.8 100.6 Samara ...... 133.3 77.5 62.1 Southern Russia ...... 105.7 69.8 35.0 Ukraine ...... 32.1 26.4 22.5 Other ...... 186.7 73.7 27.8 Total ...... 5,284.3 2,782.7 1,002.0
By Format Years ended 31 December 2007 2006 2005 (in millions of US$) Hypermarkets ...... 392.7 244.9 152.2 Supermarkets ...... 1,944.7 1,254.6 849.8 Soft discount stores ...... 2,946.9 1,283.2 – Total ...... 5,284.3 2,782.7 1,002.0
36 Like-for-Like Sales, Traffic and Basket Size The following table sets out like-for-like growth in sales, traffic and basket size for the year ended 31 December 2007 compared to the prior year by region and format:
By Region Year ended 31 December 2007 Like-for-Like Like-for-Like Like-for-Like Average Retail Sales Traffic Basket Size Moscow Hypermarkets ...... 13% 4% 9% Supermarkets ...... 26% 17% 9% Soft discount stores ...... 30% 9% 21% Total ...... 27% 12% 15% St. Petersburg Hypermarkets ...... – – – Supermarkets ...... 19% 14% 5% Soft discount stores ...... 12% 1% 11% Total ...... 13% 2% 11% Other Regions Hypermarkets ...... 21% 15% 6% Supermarkets ...... 9% 6% 3% Soft discount stores ...... 66% 35% 31% Total ...... 15% 11% 4% X5 Total by Format Hypermarkets ...... 17% 11% 6% Supermarkets ...... 22% 14% 8% Soft discount stores ...... 21% 5% 16% Total ...... 21% 9% 12%
The following table sets out like-for-like growth in sales, traffic and basket size for the year ended 31 December 2006 compared to the prior year by region and format:
By Region Year ended 31 December 2006 Like-for-Like Like-for-Like Like-for-Like Average Retail Sales Traffic Basket Size Moscow Hypermarkets ...... 13% 7% 6% Supermarkets ...... 18% 11% 7% Soft discount stores ...... – – – Total ...... 17% 10% 7% St. Petersburg Hypermarkets ...... ––– Supermarkets ...... 12% 14% (2%) Soft discount stores ...... – – – Total ...... 12% 14% (2%) Other Regions Hypermarkets ...... 15% 9% 6% Supermarkets ...... 9% 4% 5% Soft discount stores ...... ––– Total ...... 10% 5% 5% X5 Total by Format Hypermarkets ...... 14% 8% 6% Supermarkets ...... 15% 9% 6% Soft discount stores ...... ––– Total ...... 15% 9% 6%
37 Like-for-like comparisons of retail sales between two periods are comparisons of retail sales in local currency (including VAT) generated by the relevant stores. The stores that are included in like-for-like comparisons are those that have operated for at least twelve full months preceding the beginning of the last month of the reporting period. Their sales are included in like-for-like calculation starting from the first day of the month following the month of the store opening. The like-for-like comparison for each store takes into account retail sales generated by that store during the same months it was in operation in both the reporting period and the period of comparison. The retail sales of all the relevant stores in the relevant months are then aggregated and compared. Like-for-like sales are calculated on the basis of traffic and basket amounts of relevant stores in the period under review. For example, the like-for-like comparison of retail sales between 2007 and 2006 would include sales of a store that was opened or acquired on 15 October 2006, and the retail sales to be compared would be the aggregate retail sales generated by that store in November and December of 2007 and 2006. As the Pyaterochka acquisition was completed on 18 May 2006, X5 includes stores acquired in the Pyaterochka acquisition only for the months of June to December in each of 2006 and 2007 for the purposes of like-for-like retail sales presented in this Prospectus. X5 has previously publicly reported like-for-like retail sales on a pro-forma basis, calculated by including acquired Pyaterochka stores for the full year in each of 2006 and 2007. Those figures differ from the like-for-like retail sales figures presented in this Prospectus.
References to “like-for-like traffic” are to the number of customer visits and references to “like-for-like average basket size” are to the average amounts spent by customers on each purchase, in each case, in the relevant stores for the period under review on a like-for-like basis.
Average Basket Size The following table sets out the average basket size for the years ended 31 December 2007, 2006 and 2005:
By Format Year Ended 31 December 2007 2006 2005 (in U.S. dollars) Hypermarkets ...... 16.2 15.1 14.9 Supermarkets ...... 12.1 10.8 10.1 Soft discount stores ...... 8.5 7.4 – Overall average basket size ...... 10.0 9.2 10.6
References to “average basket size” are to the average amounts spent by customers on each purchase over the period under review.
Sales per Square Metre of Net Selling Space The following table sets out sales per square metre of net selling space at 31 December 2007, 2006 and 2005:
At 31 December 2007 2006 2005 (in U.S. dollars) Hypermarkets ...... 8,909 8,710 7,322 Supermarkets ...... 12,959 10,959 9,549 Soft discount stores ...... 11,375 9,116 – Total ...... 11,659 9,848 9,123
“Sales per square metre of net selling space” is calculated by dividing the total retail sales for each format for the period under review by the aggregate weighted net selling space. The weighted net selling space per store is calculated by multiplying the net selling space for that store at the end of the period under review by the number of days the store was operational during the period under review and dividing this number by 365. The weighted net selling space per store is then aggregated for all stores of that format to provide the “aggregate weighted net selling space” for that format.
“Net selling space” is the area owned or leased by X5 to sell its products. It excludes any area used for storage or administrative/technical functions as well as area that is leased or sub-leased to third parties.
38 OPERATING AND FINANCIAL REVIEW
Investors should read the following operating and financial review relating to the years ended 31December 2007, 2006 and 2005 together with the X5 Consolidated Financial Statements for the years ended 31 December 2007 and 2006 and the notes thereto included in this Prospectus and the 2005 Perekrestok Consolidated Financial Statements and the notes thereto incorporated by reference. Unless otherwise indicated, the consolidated financial data set forth below have been derived from the X5 Consolidated Financial Statements for the years ended 31 December 2007 and 2006 contained in this Prospectus and from the 2005 Perekrestok Consolidated Financial Statements incorporated by reference. As described in “Presentation of Financial Information – Reclassifications”, certain financial information in this discussion relating to the years ending 31 December 2006 and 2005 have been reclassified to conform with the presentation in a subsequent year or years.
The X5 Consolidated Financial Statements for the years ended 31 December 2007 and 2006, included in this Prospectus, have been prepared in accordance with International Financial Reporting Standards as adopted by the European Union. The 2005 Perekrestok Consolidated Financial Statements for the year ended 31 December 2005, incorporated by reference, have been prepared in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board.
As discussed more fully in “Business – History and Development – Acquisition of Pyaterochka”, the X5 Consolidated Financial Statements for the years ended 31 December 2007 and 2006 reflect the combination of Perekrestok and Pyaterochka from 18 May 2006. The business combination was accounted for as a reverse acquisition of Pyaterochka by Perekrestok. Accordingly, the X5 Consolidated Financial Statements for the years ended 31 December 2007 and 2006 are prepared as a continuation of the consolidated financial statements of Perekrestok following the reverse acquisition, and the reverse acquisition is accounted for as a purchase by Perekrestok of Pyaterochka on 18 May 2006 (see note 8 in the X5 Consolidated Financial Statements for the year ended 31 December 2006).
Summary X5 is the largest food retailer in Russia in terms of revenue. As at 31 December 2007, X5 operated 868 stores located primarily in the European part of Russia and the Urals, with total net selling space of approximately 609,210 square metres. X5 had revenues of US$5,320.4 million and US$2,803.4 million in 2007 and 2006, respectively.
X5 currently operates stores in three different formats: soft discount stores, supermarkets and hypermarkets. X5 has expanded from one supermarket in Moscow in 1995 to 868 stores in 2007, including 674 discount stores, 179 supermarkets and 15 hypermarkets. X5 currently operates its soft discount stores under the brand name “Pyaterochka” and its supermarkets and hypermarkets under the brand name “Perekrestok”. As of the end of 2007, the stores operating under “Pyaterochka” brand were located in the Moscow area, the St. Petersburg area and seven other regions of European part of Russia and the Urals and stores operating under the Perekrestok brand were located in Moscow area, St. Petersburg and 15 other regions of the European part of Russia, in addition to five supermarkets located in Ukraine. X5 is seeking to continue to expand in Moscow and St. Petersburg, where disposable income is amongst the highest in Russia, as well as in the other parts of the European part of Russia and the Urals. These regions offer high growth potential and, together with Moscow and St. Petersburg, account for approximately 84.7% of the total Russian food market.
X5 has entered into franchise arrangements with third parties pursuant to which they are licensed to operate stores under the “Pyaterochka” or “Perekrestok” brands. X5 receives revenue under these arrangements in the form of a one-off, upfront fee and ongoing royalty payments, generally calculated as a percentage of sales of the franchise stores. Unless expressly stated otherwise, store-related information presented below does not include information relating to franchise stores.
Significant Factors Affecting Results of Operations The main factors that have affected results of operations during the period under review and that can be expected to affect its results of operations in the future, are: (a) Increases in the number of stores and net selling space; (b) Macroeconomic trends and shift in the food retail market structure in Russia; (c) Purchasing policies;
39 (d) Sales of private label goods; (e) Improved warehousing and distribution; (f) Real estate operations; (g) Employee share option plans; (h) Tax contingencies; and (i) Acquisition of Formata.
Increases in Number of Stores and Net Selling Space During the period under review, X5 has pursued an aggressive store expansion strategy, with the number of stores growing from 120 at 31 December 2005 to 619 at 31 December 2006 to 868, and at 31 December 2007. Net selling space also increased significantly from 141,494 square metres at 31 December 2005 to 466,100 square metres at 31 December 2006, and to 609,210 square metres at 31 December 2007.
X5 has pursued, and will continue to pursue, four different approaches in increasing its number of stores and net selling space: (i) building or leasing new stores; (ii) tactical acquisition of stores and store chains that will be integrated into, and will operate under, an existing X5 brand; (iii) buy-out of successful franchisees; and (iv) strategic acquisitions, whereby X5 purchases strong stand-alone retail businesses that can significantly enhance X5’s leadership. An example of a strategic acquisition is the purchase of Pyaterochka Holding N.V. in May 2006. The potential acquisition of the Karusel hypermarket chain is another example of a strategic acquisition.
X5 considers transactions with a total consideration of less than US$300.0 million as “tactical” acquisitions and treats them as part of organic growth. Companies acquired as part of a tactical acquisition generally cease to exist as a stand-alone business shortly after completion of the acquisition by X5 and are integrated into a format operated by X5. Tactical acquisitions can be approved by the Chief Executive Officer and Chief Financial Officer without further review by the Supervisory Board, whereas strategic acquisitions require Supervisory Board approval.
On 18 May 2006, X5 acquired Pyaterochka Holding N.V., which operated 377 soft discount stores in Moscow, St. Petersburg and Yekaterinburg at the time. While administrative support and distribution and logistics systems for soft discount stores have been centralised, these stores continue to operate under the “Pyaterochka” brand name.
Since acquiring Pyaterochka, X5 has also acquired 108 additional stores in Russia, through tactical acquisitions, that have been re-branded as “Perekrestok” or “Pyaterochka” stores, totalling 60,700 square metres of net selling space. For example, in November 2006, X5 acquired the Merkado group of companies, which owned and operated 17 retail grocery stores in Moscow and also owned freehold property which now serves as the premises for X5’s head office in Moscow. In the first half of 2007, X5 acquired 40 soft discount stores from a former franchisee in Chelyabinsk; and in December 2007, X5 acquired the Korzinka and Strana Gerkulesia group of companies, which owned and operated 22 stores in the Lipetsk region and 29 stores in the Moscow and Tver regions, respectively. For more information on these acquisitions, see “Business – History and Development – Recent Acquisitions and Proposed Acquisition of Formata”.
In January 2008, X5 exercised an option to acquire the entire issued share capital of Formata, which owns and operates the chain of Karusel hypermarkets (see “Business – History and Development – Recent Acquisitions and Proposed Acquisition of Formata” for more information on the option). The acquisition is subject to certain conditions, including the completion of due diligence satisfactory to X5. The addition of the Karusel hypermarkets would significantly expand X5’s full size hypermarket segment. As at 31 December 2007, there were 22 hypermarkets operating under the Karusel brand, with total gross selling space of approximately 234,900 square metres (see “Business – X5 Operations and Stores – Karusel Hypermarkets” for more information on the Karusel hypermarkets).
Generally, X5 requires two to four months to open a new soft discount store, six to eighteen months to open a supermarket or compact hypermarket and one to three years to open a full size hypermarket, in each case from the acquisition of the real estate. The Russian industry is seasonal with construction works largely undertaken in the second half of spring, summer and early autumn due to difficult weather conditions during the rest of the year. As a result, a disproportionate number of stores are opened in the last quarter of each year.
40 The following tables set out the number of stores operated by X5 as at 31 December 2007 and 2006 and by Perekrestok as at 31 December 2005, presented by region and store format.
Number of Stores by Region At 31 December 2007 2006 2005 Pyaterochka Total Total Acquisition Total Moscow ...... 418 327 181 77 St. Petersburg ...... 263 221 177 9 Yekaterinburg ...... 34 25 19 – Chelyabinsk ...... 49 – – – Nizhniy Novgorod ...... 38 17 – 14 Samara ...... 15 7 – 6 Southern Russia ...... 9 7 – 5 Ukraine ...... 5 4 – 4 Other ...... 37 11 – 5 Total ...... 868 619 377 120
Number of Stores by Format At 31 December 2007 2006 2005 Pyaterochka Total Total Acquisition Total Soft discount stores ...... 674 451 377 – Supermarkets ...... 179 156 – 113 Hypermarkets ...... 15 12 – 7 Total ...... 868 619 377 120
The following tables set out net selling space as at 31 December 2007, 2006 and 2005, presented by region and store format.
Net Selling Space by Region At 31 December 2007 2006 2005 Pyaterochka Total Total Acquisition Total (in thousand square metres) Moscow ...... 299.8 252.6 110.7 85.0 St. Petersburg ...... 159.1 133.6 100.9 10.3 Yekaterinburg ...... 12.5 8.9 6.5 – Chelyabinsk ...... 18.6 – – – Nizhniy Novgorod ...... 31.4 18.5 – 13.0 Samara ...... 19.6 10.8 – 9.2 Southern Russia ...... 13.2 11.7 – 8.8 Ukraine ...... 6.2 4.9 – 4.9 Other ...... 48.8 25.1 – 10.3 Total ...... 609.2 466.1 218.1 141.5
Net Selling Space by Format At 31 December 2007 2006 2005 Pyaterochka Total Total Acquisition Total (in thousand square metres) Soft discount stores ...... 357.5 257.1 218.1 – Supermarkets ...... 191.7 162.8 – 114.0 Hypermarkets ...... 60.0 46.2 – 27.5 Total ...... 609.2 466.1 218.1 141.5
41 The following tables set out the number of stores and net selling space as at 31 December 2007, 2006 and 2005 presented by ownership status (owned or leased from a third party):
Owned/Leased Stores by Number of Stores
At 31 December 2007 2006 2005 Pyaterochka Total Total Acquisition Total Owned ...... 394 295 191 47 Leased ...... 474 324 186 73 Total ...... 868 619 377 120
Owned/Leased stores by net selling space
At 31 December 2007 2006 2005 Pyaterochka Total Total Acquisition Total (in thousand square metres) Owned ...... 288.1 234.0 115.4 60.8 Leased ...... 321.1 232.1 102.7 80.7 Total ...... 609.2 466.1 218.1 141.5
Macroeconomic Trends and Shift in the Food Retail Market Structure in Russia
Nearly all of X5’s operations are located in Russia. As a result, Russian macroeconomic trends significantly influence X5’s results of operations. Since 1998, Russia has experienced economic growth. In 2005, 2006 and 2007, real GDP growth in Russia was 6.4%, 7.4% and 8.1%, respectively, while private consumption growth was 11.2%, 11.1% and 12.9%, respectively, and year-on-year growth of Russian consumer spending in the Russian food retail market was 24.7%, 22.5% and 23.1%, respectively. Consumer price inflation was 10.9% in 2005, 9.0% in 2006 and 11.9% in 2007. X5 believes that these macroeconomic factors have contributed to, and reflect, the increasing purchasing power of X5’s customer base, which, in turn, has led to increased average basket size, supporting growth in like-for-like revenue in X5 stores during the period under review.
The strengthening of the rouble against the U.S. dollar in the period under review has contributed to X5’s increased revenue in U.S. dollar terms. While X5’s revenue is largely earned in roubles, its reporting currency is the U.S. dollar.
The effects of the increase in consumer price inflation and the appreciation of the rouble have been partially offset by inflation in wages, real estate prices and rents in Russia. According to the Federal State Statistics Service, average monthly wages in Russia have grown from RR 8,555 in 2005 to RR 10,634 in 2006. Inflation in wages, real estate prices and rents have added to X5’s cost of operations in the period under review. The adverse effect on X5’s reported costs has been intensified by the strengthening of the rouble against the U.S. dollar.
In addition, there has been a noticeable shift in consumer preference in Russia away from traditional food retail formats, such as open markets and small grocers, to the modern food retail formats that X5 operates. Between 2003 and 2007, modern retail formats grew from 13.3% of the food retail market in Russian cities with more than 100,000 residents to 33.3% (see “Food Retail Industry – Russian Food Retail Market”).
Finally, the Russian food retail market is still fragmented, with several operators each holding a small share of the overall market. X5 expects merger and acquisition activity, driven in large part by the development of modern retail formats and scarcity of retail space, to lead to industry consolidation. The consolidation of Pyaterochka and Perekrestok is a recent example of merger activity in the food retail sector in Russia, and the potential acquisition of Formata is an indication of X5’s intention to continue to play a leading role in the Russian food retail industry consolidation.
42 Purchasing Policies X5 believes that it is a significant client to many of its suppliers and that, during the period under review, it has been able to negotiate more favourable supply terms, including lower prices, rebates and certain compensation payable by suppliers compared to small food retailers. X5’s acquisition of Pyaterochka in May 2006, which considerably increased the volume of goods X5 purchases from its suppliers, contributed to its ability to obtain favourable terms, as has the increased proportion of products delivered by suppliers to X5’s distribution centres instead of directly to stores (that is, “centralisation” of X5’s distribution function).
X5’s increasing use of distribution centres, to which X5’s suppliers can deliver their goods instead of to a multiplicity of stores, reduces delivery costs for suppliers and X5 benefits from a portion of this cost saving is shared with X5 (see “Improved Warehousing and Distribution” below). X5 may be able to obtain even better terms in the future if it decreases the range of products it buys and increases the volumes of remaining products purchased.
Sales of Private Label Goods X5 sells private label goods in its stores which are manufactured for it by third parties. Sales of private label goods in X5 stores as a portion of total sales has grown since 2005. X5 plans to continue to increase the percentage of private label goods it sells over the next few years. It is X5’s long-term goal to increase sales of private label goods to between 40% and 50% of total revenue in soft discounters and to between 20% and 25% in supermarkets and hypermarkets. Due to the absence of the brand related costs for private label goods, their increasing presence in X5’s product range has a positive effect on X5’s gross margin.
X5 engages third parties to manufacture its private label goods.
Improved Warehousing and Distribution X5 was the first Russian food retail company to open a self-operated distribution centre in Russia. As at 31 December 2007, X5 operated ten distribution centres across Russia, comprising four distribution centres in Moscow, three distribution centres in St. Petersburg and one distribution centre in each of Nizhniy Novgorod, Chelyabinsk and Yekaterinburg.
X5 continues to improve the efficiency of its warehousing and distribution arrangements by increasing the volume of deliveries to its stores from its distribution centres in Moscow, St. Petersburg and other regions as a means of improving centralisation, as opposed to direct deliveries from its suppliers.
When suppliers deliver their goods to X5 distribution centres (and not directly to stores) they pay X5 compensation for logistics services (in the form of a rebate offsetting the supply price or as a payment to X5). This compensation is partially offset by increased costs associated with the maintenance of the distribution centres and the delivery of goods from the distribution centres to the stores.
X5 continues to invest in its distribution infrastructure development and intends to operate distribution centres with sufficient storage capacity in every Russian region of its store locations in five years. Improved warehousing and distribution is aimed at enhancing X5 operational efficiency as it ensures improved labour productivity, more efficient store area utilisation and decrease in inventories, leading to working capital improvement.
X5 aims to increase the portion of products distributed through distribution centres to 90% for soft discount stores, 85% for supermarkets and 75% for hypermarkets in the long term.
Real Estate Operations X5 intends to maintain its current share of owned net selling space in its store portfolio in order to reduce its exposure to rising rental costs. In addition, by owning the property, X5 has more flexibility in designing, implementing and changing store layout because it does not require the consent of any landlord (see “Business – Competitive Strengths – Extensive Portfolio of Owned Real Estate”).
X5 also leases certain areas in its stores to third parties providing complementary services to X5 customers. Lessees typically rent space in supermarkets or hypermarkets and provide services such as dry-cleaning, pharmacy kiosks, newsagents, florists, mobile phone and electronic retailers and automatic teller machines. Such arrangements not only provide X5 with additional rental income, but also help to attract and retain customers by
43 increasing the number of products and services available in stores. In certain cases, space is also leased in soft discount stores, though this is less common because of the smaller areas that are typical for that format. As X5 expands the number of full size hypermarkets which it operates, it expects to increase its leasing of space to third parties. X5 has created a new internal department to manage this activity and X5’s other real estate operations.
Employee Share Option Plans On 16 August 2005 and 2 December 2005, Pyaterochka granted a total of 6,129,088 options to acquire GDRs to key employees under an employee stock option program (the “Pyaterochka ESOP”). Upon acquisition of Pyaterochka in May 2006, X5 acquired a liability for share based payments of US$42.3 million in relation to these option grants. Option grants and other benefits under the Pyaterochka ESOP in 2006 resulted in an additional expense of US$27.7 million being recorded in that year in the X5 Consolidated Financial Statements for the year ended 31 December 2006 as part of staff costs. On 2 November 2006, the Supervisory Board approved the cancellation of the Pyaterochka ESOP. As compensation, the beneficiaries of the Pyaterochka ESOP received a one-off cash payment of US$65.6 million (approximately US$11.00 per GDR) as a cancellation fee and X5 incurred related expenses of US$4.4 million. An aggregate liability of US$70.0 million was reflected in X5’s balance sheet at 31 December 2006. Most of the cancellation fee was paid out in February and June 2007.
The General Meeting of Shareholders held on 15 June 2007 approved a new employee stock option program (“X5 ESOP”) for X5’s key executives and employees. The total number of GDRs that may be issued under options granted under the X5 ESOP is 10,824,008 GDRs (see “Description of Share Capital and Articles of Association” – “Employee Stock Option Plan” for more details). On 21 April 2008, the Supervisory Board of X5 resolved to seek approval from the General Meeting of Shareholders at the annual general meeting of shareholders, which is scheduled to be held on 16 June 2008, for an increase in the number of GDRs that may be granted under the X5 ESOP from 10,824,008 GDRs to 11,261,264 GDRs. X5 management currently intends that the X5 ESOP will be offered to approximately 180 employees of X5. The share options under the X5 ESOP are granted in four tranches with varying vesting periods, exercisable through to 18 November 2010. 4,198,000 options were granted under the first and second tranches in 2007, of which 365,000 were subsequently cancelled due to the optionholders’ cessation of employment with X5 and 250,000 options were exercised for cash in 2007. The first tranche vested immediately and covers the period of service of option holders from 1 January 2007 to 15 June 2007. The exercise price for the first tranche is US$15.96 per GDR. The second tranche will vest on 18 May 2008 and has an exercise price of US$28.58 per GDR. Participants in the X5 ESOP can exercise their share options at any time from the time of vesting until 18 November 2010.
In the year ended 31 December 2007, X5 recognised US$47.7 million in expenses related to the X5 ESOP. This amount covers X5’s liability in respect of all options that were granted in the first tranche and that portion of the second tranche that relates to the service of option holders between 15 June 2007 and 31 December 2007. The financial statements for each of 2008, 2009 and 2010 will recognise expenses relating to the X5 ESOP for that portion of the options that have vested during the relevant year and for which option holders have been employed by X5.
Tax Contingencies Please refer to “Risk Factors – Risks Relating to X5’s Business and Industry – X5’s exposure to several tax jurisdictions may have an adverse effect on X5 – Challenges to X5’s tax position by the Russian tax authorities could have a material adverse effect” and “Risk Factors – Risks Relating to Russia – Legislative and Legal Risks – X5 may be subject to vaguely drafted Russian transfer pricing rules – New Russian thin capitalisation rules could affect X5’s ability to deduct interest on certain borrowings” for details of tax issues that have affected, and could, in the future, affect X5.
X5’s consolidated balance sheet reflected provisions for tax contingencies of US$75.7 million at 31 December 2007, US$55.8 million at 31 December 2006 and US$8.0 million at 31 December 2005. Of the US$55.8 million provision at 31 December 2006, US$30.0 million was recorded in connection with the acquisition of Pyaterochka in May 2006 and US$10.0 million was recorded in connection with the acquisition of Mercado. A provision of US$8.0 million was carried over from 2005 and US$7.8 million was recorded as provisions for tax contingencies in 2006. The increase of US$19.9 million in 2007 relates to the increase in provisions for tax contingencies due to the acquisitions of Korzinka and Strana Gerkulesia in 2007 and foreign exchange movements.
44 Acquisition of Formata X5 has exercised an option to acquire Formata, which owns and operates the Karusel hypermarkets, and expects to complete the acquisition prior to 1 July 2008. X5 intends to integrate the Karusel hypermarkets into its existing hypermarket format and use X5’s supply and IT systems in the Karusel hypermarkets. Amongst other advantages, this integration will allow the Karusel hypermarkets to be serviced by X5’s distribution centres and support infrastructure. X5 also intends to relaunch the Karusel hypermarkets as “Mercado Supercenters” as part of its wider strategy for hypermarket growth. As a Mercado Supercenter, the Karusel hypermarkets will benefit from the advertising and pricing strategies of X5’s hypermarkets. X5 will introduce a wider choice of fresh produce in Karusel hypermarkets, while maintaining a balance between food and non-food products. The hypermarkets will have a wider assortment of local and private label goods and will have a focus on household goods in the non-food section. X5 expects that the Karusel hypermarkets will initially be closed for approximately one week upon acquisition to allow for the integration of IT systems and rebranding and restyling to take place (see “Risk Factors – Risks Relating to X5’s Acquisition of Formata – Acquisition of the Karusel hypermarkets entails certain risks, which may have a material adverse effect on X5’s business, financial condition and operating results”). X5 intends to change the layout of the Karusel hypermarkets by the end of 2009 to improve the aesthetic appeal of the stores to customers, including enhancing the display of non-food products, increasing the space allocated to dry food products and consolidating the areas where fresh produce is sold in each hypermarket. X5 expects that the total costs associated with rebranding, restyling and integrating the Karusel hypermarkets in 2008 and 2009 will be approximately US$150 million.
X5 anticipates that there will be significant synergy benefits after several years in integrating the Karusel hypermarkets within X5’s existing infrastructure. Integration of the Karusel hypermarkets into the X5 group will enhance X5’s purchasing power with suppliers and allow the Karusel hypermarkets to benefit from X5’s logistics infrastructure. X5 expects that there will be advantages for the Karusel hypermarkets associated with economies of scale, including optimisation of management, administrative and operating costs.
The Formata Consolidated Financial Statements for the years ended 31 December 2007 are included in this Prospectus.
Results of Operations for the Years Ended 31 December 2007, 2006 and 2005 The following table sets out the results of operations contained in the Consolidated Financial Statements included in this Prospectus for the years ended 31 December 2007 and 2006 and incorporated by reference for the year ended 2005:
Years ended 31 December 2007 2006 2005 (in millions of US$) Revenue ...... 5,320.4 2,803.4 1,014.8 Cost of sales(1) ...... (3,916.5) (2,041.7) (758.4) Gross profit ...... 1,403.9 761.6 256.4 Selling, general and administrative expenses(1) ...... (1,135.0) (630.8) (215.1) Lease/sublease and other income ...... 68.0 36.9 15.6 Operating profit ...... 336.9 167.7 56.9 Finance costs ...... (133.0) (63.0) (14.6) Finance income ...... 7.2 1.4 0.2 Net foreign exchange gain / (loss) ...... 31.5 14.1 (4.4) Profit before tax ...... 242.7 120.3 38.1 Income tax expense ...... (98.9) (36.1) (9.1) Profit for the period ...... 143.7 84.2 29.0 Attributable to: Equity holders of the parent ...... 143.7 84.2 29.1 Minority interest ...... – – (0.1) Profit for the period ...... 143.7 84.2 29.0
(1) Includes amounts reclassified to conform to the presentation adopted in the X5 Consolidated Financial Statements for a subsequent year or years. See “Presentation of Financial and Other Information – Reclassifications”.
45 Revenue The following table sets out revenues by source for the years ended 31 December 2007, 2006 and 2005:
Years ended 31 December 2007 2006 2005 (in millions of US$) Sale of goods ...... 5,295.1 2,791.5 1,012.7 Franchise services ...... 12.5 7.1 0.7 Other services ...... 12.8 4.8 1.4 Total ...... 5,320.4 2,803.4 1,014.8
The following table sets out revenues from sales of goods by store format for the years ended 31 December 2007, 2006 and 2005:
Years ended 31 December 2007 2006 2005 (in millions of US$) Soft discount stores ...... 2,946.9 1,283.2 – Supermarkets ...... 1,944.7 1,254.6 849.8 Hypermarkets ...... 392.7 244.9 152.2 Total retail sales of goods ...... 5,284.3 2,782.7 1,002.0 Other sales of goods(1) ...... 10.8 8.8 10.6 Total sales of goods ...... 5,295.1 2,791.5 1,012.7
(1) Other sales of goods include sales of goods to wholesale purchasers from distribution centres.
Revenue from sales of goods increased by 89.7% to US$5,295.1 million in 2007 from US$2,791.5 million in 2006 and by 175.6% to US$2,791.5 million in 2006 from US$1,012.7 million in 2005. Sales of goods represented 99.5% of X5’s revenue during 2007 and 99.6% of X5’s revenue during 2006. The increase was the result of an increase in the number of stores and net selling space, as well as an increase in sales per square metres of net selling space.
Sales of goods include retail sales and other sale of goods. Retail sales represented 99.3% of X5’s total revenue during 2007 and 99.3% of X5’s revenue during 2006.
Of the retail sales of goods in 2007 and 2006, US$2,946.9 million and US$1,283.2 million or 55.8% and 46.1%, respectively, was attributable to soft discount stores. The number of soft discount stores increased to 674 as at 31 December 2007 from 451 as at 31 December 2006, resulting in an increase in net selling space to 357,500 square metres at 31 December 2007 from 257,100 square metres at 31 December 2006. Sales per square metre of net selling space in soft discount stores increased to US$11,375 in 2007 from US$9,116 in 2006. X5 did not operate any soft discount stores in 2005 and acquired its first discount stores on its acquisition of Pyaterochka (see “Business – History and Development – Acquisition of Pyaterochka”).
Of the retail sale of goods in 2007, 2006 and 2005, US$1,944.7 million, US$1,254.6 million and US$849.8 million or 36.8%, 45.1% or 84.8%, respectively, was attributable to supermarkets. The number of supermarkets increased to 179 as at 31 December 2007 from 156 as at 31 December 2006 and 113 as at 31 December 2005, resulting in an increase in net selling space to 191,700 square metres at 31 December 2007 from 162,800 square metres at 31 December 2006 and 114,000 square metres at 31 December 2005. Sales per square metre of net selling space in supermarkets increased to US$12,959 in 2007 from US$10,959 in 2006 and US$ 9,549 in 2005.
Of the retail sale of goods in 2007, 2006 and 2005, US$392.7 million, US$244.9 million and US$152.2 million or 7.4%, 8.8% or 15.2%, respectively, was attributable to hypermarkets. X5 opened its first full size hypermarket in 2007, resulting in net selling space of all hypermarkets of 59,963 square metres as at 31 December 2007. Sales per square metre of net selling space in hypermarkets increased to US$8,909 in 2007 from US$8,710 in 2006 and US$7,322 in 2005.
Like-for-like sales grew by 21% and 15% in 2007 and 2006, respectively. In 2007, an increase in traffic accounted for a 9% increase in like-for-like sales and an increase in the average basket size accounted for a 12% increase in like-for-like sales. In 2006, an increase in traffic accounted for a 9% increase in sales and an increase in the average basket size accounted for a 6% increase in sales. Increases in like-for-like sales growth across all formats was driven by the introduction of new pricing policies, implementation of promotional campaigns and
46 customer loyalty programs and improvement in store operations through optimisation of product assortment, merchandising and new store layouts. Like-for-like sales growth in soft discount stores totalled 21% in 2007, with an increase in traffic and average basket size accounting for 5% and 16%, respectively. This growth in like-for-like sales was mainly due to strong performance of soft discount stores in the regions (Yekaterinburg), where both traffic and average basket size increased considerably. Soft discount stores were not included in the like-for-like calculations for 2006 as X5 did not own or operate soft discount stores in the corresponding period in 2005. Like-for-like sales growth in supermarkets totalled 22% in 2007, with an increase in traffic and average basket size accounting for 14% and 8%, respectively. Strong growth in traffic is the result, in part, of the success of X5’s promotional campaigns and reflects growing customer loyalty especially in Moscow and St. Petersburg regions. Like-for-like sales growth in supermarkets totalled 15% in 2006, with an increase in traffic and average basket size accounting for 9% and 6%, respectively. Like-for-like sales growth in hypermarkets amounted to 17% in 2007, with an increase in traffic and average basket size accounting for 11% and 6% respectively. Strong growth in traffic is the result, in part, of the success of X5’s promotional campaigns and reflects growing customer loyalty especially in Moscow and St. Petersburg regions. Like-for-like sales growth in hypermarkets totalled 14% in 2006, with an increase in traffic and average basket size accounting for 8% and 6%, respectively. Income from franchise agreements increased by 76.1% to US$12.5 million in 2007 from US$7.1 million in 2006, due mainly to an increase in the number of franchise stores from 615 in 2006 to 688 in 2007. Income from franchise agreements in respect of the “Pyaterochka” brand were included in each month in 2007 and 7 months in 2006. Franchise income increased significantly to US$7.1 million in 2006 from US$0.7 million in 2005, due mainly to the acquisition of Pyaterochka franchise agreements relating to 605 franchise stores in 2006. Other services contributing revenue are primarily from advertising, marketing services and commissions from mobile phone operators.
Cost of Sales, Gross Profit and Gross Profit Margin The following table sets out cost of sales, gross profit and gross profit margin for the years ended 31 December 2007, 2006 and 2005: Years ended 31 December 2007 2006 2005 (in millions of US$, except percentages) Cost of sales(1) ...... (3,916.5) (2,041.7) (758.4) Gross profit(2) ...... 1,403.9 761.6 256.4 Gross profit (sale of goods)(3) ...... 1,378.6 749.8 254.3 Gross profit margin(4) ...... 26.4% 27.2% 25.2% Gross profit margin (sale of goods)(5) ...... 25.9% 26.7% 25.0%
(1) Includes amounts reclassified from 2005 and 2006 to conform to the presentation adopted in the X5 Consolidated Financial Statements for the year ended 31 December 2007. See “Presentation of Financial and Other Information – Reclassifications”. (2) Gross profit is revenue less cost of sales. (3) Gross profit (sale of goods) is calculated as the sale of goods component from revenue less the cost of sales. (4) Gross profit margin is gross profit divided by revenue, expressed as a percentage. (5) Gross profit margin (sale of goods) is gross profit (sale of goods) divided by revenue, expressed as a percentage.
Cost of sales includes the purchase price of the products sold and other costs incurred in bringing the inventories to retail stores in a condition that is ready for sale. These costs include the costs of purchasing, storing, rent, salaries and transporting the products to the extent it relates to bringing the inventories to the location and condition ready for sale. Gross profit margin from the sale of goods decreased to 25.9% in 2007 from 26.7% in 2006, due to the lower gross profit margins of soft discount stores acquired from Pyaterochka compared to the gross profit margin of supermarkets and hypermarkets. Results for Pyaterochka were included for approximately 8 months of X5’s results in 2006, but were included for the full year in 2007. In addition, in the fourth quarter of 2006, X5 finalised its renegotiation of purchasing contracts following the acquisition of Pyaterochka which resulted in a significant level of additional bonuses and discounts for X5 and boosting the overall gross profit margin in 2006. In 2007, these additional savings from the supplier bonuses and discounts were partially offset by the sale of goods at discounted prices designed to increase customer loyalty. Gross profit (sale of goods) increased by 83.9% in 2007, while cost of sales rose by 91.8%.
47 Gross profit margin from the sale of goods increased to 26.7% in 2006 from 25.0% in 2005. Gross profit (sale of goods) increased by 194.8% in 2006, while cost of sales rose by 169.2%. This increase was largely the result of the synergies derived from the acquisition of Pyaterochka in 2006, including an increase in X5’s purchasing power and reduction in logistics costs.
Selling, General and Administrative Expenses Selling expenses consist of salaries and wages of store employees, store expenses, rent or depreciation of stores, utilities, advertising costs and other selling expenses. General and administrative expenses include costs of salaries and wages of support office employees, rent and depreciation of support offices, impairment and amortisation charges of non-current charges and other general and administrative expenses.
Selling, general and administrative expenses increased to US$1,135.0 million in the year ended 31 December 2007 from US$630.8 million in the year ended 31 December 2006 and US$215.1 million in the year ended 31 December 2005. As a percentage of revenue, selling, general and administrative expenses decreased from 22.5% in the year ended 31 December 2006 to 21.3% in the year ended 31 December 2007 and increased as a percentage of revenue from 21.2% in the year ended 31 December 2005 to 22.5% in the year ended 31 December 2006. The increase in selling, general and administrative expenses between 2006 and 2007 in absolute terms was largely attributable to the full year costs associated with the stores acquired in the Pyaterochka acquisition and increases in wages, rents and utilities. The increase between 2005 and 2006 was largely attributable to an expense of US$27.7 million in 2006 associated with the Pyaterochka ESOP and increases in amortisation expenses.
Leases/Sublease and Other Income The amounts received by X5 from leases, subleases and other income increased by 84.3% from US$36.9 million in 2006 to US$68.0 million in 2007 and by 136.5% from US$15.6 million in the year ended 31 December 2005 to US$36.9 million in the year ended 31 December 2006. This sustained increase was primarily due to the opening and acquisition of additional stores, particularly supermarkets and hypermarkets.
Operating Profit Operating profit for X5 in 2007, 2006 and 2005 was US$336.9 million, US$167.7 million and US$56.9 million, respectively. The increase in operating profit between 2006 and 2007 was due primarily to the decrease of selling, general and administrative expenses as a percentage of revenue, which was offset by the decrease in gross profit as a percentage of revenue. The increase in operating profit between 2005 and 2006 was due primarily to an increase in gross profit as a percentage of revenue, offset in part by an increase in selling, general and administrative expenses as a percentage of revenue. X5’s operating margin, calculated as operating profit as a percentage of revenue, increased to 6.3% in 2007 from 6.0% in 2006 and 5.6% in 2005.
The appreciation of the rouble against the U.S. dollar in the periods under review also had a positive effect on the operating profit. The average exchange rate between the rouble and the U.S. dollar in 2005, 2006 and 2007 was RR 28.32, RR 27.19 and RR 25.58 per U.S. Dollar, respectively.
Finance Income and Costs
Years ended 31 December 2007 2006 2005 (in millions of US$) Interest expense ...... 101.8 63.0 14.6 Interest income ...... (7.2) (1.4) (0.2) Other finance costs, net ...... 31.3 – – Total ...... 125.8 61.5 14.4
X5’s net finance costs increased as a percentage of revenue for the year to 2.4% in 2007 from 2.2% in 2006 and 1.4% in 2005. In 2007, net finance costs increased by 104.6% to US$125.8 million from US$61.5 million in 2006 and increased by 327.1% to US$61.5 million in 2006 from US$14.4 million in 2005. In each period, the increase in interest expense was due to an increase in borrowings by X5 (see “Liquidity and Capital Resources-Borrowings” below). In 2007, the increase in finance costs was largely the result of an increase in outstanding debt, costs associated with two bond redemptions and a rouble bond issuance during the year.
48 In 2007, other finance costs included Pyaterochka Finance’s bond redemption costs of US$10.4 million and transaction costs of US$19.5 million, resulting from repayment of syndicated loans during the year.
Net Foreign Exchange Gain/(Loss)
Years ended 31 December 2007 2006 2005 (in millions of US$, except as otherwise indicated) Foreign exchange gains/(losses) ...... 67.2 14.1 (4.4) Mark-to-market results on foreign exchange collar ...... (35.7) – – Total ...... 31.5 14.1 (4.4)
In 2007, X5 made a net foreign exchange gain of US$31.5 million reflecting a gain of US$67.2 million resulting from the weakening of the U.S. dollar against the rouble, offset by losses amounting to US$35.7 million on mark-to-market results recognised on its foreign exchange collar. X5 and its subsidiaries use a foreign exchange collar with international banking institutions to mitigate foreign currency risks associated with the Syndicated Term Loan entered into in December 2007.
In 2006, X5 made a net foreign exchange gain of US$14.1 million reflecting a weakening of the U.S. dollar against the rouble and the effect on debt instruments compared to the net foreign exchange loss of US$4.4 million in 2005. Since the end of 2006, X5 has employed foreign exchange hedging strategies to minimise its foreign exchange risks. X5 did not employ any foreign exchange hedging strategies until fourth quarter of 2006 and rouble appreciation against the U.S. dollar in 2006 was therefore not, for the most part, offset by any hedge.
X5’s net foreign exchange gain as a percentage of sales was 0.6% in 2007 and 0.5% in 2006.
The net foreign exchange loss of US$4.4 million in 2005 was due to a strengthening of the Euro in that year and the consequential effect on the Euro portion of a syndicated loan under which X5 had outstanding borrowings at that time.
Profit Before Tax For the reasons set out above, profit before tax for 2007, 2006 and 2005 was US$242.7 million, US$120.3 million and US$38.1 million, respectively.
Income Tax Expense
Years ended 31 December 2007 2006 2005 (in millions of US$) Current income tax charge ...... 120.8 63.7 7.1 Deferred income tax (benefit)/charge ...... (21.9) (27.6) 2.0 Income tax charge for the year ...... 98.9 36.1 9.1
Total income tax charge increased by US$62.8 million to US$98.9 million in 2007 and by US$27.0 million to US$36.1 million in 2006 from US$9.1 million in 2005.
The effective income tax rate for 2007 was 40.8%, compared to an effective tax rate of 30.0% in 2006 and 23.8% in 2005. The sustained increase in the effective income tax rate was due primarily to an increase in X5’s non-deductible expenses from US$7.0 million in 2005 to US$16.6 million in 2006 to US$51.9 million in 2007. Non-deductible expenses primarily include inventory shrinkage expenses, unrecognised tax losses carried forward and share-based payment expenses.
In 2007, X5 recorded additional provisions and liabilities for tax uncertainties of US$15.6 million in respect of acquisitions made in that year and US$4.3 million as a result of translation movements, resulting in total provisions as at 31 December 2007 of US$75.7 million. In 2006, X5 recorded provisions and liabilities for tax uncertainties of US$55.8 million, including a US$40.0 million increase in respect of acquisitions made in that year and additional liabilities of US$7.8 million. In 2005, X5 recorded provisions and liabilities for tax uncertainties of US$8.0 million.
49 Expenses by Nature X5 does not present a breakdown of expenses within its cost of sales and selling, general and administrative expenses. The following table therefore sets out expenses by nature, including both cost of sales and selling, general and administrative expenses, for the years ended 31 December 2007, 2006 and 2005.
Years ended 31 December 2007 2006 2005 %of %of %of revenue US$ revenue US$ revenue US$ (in millions of US$, except where indicated as percentages) Cost of product(1) ...... 72.3% (3,846.3) 71.6% (2,007.5) 73.8% (749.2) Staff costs ...... 10.4% (556.2) 10.8% (302.5) 10.3% (105.2) Operating lease expenses ...... 3.5% (184.6) 3.8% (107.2) 4.0% (40.7) Other store costs(1) ...... 1.9% (99.1) 1.8% (49.1) 2.1% (21.0) Depreciation and amortisation ...... 2.7% (142.4) 2.8% (79.1) 2.4% (24.1) Utilities ...... 1.4% (78.1) 1.1% (31.0) 1.3% (13.2) Other ...... 2.7% (144.8) 3.4% (96.1) 2.0% (20.1) Total ...... 94.9% (5,051.5) 95.3% (2,672.5) 95.9% (973.5)
(1) Includes amounts reclassified to conform to the presentation adopted in the X5 Consolidated Financial Statements for a subsequent year or years. See “Presentation of Financial and Other Information – Reclassifications”.
Cost of product increased as a percentage of revenue to 72.3% in the year ended 31 December 2007 from 71.6% in the year ended 31 December 2006 and decreased from 73.8% in the year ended 31 December 2005 to 71.6% in the year ended 31 December 2005.
Staff costs increased to US$556.2 million in 2007 from US$302.5 million in 2006 and US$105.2 million in 2005. As a proportion of revenue, staff costs were 10.4% in 2007, 10.8% in 2006 and 10.3% in 2005. The decrease in staff costs as a percentage of revenue was a result of the significant increases in revenue in 2006 and 2007, which offset the wage inflation and extensive hiring of staff for new store openings. The increase in staff costs in 2007 and 2006, in absolute terms, was a result of the increase in the number of staff required in new stores; in particular, the number of stores grew by more than five times from 31 December 2005 to 31 December 2006, mainly due to the acquisition of Pyaterochka. In addition, X5 recorded an expense of US$27.7 million in 2006 associated with the Pyaterochka ESOP and US$47.7 million in 2007 associated with the X5 ESOP.
Operating lease expenses as a percentage of revenue decreased to 3.5% in 2007 from 3.8% in 2006 and 4.0% in 2005. Operating lease expenses in 2007, 2006 and 2005 included US$176.1 million, US$105.8 million and US$39.3 million of minimum lease payments and contingent rents of US$8.5, US$1.4 million and US$1.4 million, respectively. This represented an increase of 66.4% and 169.2% in minimum lease payments between 2006 and 2007 and 2005 and 2006, respectively, and a significant increase in contingent rents between 2006 and 2007.
Depreciation and amortisation as a percentage of revenue decreased from 2.8% in 2006 to 2.7% in 2007 and increased from 2.4% in 2005 to 2.8% in 2006. The decrease in 2007 was due to the absolute increase in depreciation and amortisation as a result of X5’s aggressive expansion in number of stores and distribution centres in 2007 more than offset by the significant growth in revenue. The increase in 2006 was primarily due to the revaluation of Pyaterochka and Mercado assets.
Other expenses primarily included third party advisors (such as lawyers, accountants and consultants), advertising costs, taxes (other than income tax), third party transportation costs, bank charges and other overhead costs. As a percentage of revenue, other expenses decreased to 2.7% in 2007 from 3.4% in 2006 and increased from 2.0% in 2005 to 3.4% in 2006. The decrease in 2007 as a percentage of revenue was due to the significant increase in the revenue of X5 in 2007, together with the greater cost savings from integrating Pyaterochka into X5. The increase in 2006 reflected the costs associated with the integration of Pyaterochka into X5.
Liquidity and Capital Resources X5’s liquidity needs arise principally from the need to finance its existing operations, as well as the acquisition, construction and opening of stores. In the period under review, X5 has met all of its liquidity requirements out of net cash provided by operating activities and from bank debt and bond issuances.
50 X5 expects that the proceeds from this Offering will be used primarily to finance its acquisition of the Karusel hypermarkets (see “Business – History and Development – Recent Acquisitions and Proposed Acquisition of Formata” for more information on the Karusel Option). X5 expects that the total costs associated with the rebranding, restyling and integrating of Karusel hypermarkets in 2008 and 2009 will be approximately US$150.0 million. In addition, X5 plans to spend between approximately US$1,200.0 million and US$1,400.0 million on capital expenditure in 2008 (exclusive of amounts spent on the acquisition, rebranding, restyling and integration of Karusel hypermarkets). In order to finance planned capital expenditures in 2008, X5 intends to use the net cash generated by its operating activities as well as incur additional, but as yet uncommited, borrowings in the form of short or long term debt, which could be significant in amount. Approximately 30% to 40% of X5’s capital expenditure is discretionary. If X5 was unable to secure further loans or other alternative sources of funding, it could reduce the amount and/or alter the composition of its planned capital expenditures. At 31 December 2007, X5’s commitments for capital expenditure amounted to US$132.0 million.
X5 maintains a negative working capital position, consistent with other companies in the retail industry because of its ability to negotiate supplier credit periods that are significantly higher than its inventory turnover. At 31 December 2007 the negative working capital was US$690.8 million. Credit lines cover any temporary deficit and are refinanced when required. The balance on undrawn credit lines at 31 December 2007 was US$331.0 million.
Cash Flows The following table summarises the statement of cash flows for the years ended 31 December 2007, 2006 and 2005.
Years ended 31 December 2007 2006 2005 (in millions of US$) Net cash from operating activities ...... 427.5 316.9 40.2 Net cash used in investing activities ...... (898.8) (40.9) (167.5) Net cash from/(used in) financing activities ...... 470.0 (138.2) 105.0 Effect of exchange rate changes on cash ...... 12.8 0.2 (0.3) Net increase/(decrease) in cash ...... 11.5 138.0 (22.6)
Net Cash Provided by Operating Activities Net cash provided by operating activities for the year ended 31 December 2007 increased by US$110.6 million or by 34.9% to US$427.5 million compared to US$316.9 million for the year ended 31 December 2006. Significant increases in profits resulted in an increased cash flow from operating activities. Net cash provided by operating activities for the year ended 31 December 2007 was derived from profit before tax of US$242.7 million, positive adjustments for non-cash items of US$248.6 million, positive adjustments arising from changes in working capital of US$139.8 million and net cash outflows of US$203.6 million relating primarily to income tax and interest. Net cash generated from operations before adjusting for interest paid and received and income tax paid was US$631.1 million in 2007, compared to US$426.1 million in 2006.
Net cash provided by operating activities for the year ended 31 December 2006 increased by US$276.7 million or by 688.3% to US$316.9 million compared to US$40.2 million for the year ended 31 December 2005. The acquisition of Pyaterochka in 2006 significantly increased profits of X5 in 2006, contributing to an increased cashflow from operating activities. Net cash provided by operating activities for the year ended 31 December 2006 was derived from profit before tax of US$120.3 million, positive adjustments for non-cash items of US$156.2 million, positive adjustments arising from changes in working capital of US$149.7 million and net cash outflows of US$109.2 million relating primarily to income tax and interest. Net cash generated from operations before the adjustment for interest paid and received and income tax paid was US$426.1 million in 2006, compared to US$59.9 million in 2005.
Net Cash Used In Investing Activities Net cash used in investing activities for the year ended 31 December 2007 was US$898.8 million compared to cash used in investing activities of US$40.9 million in 2006. This increase in the cash used in investing activities in 2007 resulted, in part, from the cash used to finance certain acquisitions and for purchases of
51 property, plant and equipment relating to the construction of new stores and refurbishment of acquired stores in 2007. Acquisition of subsidiaries, net of cash acquired, cost US$211.4 million in cash, attributable to a net cash outflow of US$3.2 million, US$92.3 million, US$59.0 million and US$56.9 million arising from the acquisitions of certain stores in Chelyabinsk, the Korzinka retail chain, the Strana Gerkulesia retail chain and various other companies, respectively. US$620.2 million was used for purchases of property, plant and equipment in 2007.
Net cash used in investing activities for the year ended 31 December 2006 was US$40.9 million compared to US$167.5 million cash used in investing activities in 2005. This decrease in the cash used in investing activities in 2006 resulted from the cash inflow from certain acquisitions made by X5 in 2006. Acquisitions of subsidiaries provided US$227.9 million in cash, attributable to cash and cash equivalents of US$327.5 million in Pyaterochka (US$300.0 million of which was distributed to certain shareholders as noted above) and US$1.5 million in Mercado, offset by a payment of US$101.1 million paid for the acquisition for Mercado. US$250.7 million and US$141.6 million was used for purchases of property, plant and equipment in 2006 and 2005, respectively.
Net Cash From/(Used In) Financing Activities Net cash provided by financing activities was US$470.0 million in the year ended 31 December 2007 compared to US$138.2 million used in financing activities in 2006. In 2007, proceeds of US$583.9 million were obtained from short term loans and US$1,458.3 million was obtained from long term loans. Partially offsetting this inflow of cash in 2007 were repayments of US$396.0 million and US$1,167.3 million toward short term and long term loans, respectively.
Net cash used in financing activities was US$138.2 million in the year ended 31 December 2006 compared to US$105.0 million obtained from financing activities in 2005. In 2006, US$207.2 million was used to repay short term loans, US$225.2 million was used to repay long term loans and US$300.0 million was paid as a distribution to certain shareholders. The distribution to shareholders of US$300.0 million reflected the accounting treatment of the cash consideration paid by Pyaterochka Holding N.V. for Perekrestok Holdings Limited (see note 8 in the X5 Consolidated Financial Statements for the year ended 31 December 2006). Partially offsetting this outflow in 2006 were proceeds of US$204.1 million and US$470.2 million from short term and long term loans, respectively.
Borrowings The following table sets out X5’s borrowings as at the dates indicated:
At 31 December 2007 2006 2005 (in millions of US$, except as otherwise indicated) Short term borrowings ...... 253.7 218.0 52.6 Long term borrowings ...... 1,464.7 949.1 144.1 Total borrowings ...... 1,718.4 1,167.1 196.7
X5 increased its total borrowings by US$551.3 million, or 47.2%, from US$1,167.1 million at 31 December 2006 to US$1,718.4 million at 31 December 2007. This increased indebtedness resulted, to a large extent, from the need to finance capital expenditure in 2007 and insufficiency of X5’s own operating cashflows. In 2007, X5’s proceeds from borrowings net of repayments were US$478.9 million. The proceeds of these net borrowings were used to finance development and provide working capital.
X5 increased its total borrowings by US$970.4 million, or 493.3%, from US$196.7 million at 31 December 2005 to US$1,167.1 million at 31 December 2006. This increased indebtedness arose, in part, from the acquisition of Pyaterochka Holding N.V. and the Mercado group which, at the time of their acquisitions, had total borrowings of US$594.5 million and US$103.1 million, respectively. In addition, in 2006, the proceeds from borrowings net of repayments were US$241.9 million. The proceeds of these net borrowings were used to finance development and provide working capital.
52 The following table sets out certain details relating to borrowings (see notes 20 and 19 of the X5 Consolidated Financial Statements for the years ended 31 December 2007 and 2006, respectively and note 14 of the 2005 Perekrestok Consolidated Financial Statements):
At 31 December Currency Interest rate, % p.a. 2007 2006 2005 (in millions of US$) Short term Current portion of Perekrestok Bonds ...... RR 8.15% 0.1 56.7 51.7 Current portion of 2005 USD syndicated loan ...... USD LIBOR + 2.25%/2.5% – 112.0 – Alfa-Bank ...... USD 9.88%/6.9% -7.52% 2.6 16.4 – Commerzbank ...... USD LIBOR + 1.4% 90.5 – – Uralsib Bank ...... USD 6.95% – 12.8 – Uralsib Bank ...... USD 7.40% – 0.8 Raiffeisenbank ...... USD MOSPRIME(1) + 1.20% 16.0 – – Raiffeisenbank overdraft ...... RR 7.19% - 7.34% – 6.3 – Sberbank ...... RR 11.00% – 11.4 – Sberbank ...... RR 12.00% 1.2 – – Sberbank ...... RR 12.20% 1.8 – – AKB BIN Bank ...... RR 16.00% – 2.3 – Barclays Bank Plc ...... RR 6.50% 122.2 – – Amsterdam Trade Bank N.V...... USD LIBOR + 6% 14.7 – – Lipeczcombank ...... RR 13.00% 2.6 – – Other ...... RR – 2.0 0.1 0.1 253.7 218.0 52.6
Long term 2007 USD syndicated loan ...... USD LIBOR + 2.25%/2.0% 1,083.2 – – 2006 USD syndicated loan ...... USD LIBOR + 2.25%/2.5% – 788.0 – Pyaterochka Finance Bonds – 1st issue(2) ...... RR 11.45% 3.0 60.7 – Pyaterochka Finance Bonds – 2nd issue(2) ...... RR 9.30% 12.3 121.6 – Perekrestok Bonds(3) ...... RR 8.15% – 56.7 51.7 X5 Finance Bonds(4) ...... RR 7.60% 364.8 – – Bank Petrocommerz ...... RR 11.00% – 90.9 – 2005 USD syndicated Loan (US$ part) ...... USD LIBOR + 3% – – 70.2 2005 Euro syndicated loan (Euro part) ...... Euro EURLIBOR + 3% – – 73.9 Sberbank ...... USD 11.50% 1.4 – – Other ...... RR 0.01 – – Less: Current portion of 2006 USD syndicated loan ...... USD LIBOR + 2.25%/2.0% – (112.0) – Current portion of Perekrestok Bonds ...... RR 8.15% – (56.7) (51.7) 1,464.7 949.1 144.1 Total Borrowings ...... 1,718.4 1,167.1 196.7
(1) MOSPRIME is the Moscow Prime Offered Rate. (2) The Pyaterochka Finance Bonds were issued by Pyaterochka Finance LLC, a wholly owned subsidiary of X5. (3) The Perekrestok Bonds were issued by ZAO TH Perekrestok, a wholly owned subsidiary of X5. (4) The X5 Bonds were issued by X5 Finance LLC, a wholly owned subsidiary of X5.
As at 31 December 2007, approximately 64% of X5’s borrowings were secured and 70% were U.S. dollar denominated loans. See “Material Contracts – Syndicated Term Loan” for further information on the security given on borrowings.
In December 2007, X5 entered into the Syndicated Term Loan with a consortium of banks. The proceeds of the facility were used to re-finance X5’s one year US$1,000.0 million facility signed in June 2007 and for general corporate purposes. At 31 December 2007, US$1,100.0 million was outstanding on the facility. No amounts have been repaid by X5 since that time. See “Material Contracts – Syndicated Term Loan”.
Capital Expenditures Capital expenditures include cash outflow used in the purchases of property, plant and equipment, intangible assets and investment property.
53 X5’s total capital expenditures amounted to US$631.4 million, US$263.2 million and US$148.1 million in the years ended 31 December 2007, 2006 and 2005, respectively. X5’s capital expenditures during these periods have been largely driven by its expansion strategy and related primarily to purchase of property, plant and equipment, construction of new stores and store launch costs. The devaluation of the U.S. dollar against the Russian rouble and inflation of real estate prices and construction prices also contributed to the 139.9% increase in capital expenditure in 2007.
As at 31 December 2007, X5 had contracted capital expenditures of US$132.0 million (net of VAT), an increase of 62.2% from US$81.4 million as at 31 December 2006.
In 2008, X5 plans to spend between approximately US$1,200.0 million and US$1,400.0 million on capital expenditure (exclusive of any amounts spent on the acquisition, rebranding, restyling and integration of the Karusel hypermarkets). Approximately 85% of this amount is expected to be spent on X5’s organic growth, including the acquisition of land for new stores, building of new stores and acquisition of small retail stores or chains, and the remainder is expected to be spent on logistics, IT, maintenance of current stores and X5’s other capital needs.
Contractual Obligations and Commitments X5 had contractual obligations under certain borrowings, finance leases and operating leases in the period under review.
The amount of X5’s contractual obligations at 31 December 2007 is set out below:
As at 31 December 2007 During 1 year 1 year to 5 years After 5 years (in millions of US$) Borrowings ...... 374.0 1,665.7 – Trade payables ...... 968.5 – – Gross finance lease liabilities ...... 2.1 1.2 – Operating leases ...... 99.8 276.7 196.9 Capital expenditure ...... 132.0 – – Other finance liabilities ...... 144.8 – – Total ...... 1,721.2 1,943.6 196.9
Contingencies Russian tax, currency and customs legislation is subject to varying interpretations, and changes, which can occur frequently. Management’s interpretation of such legislation as applied to the transactions and activity of X5 may be challenged by the relevant regional and federal authorities. Recent events within the Russian Federation suggest that the tax authorities may be taking a more assertive position in their interpretation of the legislation and assessments, and it is possible that transactions and activities that have not been challenged in the past may be challenged as not having been in compliance with Russian tax laws applicable at the relevant time. In particular, the Supreme Arbitration Court issued guidance to lower courts on reviewing tax cases providing a systematic roadmap for anti-avoidance claims, and it is possible that this will significantly increase the level and frequency of tax authorities scrutiny. As a result, significant additional taxes, penalties and interest may be assessed. Fiscal periods remain open to review by the authorities in respect of taxes for three calendar years preceding the year of review. Under certain circumstances reviews may cover longer periods.
Russian transfer pricing legislation introduced on 1 January 1999 provides the possibility for tax authorities to make transfer pricing adjustments and impose additional tax liabilities in respect of all controllable transactions, provided that the transaction price differs from the market price by more than 20%. Controllable transactions include transactions with interdependent parties, as determined under the Russian Tax Code, and all cross-border transactions (irrespective of whether performed between related or unrelated parties), transactions where the price applied by a taxpayer differs by more than 20% from the price applied in similar transactions by the same taxpayer within a short period of time, and barter transactions. There is no formal guidance as to how these rules should be applied in practice. The arbitration court practice in this respect is contradictory.
Tax liabilities arising from inter-company transactions are determined using actual transaction prices. It is possible with the evolution of the interpretation of the transfer pricing rules in the Russian Federation and the changes in the approach of the Russian tax authorities, that such transfer prices could potentially be challenged in
54 the future. Given the brief nature of the current Russian transfer pricing rules, the impact of any such challenge cannot be reliably estimated; however, it may be significant to the financial condition and operations of the entity.
Russian tax legislation does not provide definitive guidance in many areas. From time to time, X5 adopts interpretations of such uncertain areas that reduce the overall tax rate of X5. As noted above, such tax positions may come under heightened scrutiny as a result of recent developments in administrative and court practices; the impact of any challenge by the tax authorities cannot be reliably estimated; however, it may be significant to the financial condition and operations of the entity.
Management regularly reviews X5’s taxation compliance with applicable legislation, laws and decrees and current interpretations published by the authorities in the jurisdictions in which X5 has operations. Furthermore, management regularly assesses the potential financial exposure relating to tax contingencies for which the three years tax inspection right has expired but which, under certain circumstances, may be challenged by the regulatory bodies. From time to time potential exposures and contingencies are identified and at any point in time a number of open matters may exist. Management estimates that possible exposure in relation to profit tax and other non-profit taxes such as intercompany transactions VAT and employee related taxes that are more than remote, but for which no liability is required to be recognised under IFRS, could be several times the additional accrued liabilities and provisions reflected on the balance sheet at that date (and potentially in excess of X5’s profit before tax for the year). This estimation is provided for the IFRS requirement for disclosure of possible taxes and should not be considered as an estimate of X5’s future tax liability. At the same time management has recorded liabilities for income taxes and provisions for taxes other than income taxes in the amount of US$75.7 million at 31 December 2007 (31 December 2006: US$55.8 million) as their best estimate of X5’s liability related to tax uncertainties as follows:
In millions of US$ Balance at 1 January 2006 ...... 8.0 Increases due to acquisitions during the year recorded as part of the purchase price allocation (see Note 8 of the X5 Consolidated Financial Statements for the year ended 31 December 2007) ...... 40.0 Additional liabilities recorded during the year ...... 7.8 Reversal of prior year – accruals ...... – Balance at 31 December 2006 ...... 55.8 Increases due to acquisitions during the year recorded as part of the purchase price allocation (see Note 8 of the X5 Consolidated Financial Statements for the year ended 31 December 2007) ...... 15.6 Translation movement ...... 4.3 Balance at 31 December 2007 ...... 75.7
See “Risk Factors – Risks Relating to X5’s Business and Industry – Challenges to X5’s tax position by the Russian tax authorities could have a material adverse effect”.
Recent Results In the first quarter of 2008, X5 reported 61.2% year-on-year growth in net retail sales to US$1,775.1 million and 29% growth in like-for-like sales. 62 new stores were opened on a net basis, adding 30,087 square metres of net selling space. Net retail sales by format in the first quarter of 2008 was generally in line with results for 2007.
At 31 March 2008, X5 operated 930 stores, consisting of 731 soft discount stores, 183 supermarkets, 15 compact hypermarkets and one full size hypermarket, with total net selling space of 639,300 square metres. At 31 March 2008, X5 franchisees also operated 711 stores across Russia and Kazakhstan, including 8 Perekrestok and 703 Pyaterochka stores.
55 The following table sets out the increase in net selling space and number of stores in the first quarter of 2008:
As at 31 December 31 March Net Added in Year-on year 2007 2008 Q1 2008 Change Selling Space (in square metres) Hypermarkets ...... 59,963 64,111 4,148 7% Supermarkets ...... 191,730 196,102 4,372 2% Soft Discounters ...... 357,517 379,084 21,567 6% Total ...... 609,210 639,297 30,087 5% Number of Stores Hypermarkets ...... 15 16 1 7% Supermarkets ...... 179 183 4 2% Soft Discounters ...... 674 731 57 8% Total ...... 868 930 62 7%
The following table sets out X5’s like-for-like sales, traffic and average basket size by region and format for the first quarter of 2008:
By Regions For the quarter ended 31 March 2008 Like-for-Like Like-for-Like Like-for-Like Average Retail Sales Traffic Basket Size Moscow Hypermarkets ...... 27% 9% 18% Supermarkets ...... 39% 20% 19% Soft Discounters ...... 34% 9% 26% Total ...... 36% 13% 23% St. Petersburg Hypermarkets ...... 0% 0% 0% Supermarkets ...... 32% 19% 13% Soft Discounters ...... 15% 1% 14% Total ...... 17% 3% 14% Other regions Hypermarkets ...... 30% 19% 11% Supermarkets ...... 21% 11% 10% Soft Discounters ...... 48% 21% 27% Total ...... 28% 16% 13% X5 Total by Format Hypermarkets ...... 29% 15% 13% Supermarkets ...... 34% 17% 17% Soft Discounters ...... 26% 6% 20% Total ...... 29% 10% 19%
In the first quarter of 2008, X5 experienced a decline in margins, primarily due to wage and rent inflation, together with promotional activities and discounted pricing.
Quantitative and Qualitative Disclosure about Market Risk Credit Risk Financial assets, which are potentially subject to credit risk, consist principally of cash and cash equivalents held in banks, trade and other receivables (see notes 10 and 16 of the X5 Consolidated Financial Statements for the year ended 31 December 2007). Due to the nature of its main activities (retail sales to individual customers), X5 has no significant concentration of credit risk. Cash is placed in financial institutions which are considered at
56 the time of deposit to have minimal risk of default. X5 has policies in place to ensure that in case of credit sales of products and services to wholesales customers only those with an appropriate credit history are selected. Although collection of receivables could be influenced by economic factors, management believes that there is no significant risk of loss to X5 beyond the provision already recorded. In accordance with X5 treasury policies and exposure management practices, counterparty credit exposure limits are continually monitored and no individual exposure is considered significant.
Foreign Exchange Risk X5 is exposed to foreign exchange risk arising from various currency exposures, primarily with respect to the US dollar. X5 has a substantial amount of foreign currency denominated long-term borrowings, and is thus exposed to foreign exchange risk (see note 20 of the X5 Consolidated Financial Statements for the year ended 31 December 2007). Therefore, X5 Treasury’s risk management policy is primarily to hedge anticipated cash outflows associated with borrowings in U.S. dollars. In 2007, X5 entered into foreign exchange collars with international banking institutions to hedge foreign currency risks associated with syndicated loans (see note 20 of the X5 Consolidated Financial Statements for the year ended 31 December 2007); however, X5 was not party to any such instruments as at 31 December 2007. In 2007, the loss incurred by X5 on foreign exchange collars amounted to US$35.7 million (see note 28 of the X5 Consolidated Financial Statements for the year ended 31 December 2007). The syndicated loan for the principal amount of US$1,100.0 million entered into in December 2007 was hedged against currency risk in February 2008 (see note 32 of the X5 Consolidated Financial Statements for the year ended 31 December 2007).
At 31 December 2007, if the Russian Rouble had weakened/strengthened by 5% against the U.S. dollar with all other variables held constant, post-tax profit for the year would have been US$34.4 million (31 December 2006: US$18.1 million) lower/higher, mainly as a result of foreign exchange losses/gains on U.S. dollar denominated borrowings.
In February 2008, X5 entered into a hedging arrangement with an international banking institution to partially hedge its foreign exchange exposure in connection with its 3 year US$1,100.0 million facility agreement (see “Business – Material Contracts – Syndicated Term Loan”).
Interest Rate Risk As X5 has no significant interest-bearing assets, X5’s income and operating cash flows are substantially independent of changes in market interest rates.
X5’s interest rate risk arises from borrowings. Borrowings issued at variable rates expose X5 to cash flow interest rate risk. It is X5’s policy to manage cash flow interest rate risk by using floating-to-fixed interest rate swaps. Under the interest rate swaps, X5 agrees with other parties to exchange, at specified intervals (primarily quarterly), the difference between fixed contract rates and floating-rate interest amounts calculated by reference to the agreed notional amounts.
In 2007, X5 entered into an interest rate swap with international banking institutions to hedge the interest rate of loans that have a floating rate of interest. The effect of the swap on X5’s profit and loss in 2007 was insignificant. The new syndicated loan for US$1,100.0 was hedged against interest rate risk in February 2008 (see note 32 of the X5 Consolidated Financial Statements for the year ended 31 December 2007). However management did not formally designate the interest rate swaps as hedging instruments and did not apply hedge accounting.
As a result of using interest rate swaps, a change in market interest rates with all other variables held constant would not significantly affect post-tax profit of X5. At 31 December 2007, if LIBOR at that date had been 50 basis points lower/higher with all other variables held constant, post-tax profit for the year would have been US$1.4 million (31 December 2006: US$0.3 million) higher/lower.
Liquidity Risk Liquidity risk is defined as the risk that an entity will encounter difficulty in meeting obligations associated with financial liabilities. X5 is exposed to daily calls on its available cash resources. Liquidity risk is managed by the X5 Treasury.
X5 management monitors monthly rolling forecasts of the group’s cash flows. X5 manages liquidity requirements by the use of both short- and long-term projections and by maintaining the availability of funding from an adequate amount of committed credit facilities.
57 The following is an analysis of the contractual undiscounted cash flows payable under financial liabilities and derivative assets and liabilities as at the balance sheet date at foreign exchange rates on those dates:
Year ended 31 December 2007 During 1 year 1 year to 3 years 3 years to 5 years After 5 years In millions of U.S. dollars Borrowings ...... 374.0 1,665.6 – – Trade payables ...... 968.5 – – – Gross finance lease liabilities ...... 2.2 1.2 – – Other finance liabilities ...... 144.8 – – – Total ...... 1,489.5 1,666.8 ––
Year ended 31 December 2006 During 1 year 1 year to 3 years 3 years to 5 years After 5 years In millions of U.S. dollars Borrowings ...... 315.2 1,057.7 – – Trade payables ...... 552.1 – – – Gross finance lease liabilities ...... 2.3 2.9 – – Other finance liabilities ...... 113.7 – – – Total ...... 983.3 1,060.6 ––
At 31 December 2007, X5 had negative working capital of US$690.8 million (31 December 2006: US$436.5 million) including short-term borrowings of US$253.7 million (31 December 2006: US$218.0 million).
At 31 December 2007, X5 had available credit lines banks of US$331.0 million (31 December 2006: nil).
Recent Volatility in Global Markets Since the second half of 2007, there has been a sharp rise in foreclosures in the U.S. subprime mortgage market. The effects have spread beyond the U.S. housing market as global investors have re-evaluated their exposure to risks, resulting in increased volatility and lower liquidity in the fixed income, equity and derivative markets. However, management assess that X5’s financial position is not currently affected by the consequences of deterioration in the liquidity of the financial markets and their increased volatility.
Critical Accounting policies, Estimates and Judgements in Applying Accounting Policies X5 makes estimates and assumptions that affect the reported amounts of assets and liabilities within the next financial year. Estimates and judgements are continually evaluated and are based on management’s experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. Management also makes certain judgements, apart from those involving estimations, in the process of applying accounting policies. Judgements that have the most significant effect on the amounts recognised in the consolidated financial statements and estimates that can cause a significant adjustment to the carrying amount of assets and liabilities within the next financial year include:
Tax Legislation Russian tax, currency and customs legislation is subject to varying interpretations (see “Contingencies” above and note 35 to the X5 Consolidated Financial Statements for the year ended 31 December 2007).
Property, Plant and Equipment X5’s management determines the estimated useful lives and related depreciation charges for its plant and equipment (see note 11 of the X5 Consolidated Financial Statements for the year ended 31 December 2007). This estimate is based on projected product lifecycles and technical requirements. X5’s management will increase the depreciation charge where useful lives are less than previously estimated lives, or it will write-off or write-down technically obsolete or non-strategic assets that have been abandoned or reclassified as held for sale.
X5 periodically assesses whether there is any indication that property, plant and equipment may be impaired. In the current period no such indications exist and therefore no assets impairment testing was performed. In the opposite case, X5 estimates the recoverable amount of the asset or cash generating unit and if it is less than the carrying amount of an asset or cash generating unit an impairment loss is recognised in the income statement.
58 Fair Value of Lease Rights X5’s management determines the fair value of lease rights acquired in business combinations. The assessment of the fair value of lease rights is based on the estimate of the market rates of the lease prepared by an independent valuation specialist (see note 14 of the X5 Consolidated Financial Statements for the year ended 31 December 2007).
Inventory Provisions X5 provides for estimated inventory shrinkage on the basis of a historical shrinkage as a percentage of cost of sales (see note 15 of the X5 Consolidated Financial Statements for the year ended 31 December 2007). This provision is adjusted at the end of each reporting period to reflect the historical trend of the actual physical inventory count results.
Provision for Impairment of Trade and Other Receivables X5 determines an allowance for doubtful accounts receivable at the end of the reporting period (see note 16 of the X5 Consolidated Financial Statements for the year ended 31 December 2007). In estimating an allowance for uncollectible accounts receivable, X5 takes into account the historical collectibility of the outstanding accounts receivable balances supplemented by the judgement of management to exclude the impact of current conditions that did not affect past periods and to remove the effects of past conditions that do not exist currently.
Classification of VAT The terms of recovery of VAT depends on the registration of certain property, plant and equipment (see note 17 of the X5 Consolidated Financial Statements for the year ended 31 December 2007).
Fair Value of Franchise Agreements X5’s management determines the fair value of franchise agreements acquired in business combinations. The assessment of the fair value of franchise agreements is based on the income method using discounted royalty payments during the period of the agreements (see note 14 of the X5 Consolidated Financial Statements for the year ended 31 December 2007).
Fair Value of Brand and Private Labels X5’s management determines the fair value of brand and private labels acquired in business combinations. The assessment of the fair value of a brand is based on the income approach using the relief-from-royalty method. The assessment of fair value of private labels is based on either the income method using discounted annual savings for the remaining useful life of the labels or the cost method (see note 14 of the X5 Consolidated Financial Statements for the year ended 31 December 2007).
Estimated Impairment of Goodwill X5 tests goodwill for impairment at least annually. The recoverable amounts of cash-generating units have been determined based on the higher of fair value less costs to sell or value in use.
Adoption of New and Revised Standards and Interpretations Certain new standards and interpretations became effective for X5 from 1 January 2007. Unless stated below, these new standards and interpretations have not resulted in any significant changes to the X5 Consolidated Financial Statements: IFRS 7 Financial Instruments: Disclosures and a complementary Amendment to IAS 1 Presentation of Financial Statements – Capital Disclosures). IFRS introduces new disclosures to improve the information about financial instruments. Specifically, it requires disclosure of qualitative and quantitative information about exposure to risks arising from financial instruments, including specified minimum disclosures about credit risk, liquidity risk and market risk including sensitivity analysis to market risk. It replaces some of the requirements in IAS 32, Financial Instruments: Disclosure and Presentation. X5 added required disclosures to comply with IFRS 7 in the X5 Consolidated Financial Statements for the year ended 31 December 2007.
59 IFRIC 7, Applying the Restatement Approach under IAS 29 (effective from 1 January 2007). The Interpretation clarifies the application of IAS 29 in the reporting period in which hyperinflation is first identified. It states that IAS 29 should initially be applied as if the economy has always been hyperinflationary. It further clarifies calculation of deferred income taxes in the opening balance sheet restated for hyperinflation under with IAS 29.
IFRIC 8, Scope of IFRS 2 (effective from 1 January 2007). The interpretation states that IFRS 2 also applies to transactions in which the entity receives unidentifiable goods or services and that such items should be measured as the difference between the fair value of the share-based payment and the fair value of any identifiable goods or services received (or to be received).
IFRIC 9, Reassessment of Embedded Derivatives (effective for periods beginning on or after 1 June 2006 that is from 1 January 2007). The Interpretation clarifies that an entity should assess whether an embedded derivative should be accounted for separately from the host contract when the entity first becomes party to the contact.
IFRIC 10 “Financial Reporting and Impairment” (effective for periods beginning on or after 1 November 2006, that is from 1 January 2007). The interpretation clarifies that an entity should not reverse an impairment loss recognised in previous periods in respect of goodwill or an investment in a financial asset carried at cost. This interpretation is applicable for interim periods.
New Accounting Pronouncements Certain new standards and interpretations have been published that are mandatory for X5’s accounting periods beginning on or after 1 January 2008 or later periods and which X5 has not early adopted: IFRS 8, Operating Segments (effective for annual periods beginning on or after 1 January 2009). The standard applies to entities whose debt or equity instruments are traded in a public market or that file, or are in the process of filing, their financial statements with a regulatory organisation for the purpose of issuing any class of instruments in a public market. IFRS 8 requires an entity to report financial and descriptive information about its operating segments and specifies how an entity should report such information. X5 is currently assessing what impact the standard will have on segment disclosures in the consolidated financial statements.
Puttable financial instruments and obligations arising on liquidation – IAS 32 and IAS 1 Amendment (effective from 1 January 2009). The amendment requires classification as equity of some financial instruments that meet the definition of a financial liability. X5 does not expect the amendment to affect its consolidated financial statements.
IAS 23, Borrowing Costs (revised March 2007; effective for annual periods beginning on or after 1 January 2009). The revised IAS 23 was issued in March 2007. The main change to IAS 23 is the removal of the option of immediately recognising as an expense borrowing costs that relate to assets that take a substantial period of time to get ready for use or sale. An entity is, therefore, required to capitalise such borrowing costs as part of the cost of the asset. The revised standard applies prospectively to borrowing costs relating to qualifying assets for which the commencement date for capitalisation is on or after 1 January 2009. X5 is currently assessing the impact of the amended standard on its financial statements.
IAS 1, Presentation of Financial Statements (revised September 2007; effective for annual periods beginning on or after 1 January 2009). The main change in IAS 1 is the replacement of the income statement by a statement of comprehensive income which will also include all non-owner changes in equity, such as the revaluation of available-for-sale financial assets. Alternatively, entities will be allowed to present two statements: a separate income statement and a statement of comprehensive income. The revised IAS 1 also introduces a requirement to present a statement of financial position (balance sheet) at the beginning of the earliest comparative period whenever the entity restates comparatives due to reclassifications, changes in accounting policies, or corrections of errors. X5 expects the revised IAS 1 to affect the presentation of its financial statements but to have no impact on the recognition or measurement of specific transactions and balances.
IAS 27, Consolidated and Separate Financial Statements (revised January 2008; effective for annual periods beginning on or after 1 July 2009). The revised IAS 27 will require an entity to attribute total comprehensive income to the owners of the parent and to the non-controlling interests (previously “minority interests”) even if this results in the non-controlling interests having a deficit balance (the current standard requires the excess losses to be allocated to the owners of the parent in most cases). The revised standard specifies that changes in a parent’s ownership interest in a subsidiary that do not result in the loss of control must
60 be accounted for as equity transactions. It also specifies how an entity should measure any gain or loss arising on the loss of control of a subsidiary. At the date when control is lost, any investment retained in the former subsidiary will have to be measured at its fair value. X5 is currently assessing the impact of the amended standard on its consolidated financial statements.
IFRS 3, Business Combinations (revised January 2008; effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after 1 July 2009). The revised IFRS 3 will allow entities to choose to measure non-controlling interests using the existing IFRS 3 method (proportionate share of the acquiree’s identifiable net assets) or on the same basis as U.S. GAAP (at fair value). The revised IFRS 3 is more detailed in providing guidance on the application of the purchase method to business combinations. The requirement to measure at fair value every asset and liability at each step in a step acquisition for the purposes of calculating a portion of goodwill has been removed. Instead, goodwill will be measured as the difference at acquisition date between the fair value of any investment in the business held before the acquisition, the consideration transferred and the net assets acquired. Acquisition-related costs will be accounted for separately from the business combination and therefore recognised as expenses rather than included in goodwill. An acquirer will have to recognise at the acquisition date a liability for any contingent purchase consideration. Changes in the value of that liability after the acquisition date will be recognised in accordance with other applicable IFRSs, as appropriate, rather than by adjusting goodwill. The revised IFRS 3 brings into its scope business combinations involving only mutual entities and business combinations achieved by contract alone. X5 is currently assessing the impact of the amended standard on its consolidated financial statements.
Vesting Conditions and Cancellations – Amendment to IFRS 2, Share-based Payment (issued in January 2008; effective for annual periods beginning on or after 1 January 2008). The amendment clarifies that only service conditions and performance conditions are vesting conditions. Other features of a share-based payment are not vesting conditions. The amendment specifies that all cancellations, whether by the entity or by other parties, should receive the same accounting treatment. X5 is currently assessing the impact of the amended standard on its consolidated financial statements.
IFRIC 13, ‘Customer loyalty programmes’ (issued in June 2007; effective for annual periods beginning on or after 1 July 2008). IFRIC 13 clarifies that where goods or services are sold together with a customer loyalty incentive (for example, loyalty points or free products), the arrangement is a multiple-element arrangement and the consideration receivable from the customer is allocated between the components of the arrangement using fair values. It is the policy of X5 to recognise deferred revenue on customer loyalty programme as a reduction of revenue, thus this interpretation will have no impact on consolidated financial statements.
Other new standards or interpretations. X5 has not early adopted the following other new standards or interpretations: • IFRIC 11, IFRS 2 – Group and Treasury Share Transactions (effective for annual periods beginning on or after 1 March 2007); • IFRIC 12, Service Concession Arrangements (effective for annual periods beginning on or after 1 January 2008); • IFRIC 14, IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction (effective for annual periods beginning on or after 1 January 2008).
Unless otherwise described above, the new standards and interpretations are not expected to significantly affect X5’s consolidated financial statements.
All of the above new standards and interpretations are not yet adopted by the European Union, except for IFRS 8 and IFRIC 11.
61 FOOD RETAIL INDUSTRY
Russian Economy Russia recorded a nominal GDP for the year ended 31 December 2007 of US$1,297 billion. Nominal GDP growth of 22.7% and real GDP growth of 8.1% in Russia in 2007 were fuelled by high levels of oil and other commodity prices in the international markets, structural changes in the economy and a substantial increase of foreign direct investments. Growing GDP has resulted in increased real incomes nationwide and a relatively low unemployment rate, which, in turn, has led to increased demand for retail products.
The following table sets out various growth factors as well as unemployment rate and consumer price inflation for Russia for the years 2002 to 2007:
2002 2003 2004 2005 2006 2007 Real GDP growth (%) ...... 4.7 7.3 7.2 6.4 7.4 8.1 Private consumption growth (%) ...... 8.3 7.3 11.6 11.2 11.1 12.9 Government consumption growth (%) ...... 2.6 2.2 2.1 1.0 2.3 4.9 Industrial production growth (%) ...... 8.7 9.4 7.1 5.2 4.6 7.4 Gross fixed investment growth (%) ...... 2.8 12.8 12.6 10.6 17.5 20.8 Unemployment rate (%) ...... 8.1 8.6 8.2 7.6 7.3 6.1 Consumer price inflation (%) ...... 15.0 12.0 11.7 10.9 9.0 11.9 Source: Economist Intelligence Unit, Rosstat
The general growth experienced by the Russian economy in recent years has facilitated a progressive erosion of the market share held by traditional retail formats and corresponding increase in the market share held by modern retail formats. Traditional retail formats include open markets, grocers, kiosks and pavilions. Modern retail formats include discounters, supermarkets and hypermarkets. The increase in disposable income has led customers to look for a wider product assortment, contributing to the growth of modern retail formats in Russia.
Russian Demographics According to Rosstat, the Russian Federation had a population of 142.0 million as of 1 January 2008. Rosstat data shows that approximately 81.7% of the Russian population lived in the western part of the country, being five of the Russian Federation’s seven Federal Districts (the Central, North-Western, Urals, Volga and Southern Districts together, the “European part of Russia and the Urals”). Together, the European part of Russia and the Urals represent around one-third of Russia’s territory.
The following table sets out selected statistics of Russia’s seven Federal Districts for the year ended 31 December 2007:
Consumer Retail Spending Spending per per Food Month Month Retail Area Cities per per per Month % Share Population (‘000 above Capita Capita per Capita of Food Federal District(1) (m)(2) km)(3) 500,000 (US$) (US$) (US$) Retail Central ...... 37.2 650 6 452 327 146 34.4% Moscow ...... 10.5 1 1 920 636 289 19.1% Central excluding Moscow ...... 26.7 649 5 269 206 90 15.3% Volga ...... 30.2 1,037 12 274 207 94 18.0% South ...... 22.8 591 4 260 188 84 12.1% Siberia ...... 19.6 5,145 7 271 206 94 11.7% North-West ...... 13.5 1,687 1 347 244 108 9.2% St. Petersburg ...... 4.6 1 1 470 314 115 3.3% North West excluding St. Petersburg ...... 8.9 1,686 0 307 208 104 5.9% Urals ...... 12.2 1,819 3 394 298 136 10.5% Far East ...... 6.5 6169 2 316 210 102 4.2% Total for Russia ...... 142.0 17,098 35 339 247 111 100.0%
Source: Business Analytica, Rosstat
62 (1) The European part of Russia encompasses the Central, Volga, South and North-West regions. (2) Population as of 1 January 2008. (3) Area as of 1 January 2007.
Russian Retail Market The retail market comprises sales of various items, such as clothing, consumer electronics, furniture and food, which in the Russian Federation is the largest item in terms of turnover. Due to the general economic growth, increased disposable income and average monthly wages referred to above, the Russian retail market has enjoyed substantial growth. According to Rosstat, Russian consumer spending per capita per month amounted to US$578 in 2007 up from US$104 in 2000, implying a compound annual growth rate (“CAGR”) of 27.8%.
The following table details the growth of total Russian consumer spending for the period between 2000 and 2007:
CAGR 2000 2001 2002 2003 2004 2005 2006 2007 2000-2007 Russian consumer spending per capita per month (RR) ...... 2,921 3,908 4,929 6,155 7,601 9,555 11,873 14,785 26.1% Year-on-year growth ..... 35.2% 33.8% 26.1% 24.9% 23.5% 25.7% 24.3% 24.5% Russian consumer spending per capita per month ($) ...... 104 134 157 201 264 338 437 578 27.8% Year-on-year growth ..... 18.3% 29.0% 17.4% 27.5% 31.6% 28.0% 29.3% 32.4%
Source: Rosstat
The Russian retail market increased in size from US$84 billion in 2000 to US$421 billion in 2007, which equated to a CAGR of 25.8%. The following table details the growth of the Russian retail market for the period between 2000 and 2007:
CAGR 2000 2001 2002 2003 2004 2005 2006 2007 2000-2007 Russian retail market (RRbn) ...... 2,369 3,092 3,794 4,564 5,642 7,041 8,690 10,758 24.1% Year-on-year growth ...... 30.8% 30.5% 22.7% 20.3% 23.6% 24.8% 23.4% 23.8% Russian retail market ($bn) ...... 84 106 121 149 196 249 320 421 25.8% Year-on-year growth ...... 14.4% 25.8% 14.2% 22.9% 31.7% 27.1% 28.4% 31.6%
Source: Rosstat
According to Rosstat, the European part of Russia and the Urals accounted for approximately 84.7% of retail turnover in 2007, with the cities of Moscow and St. Petersburg representing approximately 23.1% of the total.
The below table sets out the percentage of national retail turnover in each District and in the cities of Moscow and St. Petersburg, for the periods indicated.
2004 2005 2006 2007 (in percentages) Moscow City ...... 24.9 22.9 21.1 19.0 Central District (excl. Moscow City) ...... 14.3 14.5 14.9 15.7 St. Petersburg ...... 3.6 3.5 4.0 4.1 North-Western District (excl. St. Petersburg) ...... 5.3 5.3 5.3 5.3 Urals District ...... 8.8 9.4 10.0 10.4 Volga District ...... 16.6 17.1 17.4 17.9 Far East District ...... 4.2 4.1 4.0 3.9 Siberian District ...... 11.7 11.8 11.6 11.5 Southern District ...... 10.8 11.5 11.7 12.3 Total ...... 100.0 100.0 100.0 100.0
Source: Rosstat
63 Russian Food Retail Market The Russian food retail market increased in size from US$39 billion in 2000 to US$190 billion in 2007, implying a CAGR of 25.3%. This growth was due, in part, to a strong growth in consumer spending. Over the period 2000 to 2007, the share of national retail turnover attributable to the food retail market has been stable at approximately 46% of national retail turnover.
The below table sets out the value development of the Russian food retail market and what proportion it represents relative to the overall retail market:
CAGR 2000 2001 2002 2003 2004 2005 2006 2007 2000-2007 Russian food retail market (RRbn) ...... 1,101 1,427 1,767 2,108 2,580 3,217 3,940 4,851 23.6% Year-on-year growth ...... 26.2% 29.6% 23.8% 19.3% 22.4% 24.7% 22.5% 23.1% Russian food retail market ($bn) ...... 39 49 56 69 90 114 145 190 25.3% Year-on-year growth ...... 10.4% 24.9% 15.2% 21.8% 30.4% 27.0% 27.4% 30.9% Russian Food Retail as % of Total Russian Retail ..... 46.5% 46.1% 46.6% 46.2% 45.7% 45.7% 45.3% 45.1%
Source: Rosstat
The Russian food retail market can be categorised into several segments based on retail format. The different retail formats can be classified as either traditional or modern retail formats. Traditional retail formats are typically locally-operated, small stores that sell products over the counter, and are not part of a major retail chain. Modern retail formats are typically larger outlets, usually belonging to a retail chain. Modern retail formats include discounters, supermarkets, hypermarkets and wholesale club outlets, typically offering a wider variety of products with larger store space than traditional formats.
According to Business Analytica, traditional retail formats continue to dominate the retail food markets of Russian cities with populations of over 100,000 persons. However, the number of traditional retail format points of sale has been on a steady decline, while the share of modern retail formats in Russia has grown significantly in recent years. In 2006, the share of modern retail formats of the food retail market in cities of above 100,000 people increased to an estimated 25.4% from 13.3% in 2003. X5 believes that this trend is partially due to a change in consumer preference in favour of modern retail formats.
64 The following table sets out the market share evolution of the different segments of the Russian food retail market between 2003 and 2006.
Percentage of total food retail turnover(1) Segment Description 2003 2004 2005 2006 Traditional retail formats, total ...... 86.7% 81.3% 77.7% 74.6% Points of sales at open 45.5% 44.5% 43.2% 42.6% markets ...... Anyofthebelow, where located within a registered open market Grocers ...... Over the counter and self service grocery 27.2% 24.2% 22.6% 21.0% stores with less than 250 square metres of selling space Kiosks ...... Small grocery points of sale, selling 7.3% 6.7% 6.3% 5.9% through a window Pavilions ...... Over the counter or self-service grocery 6.6% 5.9% 5.5% 5.1% stores in a construction of a temporary nature
Modern retail formats, 13.3% 18.7% 22.3% 25.4% total ...... Discounters ...... Self-service grocery stores low-priced 5.4% 8.3% 9.9% 11.1% products and typically stocking up to 5,000 SKUs with minimal in store equipment Supermarkets ...... Self-service grocery stores with selling 5.7% 7.0% 7.6% 8.0% space of over 250 square metres in Moscow and St. Petersburg, typically with no fewer than three cashiers with scanners and typically stocking up to 20,000 SKUs, as well as self-service grocery stores over 250 square metres in the regions Hypermarkets ...... Large grocery stores with selling space of 2.2% 3.4% 4.8% 6.3% over 5,000 square metres, typically stocking up to 40,000 SKUs and having no fewer than 20 cashiers with scanners
Source: Business Analytica (1) Cities with populations of above 100,000 people
65 Competitive Environment Despite the high level of competition the Russian food retail landscape remains highly fragmented, with several operators holding small market shares. The top ten participants, which generated sales of nearly US$25.0 billion in 2007, are listed below. According to Business Analytica, the top ten participants represent approximately 13% of the total Russian food retail market.
Revenue for Revenue for Number of Number of Net Selling Net Selling the year the year Stores at Stores at Space at Space at ended ended 31 December 31 December 31 December 31 December 31 December 31 December Company Main Format 2006 2007 2006 2007 2006 2007 (in thousands (in thousands (in millions (in millions of square of square of U.S. of U.S. metres) metres) dollars) dollars) X5 Discounter, supermarket 619(1) 868(1) 446 609 2,803 5,320 Metro Wholesale club, 31 39 279(2) 351(2) 2,840(2) 4,600(2) Magnit neighbourhood stores 1,893 2,197 523 652 2,505 3,677 Auchan Hypermarket 14 18 152(2) 272(2) 2,262(2) 3,200(2) Lenta Warehouse, hypermarket 14 26 100(2) 177 1,060 1,560(2) Kopeyka Discounter 319(2) 438(2) 180(2) 224(2) 974(2) 1,490(2) Dixy Megamart Discounter, city Minimart hypermarket and economy supermarket 326 388 128 151 1,009 1,433 Seventh Continent Supermarket, Neighbourhood stores, hypermarket 123 127 138 147 958 1,273 Viktoria Supermarket, neighbourhood stores, discounter 171 194 87 100 895 1,306 O’Key Hypermarket 11(2) 12(2) 87(2) 96(2) 600(2) 1,115(2) Ramstore Supermarket, hypermarket, neighbourhood stores 62(2) 64 155(2) 130(2) 735(2) N/A Karusel Hypermarket 19 22 N/A 115(3) 361 831 Mosmart Hypermarket 11(2) 30(2) 67(2) 84(2) 309(2) 377(2)
Source: Public filings, company websites and Business Analytica for private companies (1) Excludes X5 franchise stores: 680 franchise stores under the ‘Pyaterochka’ brand and 8 under the ‘Perekrestok’ brand as at 31 December 2007 (605 and 10 respectively as of 31 December 2006). (2) Business Analytica (information as of 16 April 2008). (3) Karusel estimated 2007 net selling space based on publicly available information.
X5 believes that the market in cities outside Moscow and St. Petersburg is significantly more fragmented than the Moscow and St. Petersburg markets and that modern retailers will continue to take market share from traditional formats. Domestic (non-multinational) operators represent the largest share of modern food retail sales in Russia. X5 and its modern format retail competitors also compete with traditional retail formats, such as small groceries and open markets, which are prevalent in Russia.
The key operators within each of the modern retail formats are outlined below.
Discounters: Discounters compete with X5’s Pyaterochka brand. Key operators in this segment include Pyaterochka, Dixy, Kopeyka and Magnit. The largest operator and largest competitor of Pyaterochka by sales in Russia is Magnit which operated 2,197 stores and reported US$3,677 million in sales in 2007.
66 Supermarkets: Supermarkets compete directly with X5’s Perekrestok brand. Key operators in the supermarket segment include Perekrestok, Viktoria, Seventh Continent and Ramstore. Seventh Continent is the second largest operator in the segment after Perekrestok and its largest competitor. Seventh Continent operated 127 stores in Moscow and in the Kaliningrad region and reported revenue of US$1,273 million for 2007. Seventh Continent operates three different formats targeting low, mid and upper income customers.
Hypermarkets/wholesale club: Hypermarkets have quickly increased their share of the overall food retail market from 2.2% in 2003 to 6.3% in 2006. Key operators in this segment include Lenta, Auchan, Karusel, O’Key and Mosmart. Metro is the only wholesale club operator in Russia.
As of the end of 2007, some of the largest food retailers in the Russian Federation, such as Metro, Ramstore and Auchan, were international operators. Such international operators have focused principally on large-space outlets, such as hypermarkets, cash-and-carry stores or supermarkets rather than discounter stores.
Market Consolidation The Russian food retail market is still fragmented, with several operators each holding a small share of the overall market. X5 expects merger and acquisition activity, driven in large part by the proliferation of modern retail formats and scarcity of retail spaces, to lead to industry consolidation. X5 intends to continue to play a leading role in the Russian food retail industry consolidation.
67 BUSINESS
X5 is Russia’s largest food retailer in terms of revenue and the country’s leading multi-format food retailer, currently operating three store formats: soft discount stores, supermarkets and hypermarkets. X5 has grown from one supermarket in Moscow in 1995 to 868 stores in 2007, including 674 soft discount stores, 179 supermarkets and 15 hypermarkets. X5 currently operates its soft discount stores under the brand name “Pyaterochka” and its supermarkets and hypermarkets under the brand name “Perekrestok”. As at the end of 2007, soft discount stores operating under “Pyaterochka” brand were located in the Moscow area, St. Petersburg area and seven other regions of the European part of Russia and the Urals. Supermarkets and hypermarkets operating under the “Perekrestok” brand were located in the Moscow area, St. Petersburg and 15 other regions of the European part of Russia, in addition to five supermarkets in Ukraine.
This multi-format approach allows X5 to diversify its client base and ensure a balance between growth and profitability, whilst benefiting from economies of scale by leveraging purchasing power and common infrastructure. The multi-format approach also allows X5 to more efficiently integrate stores with varying sizes and retail formats.
To facilitate its multi-format presence and to ensure maximum coverage of its target customer base, X5 intends to launch two new store concepts: a new full size hypermarket under the “Mercado Supercenter” brand is expected to open in June 2008 and a premium supermarket under the “Green Perekrestok” brand is expected to open in July 2008.
At 31 December 2007, in addition to the Company managed stores detailed above, X5’s franchisees also operate 680 stores across Russia and Kazakhstan under the “Pyaterochka” brand and eight stores under the “Perekrestok” brand in the Moscow region.
X5’s soft discount stores currently offer, on average, 3,500 food and non-food SKUs. Soft discount stores focus on quality and value for money for its customers. They are distinguished from “hard” discount retailers by offering an extended assortment and better quality of service. The stores have a net selling space of between 500-800 square metres and feature a simple store layout. They are generally located in densely populated residential areas and are open from 9am until 11pm, seven days a week.
X5’s supermarkets offer, an average, 15,000 different food and non-food products. They focus on providing customers with a variety of fresh food and non-food items in locations that are easily accessible. Each supermarket has a net selling space between 800 square metres and 1,600 square metres and features an open store layout. They are generally located close to residential areas or inside shopping centres. The majority of supermarkets are open 24 hours a day, seven days a week.
X5’s hypermarkets are divided into two segments: compact hypermarkets and full size hypermarkets. X5 intends to rebrand its full size hypermarkets as “Mercado Supercenters” from June 2008. Compact hypermarkets are currently very similar in design and concept to supermarkets, but offer a wider range of products. Compact hypermarkets offer, on average, 30,000 different food and non-food SKUs, while full size hypermarkets offer between 40,000 and 60,000 SKUs. Hypermarkets focus on providing customers with a “one stop shop” for shopping needs. Compact hypermarkets have, on average, net selling space of 4,000 square metres, while full size hypermarkets have net selling space of between 5,000 and 10,000 square metres. Hypermarkets feature a spacious layout where products are easily located. Compact hypermarkets are usually located close to residential areas or inside shopping centres and most are open 24 hours a day, seven days a week. X5 currently operates 14 compact hypermarkets and one full size hypermarket.
X5 contracts with third parties to produce private label goods, which it then sells through its soft discount stores, supermarkets and hypermarkets.
In 2007, X5 was supplied by approximately 4,000 suppliers. In the year ended 31 December 2007, X5’s ten largest suppliers accounted for approximately 10% of all products supplied to X5. Approximately 60% of X5’s products are produced in Russia, including products produced by multinational companies with operations in Russia.
As at 31 December 2007, X5 operated ten distribution centres across Russia, comprising four distribution centres in Moscow, three distribution centres in St. Petersburg and one distribution centre in each of Nizhniy Novgorod, Chelyabinsk and Yekaterinburg.
X5 operates both through leased retail space and owned stores. As at 31 December 2007, approximately 47% of X5’s net selling space was owned.
68 In January 2008, X5 exercised an option to acquire the entire issued share capital of Formata, which owns and operates the chain of Karusel hypermarkets (see “Business – History and Development – Recent Acquisitions and Proposed Acquisition of Formata”). The acquisition is subject to the completion of due diligence satisfactory to X5 and the receipt of approvals from the FAS. As at 31 December 2007, there were 22 hypermarkets operating under the Karusel brand in the Moscow region, St. Petersburg, Leningrad region, Volgograd, Izhevsk and Nizhniy Novgorod. An additional Karusel hypermarket was opened in Dzerzhinsk in March 2008.
In the year ended 31 December 2007, revenue for X5 was US$5,320.4 million, and EBITDA was US$479.3 million.
History and Development On 18 May 2006, the businesses of Pyaterochka Holding N.V. and Perekrestok Holdings Limited were combined. This combination formed the basis of X5’s current business.
The following sub-section describes the history of Pyaterochka Holding N.V. and Perekrestok Holdings Limited prior to 18 May 2006. It also sets out certain acquisitions that have occurred since the combination and significant businesses that X5 has an agreement to acquire in the future.
Perekrestok Holdings Limited (“Perekrestok”) Perekrestok was founded by Alfa Group and Alexander Kosiyanenko in 1995, opening its first supermarket in Moscow that year. In 1998, Perekrestok was the first Russian food retailer to open its own distribution centre in Moscow. In 2002, Perekrestok launched its hypermarket format through the first compact hypermarket and opened its first store outside Moscow.
From 31 December 2002 to 31 December 2005, the number of Perekrestok supermarkets and compact hypermarkets grew more than two and a half times from 45 stores to 120 stores. In that time, Perekrestok also doubled the capacity of its Moscow distribution centres and launched its ready meals range which, at 31 December 2007, were sold across “Perekrestok” branded supermarkets and hypermarkets.
Pyaterochka Holding N.V. (“Pyaterochka”) Pyaterochka was founded by Andrei Rogachev and Alexander Girda in St. Petersburg in 1998. In February 1999, the first Pyaterochka store was opened in St. Petersburg, followed by 16 further such stores during 1999.
The stores became popular with St. Petersburg’s lower and middle income population. In July 2001, the first Pyaterochka store was opened in Moscow. In 2004, Pyaterochka’s franchisees set up operations in Kazakhstan and Ukraine, making Pyaterochka the first Russian grocery chain to expand abroad.
On 11 May 2005, Pyaterochka obtained a listing of GDRs on the London Stock Exchange resulting in a free float of 32.07%.
In June 2005, Pyaterochka acquired 18 stores of the Kopeika retail chain in St. Petersburg for US$60.8 million and rebranded these stores as Pyaterochka stores. On 30 December 2005, Pyaterochka acquired the franchise network in Yekaterinburg, including 21 stores, a warehouse, a regional head office and a training centre for US$14.5 million. On 20 March 2006, the franchisee network was sold to third parties for a nominal value and as a result, three stores in the franchise network were closed. Through the opening of new stores and acquisitions of small chains, Pyaterochka operated 326 stores by the end of 2005.
In 2006, Pyaterochka acquired control of LLC Tsentr Roznichnoy Torgovli, the largest franchisee of the Kopeika retail chain in the Moscow area with 25 stores, for US$90.0 million. This increased the number of Pyaterochka stores in Moscow by 14, in the Moscow region by nine stores and in the city of Vladimir by two stores. At 18 May 2006, Pyaterochka owned 377 soft discount stores in Moscow, St. Petersburg and Yekaterinburg.
Acquisition of Pyaterochka On 18 May 2006, X5 acquired Pyaterochka. The transaction was legally structured as an acquisition by Pyaterochka Holding N.V. of Perekrestok Holdings Limited. However, because on completion of the transaction, shareholders and other related parties of Perekrestok Holdings Limited obtained control over 56% of the shares of Pyaterochka Holding N.V., the transaction is accounted for as a reverse acquisition of Pyaterochka Holding N.V. by Perekrestok Holdings Limited.
69 The transaction was structured in two stages: as a preliminary step, the shareholders of Perekrestok Holdings Limited acquired 14,536,032 ordinary voting shares of Pyaterochka Holding N.V. for cash consideration of US$1,178.0 million. The consideration was equivalent to US$20.26 per Pyaterochka GDR and represented a 20.4% premium to the average closing price per Pyaterochka GDR of US$16.83 during the 30 trading days prior to and including 5 April 2006 (being the last trading day prior to Pyaterochka’s announcement that it was in discussions to acquire Perekrestok).
The second step involved the acquisition of 100% of the ordinary voting shares of Perekrestok Holdings Limited by Pyaterochka Holding N.V. for 15,813,253 newly issued shares and cash consideration of US$300.0 million. Based on the average closing price per Pyaterochka GDR of US$16.83 during the 30 days prior to and including 5 April 2006, the transaction valued Perekrestok at US$1,365.0 million.
Recent Acquisitions and Proposed Acquisition of Formata In October 2006, X5 acquired 100% of the Mercado group, which operated 17 supermarkets in Moscow. The acquisition added 14,000 square metres of net selling space to X5’s portfolio and also included an office in central Moscow of 17,000 square metres (where X5 currently maintains its headquarters). The total consideration, including net debt assumed, amounted to US$200.4 million.
In the beginning of 2007, X5 gained control over 40 soft discount stores in Chelyabinsk, previously operated by a franchisee under the Pyaterochka brand, with the total net selling space of 13,800 square metres.
In December 2007, X5 completed the acquisition of 22 Korzinka stores operating in the Lipetsk region with net selling space of 20,000 square metres, for a total consideration of US$109.2 million, including debt. 15 of the purchased stores are being integrated into X5’s soft discount store format, six into the supermarket format and one store into the hypermarket network.
In December 2007, X5 also acquired 29 soft discount stores with a total net selling space of 12,900 square metres operating under the Strana Gerkulesia brand located in Moscow and the Moscow region and Tver region. Of the 29 stores, 26 were operational under the Strana Gerkulesia brand at the end of 2007 (11,700 square metres in selling space) and three were scheduled for opening in 2008 (comprising 1,200 square metres of selling space). As part of the acquisition of Strana Gerkulesia, X5 also purchased an office building and construction in progress that potentially could be converted into selling space in the future. The total consideration for the acquisition, including net debt assumed, amounted to US$63.3 million.
In April 2008, X5 acquired the Kama Retail company, a Pyaterochka franchisee, for a total consideration, including net debt assumed, of approximately US$18.0 million. Kama Retail operates 28 soft discount stores in the Perm region, encompassing 9,300 square metres of net selling space.
In January 2008, X5 exercised an option to acquire Formata pursuant to the terms of the Call Option Agreement. Formata owns and operates the Karusel hypermarket chain of stores across Russia (for more information on the Karusel hypermarkets, see “X5 Operations and Stores – Karusel Hypermarkets”).
The amount payable by X5 for the acquisition of Formata under the Call Option Agreement is calculated as follows: (a) the amount being the lesser of: (i) 1.1 multiplied by the consolidated net sales of Formata in 2007; or (ii) 14.5 multiplied by the greater of (A) Formata’s 2007 EBITDA (as calculated in accordance with the Call Option Agreement); or (B) 5% of consolidated net sales of Formata in 2007; plus (b) the value of the land and other real estate in the course of construction (where business is not carried out as at 31 December 2007), as determined by an independent real estate valuer; less (c) the aggregate amount of Formata’s net debt at 31 December 2007,
in each case calculated by reference to the Formata Consolidated Financial Statements for the year ended 31 December 2007.
In 2007, Formata reported revenue of US$831.1 million, net debt was US$137.4 million and EBITDA was US$70.2 million.
70 X5 estimates that the consideration for the exercise of the Karusel Option will be up to US$970.0 million, of which it has an option to pay 75% in cash and up to 25% in Shares. X5 intends to use part of the proceeds from the Offering to pay the cash portion of the exercise price under the Call Option Agreement. The issuance of Shares for payment of 25% of the consideration is subject to approval by the Supervisory Board and Management Board, who will consider, amongst other things, whether such issuance is of economic benefit to X5 as a whole, at the time of the issuance.
Under the Call Option Agreement, completion of the acquisition is required to take place by 1 July 2008. The acquisition of Formata was approved by the Supervisory Board on 10 April 2008, but is also subject to certain conditions, including the completion of due diligence satisfactory to X5 and the receipt of approvals from the FAS.
Competitive Strengths X5 believes that the following competitive strengths will help it to sustain its leading position in the Russian food retail market:
Market Leadership in an Attractive Market X5 is the largest food retailer in Russia by revenue.
The food retail market in Russia is currently undergoing significant structural change as consumers move from traditional retail formats, such as open markets, grocers, kiosks and pavilions, to modern retail formats which X5 operates. From 2003 to 2006, modern retails formats grew from 13.1% of total food retail turnover in Russia to 25.4% in Russian cities where the population exceeds 100,000 people. While the Russian food retail market is still highly fragmented, X5 believes that the proliferation of modern retail formats and scarcity of retail space will lead to industry consolidation, and expects consumers to continue moving away from traditional retail formats to modern formats (see “Food Retail Industry – Russian Food Retail Market”). X5’s leading market position places it in a strong competitive position to benefit from this trend.
X5’s size allows it to benefit from significant economies of scale through centralisation of its functions such as operations, supply chain management, distribution, finance and development of private label products. X5’s scale also puts it at an advantage compared to its competitors because the large volume of X5’s centralised purchases allow it to secure competitive prices with suppliers, thus allowing X5 to offer competitive prices to customers while maintaining margins. Larger volumes also allow X5 to spread its distribution costs, such as the costs of maintaining its distribution centres, across a larger number of stores, while centralisation of financing allows X5 to negotiate more favourable terms on its loans. X5 also sells its own private label products, produced by third party manufacturers, through its stores. As the number of its stores and demand for its private label goods increase, X5 believes that average costs of production of private label products should fall.
X5 generally focuses on opening stores in those parts of Russia which have the highest population densities and the highest net disposable incomes. X5 maintains its strongest presence in Moscow and St. Petersburg – as at 31 December 2007, X5 had 681 store in the Moscow and North-West regions (including St. Petersburg) with net selling space of 458,912 square metres, accounting for 78.5% of its stores and 75.3% of its net selling space at that date. Other principal markets for X5 include regions in the European part of Russia and the Urals. X5’s presence in Russia’s principal markets gives it a solid platform of local infrastructure, management and knowledge on which it can build to enhance its position in these localities.
Multi-Format Operations X5 operates three different modern retail formats in the form of soft discount stores, supermarkets and hypermarkets and is the leading multi-format operator in Russia’s food retail industry. A wide range of formats allows X5 to diversify its customer base, so that the format, type and variety of products sold in each store can be tailored to serve the needs of different target customers. Accordingly, X5 is able to penetrate the most attractive markets in each particular region with an offering designed to meet local consumer preferences and income levels. The variety of goods that X5 is able to stock in its different types of stores also allows X5 to respond to changes in consumer preference.
Multi-format operations also allow X5 to balance its growth and profitability, whilst benefiting from economies of scale by leveraging purchasing power and common infrastructure. Additionally, multi-format operations allow X5 to more efficiently integrate stores with varying sizes and retail formats because it has multiple formats into which it can integrate an acquired store.
71 Brand Recognition Amongst Consumers X5’s core brands, “Pyaterochka” and “Perekrestok”, are widely recognised in the markets in which X5 operates and have strong associations with certain value propositions for customers. According to a study by AC Nielsen, a market information provider, published in May 2007, spontaneous customer awareness of the “Pyaterochka” brand name was, on average, 71% in St. Petersburg and 60% in Moscow, which was the second highest result in spontaneous customer awareness recorded for modern format food retailers in both regions. The same study found that spontaneous customer awareness of the “Perekrestok” brand name was, on average, 11% in St. Petersburg and 55% in Moscow and that customers associated Pyaterochka with low prices, good value, quality private label products which provided a viable alternative to other brands, convenience and attractive loyalty programs, while Perekrestok was associated with spacious surroundings, efficient checkout counters and good quality instant cooked foods.
These brand name associations place X5 at an advantage in attracting and retaining customers. X5 capitalises on this advantage through a multitude of loyalty and promotion programs (see “Marketing and Customers – Marketing and Promotion” below)
Extensive Portfolio of Owned Real Estate As at 31 December 2007, X5 owned approximately 47% of its 609,210 square metres of net selling space and leased the remainder. By owning the land and property, X5 is able to protect itself against rising rent prices. X5 attempts to further reduce this risk by signing leases that generally have initial terms ranging from five to ten years duration and, in some cases, extend to 15 years duration. These leases also provide stability and assurance of continuity for X5’s business because they can secure sites for longer terms.
Ownership of stores also allows X5 more flexibility in designing, implementing and changing its store layout than if X5 were required to seek consent from a landlord on leased property. X5 builds stores on the basis of standardised designs, which helps to lower construction and maintenance costs and to reduce financial and operational risk.
Strong brand recognition in the wider community also enhances X5’s real estate opportunities. X5’s track record of reliability and strong customer traffic has allowed X5 to negotiate favourable terms when leasing real estate and on development projects to build new stores, particularly in shopping centres.
Experienced Management Team The X5 management team includes executives with extensive experience in major Russian companies and leading international retail chains. The acquisition of Pyaterochka in 2006 enabled X5 to retain highly qualified executives from both the Perekrestok and Pyaterochka chains. This team has also been further strengthened by international managers with extensive knowledge and experience of European retail markets.
X5 has a strong expansion team which is able to source suitable sites for new stores. This team is complemented by a strong operations teams with professionals that understand Russian customers and are familiar with international standards in retail operations. The operations teams pursue smart pricing policies, run innovative promotional campaigns and develop loyalty programs. This combination has led to the success of new stores and continuing improvement of the performance of existing stores by achieving balanced like-for-like sales growth.
The X5 M&A team includes executives able to source, execute and integrate acquisitions. This team was involved in the acquisition of a number of store chains beginning in 2006, such as the acquisition of Pyaterochka, and a number of acquisitions since then, including the Mercado group of companies, the Chelyabinsk franchise and the Korzinka and Strana Gerkulesia chain of stores (see “Business – History and Development – Recent Acquisitions and Proposed Acquisition of Formata”). In each case, the team identified the target, negotiated the terms of the transaction, and assisted in the integration of the new business following completion. On acquisition of new stores and chains, X5’s management have the capability and experience to integrate these stores in the most efficient manner by re-branding, changing the product assortment, applying X5’s pricing policy and reducing costs.
The management team is supported by the Supervisory Board; in particular, its independent directors with extensive knowledge of, and experience in, the international food retail market.
72 Strategy X5 aims to strengthen its position as the leading operator of multi-format food retail stores in Russia. To accomplish this goal, it intends to pursue the following strategies:
Maintain focus on Multi-Format Development In order to maintain and enhance its overall market leadership, X5 plans to continue development of its soft discount and supermarket formats. For example, to strengthen its position in the supermarket segment, X5 intends to launch a new supermarket concept under the “Green Perekrestok” brand in July 2008 to provide more services and premium assortment to high income customers.
Going forward, it also intends to significantly increase its presence in hypermarkets. X5’s management believes that, in the medium-term, the hypermarket format has the highest growth potential in the Russian food retail market and aims to become a leading player in this market segment.
Hypermarkets are a relatively new store format for Russia in general and X5 in particular. X5 anticipates opening six new compact hypermarkets and two full size hypermarkets by the end of 2008.
In 2008, X5 intends to launch a new hypermarket concept under the “Mercado Supercenter” brand. Each Mercado Supercenter will focus on providing products based on local market preferences, a balanced assortment of food and non-food products, a customer-friendly layout, a private label bakery and deli and ample parking. X5 plans to rebrand its existing full size hypermarket store in Lipetsk in June 2008. This first store will offer approximately 40,000 SKUs and will offer customers additional facilities such as a café and a children’s room.
Expand Through Organic Growth and Acquisitions In 2007, X5 was the largest food retailer in Russia based on revenue, but represented only 2.8% of the turnover in the Russian food retail market as a whole (see “Food Retail Industry”). X5 sees substantial potential for growth in this fragmented market.
X5 will pursue expansion through organic growth and acquisitions. Organic growth is expected to take place through the leasing and purchasing of real estate including vacant land for development of stores (see “Competitive Strengths – Extensive Portfolio of Owned Real Estate” above). X5 also views the acquisition of small chains and successful franchisees as part of its organic growth. Upon acquisition, X5 intends to rebrand, own and operate its acquired stores.
X5 expects to add between 140,000 and 160,000 square metres of net selling space (net of potential store closings) in 2008 through organic growth, including opening eight hypermarkets (comprised of six compact hypermarkets and two full size hypermarkets).
X5 has also been expanding through acquisition of larger retail chains (see “Business – History and Development” above) and plans to continue doing so. In January 2008, X5 exercised an option to acquire the Karusel chain of hypermarkets (see “Business – History and Development – Recent Acquisitions and Proposed Acquisition of Formata” above). The acquisition is subject to the completion of due diligence satisfactory to X5 and the receipt of approvals from the FAS. X5 intends to relaunch the Karusel hypermarkets as “Mercado Supercentres” as part of its wider strategy for hypermarket growth. In the next few years, X5 plans to continue to expand in Moscow and St. Petersburg, where disposable income is amongst the highest in Russia, as well as in the other parts of the European part of Russia and the Urals. X5 believes that these regions offer high growth potential as they, together with Moscow and St. Petersburg, account for approximately 84.7% of the Russian retail market as a whole.
Develop Infrastructure to Support Growth and Enhance Efficiency X5 plans to pursue strategic investments in infrastructure in order to support its expansion plans. These investments will take place primarily in distribution and IT systems.
To support its continued expansion, X5 intends to invest in upgrading its logistics infrastructure and to operate distribution centres with sufficient storage capacity in every region of its store locations within five years. Improved warehousing and distribution is aimed at enhancing X5 operational efficiency by facilitating improved labour productivity, more efficient store area utilisation and a decrease in inventories, leading to working capital improvement. X5 also expects to strengthen its competitive position due to better product availability, better support for promotional campaigns and private label development as well as support timely delivery and availability of perishable goods.
73 Another area of focus is X5’s IT system upgrade. X5 has chosen to implement SAP for Retail as its enterprise resource planning system to provide it with a strong platform for further growth and allow for regional expansion in its multi-format strategy. X5 believes SAP will enable it to facilitate controls over processes across all major levels of company management, from store operations to strategic planning. The introduction of the SAP system will be conducted in stages. The first phase of the launch will create a technological platform to manage retail operations, including transactions, purchasing, and logistics, inventory and accounting. This is expected to standardise business processes in X5’s operational activities, optimise the receipt of combined managing reports on store operations, and create a platform to implement future steps of SAP functionality, including expanding functional financial models. This first implementation stage is scheduled to be completed by the end of 2009. X5 estimates that this first stage will cost approximately US$35 million.
Further Improve Operational Performance X5 seeks to further improve its operational performance by increasing sales from its existing stores, optimising its product mix, increasing the sale of its private label products and obtaining better terms from its suppliers.
X5 aims to continue increasing its sales per square metre by increasing the number of customers in each store and increasing the number of items purchased by those customers on each visit. X5 seeks to leverage its well-recognised “Pyaterochka” and “Perekrestok” brand names to encourage new customers. Existing customers are enticed to return through promotional deals and loyalty card schemes, which offer benefits such as lower prices and loyalty points which can be redeemed for certain products (see “Business – Marketing and Customers – Marketing and Promotion”). X5 also maintains its competitive prices through regularly monitoring its competitors.
X5 regularly reviews its product mix and eliminates products with low turnover. Low turnover for a particular product often arises because there is a large number of brands in a single product category (for instance, rice, pasta, condiments and spices).
X5 also aims to increase the share of its private label products. Private label products allow X5 greater opportunities to compete with other products on the basis of price. X5 generally prices its private label products at 20% to 30% below the brand leader, while maintaining comparable quality and higher margins. It is X5’s long-term goal to increase sales of private label goods to 40% to 50% of total revenue in soft discount stores and 20% to 25% in supermarkets and hypermarkets. Due to the absence of brand related expenses in the cost of private label goods, the increasing presence of X5’s private label goods in X5’s product range should have a positive effect on X5’s gross margin.
As X5 has grown, its purchasing power has improved and it has been able to negotiate better terms and prices with its suppliers. X5 believes that the suppliers’ market is highly fragmented, with only a few buyers in several Russian regions, especially in key product categories such as fresh food. As X5 streamlines its product selection to eliminate low turnover products, it will increase the ordering volume of remaining products, strengthening its purchasing power with suppliers. X5 will therefore seek to negotiate lower prices and improve its payment terms with suppliers as a result of its growing scale, regional expansion and the hypermarket format rollout.
X5 Operations and Stores X5 stores are currently divided into three different formats: soft discount stores, supermarkets and hypermarkets. In 2007, X5 gained additional net selling space of 143,074 square metres, reaching a total net selling space of 609,210 square metres by year end. At 31 December 2007, X5 owned or leased 357,517 square metres of net selling space for soft discount stores, 191,730 thousand square metres of net selling space for supermarkets and 59,963 thousand square metres of net selling space for hypermarkets.
74 The following map shows the location of X5 stores in each region of Russia at 31 December 2007:
Number of stores as of 31 December 2007 Moscow region – 418; St. Petersburg region – 263; Central region – 28; Volga region – 62; Urals region – 83; Southern Russian region – 9; Ukraine – 5. TOTAL - 868
The following tables set out the number of stores operated by X5 in each region and corresponding net selling space by format on 31 December 2007:
Soft discount stores At 31 December 2007 Number of Net selling space stores (in square metres) Moscow ...... 309 175,101 St. Petersburg ...... 244 135,006 Nizhny Novgorod ...... 18 6,946 Samara ...... 5 1,940 Southern Russia ...... 0 0 Ukraine ...... 0 0 Other ...... 98 38,524 Total ...... 674 357,517
75 Supermarkets At 31 December 2007 Number of Net selling space stores (in square metres) Moscow ...... 105 107,554 St. Petersburg ...... 19 24,061 Nizhny Novgorod ...... 18 16,974 Samara ...... 8 9,978 Southern Russia ...... 8 9,599 Ukraine ...... 5 6,155 Other ...... 16 17,409 Total ...... 179 191,730
Hypermarkets At 31 December 2007 Number of Net selling space stores (in square metres) Moscow ...... 4 17,189 St. Petersburg ...... 0 0 Nizhny Novgorod ...... 2 7,473 Samara ...... 2 7,721 Southern Russia ...... 1 3,646 Ukraine ...... 0 0 Other ...... 6 23,934 Total ...... 15 59,963
Soft Discount Stores Soft discount stores are operated under the “Pyaterochka” name. At 31 December 2007, there were 674 soft discount stores, with total net selling space of 357,517 square metres, accounting for approximately 58.7% of X5’s total net selling space. In the year ended 31 December 2007, soft discount stores reported net sales of US$2,964.9 million. Sales per square metre of net selling space for the year ended 31 December 2007 for soft discount stores was US$11,375.
In response to customer demand, a greater selection of fresh and perishable products, including a wider selection of fresh fruit and vegetables, meat and fish, and non-food products was introduced in 2006. Soft discount stores offer 3,500 SKUs on average and sell mainly food products. In the year ended 31 December 2007, fresh and perishable products, comprising dairy products, meat and meat products, vegetables and fruit accounted for approximately 46% of sales.
X5’s soft discount stores are characterised by simple store layouts, which X5 believes responds to customer demand for hygienic and self-service shopping, presenting an attractive alternative to open markets. X5 believes that the key factors underlying the appeal of the soft discount stores to customers are convenient store location, competitive prices and an attractive range of products. Soft discount stores focus on ensuring the lowest prices for quality goods, so as to attract a broad range of potential customers, to retain repeat customers and to maximise the average basket value. X5’s aim is to ensure that soft discount stores remain low cost operations through minimal shelf displays, minimal store decorations, centralisation of operations and a flat organisational structure.
X5’s soft discount stores are predominantly located in residential districts, close to customers’ apartments, underground stations, adjacent to major traffic intersections or thoroughfares. Due to the combination of the relatively low car ownership prevalent in Russia, the cold climate and the relatively small apartments in which many target customers live, X5 seeks to locate its soft discount stores in convenient neighbourhood locations in densely populated residential areas, enabling customers to shop frequently and without having to travel long distances.
As part of X5’s strategy, X5 aims to sell approximately 350 food and non-food SKUs typically referenced by customers to compare the price attractiveness of various grocery retailers, referred to as “known value items”, at the lowest price available in the relevant regional retail market, with the remaining products sold at the average price of direct local competitors.
The private label range is primarily focused on fast selling, non-perishable and medium length shelf life products and beverages and includes a large number of non-food items.
76 The policy for X5 stores, including soft discount stores, supermarkets and hypermarkets, is that the price for private label products should be between 20% and 30% lower than the price leader in that product category. As there are limited, or no, associated promotional costs in the price of these goods, these savings translate into lower costs and ultimately, to higher gross margins compared with similar branded products. X5 monitors the price of private label goods so that they comply with the pricing strategy.
Supermarkets Supermarkets are operated under the “Perekrestok” name and have net selling space between 800 and 1,600 square metres, with additional parking.
At 31 December 2007, there were 179 supermarkets, with total net selling space of 191,730 square metres. In the year ended 31 December 2007, supermarkets reported net sales of US$1,944.7 million. Sales per square metre of net selling space for the year ended 31 December 2007 for supermarkets was US$12,959.
Supermarkets offer, on average, 15,000 products, comprised mostly of food items. Supermarkets offer a wider range of fresh products than soft discount stores in the following categories: fruits and vegetables, on site bakery products, meat and fish products. In the year ended 31 December 2007, fresh and perishable products, comprising dairy products, meat and meat products, vegetables and fruit, accounted for approximately 41% of sales in supermarkets.
Supermarkets target middle to high income customers. X5 believes that the key factors underlying the appeal of the supermarkets for these customers are convenient store location, competitive prices and their range of fresh products. X5’s supermarkets are typically located in residential districts, close to or in major shopping centres, adjacent to major traffic centres, thoroughfares or major roads.
Supermarkets are focused on providing a variety of quality goods at competitive prices. X5 aims to sell 500 “known value items” at not more than 5% above the lowest price otherwise available in the relevant regional retail market, with the remaining products sold at the average price of direct competitors in the local market.
The private label brands are divided into the “red label” range, aimed at increasing its appeal to lower income customers, and the “blue label” range targeting middle income customers.
In response to customer demand, X5 plans to launch a new supermarket concept under the “Green Perekrestok” brand name in July 2008. Green Perekrestok stores are expected to offer a greater premium assortment of products and a higher level of service to the growing number of high income customers.
Hypermarkets Hypermarkets are also divided into smaller and larger stores, known as “compact” hypermarkets and “full size” hypermarkets. Compact hypermarkets have, on average, net selling space of 4,000 square metres, while full size hypermarkets have net selling space between 5,000 and 10,000 square metres. Hypermarkets concentrate on providing wide selection products to customers and are “one-stop shops” at competitive prices.
At 31 December 2007, X5 operated 14 compact hypermarkets and one full size hypermarket, with total net selling space of 59,963 square metres. In the year ended 31 December 2007, hypermarkets reported net sales of US$392.7 million. Sales per square metre of net selling space for the year ended 31 December 2007 for hypermarkets was US$8,909.
X5’s compact hypermarkets offer an average product range of 30,000 products, while full size hypermarkets offer an average product range between 40,000 to 60,000 products, including various non-food products. Key non-food product categories include clothing, electronics, white goods and other household goods. In the year ended 31 December 2007, fresh and perishable products, comprising dairy products, meat and meat products, vegetables and fruit accounted for approximately 40% of sales.
X5 believes that customers are drawn to X5’s hypermarkets because they are located in accessible locations and offer a unique shopping experience for customers to purchase fresh food, dry products and non-food items. Customers will typically drive their cars to shop at hypermarkets, most of which are located in shopping centres within the vicinity of residential areas.
X5 aims for approximately 500 “known value items” to be sold at not more than 5% above the lowest price otherwise available in the relevant regional retail market, with the remaining products sold at the average price of direct local competitors.
77 X5 intends to launch a new full size hypermarket concept under the “Mercado Supecenter” brand name in June 2008. This concept is modelled on European retailers, but adapted to the needs and expectations of Russian consumers.
In January 2008, X5 exercised an option to acquire the entire issued share capital of Formata, which owns and operates the chain of Karusel hypermarkets. The acquisition was approved by the Supervisory Board on 10 April 2008, but is subject to the completion of due diligence satisfactory to X5 and the receipt of approvals from the FAS. For more information on the current operations of the Karusel hypermarkets, see “Karusel Hypermarkets” below.
Karusel Hypermarkets The information about Formata contained in this section is drawn from information publicly available on Formata’s website and other information publicly available. The Formata Consolidated Financial Statements have been extracted from Formata’s website and are included in the Appendix to this Prospectus.
The “Karusel” brand of hypermarkets began operating in 2004 as part of the Formata Group and was founded by, amongst others, Mr. Andrei Rogachev and Mrs. Tatiana Franus. Mr. Andrei Rogachev and Mrs. Tatiana Franus are both former members of X5’s Supervisory Board. Mr. Rogachev recently resigned from his position on the X5 Supervisory Board with effect from 21 April 2008. Mrs. Franus recently resigned from her position on the X5 Supervisory Board with effect from 23 April 2008. At 31 December 2007, the Formata Group was the fourth largest hypermarket operator in Russia by sales and net selling area. At 31 March 2008, the Formata Group owned and operated 23 Karusel hypermarkets. The hypermarkets are located close to several of Russia’s largest cities, including four hypermarkets close to or in the Moscow region, 13 hypermarkets in St. Petersburg, two hypermarkets in the Leningrad region and one hypermarket in each of Volgograd, Izhevsk, Nizhniy Novgorod and Dzerzhinsk. Three further hypermarkets are under construction in Yekaterinburg, Yaroslavl and St. Petersburg. Karusel owns its hypermarkets stores which are generally built on land owned or leased by the Formata Group.
Karusel stores vary in size, with net selling space of approximately 3,600 square metres to approximately 11,400 square metres. At 31 December 2007, Karusel hypermarkets occupied a total selling area of 234,900 square metres, compared to total selling area of 205,800 square metres at 31 December 2006. At 31 December 2007 and 31 December 2006, the Formata Group employed 7,311 and 4,837 staff, respectively (including outsourced personnel).
Each hypermarket offers food and non-food products, including private label foods, ready made meals and electrical equipment such as household appliances and electronics. Each store offers up to 35,000 SKUs, which Karusel prices to target customers across all income ranges.
In 2007 and 2006, the Formata Group reported revenue of US$831.1 million and US$360.6 million and gross profit of US$206.7 million and US$85.5 million, respectively. Profit before tax for 2007 and 2006 was US$31.8 million and US$13.5 million, net profit for the year was US$19.9 million and US$9.9 million, net debt of US$137.4 million and US$200.3 million and EBITDA was US$70.2 million and US$28.5 million, respectively. At 31 December 2007 and 2006, the Formata Group had total assets of US$812.6 million and US$602.5 million, shareholders’ equity of US$252.7 million and US$218.7 million, inventories of US$92.5 million and US$62.7 million, receivables and prepayments of US$62.6 million and US$82.5 million and trade payables of US$231.3 million and US$108.3 million, respectively. The average basket size for the Karusel hypermarkets in 2007 and 2006 was US$18.7 and US$18.5, respectively.
According to the Formata Group’s preliminary unaudited results, in the first quarter of 2008, the Formata Group reported a 66.8% year-on-year growth in net sales to US$252.5 million and 43.3% growth in like-for-like sales compared to the same period in 2007. The average basket size of the Karusel hypermarkets in the same period was US$22.97 (net of VAT).
78 A reconciliation of the Formata Group’s EBITDA from profit for 2007 and 2006 is as follows:
Years ended 31 December 2007 2006 (in millions of US$, except as otherwise indicated) Profit for the year ...... 19.9 9.9 Income tax expense ...... 12.0 3.6 Other non-operating gains/losses ...... 1.4 (0.8) Net finance costs ...... 12.3 8.5 Foreign exchange loss/gain ...... 0.1 (3.5) Depreciation and amortisation ...... 24.5 10.8 EBITDA ...... 70.2 28.5
In 2007, the shareholders of the Formata Group, including Mr. Rogachev (who recently resigned from X5’s Supervisory Board with effect from 21 April 2008) and Mrs. Franus (who recently resigned from X5’s Supervisory Board with effect from 23 April 2008), established a group of companies consisting of a holding company, Donson B.V., incorporated in The Netherlands and its Russian subsidiaries, to carry out development activities, which consists of sourcing and acquiring land plots and constructing hypermarkets. Donson B.V. is affiliated with Mr. Rogachev and Mrs. Franus, but is not part of the Formata Group. In the first quarter of 2008, Kaizer LLC, a subsidiary of Formata, entered into a number of investment agreements with Russian subsidiaries of Donson B.V. for construction of five hypermarkets in Yaroslavl, Volzhsky (Volgograd region), Lipetsk, Ramenskoye and Zelenograd (Moscow region) during 2009 to 2010. The Formata Group’s capital commitments under these agreements are estimated to be approximately US$223.0 million. Additionally, in the first quarter of 2008, the Formata Group entered into the Donson Framework Agreement with Russian subsidiaries of Donson B.V. for the building of additional hypermarkets during 2010 to 2012 in a number of Russian cities, including Yaroslavl, Nizhiniy Novgorod and Klin (Moscow region). Under the Donson Framework Agreement, the Russian subsidiaries of Donson B.V. will acquire land plots, collect all permits and build hypermarkets for the Formata Group. The Formata Group has agreed to finance these projects in accordance with respective investment agreements and based on an agreed payment schedule (see also “Risk Factors – Risks Relating to X5’s Acquisition of Formata” and note 26 of the Formata Consolidated Financial Statements).
Upon acquisition of the Karusel hypermarkets under the Call Option Agreement, X5 will operate 39 hypermarkets and will account for 3.2% of the Russian food retail market and 23.8% of the market comprised of the top 10 Russian food retailers and the Formata Group. Based on X5’s figures available for 31 December 2007, the Karusel hypermarkets will add approximately 20% more net selling space to X5’s net selling space. The location of the Karusel hypermarkets will complement X5’s existing regional presence and is expected to result in significant synergies.
See “Operating and Financial Review – Significant Factors Affecting Results of Operations – Acquisition of Formata”.
Recent Developments In 2008, X5 signed an agreement with a group of third party private investors to allow these parties to launch small convenience stores across the Moscow and St. Petersburg regions. X5 has also agreed to provide certain of its IT systems for the use of the convenience stores. The agreement provides that X5 will initially hold a 40% interest in the joint venture, with an option to purchase a further 30% in 2011 and the remainder in 2013. In addition, X5 holds an option to sell its interest in the joint venture to existing partners during the period from 2011 to 2013.
Regulatory Matters X5 is subject to certain Russian legislation governing the sale of products. Under the relevant legislation, X5 is obliged to sell goods of reasonable quality and to provide consumers with certain information regarding the goods and the manufacturers of those goods. X5 is also subject to specific requirements regarding the hygiene, packaging, storage, transportation and sale of goods, together with regulations governing the destruction of poor quality or unsafe food products. Food products that do not conform to established sanitary rules must be withdrawn from production and sale immediately. In addition, X5 is subject to Russian legislation requiring it to obtain licences for the retail sale of alcohol beverages from regional authorities.
79 The regulatory environment for retailers in Russia is relatively light compared to their counterparts in other European countries. Russian regulatory authorities do not currently impose any material restrictions on the location or operation of retail outlets. While various regulatory bodies seek to impose certain restrictions, mainly related to alcohol and tobacco sales, from time to time, such restrictions are usually lifted shortly afterwards.
X5’s operations can be positively, as well as negatively, affected by indirect regulation. For example, legislation introduced in 2007 has restricted the number of non-Russian citizens that are able to trade in open air markets. This law has resulted in a dramatic reduction of sales in open air markets and has redirected consumer traffic to organised retail chains, such as X5’s soft discount, supermarket and hypermarket stores.
See “Risk Factors – Legislative and Legal Risks – The focus by certain Russian regulatory authorities on the retail industry and large retailers may have a material adverse effect on X5’s business, financial condition and operating results”.
Marketing and Customers Marketing and Promotion The objectives of X5’s marketing and advertising activities are to attract and retain customers, improve brand awareness, engender customer trust in the quality of the products that X5 sells and to promote its private label goods.
X5 offers regular promotions to, and special discounts for, its customers. Customers of soft discount stores benefit from a Pyaterochka loyalty card called “Favourite Customer” which allows them to receive a discount of between 5% and 10% off the price of a certain number of products. Regular promotions are carried out on a weekly basis for soft discount stores and once every two weeks for supermarket and hypermarket stores, with advertisements accompanying such promotions in the Russian mass media (including TV and press). Moreover, X5 arranges for ‘Mega Promo’ actions 2 to 3 times a year, offering a larger range of SKUs depending on format. During such promotions, X5 prices a number of products at prices that are equal to, or lower than, those of its closest competitor for that product.
In addition, in September 2007, X5 launched a pilot program in selected soft discount stores to promote eight SKUs twice a month at discount rates and to trial an offer of a 10% discount to any customer who purchased any of the 30 to 40 products available in box quantities at a soft discount store.
X5 considers that a key strategy for its supermarkets and hypermarkets is to ensure that the stores are seen as part of the communities in which they are established. Accordingly, X5’s supermarkets and hypermarkets run a number of programs, set out below, for particular members of their communities such as school children, veterans and children in need.
In August 2007, 160 of X5’s supermarkets and hypermarkets in 40 Russian cities launched their third annual “Perekrestok to Schools” (Perekrestok shkolam) program. Under this program, personal computers and interactive blackboards for classrooms were given to schools who scored the highest rating based on votes from Perekrestok customers. In January 2006, X5 donated a percentage of sales from private label goods in supermarkets and hypermarkets to Nezavisimost, a charity supporting handicapped children. In October 2006, X5 joined with Lifeline, a Russian charity assisting seriously ill children, in raising money for Lifeline’s activities. Fifty supermarkets and hypermarkets placed money boxes in store to collect donations for surgical operations needed by children who suffer from heart defects or brain damage.
Supermarkets and hypermarkets have also pursued in-store promotions over a number of years. The “Club Perekrestok” program was launched in several chosen supermarkets and hypermarkets in 2006 and subsequently extended to all supermarkets and hypermarkets from the beginning of 2007. The program is based on a cumulative bonus principle and replaces the former discount program at the supermarkets and hypermarkets. Under the program, bonus points are accrued for purchases made at supermarkets and hypermarkets. These bonus points can then be used to pay for future purchases made at supermarkets or hypermarkets. Points are earned for every purchase, and 10 points are the equivalent of 1 rouble. Additional bonus points are accumulated for purchases over 500 roubles made in the morning, purchases of private label brands, brands that are subject to special promotions and purchases made on the customer’s birthday. Moreover, once every two weeks, X5 carries out promotions for Club Perekrestok cardholders under which customers receive up to 10% of the amount spent purchasing certain products credited to their Club Perekrestok card. X5 plans to expand the Club Perekrestok program in the future to include select third party business partners, allowing customers to receive discounts from those third parties.
80 Since the launch of the Club Perekrestok program in 2006, X5 has issued approximately 500,000 cards to customers. In 2007, approximately 20% of all purchases in X5’s Moscow supermarket and hypermarket stores were made by Club Perekrestok cardholders.
In addition, in November 2006, X5 signed a contract with the Russian Football Union valid until mid-2012, under which X5 is the designated “Official Partner of the Russian National Football Team” and “General Partner of the Russian Football Union”. Under the agreement, X5 is entitled to advertise its brands during official games of the Russian Football Union held in Russia and to use its titles and the logo of the Russian Football Union on its products.
Customers X5 estimates there were approximately 605 million customer visits to its stores in 2007. Of this number, approximately 394 million customer visits were to soft discount stores, while approximately 211 million customer visits were to supermarkets or hypermarkets.
Real Estate and Development of New Stores Real Estate X5 both owns and leases land on which its stores are located. Decisions as to whether land is purchased or leased for new stores depends on a variety of factors, such as the price of the land, its location and the store format that is proposed to be built. As at 31 December 2007, X5 owned approximately 47% of its net selling space.
Initially, almost all of the X5’s soft discount stores operated on premises leased from third parties, which, in the view of X5, allowed the most efficient roll out of that format. However, in recent years, X5 has begun opening soft discount stores on its own premises and constructing its own purpose-built stores. Whilst X5 believes that, historically, the use of leased retail space has been less capital intensive and has required less time for store rollout, the use of its own and, in particular, purpose-built stores results in a more efficient use of retail space and leads to greater financial and operational security, affording higher revenue per square metre of retail space. To support its store construction programme, X5 acquired rights to acquire sites which it considers to be favourable to one or more of its store formats after engaging in customary due diligence on the site. X5 then holds the land sites until such time as construction can begin to build new stores. X5 intends that all real estate owned by it and its subsidiaries will gradually be transferred to two wholly-owned subsidiaries, Alpegru Retail Properties Limited (Cyprus) and CJSC X5 Nedvizhimost.
With respect to leased soft discount stores, X5’s current policy is to generally have lease terms of at least five years. As at 31 December 2007, there were 39 soft discount stores with unexpired lease terms of less than one year. Rents are usually re-calculated once every 12 months based on inflation related adjustments X5 believes that it has a good reputation as a tenant in both the Moscow and St. Petersburg areas which has allowed it to negotiate favourable lease terms and renew leases on expiry.
Due to the location of the X5’s supermarkets and hypermarkets in shopping centres, leasehold properties are more typical for these stores. As supermarkets and hypermarkets are an important driver in the number of customers in shopping centres, X5 believes it is able to negotiate favourable terms for its leases and renew leases on expiry because these stores draw customers into shopping centres. Store leases for supermarkets and hypermarkets are long term, with typical initial lease terms of eight to ten years (although some lease agreements have lease terms of up to 15 years). X5 has the right to terminate a lease unilaterally with three months’ notice with no penalty in approximately one-quarter of its lease contracts, thereby preserving operating and financial flexibility. Historically, supermarkets and hypermarkets have been subject to fixed rental terms, although real estate developers have more recently insisted upon variable rental terms linked to the store revenue ranging from 2.5% to 6%. Lease costs (per square metre of selling space) are lower in the Russian regions and Ukraine, as compared to Moscow and St. Petersburg.
To minimise its rental costs and provide its customers with complementary services, X5 also sublets some store spaces to third parties such as mobile phone operators, pharmacy kiosks, newsagents and florists, where space permits.
81 The table below shows the respective share of leased and owned net selling space in X5 as at 31 December 2007.
Owned net Leased net selling space selling space (as a percentage (as a percentage of the total of the total number number of By Region of stores) stores) Moscow ...... 58% 42% St. Petersburg ...... 36% 64% Other regions ...... 60% 40% Total for X5 ...... 53% 47%
Leased net Owned net selling space selling space (as a percentage (as a percentage of the total of the total number of number of By Format stores) stores) Soft discount stores ...... 51% 49% Supermarkets ...... 62% 38% Hypermarkets ...... 48% 52% Total for X5 ...... 53% 47%
Development of New Stores As part of its expansion strategy, X5 actively sources new land sites on which to build new stores. X5 pursues this form of organic growth for all three formats which it operates.
The size and location of potential new stores are sourced by dedicated regional expansion teams. Investment decisions are determined centrally. For soft discount stores, location and convenience are the key factors in selecting land sites and premises for new stores. In addition to the areas which soft discount stores are traditionally located (see “X5 Operations and Stores – Soft Discount Stores” above), X5 also considers the following in selecting sites for new soft discount stores: the number of residents in the adjacent area and proximity to, and visibility from, roads, easy access by vehicles (including lorries) and, in respect of “greenfield” sites being acquired for the development of newly built stores, the shape of the site (which must be consistent with the standardised X5’s soft discount store designs – see below) and availability of suitable property rights, such as ownership or a leasehold with a term of at least five years.
Potential new store locations for X5’s supermarkets and hypermarkets are considered by reference to a set of criteria, including location and suitability in terms of size and layout, customer demographics and the level of competition in each potential store’s surrounding area. X5’s supermarkets and hypermarkets are predominantly located in densely populated residential districts, close to underground stations, close to or in major shopping centres, adjacent to major traffic intersections or thoroughfares, or adjacent to major roads.
X5’s development teams have produced standardised designs for the construction of new soft discount stores, supermarkets and hypermarkets. X5 believes that this significantly reduces the design, construction and maintenance costs. The store designs for soft discount stores are also made available to franchisees.
Suppliers and Logistics Suppliers A significant portion of X5’s revenue is generated by a relatively limited number of products, which further strengthens its purchasing power with suppliers. Supplier credit is relatively limited in Russia, partly because access to financing is limited for suppliers themselves, many of which are small companies. X5 receives various types of allowances from suppliers in the form of listing fees, volume discounts and other forms of payment that effectively reduce the cost of goods purchased from the supplier or the cost of promotional activities conducted by X5 for the benefit of the supplier. Bonuses received from suppliers are recorded as a reduction in the price paid for the products and are recognised in cost of sales as the related inventory is sold. X5 is working to consolidate its position with suppliers to secure further price discounts and other favourable terms (such as supplier rebates and bonuses repayable by its suppliers).
82 More than half of X5’s supplies are negotiated through a central department to optimise buying benefits; the remainder, mainly consisting of local produce, is sourced from the surrounding areas.
At 31 December 2007, X5 was supplied by approximately 4,000 suppliers. In the year ended 31 December 2007, products acquired from X5’s ten largest suppliers accounted for approximately 10% of X5’s total purchases.
Distribution and Logistics X5 was the first Russian food retail company to open a self-operated distribution centre in Russia. X5 continues to improve the efficiency of its warehousing and distribution arrangements by increasing the volume of deliveries to its stores from its distribution centres in Moscow, St. Petersburg and other regions as a means of improving centralisation, as opposed to direct deliveries from its suppliers.
When suppliers deliver their goods to X5 distribution centres (and not directly to stores), they pay X5 compensation for logistics services (in the form of a rebate offsetting the supply price or as a payment to X5). This compensation is partially offset by increased costs associated with the maintenance of the distribution centres and the delivery of goods from the distribution centres to the stores.
As at 31 December 2007, X5 operated ten distribution centres located in the European part of Russian and the Urals with a total storage space of 143,700 square metres including four distribution centres in Moscow with total storage space of 88,000 square metres, three distribution centres in St. Petersburg with a total storage space of 37,200 square metres, one distribution centre in Nizhniy Novgorod (13,500 square metres), one centre in Chelyabinsk and one centre in Yekaterinburg (2,500 square metres each). As at 31 December 2006, X5 operated five distribution centres located in the European part of Russian and the Urals with a total storage space of 65,600 square metres, including three distribution centres in Moscow with total storage space of 42,100 square metres and one distribution centre in each of St. Petersburg and Yekaterinburg with total storage space of 21,000 square metres and 2,500 square metres, respectively. At the end of 2007, deliveries via X5’s distribution centres represented approximately 47% of all products delivered to X5’s stores. X5 also owns most of the trucks used to transport goods between distribution centres and stores.
X5 continues to invest in its distribution infrastructure development and intends to operate distribution centres with sufficient storage capacity in every Russian region of its store locations within five years. Improved warehousing and distribution is aimed at enhancing X5 operational efficiency as it ensures improved labour productivity, more efficient store area utilisation and decrease in inventories, leading to working capital improvement.
X5 aims to increase the levels of products distributed through distribution centres to 90% for soft discount stores, 85% for supermarkets and 75% for hypermarkets in the long term.
Supply Chain Management X5 has established a supply chain management department to co-ordinate and control all the stages of logistics chain from supplier to store. The department is responsible for logistical support for the supply process, including direct imports. The department takes a systematic approach to managing the movement and storage of products in distribution centres.
Franchise Operations X5 grants franchises to independent operators as a cost effective method to test new markets and gain an understanding of local consumer preferences. Franchisees are provided with access to X5’s IT system and allowed to use a defined brand name, such as “Pyaterochka” or “Perekrestok”. X5 monitors the performance of its franchisees with the intention of acquiring those stores which are consistently profitable or which show potential for profit.
As at 31 December 2007, 680 Pyaterochka branded soft discount stores operated under franchise agreements across Russia and Kazakhstan and eight Perekrestok branded supermarkets were operated in the Moscow region by franchisees. However, X5 does not intend to pursue expansion of its franchise operations in the future, except in limited circumstances to mitigate risks where X5 wishes to enter a new region.
83 The typical franchise agreement for a soft discount store has a term of approximately ten years, in which X5 agrees to grant the franchisee rights to use certain trademarks, IT systems, business processes and access to know-how. X5 trains the key personnel of its franchises at its employee training centre in St. Petersburg and sends a launch team to assist with the start up of operations and provide advisory assistance until their operations are well established. Each franchisee agrees to make an upfront, one time payment which, for most agreements entered into in 2007, varied between US$0.5 million and US$1 million, and to pay to X5 an average annual fee based on its turnover in the amount of 1.4% to 1.9% of revenue.
Although historical franchise agreements did not provide X5 with an express contractual right to purchase equity interests in the franchisee, X5 is currently in discussions with several of its existing franchisees with a view to acquiring such interests. The acquisition of 40 soft discount stores in Chelyabinsk from a former franchisee in 2007 was the first such acquisition (see “History and Development – Recent Acquisitions and Proposed Acquisition of Formata” above). X5 has also entered into a joint venture agreement, call option agreements and partnership agreements with 3 franchisees, who together, operated 85 soft discount stores as at 31 December 2007, which give X5 a right to acquire a 26% interest in such franchisees in certain circumstances.
X5 has not traditionally pursued an active franchising strategy for supermarkets and hypermarkets. As at 31 December 2007, there were eight stores operating under the Perekrestok brand as franchisees. All Perekrestok franchisees benefit from the use of X5 IT systems, infrastructure and purchasing arrangements.
IP Rights and Key Trademarks Under the laws of Russia, the main market in which X5 operates, the right to use a trademark is acquired upon the trademark’s registration with the Federal Service for Intellectual Property, Patents and Trademarks (the “Rospatent”). X5 or its wholly owned subsidiaries hold the “Pyaterochka” in Cyrillic trademark and the graphic logo “5” trademark in Russia. X5, through its subsidiaries, LLC Agrotorg and CJSC X5 Nedvizhimost, also owns the “Pyaterochka” trademark in Kazakhstan and Belarus, respectively and the “Pyaterochka” trademark and the graphic logo “5” in the Ukraine through its subsidiary, LLC Agrotorg, and has filed several applications for registration of trademarks with the Kazakh intellectual property rights authority. An application for the registration of the “X5 Retail Group” trademark is currently pending before Rospatent.
In addition, X5 owns a number of trademarks relating to the “Perekrestok” name, including 3 Ukranian trademark registrations. X5 also owns several domain names, including perekriostok.ru, perekrestok.ru, perekrestok.com, x5.ru and e5.ru.
X5 actively uses “umbrella trademarks” and characteristic designs covering lines of products sold at its stores, rather than individual products, to reduce the time and costs involved in trademark registration.
Employees The following table sets out the number of employees in X5 in 2007, 2006 and 2005 employed in certain segments of the business. These numbers do not include any staff providing services to X5 who were employed by third parties.
Number of X5 employees engaged as at Business Activity 31 December 2007 2006 2005 Store personnel ...... 37,126 31,151 12,166 Logistics ...... 3,590 1,241 509 Production ...... 248 261 252 Headquarters ...... 3,128 2,288 944 Total ...... 44,092 34,941 13,871
As X5 moves forward to greater centralisation of supplier, distribution and pricing activities, a reduction in the number of products ordered (see “Strategy – Further Improve Operational Performance” above) and greater automation of processes in stores, the number and range of staff required in each store will decrease. However, this will be offset to some extent by the creation of specialised departments to manage and provide support for each of the store formats. As a result of implementation of its strategy, X5 expects a slight increase in the number of employees at its head office due to the need for staff to manage its hypermarket format. X5 is committed to recruiting and retaining highly skilled personnel, and to promoting from within whenever possible. On 1 August
84 2007, X5 began a programme for the development and promotion of talented managers. X5 intends to continue developing and expanding this programme to retain talented managers within X5 and plans, by the end of 2008, to implement new measures to evaluate store manager performance by reference to their store turnover ratio and like-for-like results, set new salary benchmarks to determine salaries for basic personnel at market rates and institute new packages comprising a range of benefits such as parking, meals and medical insurance.
To the best of X5’s knowledge, none of its employees belong to trade unions, labour or workers’ syndicates and there are no collective bargaining agreements between of X5 and their employees.
Competition X5 competes with both traditional and modern retail operators on price, but also competes with modern retailers on the basis of convenience, presentation and additional benefits such as loyalty cards which traditional retailers do not offer. See “Food Retail Industry – Competitive Environment”.
85 MANAGEMENT AND CORPORATE GOVERNANCE
Supervisory Board In the two-tier structure under Dutch law, the Supervisory Board is responsible for advising and supervising the Management Board and the general course of affairs in X5 and its business. In performing its duties, the Supervisory Board is required to act in the interests of X5 and its business. It is empowered to make a binding recommendation to the General Meeting of Shareholders of persons to be appointed as members of the Supervisory Board or the Management Board. Major business decisions require the approval of the Supervisory Board. The Supervisory Board also supervises the structure and management of systems of internal controls as well as the financial reporting process. It determines the remuneration of the individual members of the Management Board within the remuneration policy adopted by the General Meeting of Shareholders. While retaining overall responsibility, the Supervisory Board assigns certain tasks to its five permanent committees (see “Supervisory Board Committees” below for further details). The Supervisory Board meets at least four times per year.
The Supervisory Board currently consists of six members. The table below shows the current members of X5’s Supervisory Board and their terms of appointment. The business address for each member of the Supervisory Board is Prins Bernhardplein 200, 1097 JB, Amsterdam, The Netherlands.
Year Year of End of Current of Initial Term of Name Birth Position Appointment Appointment Mr. Hervé Defforey ...... 1950 Chairman 2006 2010 Mr. Mikhail Fridman ...... 1964 Member 2006 2009 Mr. Alexander Savin ...... 1969 Member 2006 2009 Mr. David Gould ...... 1969 Member 2006 2010 Mr. Vladimir Ashurkov ...... 1972 Member 2006 2010 Mr. Carlos Criado-Pérez Trefault ...... 1952 Member 2007 2011
On 21 April 2008, Mr. Andrei Rogachev resigned from the Supervisory Board with effect from 21 April 2008. On 22 April 2008, Mrs. Tatiana Franus resigned from the Supervisory Board with effect from 23 April 2008. Neither Mr. Rogachev nor Mrs. Franus participated in the meeting of the Supervisory Board of 21 April 2008, at which meeting the Supervisory Board resolved on matters relating to the Offering.
Hervé Defforey Mr. Defforey, a French citizen, is a partner of GRP Partners, London and Los Angeles. He heads GRP Partners’ European venture capital activities and serves on the boards of the following companies: IFCO Systems N.V. and Ulta, Corp. Mr. Defforey formerly held positions at Carrefour, S.A. (Paris), Azucarera EBRO S.A. (Madrid), BMW A.G. (Munich) and graduated from University of St Gallen, Switzerland with a degree in Business Administration.
Mikhail Fridman Mr. Fridman, a Russian citizen, serves as Chairman of the Supervisory Board of Alfa Group and is one of the principal founders of the Alfa Group Consortium. He also serves as the Chairman of the Board of Directors of TNK-BP and is a member of the Board of Directors of Alfa-Bank and VimpleCom. He is also a member of the International Advisory Board of the Council of Foreign Relations (USA). Mr. Fridman graduated from the Moscow Institute of Steel and Alloys.
Alexander Savin Mr. Savin, a Russian citizen, serves as Managing Director of A1 Group. His main non-executive/ancillary positions include member of the Supervisory Board of Alfa Group Consortium and member of the A1 Group Advisory Committee. Mr. Savin formerly supervised direct investments in the energy sector at Renaissance Capital Group and has had experience as a strategic consultant at Bain & Company in Moscow, London and Boston. Mr. Savin graduated from the Moscow State University with a degree in Economic Geography and Harvard Business School with an MBA.
86 David Gould
Mr. Gould, an American citizen, serves as Deputy Director for Corporate Development Finance and Control at Alfa Group Consortium. He also serves as member of the Board of Directors of Alfa Finance Holdings SA. Mr. Gould formerly held positions at PricewaterhouseCoopers and graduated from Colgate University with a Bachelor of Geography and Economics and a MBA-MS in Business and Accounting from Northeastern University. He qualified as a Certified Public Accountant in 1992 and a Chartered Financial Analyst in 1999.
Vladimir Ashurkov
Mr. Ashurkov, a Russian citizen, serves as Director of Group Portfolio Management and Control in Alfa Group Consortium. His main non-executive/ancillary positions include member of the A1 Group Advisory Committee and member of the Russian Technologies Advisory Committee. Prior to joining Alfa Group, Mr. Ashurkov served as Vice President of Strategic Development in Industrial Investors Group (which owns the controlling stake in Far East Shipping Company) and gained experience in other transport and logistics companies and investment banks. Mr. Ashurkov graduated from Moscow Institute of Physics and Technology with a Bachelor of Science (Physics) and from the Wharton School, University of Pennsylvania, with a Master of Business Administration.
Carlos Criado-Pérez Trefault
Mr. Criado-Pérez Trefault, an Argentine citizen residing in Spain, serves as the Executive Chairman of Dinosol Supermercados and as member of Permira UK Advisory Board. He is also an adviser to Marks and Spencers on international expansion, adviser to the CEO of Marks and Spencers and senior adviser to UBS Bank. He has held a number of positions in various companies such as SHV Makro, Wal-Mart International and Safeway Plc in the past. Mr. Carlos Criado-Pérez Trefault graduated from Darden School Management Course, University of Virginia.
Management Board
Pursuant to the Articles, the Management Board is responsible for X5’s overall management. In addition, the Management Board also has responsibility for achieving the aims, strategy and policy and results of X5, managing the risks associated with the activities of X5, ensuring proper financing and establishing and maintaining disclosure controls and procedures which ensure that all material financial information is provided to the Management Board.
The Management Board of X5 currently consists of three members. The table below shows the current members of X5’s Management Board and their terms of appointment. The business address for each member of the Management Board is Prins Bernhardplein 200, 1097 JB, Amsterdam, The Netherlands.
Year End of Current of Year of Initial Term of Name Birth Position Appointment Appointment Mr. Lev Khasis ...... 1966 Chief Executive Officer, 2006 2010 Chairman of Management Board Mr. Evgeny Kornilov ...... 1969 Chief Financial Officer 2008 2012 Mr. Frank Lhoëst ...... 1962 Corporate Secretary 2007 2011
Lev Khasis
Mr. Khasis is the former Chairman of Perekrestok Supervisory Board and a founding member of Investment Company Fosbourne, which invests in various businesses, including retail businesses in Russia. In addition to his activities at Perekrestok, Mr. Khasis has held a number of senior board and management positions including Chairman of the Board of OJSC Trade House GUM, Chairman of the Board of OJSC Trade House TsUM and Chief Executive Officer of OJSC Samara Trading House. Mr. Khasis is an experienced businessman in Russia and received a number of public awards including 2004 Businessman of the Year and 2003 Person of the Year – in the nomination Head of Retail Business.
87 Mr. Khasis graduated from the Aircraft Construction Faculty of the Samara Aircraft University, from the Banking Faculty of the Financial Academy of the Government of the Russian Federation and from the Law Faculty of the University of the Interior Ministry of the Russian Federation and holds a PhD in Law and a PhD in Technology.
Evgeny Kornilov Mr. Kornilov was appointed Chief Financial Officer of X5 on 18 January 2008. Mr. Kornilov was initially appointed as the Chief Financial Officer of Perekrestok in August 2006 and became the Deputy Chief Financial Officer of X5 in November 2006. He graduated from the Moscow Foreign Affairs University with a degree in Economics, International Trade and Foreign Languages. Prior to joining X5, Mr. Kornilov was the Chief Financial Officer and Chief Controller of SUN Interbrew in Russia and worked in the Management Consultancy and Audit Services practice of PricewaterhouseCoopers in Russia between 1992 and 1999.
Frank Lhoëst Mr. Lhoëst was appointed a Director B and Corporate Secretary of X5 on 5 November 2007. Since 1991, Mr Lhoëst has held several positions at Fortis Intertrust, from account manager in The Netherlands Antilles to founder and director of the Fortis Intertrust office in Vienna, Austria. In 2002, Mr. Lhoëst established the Intellectual Property Group of Fortis Intertrust in The Netherlands. Mr. Lhoëst graduated from the Leiden University with a degree in Law.
Other Administrative, Management or Supervisory Board Memberships or Partnerships Save as set out below, the members of the Supervisory Board and Management Board have not been members of administrative, management or supervisory bodies in any other company (other than subsidiaries of X5) or partners in any partnership at any time in the last five years prior to the date of this Prospectus:
Current administrative, Former administrative, management management or supervisory body or supervisory body memberships or Name memberships or partnerships(1) partnerships(1) Hervé Defforey ...... GRPPartners Carrefour S.A. Member of the Board of Directors of Azucarera EBRO S.A. (Madrid) Prepay Technologies BMW A.G. Member of the Board of Directors of IFCO Systems N.V. Member of the Board of Directors of Ulta, Corp. Member of the Board of Directors of Kyriba SAS Mikhail Fridman ...... Chairman of the Supervisory Board Member of the Supervisory Board of of Alfa Group; Directors of Crown Commodities; Member of the Board of Directors of Member of the Supervisory Board of Alfa-Bank; Directors of Alfa Estate; Chairman of the Board of Directors of TNK-BP; Member of the Board of Directors of VimpelCom; Member of the International Advisory Board of the Council on Foreign Relations (USA); Member of A1 Group Advisory Committee; Member of Altimo Advisory Committee; Chairman of the Board of Directors of Alfa Finance Holdings S.A.
88 Current administrative, Former administrative, management management or supervisory body or supervisory body memberships or Name memberships or partnerships(1) partnerships(1) Alexander Savin ...... Member of the Supervisory Board of Member of the Board of Directors of Alfa Group; OJSC Kuzbassenergo; Member of the A1 Group Advisory Director of Investment Banking in Committee; Renaissance Capital; Managing Director of Al Group Member of the Board of Directors of subholding OJSC Mosenergo Member of the Supervisory Board of Independence Holdings Managing Director of Alfa Eco Group Subholding David Gould ...... Deputy Director for Corporate Member of the Board of Directors of Development Finance and Control, Alfa-Bank. Alfa Group; Member of the Board of Directors of Alfa Finance Holdings S.A.; Member of the Audit Committee of Alfa Finance Holdings S.A. Vladimir Ashurkov ...... Director for Group Portfolio Vice President of Strategic Management and Control, Alfa Development in Industrial Investors Group Group Member of the A1 Group Advisory Director of the Strategy Committee Committee of the Far Eastern Shipping Member of the Russian Company Technologies Advisory Committee General Director of Transcare Consultancy Carlos Criado-Pérez Trefault . . . Non-executive Chairman of Dinosol Executive Chairman of Dinosol Supermercados Supermercados Member of the Board of Directors of Chief Executive Officer of Safeway Permira UK Advisory Board plc Senior advisor to Marks and Spencers Senior advisor to UBS Bank Non-executive Chairman of Las Bodegas Lev Khasis ...... Member of the Consumer Market Member of the Supervisory Board of Committee of the Trade Industrial Alfa Group; Chamber of the Russian Federation; Member of the Board of Directors of Member of the Board of Directors of CJSC Betanol Rus; LLC DailyFoods; Member of the Board of Directors of Member of the Board of Directors of LLC Lankor; LLC Stolichnaya Torgovaya Member of the Board of Directors of Companiya; CJSC TDS Logistic; Member of the Board of Directors of Chairman of the Board of Directors CJSC TVK Aviapark; of OJSC Trade House Gum; Member of the Board of Directors of Chairman of Board of Directors of OJSC Aviation Company OJSC Trade House TsUM; TRANSAERO Member of the Board of Directors of CJSC Trade House Perekrestok. Director of Perekrestok Holdings Limited Evgeny Kornilov ...... None Chief Financial Officer of SUN Interbrew in Russia Chief Controller of SUN Interbrew in Russia
89 Current administrative, Former administrative, management management or supervisory body or supervisory body memberships or Name memberships or partnerships(1) partnerships(1) Frank Lhoëst ...... MemberoftheBoardofDirectorsof: Member of the Board of Directors Estview B.V. of: Adhesive Technology Intercross Investments B.V. (International) Licensing B.V. Lopez-Cambil International Cardis Enterprises International B.V. Licensing B.V. Cinram Europe B.V. El Rocio B.V. Coöperatie Cinram Netherlands U.V. Forest Finance B.V. Dome Technology B.V. Marsu B.V. EUCO Holdings B.V. Fintage Licensing B.V. i-CAP Netherlands B.V Komag Technology (N) B.V. Lakei B.V. Lattice Systems B.V. Magistrate Holding B.V MGA Entertainment International Holdings Coöperatief U.A. MGA Entertainment (Netherlands) B.V. European Sports Merchandising B.V. MGA Entertainment International B.V. Mida Systems Enterprises B.V. Movie Right Exploitation Company B.V. Rib Loc Technologies B.V. Tecnocap International B.V. Tecnocap Patents B.V. Theta Films B.V. TyC International B.V. Yuse B.V. Zarine B.V. Nando’s Resources Int’l B.V. Caucasus Capital Fund N.V. Senior Manager Fortis Intertrust
(1) This table includes references to membership of the Supervisory Board of Alfa Group, Russian Technologies Advisory Committee, A1 Group Advisory Committee and Altimo Advisory Committee. These are references to memberships of informal supervisory bodies which review major and strategic decisions of the company concerned but which are not constituted as a legal board.
Proceedings Against X5’s Management At the date of this Prospectus, no member of X5’s Management Board or Supervisory Board for at least the previous five years: (a) has had any convictions in relation to fraudulent offences; (b) has held an executive function in the form of a senior manager or a member of the administrative, management or supervisory bodies, of any company at the time of or preceding any bankruptcy, receivership or liquidation; or (c) has been subject to any official public incrimination and/or sanction by any statutory or regulatory authority (including any designated professional body) nor has ever been disqualified by a court from acting as a member of the administrative, management or supervisory bodies of a company or from acting in the management or conduct of the affairs of any company.
90 Remuneration of Directors and Management In 2007, members of the Supervisory Board and Management Board were paid total compensation of US$8,216,771, in addition to options worth US$33,111,127.
The following table sets out individual remuneration paid to members of the Supervisory Board in 2007:
Share Based Base Salary Bonus Payments Name (in US$) (in US$) (in US$) Period of Service in 2007 Mr. Hervé Defforey ...... 175,668 Nil 374,729 1 January – 31 December Mr. Andrei Rogachev(1) ...... 73,195 Nil Nil 1 January – 31 December Mrs. Tatiana Franus(2) ...... 73,195 Nil Nil 1 January – 31 December Mr. Mikhail Fridman ...... 73,195 Nil Nil 1 January – 31 December Mr. Alexander Savin ...... 73,195 Nil Nil 1 January – 31 December Mr. David Gould ...... 109,793 Nil Nil 1 January – 31 December Mr. Vladimir Ashurkov ...... 109,793 Nil Nil 1 January – 31 December Mr. Alexander Kosiyanenko(3) ...... 109,793 Nil Nil 1 January – 31 December Mr. Carlos Criado-Pérez Trefaul ...... 29,278 Nil 159,999 5 November – 31 December Total ...... 827,105 Nil 534,728
(1) Mr. Rogachev resigned from the Supervisory Board with effect from 21 April 2008. (2) Mrs. Franus resigned from the Supervisory Board with effect from 23 April 2008. (3) Mr. Kosiyanenko resigned from the Supervisory Board with effect from 13 February 2008.
The following sets out individual remuneration paid to members of the Management Board in 2007.
Base Salary Bonus Options Name (in US$) (in US$) (in US$) Period of Service in 2007 Mr. Lev Khasis ...... 1,123,025 2,750,000 23,873,097 1 January – 31 December Mr. Vitaliy Podolskiy(1) ...... 755,772 800,000 4,500,000 1 January – 31 December Mr. Wim Rieff ...... 29,277 Nil Nil 1 January – 5 November Mr. Andrei Gusev ...... 294,819 409,315 3,948,618 1 January – 15 June Mr. Pawel Musial ...... 198,000 Nil Nil 1 January – 15 June Mr. Oleg Vysotsky ...... 251,902 341,096 181,917 1 January – 15 June Ms. Angelika Li ...... 251,902 122,249 72,767 1 January – 15 June Mr. Frank Lhoëst ...... 48,309 14,000 Nil 5 November – 31 December Total ...... 2,953,006 4,436,660 32,576,399
(1) Mr. Podolskiy resigned from the Management Board on 18 January 2008.
X5 has not set aside any amounts for pensions and retirement benefits for members of the Management and Supervisory Boards.
Certain members of the Management Board and other senior management have entered into arrangements with X5 that provide for a cash payment to be made to those persons on termination of their employment with X5. In each case, the cash amount that is agreed and paid is between six and twelve months’ salary, calculated at the time of termination, for that person. The arrangements are entered into at the time the member accepts his or her position with X5. Such arrangements are reviewed by the Remuneration Committee and approved by the Supervisory Board.
Interests and Conflicts of Interests of Directors and Management At the Annual General Meeting held on 15 June 2007 and the Extraordinary General Meeting held on 5 November 2007, respectively, the shareholders approved the granting of options on GDRs of X5 to the Chairman of the Supervisory Board, Mr. Hervé Defforey and the independent board member, Mr. Criado-Pérez Trefault, respectively. Pursuant to the resolutions, 10,000 options were granted in June 2007 to Mr. Defforey and vested immediately; 20,000 options were granted in June 2007 and will vest in May 2008; 20,000 options will be granted in May 2008 and will vest in May 2009; and a final tranche of 30,000 options will be granted in May 2009 and will vest in May 2010. In addition, 60,000 options on X5 GDRs were granted in three tranches of 20,000 GDRs each to Mr. Criado-Pérez Trefault, the first tranche to vest in May 2008.
The exercise price of the first tranche of options granted to Mr. Hervé Defforey will be US$15.96 per GDR (the share price at the date of completion of the Acquisition on 18 May 2006 adjusted pursuant to a resolution of the Supervisory Board in connection with the dilutive effect resulting from the Offering). The exercise price of
91 the second tranche granted to Mr. Defforey and the first tranche to Mr. Criado-Pérez Trefault will be equal to US$28.58 per GDR (the average market value of the GDRs during 30 days prior to 18 May 2007 adjusted pursuant to a resolution of the Supervisory Board in connection with the dilutive effect resulting from the Offering). The exercise price of the final two option tranches for Mr. Defforey and Mr. Criado-Pérez Trefault will equal to the average market value of the GDRs during 30 days prior to the granting date of each of these options. The options granted to Mr. Hervé Defforey and Mr. Criado-Pérez Trefault are to be funded from the Employee Stock Option Program and will count towards its limit.
Certain members of the Supervisory Board, including Mr. Fridman and Mr. Gould also hold beneficial interests in X5 (see “Principal Shareholdings” for more details).
In addition, certain members of the Supervisory Board, including Mr. Fridman and Mr. Gould, are affiliated with the Alfa Group Consortium. The Alfa Group Consortium is the ultimate parent company of Cesaro Holdings Limited and Luckyworth Limited, who together control 43.05% of X5’s GDRs. If the interests of these GDR holders conflict with the other GDR holders, or if significant holders of GDRs choose to cause X5’s business to pursue strategic objectives that conflict with the interests of the other GDR holders, those other GDR holders could be disadvantaged.
Except as disclosed in this section, there are no potential conflicts of interest between the duties to X5 of the members of the Supervisory and Management Boards and their private interests and/or other duties.
Dutch Corporate Governance Code
On 9 December 2003, a committee commissioned by the Dutch government (Commissie Tabaksblat) published the Dutch Corporate Governance Code. The provisions of the Dutch Corporate Governance Code took effect on 1 January 2004. Some of the Dutch Corporate Governance Code’s best practice provisions have been incorporated into Dutch law, including the obligation for companies to discuss in their annual report in detail the items on which they do not comply with the Dutch Corporate Governance Code, and to explain the reasons for not doing so. Any substantial changes to the corporate governance structure of a company or any substantial changes to compliance with the Dutch Corporate Governance Code must be discussed at the annual general meeting of shareholders. The Dutch Corporate Governance Code provides that if a company’s general meeting of shareholders approves the corporate governance structure of a company and the company’s explanations for any deviations therefrom, the company will be deemed to comply with the Dutch Corporate Governance Code.
X5 is subject to the Dutch Corporate Governance Code. For the reasons set out below, X5 does not comply with the following best practice provisions of the Dutch Corporate Governance Code:
Provision II.2.2: Grant of Unconditional Options to Members of the Management Board
Pursuant to the Dutch Corporate Governance Code, if a company grants unconditional options to its members of the management board, such grant should be subject to certain performance criteria and the options should not be exercisable within three years following the date of grant.
On 15 June 2007, the General Meeting of Shareholders approved the adoption of X5’s Employee Stock Option Plan (“ESOP”). Options will be granted in four tranches, issued over a period of four years with immediate vesting for the first tranche, an 11 month vesting period for the second grant and a one year vesting period for the third and fourth grants.
While the ESOP is considered a long-term compensation for its participants, and the grant of options will be linked to pre-determined, measurable performance based targets, X5 acknowledges that in terms of vesting period the ESOP deviates from the Dutch Corporate Governance Code. However, since X5’s operational activities are mainly based in the Russian Federation, Ukraine and Kazakhstan and the grant of unconditional options with a shorter than three year vesting period is customary in these markets, it is important for X5 to deviate on this point from the Dutch Corporate Governance Code in order to attract and reward the best professionals in these markets.
92 Provision II.2.11: Immediate Publication of Main Elements of Contracts with Members of the Management Board Pursuant to the Dutch Corporate Governance Code, the main elements of contracts with members of the management board should be made public immediately following the entering into of such a contract.
X5 acknowledges that on this point it has deviated from the Dutch Corporate Governance Code. However, the main elements of the contracts with the members of the Management Board will be included in the 2007 Remuneration Report, which will be made available on X5’s website upon publication of the Annual Report for 2007.
Provision III.2.1: Independence of Members of the Supervisory Board Pursuant to the Dutch Corporate Governance Code, all, but one, of the members of the Supervisory Board should be independent.
All members of the Supervisory Board, with the exception of two (that is, the chairman, Mr. Hervé Defforey and Mr. Carlos Criado-Pérez Trefault), (i) have a substantial shareholder interest in X5 or (ii) are related to companies that are owned or controlled by companies that ultimately hold 10% or more of the Shares or GDRs in X5. These members of the Supervisory Board are, therefore, not considered to be independent within the meaning of the Dutch Corporate Governance Code. Mr. Hervé Defforey and Mr. Carlos Criado-Pérez Trefault are independent with the meaning of the Dutch Corporate Governance Code.
X5 believes that the non-independent members of the Supervisory Board have an in-depth knowledge of the food-retail industry and the markets in which X5 operates that is of particular advantage to X5 and its stakeholders.
Finally, X5 intends to nominate a third independent member of the Supervisory Board for appointment by the General Meeting of Shareholders at the annual general meeting of shareholders to be held on 16 June 2008, to fill the vacancy created through the resignation of Mr. Alexander Kosiyanenko on 13 February 2008.
Provision III.7.1: No Grant of Shares and Options to Members of the Supervisory Board Pursuant to the Dutch Corporate Governance Code, members of the supervisory board should not be granted any shares and/or rights to subscribe for shares as remuneration for their membership of the supervisory board.
On 15 June 2007 and 5 November 2007, the General Meeting of Shareholders approved that Mr. Hervé Defforey and Mr. Carlos Criado-Pérez Trefault, as members of the Supervisory Board, were granted options under the ESOP. X5 acknowledges that such grant deviates from the Dutch Corporate Governance Code. However, in order to attract and reward experienced individuals with a proven track record in the food retail industry, X5 believes it is necessary to grant stock options also to certain members of the Supervisory Board.
Supervisory Board Committees X5’s Supervisory Board has formed five committees: (i) an Audit Committee, (ii) a Remuneration Committee, (iii) a Selection and Appointment Committee, (iv) a Related Party Committee and (v) a Strategy Committee from among its members. The committees operate pursuant to terms of reference established by the Supervisory Board, in accordance with the Dutch Corporate Governance Code.
Audit Committee. The Audit Committee assists the Supervisory Board in fulfilling its supervision and monitoring responsibilities in respect of the integrity of X5’s financial statements, system of internal business control and risk management, financing and finance related strategies and tax planning. It furthermore advises in respect of the appointment of the auditor and its remuneration.
The Audit Committee is composed of at least two members, at least one of whom must be independent within the meaning of the Dutch Corporate Governance Code. The members are appointed by the Supervisory Board. The Audit Committee makes decisions by a simple majority with no member having a casting vote. The Audit Committee is required to meet at least once a year and whenever one or more of its members request a meeting. In 2007, the Audit Committee met five times.
Remuneration Committee. The Remuneration Committee recommends the remuneration policy for the Management Board to be adopted by the General Meeting of Shareholders, prepares proposals to the Supervisory Board for remuneration of the individual members of the Management Board and advises the Management Board on the level and structure of compensation for other senior personnel.
93 The Remuneration Committee is composed of at least two members, at least one of whom must be independent within the meaning of the Dutch Corporate Governance Code. The members are appointed by the Supervisory Board. The Remuneration Committee makes decisions by a simple majority with no member having a casting vote. The Remuneration Committee is required to meet at least once a year and whenever one or more of its members request a meeting. In 2007, the Remuneration Committee met two times.
Selection and Appointment Committee. The Selection and Appointment Committee advises in respect of the selection and appointment of members of the Supervisory Board and the Management Board. At least annually the size and composition of the Supervisory Board and the Management Board and the functioning of the individual members is assessed by the Selection and Appointment Committee.
The Selection and Appointment Committee is composed of at least two members, at least one of whom must be independent within the meaning of the Dutch Corporate Governance Code. The members are appointed by the Supervisory Board. The Selection and Appointment Committee makes decisions by a simple majority with no member having a casting vote. The Selection and Appointment Committee is required to meet at least once a year and whenever one or more of its members request a meeting. In 2007, the Selection and Appointment Committee met two times.
Related Party Committee. The Related Party Committee advises the Supervisory Board on handling and deciding on reported potential conflicts of interests and any other related party transactions which are contemplated between X5, on the one hand, and any conflicted persons or entities, including but not limited to its shareholders, members of the Supervisory Board and members of the Management Board, on the other hand.
The Related Party Committee is composed of at least two members, at least one of whom must be independent within the meaning of the Dutch Corporate Governance Code. The members are appointed by the Supervisory Board. The Related Party Committee makes decisions by a simple majority with no member having a casting vote. The Related Party Committee is required to meet at least once a year and whenever one or more of its members request a meeting. In 2007, the Related Party Committee met two times.
Strategy Committee. The Strategy Committee advises in respect of the general strategy of X5, including, but not limited to, the future direction to be taken by X5 as a whole and each of its affiliated businesses, overall growth and development strategy, mergers and acquisitions and financing strategy.
The Strategy Committee is composed of at least two members, at least one of whom must be independent within the meaning of the Dutch Corporate Governance Code. The members are appointed by the Supervisory Board. The Strategy Committee makes decisions by a simple majority with no member having a casting vote. The Strategy Committee is required to meet at least once a year and whenever one or more of its members request a meeting. In 2007, the Strategy Committee met two times.
Selection & Audit Remuneration Appointment Related Party Strategy Name Committee Committee Committee Committee Committee
H. Defforey ...... Member Member Member Member Member V. Ashurkov ...... Chairman Chairman Chairman M. Fridman ...... D. Gould ...... Chairman A. Savin ...... Member Member Member C. C-P Trefault ...... Member Member Chairman Member
Employee Stock Option Plan The General Meeting of Shareholders held on 15 June 2007 approved the adoption of the X5 ESOP to grant options of X5’s current issued stock to any individual employed by a member of X5 at no cost. Under the X5 ESOP, 10,824,008 options for X5 GDRs may be issued and such GDRs may either be purchased on the market using financial resources provided by X5 or be additionally issued by X5. On 21 April 2008, the supervisory board of X5 resolved to seek approval from the General Meeting of Shareholders at the annual general meeting of shareholders, which is scheduled to be held on 16 June 2008, for an increase in the number of GDRs that may be granted under the X5 ESOP from 10,824,008 GDRs to 11,261,264 GDRs. Options will be granted in four tranches, each tranche amounting to 2,706,002 GDRs, issued over a period of four years with
94 immediate vesting for the first tranche, an 11 month vesting period for the second grant and a one year vesting period for the third and fourth grants. If the number of GDRs in respect of which options are granted in any tranche is less than one-quarter of the total authorised number of options under the X5 ESOP, the remaining number of options may be granted in a subsequent tranche. The first and second tranches will be deemed to have been issued on 15 June 2007. The third and fourth tranches will be issued on 19 May 2008 and 19 May 2009 respectively. X5 management currently intends that the X5 ESOP will be offered to approximately 180 employees of X5.
The exercise price of the first tranche of options is US$15.96 per GDR, the exercise price of the second tranche of options is US$28.58 per GDR, while the exercise price of the third and fourth tranches of options will be equal to the average market value of the GDRs during the 30 days prior to the date on which those options are granted. The granting of options will be linked to pre-determined, measurable targets that must be achieved by the employee participating in the X5 ESOP (a “Participant”).
If a Participant ceases his employment with X5 due to retirement or disability or he is dismissed for a reason other than gross misconduct or the commission of a criminal office or where the Participant holds a vested option on cessation of employment, the Participant may exercise his option within 3 months of the date of cessation. In the event of a Participant’s death, the Participant’s beneficiaries will receive a sum equal to the average market value of the GDR which is the subject of the option (calculated by reference to the volume weighted average price over the past 30 days) less the applicable exercise price of the option.
In the event of a change of control in the Participant’s employer or in X5, the Participant will be able to exercise his option within 3 months of receiving confirmation of the change of control.
A foundation, known as Stichting X5 Participations (the “Foundation”), has been incorporated to act as an intermediary between X5 and the Participants and to administer the X5 ESOP. Fortis Intertrust (Netherlands) B.V., Mr. Andrei Gusev and Mr. Valentin Ponomar have been appointed as board members of the Foundation.
95 PRINCIPAL SHAREHOLDINGS
The following table sets out information regarding the ownership of X5’s Shares, which are all held by the Depositary and in respect of which, GDRs have been issued, as at the date of this Prospectus.
Percentage of X5 GDR Holder GDRs held Cesaro Holdings Limited ...... 22.19% Luckyworth Limited ...... 20.86% Marie-Carla Corporation N.V...... 13.43% Tayleforth N.V...... 7.63% The Royal Bank of Scotland plc ...... 5.36% Dasana Investments Limited ...... 3.30% Seaton Consultants Limited ...... 1.88% Perekrestok Holdings Limited ...... 1.74% Wild Wings N.V...... 1.04% Other ...... 22.57% Total ...... 100%
No shareholder or GDR holder has voting rights different from any other holder of X5 Shares or GDRs.
Luckyworth Limited and Cesaro Holdings Limited are wholly owned subsidiaries of the Alfa Group Consortium. As at 31 December 2007, the ultimate parent company of the Alfa Group Consortium was CTF. CTF is under the common control of Mr. Fridman, Mr. Khan and Mr. Kuzmichev (the “Alfa Shareholders”). None of the Alfa Shareholders individually controls and/or owns 50% or more in CTF. Mr. Fridman, a member of the Supervisory Board, has a beneficial interest of 19.44% in X5, of which 10.02% is held indirectly through Cesaro Holdings Limited and the remainder held through Luckyworth Limited.
Marie-Carla Corporation N.V. and Tayleforth N.V. are companies controlled by, amongst others, Mr. Rogachev and Mrs. Franus. Mr. Rogachev, a former member of the Supervisory Board who recently resigned from X5’s Supervisory Board with effect from 21 April 2008, is a shareholder of Formata and has a beneficial interest of 11.14% in X5. Mrs. Franus, a former member of the Supervisory Board who recently resigned from X5’s Supervisory Board with effect from 23 April 2008, is also a shareholder of Formata and has a beneficial interest of 1.33% in X5. These beneficial interests in X5 are held indirectly through Marie-Carla Corporation N.V. and Tayleforth N.V.
Mr. Khasis, the Chief Executive Officer and chairman of the Management Board, has a beneficial interest of 1.88% in X5. This beneficial interest is held indirectly through Seaton Consultants Limited.
Mr. Gould, a member of the Supervisory Board, has a beneficial interest of 0.03% in X5. This beneficial interest in X5 is held indirectly through Talkoviy Enterprises Limited.
The Royal Bank of Scotland plc holds its GDRs under a repurchase transaction with Luckyworth Limited.
Perekrestok Holdings Limited is a wholly owned subsidiary of X5. Shares held by Perekrestok Holdings Limited are regarded as treasury shares.
Save as disclosed above, X5 is not aware of any other person who, directly or indirectly, is interested in 3% or more of X5’s capital as at the date of this document.
Save as disclosed above, there are no other persons who could exercise control over X5 and no person has any right or option to acquire X5 Shares, GDRs or any other securities of X5.
Save as disclosed in this section and the section “Transactions with Related Parties”, none of the members of the Board of Supervisory Directors or the Management Board had or has any interests in any transactions which are or which were unusual in their nature or conditions or significant to the business of X5 and which were effected by X5 during the current financial year, during the financial year ended 31 December 2007 or during any previous financial year and which remain in any respect outstanding or unperformed.
96 MATERIAL CONTRACTS
The following contracts, which are or may be material, have been entered into by X5 or Pyaterochka (where X5 has assumed those obligations) otherwise than in the ordinary course of business in the two years immediately preceding the date of this Prospectus or contain any provision under which X5 has any obligation or entitlement which is material to X5 as at the date of this Prospectus.
Karusel Call Option Agreement On 11 April 2006, X5 entered into the Call Option Agreement pursuant to which it acquired the Karusel Option. In January 2008, X5 exercised the Karusel Option and expects to complete its acquisition of Formata on or before 1 July 2008. X5 anticipates that the consideration for the exercise of the Karusel Option will be up to US$970.0 million. X5 may elect to pay 75% of the consideration in cash and up to 25% in Shares. Any acquisition of Formata is also subject to the completion of due diligence satisfactory to X5 and the receipt of approvals from the FAS. The payment of 25% of the consideration in the form of Shares is also subject to the approval of the Supervisory Board and Management Board, who will consider, amongst other things, whether such issuance is of economic benefit to X5 as a whole, at the time of the issuance. For more information, see “Business – Option to acquire Karusel”.
Syndicated Term Loan On 18 December 2007, X5 entered into a three year facility agreement with (among others) BNP Paribas, CALYON, HSBC Bank plc, ING Bank N.V. and Raiffeisen Zentralbank Österreich AG as Initial Mandated Lead Arrangers and Societe Generale and Unicredit as Mandated Lead Arrangers (the “Facility Agreement”) for a principal amount of US$1,100.0 million, divided into two term loan facilities. The first facility was used to refinance in full loans under a US$1,000.0 million bridge facility agreement entered into by X5 on 21 June 2007. The second facility, in a principal amount of US$100.0 million was used for general corporate purposes of the Group. The loans bear an initial interest rate of LIBOR plus 2.25% per annum plus any mandatory costs of compliance by certain financing parties with certain regulatory requirements. From the date falling 12 months after the first utilisation under the Facility Agreement, the margin will be subject to adjustment according to a leverage ratio.
Under the Facility Agreement, certain subsidiaries of X5 (the “Obligors”) guarantee the performance of X5’s obligations under the Facility Agreement. Those obligations are secured by pledges or other security over the shares in the Obligors, security over certain intercompany loans owing by the Obligors, security over certain of the Obligors’ bank accounts, the assignment of X5’s rights under a certain agreement and amendments to certain insurance policies relating to real property to provide for HSBC Bank plc (as lender of record) to be loss payee if an event of default occurs. X5 has also entered into hedging arrangements with certain international banking institutions in connection with the Facility Agreement and it is intended that such arrangements will be secured by substantially the same security.
X5 also gives certain undertakings under the Facility Agreement, including undertakings to provide financial information and to comply with certain financial covenants. The terms of the Facility Agreement also prohibit X5 (and in some cases its subsidiaries) from, among other things, incurring any further financial indebtedness, making any investment, disposing of or creating further security over its assets and declaring dividends or distributions (in each case subject to exceptions). In particular, there is an exception under the investment covenant permitting the acquisition of Formata (or the business of Karusel in any other form) under the Karusel Option.
The Facility Agreement also contains mandatory prepayment provisions which require the loans to be prepaid in certain circumstances including from certain debt proceeds and disposal proceeds.
97 TRANSACTIONS WITH RELATED PARTIES
The following describes transactions that X5 has entered into with affiliates and other entities and persons known to X5, in which either X5 or its management, directors or major shareholders have a controlling interest or over which any of the foregoing have a significant influence, and which X5 believes are material to it or to the other party. For the description of certain other transactions with related parties, see note 9 to the X5 Consolidated Financial Statements for the year ended 31 December 2007 included in this Prospectus.
Currently, any related party transactions proposed to be entered into by X5 are subject to the review of the Related Party Committee and approval of the Supervisory Board and must be on terms negotiated on an arm’s- length basis.
Transactions with the Alfa Group Consortium X5 has entered into various transactions with members of the Alfa Group Consortium, including Alfa-Bank, a Russian bank. The Alfa Group Consortium is an indirect majority shareholder of X5. Mr. Fridman, a member of the Supervisory Board, is also Chairman of the Supervisory Board of Alfa Group, a member of the Alfa-Bank Board of Directors and one of the principal founders of the Alfa Group Consortium. Mr. Fridman also serves as a member of the Board of Directors of VimpelCom. To the best of X5’s knowledge, Mr Fridman has not received any fees or other remuneration from the Alfa Group Consortium or X5 in connection with any of the transactions described below.
X5 has an open credit line with Alfa-Bank. This credit line has a maximum of US$150.0 million. At 31 December 2007, X5 had US$2.6 million under this credit line bearing an interest rate of 9.88% and therefore had available credit lines of US$147.4 million. X5 paid US$3.3 million and US$0.9 million in interest and bank charges to Alfa-Bank in 2007 and 2006, respectively.
X5 purchased communication services from VimpelCom for US$0.5 million and US$0.5 million in 2006 and 2007, respectively. X5 also provided mobile phone payments processing to VimpelCom for which VimpelCom paid US$0.5 million and US$0.6 million in 2006 and 2007, respectively and purchased communication services from Golden Telecom in the amount of US$1.6 million and US$2.0 million in 2006 and 2007, respectively.
In addition, X5 received management services from CTF for which it paid US$0.9 million and US$1.3 million in 2006 and 2007, respectively.
Call Option Agreement In 2006, X5 entered into an agreement under which it acquired the Karusel Option. In January 2008, X5 exercised the Karusel Option and will complete its acquisition of Formata on or before 1 July 2008. Mr. Rogachev is a member of the Supervisory Board of Formata and a former member of the Supervisory Board of X5. X5 anticipates that the consideration for the exercise of the Karusel Option will be up to US$970.0 million. X5 may pay 75% of the consideration in cash and up to 25% in Shares. The acquisition of Formata is also subject to the satisfactory outcome of due diligence being conducted by X5 and the receipt of approvals from the FAS. For more information, see “Business – History and Development – Recent Acquisitions and Proposed Acquisition of Formata”.
Other Related Party Transactions The following transactions were also carried out with other related parties controlled by management of X5: (a) At 31 December 2006, X5 recorded a long-term loan issued to Donette Investments Limited (“Donette”) in the amount of US$5.3 million with an interest rate of 10% p.a. and maturity in 2014. In 2007, X5 converted its loan into 30% of the share capital of Donette and subsequently purchased the remaining 70% of the share capital. X5 acquired provisional assets of US$45.7 million in Donette at the date of acquisition. The purchase consideration comprised cash and cash equivalents paid of US$20.3 million and loans receivable of US$25.4 million. The details of the acquisition of Donette are disclosed in Note 8 of the X5 Consolidated Financial Statements for the year ended 31 December 2007.
98 (b) In 2006 and 2007, X5 incurred US$0.9 million and US$1.2 million of operating lease expenses, respectively and in 2007, paid US$0.1 million to CJSC Novye Roznichnye Technologii in respect of communication services. CJSC Novye Roznichnye Technologii is a wholly owned subsidiary of Donette and therefore became a wholly owned indirect subsidiary of X5 upon the acquisition of Donette by X5 in 2007.
(c) In 2006 and 2007, X5 provided to LLC Rusel and LLC Rusel M with US$1.5 million and US$0.1 million of outsourcing services, respectively and received rental income of US$0.5 million and US$0.5 million, respectively.
(d) X5 provided advertising services to LLC Media 5 and LLC Media 5M in 2006 and 2007, for which it received US$3.3 million and US$0.2 million, respectively.
(e) In 2006 and 2007, X5 paid US$0.8 million and US$1.5 million, respectively to LLC Makromir for construction services provided to X5.
(f) X5 has entered into an agreement with Multiserve Holdings Limited for payment of a commission directly attributable to the acquisition of property, plant and equipment. A commission of US$1.2 million was paid upon completion of this transaction in 2007.
X5 entered into other related party arrangements in the past, but none gave rise to transactions reflected in the X5 Consolidated Financial Statements for the years ended 31 December 2007 and 31 December 2006.
99 DESCRIPTION OF SHARE CAPITAL AND ARTICLES OF ASSOCIATION
The summary below describes the Shares, the material provisions of the Articles in effect as of the date of this Prospectus and certain requirements of Dutch law applicable to X5 and the Shares. This summary does not purport to be complete and is qualified in its entirety by reference to the Articles and applicable provisions of Dutch law.
Purpose Article 3 of the Articles provides that the objects of X5 include, among others, the incorporation, participation, management, supervision, operation and promotion of enterprises, businesses and companies, being and acting as a holding company, the financing of and supply of advice and services to businesses and companies, and borrowing, lending and raising of funds (including the issue of bonds, promissory notes or other securities) and the use of its assets as security for the obligations of other companies and enterprises. The Articles provide X5 with a broad allowance to perform any and all activity of an industrial, financial or commercial nature, including trading and investing in currencies, securities and other property, obtaining, alienating, managing and exploiting property and the development of intellectual property rights.
Description of Share Capital General The Shares are in registered form. They are available in the form of an entry in the share register of X5 without the issuance of a share certificate.
Subject to Dutch law and the Articles, shares in registered form can only be transferred by a notarial written deed of transfer executed before a civil law notary residing in The Netherlands. However, if the shares or depositary receipts issued with the co-operation of the issuer are listed, or if there are well founded expectations that the shares or such depositary receipts will be listed shortly, a private written deed suffices. To ensure the effectiveness of the transfer vis-à-vis X5, the transfer must be acknowledged by X5, or the deed of transfer must be served on X5, in accordance with the applicable provisions of Dutch law and the Articles.
X5’s share capital currently consists of 54,120,038 issued ordinary shares with a nominal value of €1.00 each. In addition, X5 is authorised by its Articles to issue an additional 135,879,962 ordinary shares. Following the Offering, X5 expects its issued share capital to consist of 66,146,713 ordinary shares. No other classes of shares have been issued or have been authorised to be issued.
Qualification of GDRs under Dutch Law Under Dutch law, holders of depositary receipts (certificaten van aandelen) have certain rights vis-à-vis a Dutch N.V. For example, holders of depositary receipts who solely or jointly represent at least one-tenth of the issued capital of a Dutch N.V. or who solely or jointly hold depositary receipts in respect of underlying shares in a Dutch N.V. with an aggregate nominal value of €225,000, have the right to file an application for an inquiry into the policy and conduct of business of a Dutch N.V. In addition, a Dutch N.V. must, in principle, treat equally-situated holders of depositary receipts and shares equally.
Under Dutch law, there are two categories of depositary receipts: (i) depositary receipts issued with the co-operation of the issuer (that is, the Dutch N.V.) of the underlying shares and (ii) depositary receipts issued without the co-operation of the issuer (that is, the Dutch N.V.) of the underlying shares.
Holders of depositary receipts issued with the co-operation of the Dutch N.V. have certain additional rights vis-à-vis the Dutch N.V. and its shareholders. Such additional rights, which are generally of a mandatory nature (dwingend recht), include the right to request the Dutch N.V. to convene meetings of the General Meeting of Shareholders and the right to attend and speak at such meetings. In addition, Dutch law provides that holders of such depositary receipts have, jointly, a right of pledge over the underlying shares (pandrecht van certificaathouders). Holders of depositary receipts issued with the co-operation of the Dutch N.V. also have certain rights vis-à-vis other shareholders pursuant to Dutch takeover legislation, which implements the EU Takeover Bids Directive, including, for example, the sell-out right as referred to in “EU Takeover Bids Directive – Sell-Out Right” below.
A Dutch N.V. is able to exclude its ability to co-operate in the issuance of depositary receipts through a specific provision in its articles of association. In the event of X5, the Articles specifically state that X5 may co-operate in the issuance of depositary receipts.
100 Under Dutch law, in the absence of a court decision or other authoritative guidance on point, it is uncertain whether or not the GDRs, which are governed by English law, qualify as depositary receipts, although it is considered likely. It is therefore uncertain whether the holders of GDRs are entitled to any of the abovementioned rights, most of which rights are of a mandatory nature (dwingend recht). To the extent that the GDRs do qualify as depositary receipts pursuant to Dutch law, it is likely that they are deemed to have been issued with the co-operation of X5.
Finally, holders of GDRs can exercise the voting rights attached to the underlying Shares through voting instructions to, or a power of attorney from, the Depositary and are, in principle, entitled to any distributions on, or pre-emptive rights with respect to, the underlying Shares, as described in “Terms and Conditions of the Global Depositary Receipts”.
Issuance of Shares and Pre-emption Rights Shares in X5 may be issued and rights to subscribe for Shares may be granted pursuant to a resolution of the General Meeting of Shareholders or another corporate body (vennootschapsorgaan) of X5 to which the General Meeting of Shareholders has delegated the authority to issue Shares or to grant rights to subscribe for Shares for a specified period not exceeding five years. If another corporate body has been delegated the authority to issue Shares or to grant rights to subscribe for Shares, the resolution pursuant to which such delegation is granted must specify the maximum number of Shares that may be issued and the period during which the delegation will be effective. The delegation of the authority to issue Shares to another corporate body may from time to time be extended for a period of not more than five years. Unless the resolution provides otherwise, the delegation of the authority to issue Shares or to grant rights to subscribe for Shares is irrevocable. As long as another corporate body is authorised to issue Shares or to grant rights to subscribe for Shares, the General Meeting of Shareholders may not resolve to do so. When resolving to issue Shares, the General Meeting of Shareholders or the corporate body to which such authority has been delegated must determine the price and the other terms and conditions of the issuance. Unless permitted by Dutch law, Shares may not be issued below their nominal value.
Subject to Dutch law and the Articles, shareholders have a right of pre-emption to subscribe for Shares upon the issuance of Shares in proportion to the aggregate amount of Shares they hold. Pursuant to the Articles, such a right of pre-emption also applies to the issuance of Shares for contributions in kind. According to Dutch law and the Articles, the right of pre-emption does not apply in connection with any issuance of Shares to the employees of X5 or the employees of a group company (groepsmaatschappij) of X5 or to a party that exercises a previously granted right to subscribe for Shares. The right of pre-emption applies equally to the grant of rights to subscribe for Shares.
X5 must announce any issuance of Shares to which pre-emption rights apply and the period during which shareholders can exercise their pre-emption rights in the Dutch Official Gazette (Staatscourant) and in a Dutch daily newspaper with nation-wide distribution, unless all Shares are registered shares (aandelen op naam) and all shareholders have been notified in writing. Currently, all Shares are registered shares. The period during which pre-emption rights can be exercised must be at least two weeks from the day after the day on which the issuance is announced in the Dutch Official Gazette or the notification has been sent to shareholders. These pre-emption rights will expire if they are not exercised within the exercise period.
Pre-emption rights may be restricted or excluded by, or pursuant to, a resolution of the General Meeting of Shareholders. The written proposal for such a resolution must contain the reasons for the restriction or the exclusion, and the proposed issue price for the Shares. If another corporate body of X5 has been delegated the authority to issue Shares, the General Meeting of Shareholders may authorise that corporate body to restrict or exclude pre-emption rights for a specified period not exceeding five years. The delegation of the authority to restrict or exclude pre-emption rights may from time to time be extended for a period of not more than five years. If less than half of the issued capital is present or represented at the meeting of the General Meeting of Shareholders at which the vote is taken, a resolution to restrict or exclude pre-emption rights or to delegate the authority to restrict or exclude pre-emption rights to another corporate body of X5, requires a majority of at least two-thirds of the votes cast. Unless the resolution provides otherwise, the delegation of the authority to restrict or exclude pre-emption rights cannot be revoked.
As of the date of this document, the authority to issue Shares and to grant rights to subscribe for Shares, and the authority to restrict or exclude pre-emption rights in connection therewith, has been delegated to the Supervisory Board until 21 October 2009.
101 Repurchase of Shares The Management Board may, subject to Dutch law, the Articles and authorisation by the General Meeting of Shareholders, resolve to cause X5 to purchase Shares or depositary receipts thereof provided that (i) X5’s shareholders equity (eigen vermogen) less the amount to be paid for the Shares or the depositary receipts thereof is not less than the sum of X5’s issued and fully paid-in share capital plus any legal reserves required to be maintained pursuant to Dutch law and the Articles, and (ii) X5 and its subsidiaries (dochtermaatschappijen) would thereafter not hold, or hold as pledgee, Shares or depositary receipts thereof with an aggregate value exceeding one-tenth of X5’s issued share capital. These restrictions do not apply to the acquisition of Shares or depositary receipts thereof for no consideration. X5 may not acquire Shares or depositary receipts thereof if more than six months have lapsed after the end of the last preceding financial year and no annual accounts have been adopted in respect of that financial year.
The General Meeting of Shareholders may delegate the authority to cause X5 to purchase Shares or depositary receipts thereof to the Management Board for a maximum period of 18 months. In its resolution, the General Meeting of Shareholders must provide the maximum number of Shares or depositary receipts thereof that X5 may purchase, the method of purchase and the price range to be observed. The disposal of Shares or depositary receipts thereof held by X5 is subject to a resolution of the General Meeting of Shareholders, if the General Meeting of Shareholders has not delegated that authority to another corporate body of X5. When resolving to dispose of the Shares or the depositary receipts thereof, the General Meeting of Shareholders must determine the conditions of the disposal.
Shares held by X5 or a subsidiary may not be voted on and are not taken into account for determining whether quorum requirements, if any, are satisfied.
At the annual general meeting of shareholders held on 15 June 2007, X5’s shareholders delegated the authority to the Management Board, for a period of 18 months from the date of the annual general meeting of shareholders, to cause X5 to purchase up to 10% of the Shares or the depositary receipts thereof. In addition, on 15 June 2007, X5’s shareholders delegated the authority to the Management Board, for a period of 18 months from the date of the annual general meeting of shareholders, to cause X5 to dispose of Shares or depositary receipts thereof held by X5.
Capital Reduction The General Meeting of Shareholders may resolve to reduce the issued share capital by canceling (intrekken) Shares and depositary receipts thereof held by X5, or by reducing the nominal value of Shares by an amendment to the Articles. A resolution to reduce the issued share capital requires the approval of at least a majority of the votes cast and, if less than half of the issued capital is present or represented at the meeting of the General Meeting of Shareholders at which the vote is taken, the approval of at least two-thirds of the votes cast. The notice convening the meeting at which the General Meeting of Shareholders will be requested to approve the reduction must identify the Shares and depositary receipts thereof that will be affected by the reduction, and state the purpose of the reduction and the manner in which the reduction will be effected.
Meetings of the General Meeting of Shareholders Meetings of the General Meeting of Shareholders are convened by the Management Board or the Supervisory Board and are held in Amsterdam or Haarlemmermeer (Schiphol Airport). An annual meeting of the General Meeting of Shareholders will be held within six months after the end of each financial year. Notice of a meeting of the General Meeting of Shareholders must be given to the shareholders and the holders of depositary receipts no later than the fifteenth day before the date of the meeting and must include an agenda stating the items to be discussed during the meeting. The agenda for the annual general meeting of shareholders must contain, among other items, the following items for discussion, approval and/or adoption: (a) annual report; (b) adoption of the annual accounts; (c) reservation and dividend policy; (d) appropriation of accrued profits; (e) granting of discharge to members of the Management Board for their management during the financial year concerned and to the members of the Supervisory Board for their supervision thereon; and (f) other items brought up for discussion by the Management Board or the Supervisory Board.
102 Unless it would be detrimental to an important interest (zwaarwichtig belang) of X5, the agenda must also contain the items requested in writing by one or more shareholders or holders of depositary receipts issued with the co-operation of X5 who, individually or in the aggregate, hold at least 1% of the issued share capital or, to the extent such shares or depositary receipts are admitted to trading on an official stock exchange such as the London Stock Exchange, hold such shares or depositary receipts representing a value of at least EUR 50 million. Such a request must have been received by X5 not later than the sixtieth day prior to the date of a meeting of the General Meeting of Shareholders.
Meetings of the General Meeting of Shareholders will be held as often as the Management Board or the Supervisory Board deems it necessary. In addition, holders of Shares or holders of depositary receipts issued with the co-operation of X5 who in the aggregate hold directly or, through the depositary receipts, indirectly at least 10% of the issued share capital, may request that a meeting of the General Meeting of Shareholders be held. In their request, such holders must state the items that they wish to be discussed during the meeting. If, in such case, the Management Board or the Supervisory Board has not convened a meeting of the General Meeting of Shareholders within four weeks in such a manner that the meeting can be held within six weeks after the request, such holders of Shares and depositary receipts will be entitled to convene the meeting, subject to the applicable provisions of Dutch law.
Unless the Supervisory Board has designated another person to act as chairman of a meeting of the General Meeting of Shareholders, such meeting will be presided over by the chairman of the Supervisory Board or, in his or her absence, by the deputy chairman of the Supervisory Board. In the event that both the chairman and the deputy chairman of the Supervisory Board are absent, the remaining members of the Supervisory Board will elect a chairman from among themselves. If the chairman has not been elected in accordance with the previous sentence, the General Meeting of Shareholders will elect a chairman. Until the General Meeting of Shareholders has elected a chairman, a member of the Management Board will act as chairman. In the absence of a member of the Management Board, the oldest person present will act as chairman.
All shareholders and other persons who, pursuant to Dutch law or the Articles, are entitled to attend and/or vote at a meeting of the General Meeting of Shareholders are entitled to address the General Meeting of Shareholders. Only shareholders are entitled to vote. Pursuant to Dutch law, holders of depositary receipts issued with the co-operation of X5 that are admitted to trading on an EU regulated market may request the holder of the underlying shares to issue a power of attorney entitling the holder of the depositary receipt to vote the underlying shares at its own discretion; such power of attorney can only be refused or restricted in certain limited circumstances as provided for by Dutch law.
Subject to the prior approval of the Supervisory Board, the Management Board may set a record date to establish which shareholders are entitled to attend and vote at the meeting of the General Meeting of Shareholders.
As described in “Terms and Conditions of the Global Depositary Receipts”, holders of GDRs may instruct the Depositary with regard to the exercise of the voting rights connected to the Shares underlying their GDRs. Alternatively, upon request of the holders of such GDRs, the Depositary will grant a proxy to such holders who wish to vote in person at a meeting of the General Meeting of Shareholders. Persons who hold a written proxy may represent shareholders at a meeting of the General Meeting of Shareholders. The written proxy must be duly executed and legalised in accordance with the laws of the country where the proxy is issued.
Members of the Management Board and the Supervisory Board are authorised to attend a meeting of the General Meeting of Shareholders and have, in that capacity, an advisory vote (raadgevende stem) in the General Meeting of Shareholders.
Resolutions of shareholders may also be adopted in writing outside a meeting of the General Meeting of Shareholders, provided that they are adopted by unanimous vote representing the entire issued capital and that there are no depositary receipts issued with the co-operation of X5.
See “Description of Share Capital and Articles of Association – Qualification of GDRs under Dutch Law” for a discussion of the possible qualification under Dutch law of the GDRs as depositary receipts (certificaten van aandelen).
103 Voting Rights Each Share confers the right to cast one vote in the General Meeting of Shareholders. There are no restrictions, either under Dutch law or in the Articles, on the right of non-residents of The Netherlands or foreign owners to hold or vote the Shares, other than those also imposed on residents of The Netherlands. Unless Dutch law or the Articles provide otherwise, all resolutions of the General Meeting of Shareholders will be passed by a simple majority of the votes cast in a meeting where more than 25% of the issued share capital is present or represented. If 25% or less of the issued share capital is present or represented, a second meeting should be convened and held no later than four weeks following the first meeting. At such second meeting, no quorum requirement will apply.
If there is no majority in the event of an election of persons for a vacancy on the Supervisory Board or on the Management Board, a second vote will be taken. If there is a tie in voting at the second vote, a drawing of lots will determine the issue. If there is a tie in voting on matters other than the election of persons, the proposal will be considered rejected.
Dividend Rights Any distribution of profits to shareholders will be made after the adoption by the General Meeting of Shareholders of the annual accounts of X5 from which it appears that such distribution is permitted. X5 may only declare distributions to the shareholders and other persons entitled to distributable profits insofar as X5’s shareholders equity, less the amount to be paid as distributions is not less than the sum of X5’s issued and fully paid-in share capital plus any legal reserves required to be maintained pursuant to Dutch law and the Articles. A loss may only be applied against such reserves to the extent permitted by Dutch law. On a proposal of the Supervisory Board, the General Meeting of Shareholders will determine which part of the profits will be added to the reserves that must be maintained pursuant to Dutch law and the Articles and the allocation of the remaining profits.
On a proposal of the Supervisory Board, the General Meeting of Shareholders may resolve to pay an interim dividend insofar as X5’s shareholders’ equity less the amount to be paid as an interim dividend is not less than the sum of X5’s issued and fully paid-in share capital plus any legal reserves required to be maintained pursuant to Dutch law and the Articles, as evidenced by an interim financial statement prepared and signed by all the members of the Management Board. In addition, insofar as X5’s shareholders equity less the amount resulting from such distribution is not less than the sum of X5’s issued and fully paid-in share capital plus any legal reserves required to be maintained pursuant to Dutch law and the Articles, on a proposal of the Supervisory Board and subject to Dutch law, the General Meeting of Shareholders may resolve to make other distributions to the shareholders out of any reserves that need not be maintained pursuant to Dutch law or the Articles.
Dividends and other distributions that have not been claimed within five years after the date on which they became due and payable revert to X5.
Annual Accounts The financial year of X5 corresponds with the calendar year. The Management Board must prepare the annual accounts within five months after the end of the financial year. Under exceptional circumstances, the General Meeting of Shareholders may extend the five-month period for not more than six months. The annual accounts must be made available to the holders of Shares and the holders of depositary receipts issued with the co-operation of X5 for inspection at the offices of X5 within the same period.
Subject to Dutch law, the annual accounts must be accompanied by an auditors’ report (accountantsverklaring), an annual report (jaarverslag) and certain other mandatory information. The General Meeting of Shareholders will appoint an auditor to audit the annual accounts. The Management Board must prepare the annual accounts and all of the members of the Management Board and the Supervisory Board must sign the annual accounts. The General Meeting of Shareholders adopts the annual accounts.
The amount of profit or loss, the size of the distributable reserves, and whether X5 is permitted to repurchase Shares or depositary receipts thereof, must, among others, be determined on the basis of X5’s statutory annual accounts, which will be prepared in accordance with IFRS.
Amendment of Articles of Association, Merger, Demerger or Dissolution On a proposal of the Management Board, the General Meeting of Shareholders may resolve to amend the Articles, merge (fusie), demerge (splitsing) or dissolve X5. Such a proposal must be included in the notice for a General Meeting of Shareholders. The proposal to amend the Articles including the text of the proposed
104 amendment must be made available to holders of Shares and the holders of depositary receipts issued with the co-operation of X5 for inspection at the offices of X5 as of the date of the notice convening the meeting of the General Meeting of Shareholders until the end of the meeting of the General Meeting of Shareholders at which the proposed amendment is voted on. The proposal and a copy of the proposed amendment must also be made available at the General Meeting of Shareholders. If less than half of the issued capital is present or represented at the meeting of the General Meeting of Shareholders at which the vote is taken, a resolution to merge or demerge requires a majority of at least two-thirds of the votes cast.
In the event that the General Meeting of Shareholders resolves to dissolve X5, the Management Board will be charged with the liquidation of the business of X5 under the supervision of the Supervisory Board. After payment of the creditors of X5, the Management Board will distribute the remaining balance to the shareholders in proportion to the aggregate amount of Shares they hold.
See “Description of Share Capital and Articles of Association – Qualification of GDRs under Dutch Law” for a discussion of the possible qualification under Dutch law of the GDRs as depositary receipts (certificaten van aandelen).
Significant Transactions Requiring Shareholder Approval Pursuant to Dutch law and the Articles, resolutions of the Management Board involving a significant change in the identity or character of X5 or its business are subject to the prior approval of the General Meeting of Shareholders. Such resolutions include: (a) the transfer of all or substantially all of X5’s business to a third party; (b) the entry into or termination of a lasting co-operation by X5 as a fully liable partner in a limited partnership or a general partnership, if such co-operation or the termination thereof is of far-reaching significance to X5; or (c) the entry into any transaction or a number of related transactions with a value of 33% of X5’s assets according to X5’s most recently adopted audited annual accounts.
Board Practices Supervisory Board Composition. Pursuant to the Articles, the Supervisory Board consists of one or more individuals. The General Meeting of Shareholders determines the number of members of the Supervisory Board.
Appointment, Suspension and Dismissal. The General Meeting of Shareholders appoints the members of the Supervisory Board from a list of nominees, provided by the Supervisory Board, containing the names of at least two persons for each vacancy. As soon as a position on the Supervisory Board is or becomes vacant, the Management Board will request the Supervisory Board in writing to provide a list of nominees. The Supervisory Board’s list of nominees is binding on the General Meeting of Shareholders if it has been provided within four weeks after the Management Board’s written request. The General Meeting of Shareholders, however, may overrule the binding character of the list of nominees by a resolution adopted with a two-thirds majority of the votes cast, which majority must represent more than half of the issued capital. If the Supervisory Board does not provide a list of nominees within four weeks after the Management Board’s written request, the General Meeting of Shareholders may resolve to fill a vacancy at its own discretion.
Pursuant to the Articles, the General Meeting of Shareholders can dismiss or suspend members of the Supervisory Board at any time.
Finally, the General Meeting of Shareholders determines the remuneration of the members of the Supervisory Board.
Role of Supervisory Board. Pursuant to the Articles, the Supervisory Board supervises the Management Board’s management of and the general course of affairs and business of X5. In addition, the Supervisory Board advises the Management Board. In performing their duties, the members of the Supervisory Board will act in accordance with the interests of X5 and of the businesses connected with it. Certain resolutions of the Management Board specified in, or pursuant to, the Articles require the prior approval of the Supervisory Board. Finally, at least once a year, the Management Board will inform the Supervisory Board in writing about the state of affairs in respect of the general, strategic and financial risks facing X5 and the control and monitoring mechanisms (beheers- en controlesysteem) in relation thereto.
105 Decision-Making Process. The Supervisory Board will elect a chairman and a deputy chairman from among its members. The deputy chairman will take the place of the chairman during his or her absence. The Supervisory Board will meet as often as any member of the Supervisory Board or the Management Board deems it necessary. The Supervisory Board will meet together with the Management Board as often as any member of the Supervisory Board or any Director A deems it necessary.
The Supervisory Board adopts resolutions by a majority of the votes cast at a meeting at which at least half of the members of the Supervisory Board are present or represented. However, certain resolutions of the Supervisory Board specified in the Articles can only be adopted by a majority of the votes cast in a meeting in which at least three-fourth of the members of the Supervisory Board are present or represented.
The Supervisory Board may adopt resolutions in writing without holding a meeting, provided that the written resolutions will be signed by all members of the Supervisory Board indicating their vote as “yes”, “no” or “abstain”.
Finally, the Rules governing the Principles and Practices of the Supervisory Board of X5 (the “Supervisory Board Rules”) require that each member of the Supervisory Board immediately reports any potential conflict of interest to the chairman of the Supervisory Board. A member of the Supervisory Board may not participate in the discussions and/or decision-making process on a subject or transaction in relation to which he or she has a conflict of interest with X5. Such transaction, if approved, must be concluded on terms at least customary in the food and retail sector, and must be approved by the Supervisory Board.
Committees. Pursuant to the Articles, the Supervisory Board has an audit committee, a remuneration committee and a selection and appointment committee. The Supervisory Board may adopt rules regarding each committee. The committees will conform their operation and practices to any regulations imposed on them by the Supervisory Board.
Management Board Composition. Pursuant to the Articles, the Management Board consists of two or more Directors A, one Director B and, optionally, any number of Directors C. The General Meeting of Shareholders will determine the number of Directors A. Both individuals and legal entities can serve as members of the Management Board. The Supervisory Board will determine the titles of the members of the Management Board. One of the Directors A will have the title of Chief Executive Officer and another Director A will have the title of Chief Financial Officer.
Appointment, Suspension and Dismissal. The General Meeting of Shareholders will appoint the members of the Management Board from a list of nominees provided by the Supervisory Board, containing the names of at least two persons for each vacancy. As soon as a position on the Management Board is or becomes vacant, the Management Board will request the Supervisory Board in writing to provide a list of nominees. The Supervisory Board’s list of nominees is binding on the General Meeting of Shareholders if it has been provided within four weeks after the Management Board’s written request. The General Meeting of Shareholders, however, may overrule the binding character of the list of nominees by a resolution adopted with a two-thirds majority of the votes cast, which majority must represent more than half of the issued capital. If the Supervisory Board does not provide a list of nominees within four weeks after the Management Board’s written request, the General Meeting of Shareholders may resolve to fill a vacancy at its own discretion. Members of the Management Board will be appointed for a period of up to four years. Members of the Management Board may be re-appointed for a period of up to four years.
Pursuant to the Articles, the General Meeting of Shareholders may dismiss or suspend members of the Management Board at any time. In addition, the Supervisory Board may suspend members of the Management Board at any time.
Finally, the Supervisory Board will determine the remuneration and further conditions of employment for each member of the Management Board, with due observance of the remuneration policy adopted by the General Meeting of Shareholders on the proposal of the Supervisory Board. The granting of options to subscribe for Shares or GDRs to members of the Management Board or the participation in option plans by members of the Management Board is subject to the approval of the General Meeting of Shareholders.
Role of Management Board. Pursuant to Dutch law and the Articles, the Management Board is charged with the management of X5, and represents and binds X5 vis-à-vis third parties (“external representation”). In performing their duties, the members of the Management Board must act in accordance with the interests of X5 and of the business connected with it.
106 Decision-Making Process. The Management Board adopts resolutions with a majority in a meeting where (i) all Directors A and (ii) at least fifty percent or all the members of the Management Board are present or represented. If there is a tie in voting, the Chief Executive Officer will have a casting vote.
The Management Board may adopt resolutions in writing without holding a meeting, provided that the written resolutions will be signed by all members of the Management Board indicating their vote as “yes”, “no” or “abstain”.
Finally, the Rules governing the Principles and Practices of the Management Board of X5 (the “Management Board Rules”) require that each member of the Management Board immediately reports any potential conflict of interest to the chairman of the Supervisory Board and to the other members of the Management Board. A member of the Management Board may not participate in the discussions and/or decision- making process on a subject or transaction in relation to which he or she has a conflict of interest with X5. Such transaction, if approved, must be concluded on terms at least customary in the food and retail sector, and must be approved by the Supervisory Board.
External Representation. Only the entire Management Board is authorised to represent and bind X5. In addition, on a proposal of the Supervisory Board, the Management Board may appoint authorised representatives (procuratiehouders) (including members of the Management Board) with general or limited powers to represent X5. These authorised representatives can represent X5 with due observance of any restrictions imposed on them. Finally, the Articles provide that in the event of a conflict of interest between X5 and a member or all members of the Management Board, a member of the Supervisory Board designated by the Supervisory Board will represent X5. In the event of such a conflict of interest, the General Meeting of Shareholders can, at all times, designate one or more other persons to represent X5. According to Dutch case law, legal acts performed by members of the Management Board in violation of the conflicts of interest rules, do not bind a company such as X5 vis-à-vis third parties if such third party knew or should have known of the conflict of interest.
Dutch Corporate Governance Code On 9 December 2003, a committee commissioned by the Dutch government (Commissie Tabaksblat) published the Dutch Corporate Governance Code. The provisions of the Dutch Corporate Governance Code took effect on 1 January 2004. Some of the Dutch Corporate Governance Code’s best practice provisions have been incorporated into Dutch law, including the obligation for companies to discuss in their annual report in detail the items on which they do not comply with the Dutch Corporate Governance Code, and to explain the reasons for not doing so. Any substantial changes to the corporate governance structure of a company or any substantial changes to compliance with the Dutch Corporate Governance Code must be discussed at the annual general meeting of shareholders. The Dutch Corporate Governance Code provides that if a company’s general meeting of shareholders approves the corporate governance structure of a company and the company’s explanations for any deviations therefrom, the company will be deemed to comply with the Dutch Corporate Governance Code.
For more information regarding X5’s present compliance with the Dutch Corporate Governance Code, see “Management and Corporate Governance”.
Information to General Meeting of Shareholders Pursuant to the Management Board Rules, the Management Board must provide the General Meeting of Shareholders with all information that it may require, unless important interests of X5 or any law, rule or regulation applicable to X5 would prevent it from doing so. Pursuant to the Supervisory Board Rules, the Supervisory Board must inform the General Meeting of Shareholders by means of a circular for shareholders of all facts and circumstances relevant to the items on the agenda. It must also provide the General Meeting of Shareholders with all information that the General Meeting of Shareholders may require concerning any item on the agenda, unless important interests of X5 or any law, rule or regulation applicable to X5 would prevent it from doing so.
EU Takeover Bids Directive This paragraph “EU Takeover Bids Directive” discusses the applicability of the Dutch and English law implementation of the EU Takeover Bids Directive to X5. As it is uncertain whether or not the GDRs qualify as depositary receipts issued with or without the co-operation of X5, for purposes of the Dutch law description contained in this paragraph “EU Takeover Bids Directive”, it is assumed that the GDRs qualify as depositary receipts issued with the co-operation of X5 under Dutch law (see also “Description of Share Capital and Articles of Association – Qualification of GDRs Under Dutch Law”).
107 X5 is a company incorporated under the laws of The Netherlands and its voting securities, that is, the GDRs, are admitted to trading solely on the regulated market of the London Stock Exchange. Therefore, pursuant to the Dutch and English law implementation of the EU Takeover Bids Directive, matters relating to the bid procedure, and, in particular, the information on the offeror’s decision to make a bid, the contents of the offer document and the disclosure of the bid are to be dealt with in accordance with English law. In matters relating to the information to be provided to X5’s employees and in matters relating to company law, in particular the percentage of voting rights which triggers a mandatory bid and any derogations therefrom, as well as the conditions under which the Management Board and the Supervisory Board may undertake any action that might result in the frustration of the bid, Dutch law applies.
As of the date of this document, X5 has not elected to be subject to the Dutch law implementation of the EU Takeover Bids Directive’s “breakthrough rule” or the “board passivity rule”. The General Meeting of Shareholders could, however, decide that X5 must be subject to the “breakthrough rule” and/or the “board passivity rule”, with or without the reciprocity option as provided for by Dutch law.
Mandatory Bid Under the Dutch law implementation of the EU Takeover Bids Directive, a holder of shares or depositary receipts issued with the co-operation of the company (certificaten van aandelen uitgegeven met medewerking van de vennootschap) or group of holders of such securities acting in concert, is required to launch a mandatory bid when it holds 30% or more of the voting rights in a Dutch N.V. with voting securities admitted to trading on an EU regulated market (“Listed Dutch N.V.”). The current indirect significant shareholder of X5, CTF, which has an interest of 43.05% in X5 is, however, exempt from this mandatory bid obligation since it acquired such interest before the date on which the Dutch law implementation of the EU Takeover Bids Directive took effect in The Netherlands on 28 October 2007.
Squeeze-Out Right Pursuant to the Dutch law implementation of the EU Takeover Bids Directive, when an offer (mandatory or voluntary) is made to all of the holders of shares or depositary receipts thereof issued with the co-operation of a Listed Dutch N.V. and after such offer the offeror holds 95% of the shares or depositary receipts thereof and 95% of the voting rights, it can require the holders of the remaining securities to sell those shares (of the same class) or depositary receipts thereof to the offeror. The price offered for such shares or depositary receipts thereof must be a “fair price”. The price offered in a voluntary offer would be considered a “fair price” in the buy-out proceedings if 90% of the shares or depositary receipts thereof were acquired in such voluntary offer; however, a Dutch court may set a different price. The price paid in a mandatory offer is deemed a “fair price”. The consideration paid in the buy-out proceedings consists of cash. Finally, pursuant to Dutch law, the right to initiate such buy-out proceedings must be exercised within three months following the expiration of the acceptance period of the offer.
Sell-Out Right Pursuant to the Dutch law implementation of the EU Takeover Bids Directive, when an offer (mandatory or voluntary) is made to all of the holders of shares and depositary receipts thereof issued with the co-operation of a Listed Dutch N.V. and after such offer the offeror holds 95% of the shares or depositary receipts thereof and 95% of the voting rights, the remaining holders of shares or depositary receipts thereof can require that the offeror buys the remaining shares (of the same class) or depositary receipts thereof. The price offered in a voluntary offer would be considered a “fair price” in the sell-out proceedings if 90% of shares or depositary receipts thereof were acquired in such voluntary offer. The price paid in a mandatory offer is deemed a “fair price”. The consideration paid in the sell-out proceedings consists of cash. Finally, pursuant to Dutch law, the right to initiate such sell-out proceedings must be exercised within three months following the expiration of the acceptance period of the offer.
Squeeze-Out Right In addition to the squeeze out right pursuant to the Dutch law implementation of the EU Takeover Bids Directive, Dutch law provides that if a person, or a group of persons acting in concert, holds in total 95% of a Dutch N.V.’s issued share capital by nominal value for its own account, such person, or group of persons acting in concert, can opt to acquire the remaining shares in the Dutch N.V. by initiating proceedings against the holders of the remaining shares. The price to be paid for such shares will be determined by the Enterprise Chamber of the Amsterdam Court of Appeal.
108 Significant Ownership of Shares and GDRs As it is uncertain whether or not the GDRs qualify as depositary receipts, it is assumed in this section “Significant Ownership of Shares and GDRs” that the GDRs qualify as depositary receipts under Dutch law. Pursuant to the Dutch Act on Financial Supervision (Wet op het financieel toezicht), any person who, directly or indirectly, acquires or disposes of an interest in X5’s capital or voting rights must immediately give written notice to The Netherlands Authority for the Financial Markets (Stichting Autoriteit Financiële Markten) (the “AFM”) by means of a standard form or electronically, if, as a result of such acquisition or disposal, the percentage of capital interest or voting rights held by such persons reaches, exceeds or falls below any of the following thresholds: 5%, 10%, 15%, 20%, 25%, 30%, 40%, 50%, 60%, 75% and 95% of X5’s issued capital.
A notification requirement also applies if a person’s capital interest or voting rights reaches, exceeds or falls below any of the abovementioned thresholds as a result of a change in X5’s issued capital or voting rights. Such notification has to be made no later than the fourth trading day after the AFM has published X5’s notification as described below. X5 is required to notify the AFM immediately of any changes in its outstanding capital or voting rights of 1% or more since X5’s previous notification.
In addition to the above, every holder of 5% or more of X5’s capital or voting rights whose interest has, in the period after their most recent notification to the AFM, changed as a result of certain acts (including but not limited to the exercise of a right to acquire GDRs) must notify the AFM of the composition of his or her holding within four weeks from the end of the calendar year.
For the purpose of calculating the percentage of capital interest or voting rights in X5, the following interests must be taken into account: (i) GDRs directly held (or acquired or disposed of) by any person; (ii) GDRs held (or acquired or disposed of) by such person’s subsidiaries or by a third party for such person’s account or by a third party with whom such person has concluded an oral or written voting agreement and (iii) GDRs which such person, or any subsidiary or third party referred above, may acquire pursuant to any option or other right held by such person (or acquired or disposed of, including, but not limited to, convertible bonds).
Special rules apply to the attribution of GDRs that are part of the property of a partnership or other community of property.
In addition, pursuant to the Dutch Act on Financial Supervision, members of the Management Board, members of the Supervisory Board, certain key employees of X5, and persons who are closely associated with such persons (“Insiders”), have an obligation to notify the AFM of transactions for their own account in shares that have been issued by X5, or securities whose value is determined in part by the value of those shares.
Insiders should notify the AFM of their transactions in shares that have been issued by X5, or securities whose value is determined in part by the value of those shares no later than five working days after the date of the transaction. Notification can be delayed until the moment that the value of the transactions performed by the Insider for its own account or together with the transactions carried out for their own account by the people closely associated with the Insider concerned, reaches or exceeds the amount of €5,000 in the calendar year in question.
The AFM keeps a public register of and publishes all notifications made pursuant to the Dutch Act on Financial Supervision.
Non-compliance with the reporting obligations under the Dutch Act on Financial Supervision could lead to criminal fines, administrative fines, imprisonment or other sanctions. In addition, non-compliance with the reporting obligations under the Dutch Act on Financial Supervision may lead to civil sanctions, including (i) general suspension of voting rights in respect of Shares, or Shares underlying any GDRs or other depositary receipts, for a period of up to three years; and/or (ii) a court order prohibiting a person from (acquiring or) exercising voting rights in respect of Shares, or Shares underlying any GDRs or other depositary receipts, for a period of up to five years.
109 TERMS AND CONDITIONS OF THE GLOBAL DEPOSITARY RECEIPTS
The following terms and conditions (subject to completion and amendment and excepting sentences in italics) will apply to the Global Depositary Receipts, and will be endorsed on each Global Depositary Receipt certificate.
The Global Depositary Receipts (“GDRs”) represented by this certificate are each issued in respect of 0.25 ordinary shares of par value €1.00 each (the “Shares”) in X5 Retail Group N.V. (the “Company”) pursuant to and subject to an agreement dated 11 May 2005, and made between the Company and The Bank of New York in its capacity as depositary (the “Depositary”) for the “Regulation S Facility” and the “Rule 144A Facility”) (such agreement, as amended from time to time, being hereinafter referred to as the “Deposit Agreement”). Pursuant to the provisions of the Deposit Agreement, the Depositary has appointed ING Securities Services as the Custodian (the “Custodian”) to receive and hold on its behalf any relevant documentation respecting certain Shares (the “Deposited Shares”) and all rights, interests and other securities, property and cash deposited with the Custodian which are attributable to the Deposited Shares (together with the Deposited Shares, the “Deposited Property”). The Depositary shall hold Deposited Property for the benefit of the Holders (as defined below) as bare trustee in proportion to their holdings of GDRs. In these terms and conditions of the GDRs (the “Conditions”), references to the “Depositary” are to The Bank of New York and/or any other depositary which may from time to time be appointed under the Deposit Agreement, and references to the “Custodian” are to ING Securities Services or any other custodian from time to time appointed under the Deposit Agreement and references to the “Main Office” mean, in relation to the relevant Custodian, its head office in the city of Amsterdam or such other location of the head office of the Custodian in The Netherlands as may be designated by the Custodian with the approval of the Depositary (if outside the city of Amsterdam) or the head office of any other custodian from time to time appointed under the Deposit Agreement.
The Offering comprises an offering of up to 48,106,700 New GDRs at a Subscription Price of US$21.37 per GDR. It is expected that listing of the New GDRs will take place on or about 7 May 2008. The admission of the GDRs to the Official List of the UKLA and to trading on the London Stock Exchange’s Market for Listed Securities is conditional upon the issuance of the GDRs by the Depositary.
The GDRs will, upon issue, be represented by interests in a Master Regulation S GDR, evidencing Regulation S GDRS (as each such term is defined in the Deposit Agreement) and a Master Rule 144A GDR evidencing Rule 144A GDRs (as each such term is defined in the Deposit Agreement). The GDRs are exchangeable in the circumstances set out in “Summary of Provisions Relating to the GDRs while in Master Form” for a certificate in definitive registered form in respect of GDRs representing all or part of the interest of the holder in the Master Regulation S GDR or Master Rule 144A GDR, respectively.
References in these Conditions to the “Holder” of any GDR shall mean the person or persons registered on the books of the Depositary maintained for such purpose (the “Register”) as holder. These Conditions include summaries of, and are subject to, the detailed provisions of the Deposit Agreement, which includes the forms of the certificates in respect of the GDRs. Copies of the Deposit Agreement are available for inspection at the specified office of the Depositary and each Agent (as defined in Condition 17) and at the Main Office of the Custodian. Terms used in these Conditions and not defined herein but which are defined in the Deposit Agreement, have the meanings ascribed to them in the Deposit Agreement. Holders of GDRs are not party to the Deposit Agreement which specifically disallows application of the Contracts (Rights of Third Parties) Act 1999 and thus, under English Law, have no contractual rights against, or obligations to, the Company or Depositary. However, the Deed Poll executed by the Company in favour of the Holders provides that, if the Company fails to perform the obligations imposed on it by certain specified provisions of the Deposit Agreement, any Holder may enforce the relevant provisions of the Deposit Agreement as if it were a party to the Deposit Agreement and was the “Depositary” in respect of that number of Deposited Shares to which the GDRs of which he is the Holder relate. The Depositary is under no duty to enforce any of the provisions of the Deposit Agreement on behalf of any Holder of a GDR or any other person.
As further described in “Description of Share Capital and Articles of Association – Qualification of GDRs Under Dutch Law”, it is uncertain whether or not the GDRs, which are governed by English law, qualify as depositary receipts. In the event that the GDRs qualify as such depositary receipts, the holders of the GDRs are entitled to certain rights as provided for by Dutch law, most of which rights are of a mandatory nature (dwingend recht). Accordingly, in the event of a conflict between the terms and conditions of the GDRs as provided for in the Deposit Agreement and the rights of holders of such depositary receipts that are of a mandatory nature, such rights shall, as a matter of Dutch law, prevail.
110 1. WITHDRAWAL OF DEPOSITED PROPERTY AND FURTHER ISSUES OF GDRS 1.1 Any Holder may request withdrawal of, and the Depositary shall thereupon relinquish, the Deposited Property attributable to any GDR upon production of such evidence of the entitlement of the Holder to the relative GDR as the Depositary may reasonably require, at the specified office of the Depositary or any Agent accompanied by: (i) a duly executed order (in a form approved by the Depositary) requesting the Depositary to cause the Deposited Property being withdrawn to be delivered at the Main Office of the Custodian, or (at the request, risk and expense of the Holder, and only if permitted by applicable law from time to time) at the specified office located in New York, London or The Netherlands of the Depositary or any Agent, or to the order in writing of, the person or persons designated in such order; (ii) the payment of such fees, taxes, duties, charges and expenses as may be required under these Conditions or the Deposit Agreement; (iii) the surrender (if appropriate) of GDR certificates in definitive registered form properly endorsed in blank or accompanied by proper instruments of transfer satisfactory to the Depositary to which the Deposited Property being withdrawn is attributable; and (iv) the delivery to the Depositary of a duly executed and completed certificate substantially in the form set out in Schedule 4, Part B, to the Deposit Agreement, if Deposited Property is to be withdrawn or delivered in respect of surrendered 144A GDRs. 1.2 Upon production of such documentation and the making of such payment as aforesaid for withdrawal of the Deposited Property in accordance with Condition 1.1, the Depositary will direct the Custodian, by tested telex, facsimile or SWIFT message, within a reasonable time after receiving such direction from such Holder, to deliver at its Main Office to, or to the order in writing of, the person or persons designated in the accompanying order: (i) a certificate (if any) for, or other appropriate instrument of title (if any) to or evidence of a book- entry transfer in respect of the relevant Deposited Shares, registered in the name of the Depositary or its nominee and accompanied by such instruments of transfer in blank or to the person or person specified in the order for withdrawal and such other documents, if any, as are required by law for the transfer thereof; and (ii) all other property forming part of the Deposited Property attributable to such GDR, accompanied, if required by law, by one or more duly executed endorsements or instruments of transfer in respect thereof; provided however, that the Depositary may make delivery at its specified office in New York of any Deposited Property which is in the form of cash;
PROVIDED THAT the Depositary (at the request, risk and expense of any Holder so surrendering a GDR): (a) will direct the Custodian to deliver the certificate for, or other instruments of title to, or book-entry transfer in respect of, the relevant Deposited Shares and any document relative thereto and any other documents referred to in sub-paragraphs 1.2(i) and (ii) of this Condition (together with any other property forming part of the Deposited Property which may be held by the Custodian or its agent and is attributable to such Deposited Shares); and/or (b) will deliver any other property forming part of the Deposited Property which may be held by the Depositary and is attributable to such GDR (accompanied, if required by law, by one or more duly executed endorsements or instruments of transfer in respect thereof); in each case to the specified office located in New York or London of the Depositary (if permitted by applicable law from time to time) or at the specified office in The Netherlands of any Agent as designated by the surrendering Holder in the order accompanying such GDR. 1.3 Delivery by the Depositary, any Agent and the Custodian of all certificates, instruments, dividends or other property forming part of the Deposited Property as specified in this Condition will be made subject to any laws or regulations applicable thereto. 1.4 The Depositary may, in accordance with the terms of the Deposit Agreement and upon delivery of a duly executed order (in a form reasonably approved by the Depositary) and a duly executed certificate substantially in the form of (a) Schedule 3 of the Deposit Agreement (which is described in the following paragraph) by or on behalf of any investor who is to become the beneficial owner of the Regulation S GDRs or (b) Schedule 4, Part A of the Deposit Agreement by or on behalf of any investor who is to become the beneficial owner of Rule 144A GDRs from time to time execute and deliver further GDRs
111 having the same terms and conditions as the GDRs which are then outstanding in all respects (or the same in all respects except for the first dividend payment on the Shares represented by such further GDRs) and, subject to the terms of the Deposit Agreement, the Depositary shall accept for deposit any further Shares in connection therewith, so that such further GDRs shall form a single series with the already outstanding GDRs. References in these Conditions to the GDRs include (unless the context requires otherwise) any further GDRs issued pursuant to this Condition and forming a single series with the already outstanding GDRs. The certificate to be provided in the form of Schedule 3 of the Deposit Agreement certifies, among other things, that the person providing such certificate is located outside the United States. 1.5 Any further GDRs issued pursuant to Condition 1.4 which correspond to Shares which have different dividend rights from the Shares corresponding to the outstanding GDRs will correspond to a separate temporary global Regulation S GDR and/or Rule 144A GDR. Upon becoming fungible with outstanding GDRs, such further GDRs shall be evidenced by a Master Regulation S GDR and a Master Rule 144A GDR (by increasing the total number of GDRs evidenced by the relevant Master Regulation S GDR and the Master Rule 144A GDR by the number of such further GDRs, as applicable). 1.6 The Depositary may issue GDRs against rights to receive Shares from the Company (or any agent of the Company recording Share ownership). No such issue of GDRs will be deemed a “Pre-Release” as defined in Condition 1.7. 1.7 Unless requested in writing by the Company to cease doing so, and notwithstanding the provisions of Condition 1.4, the Depositary may execute and deliver GDRs, or issue interests in a Master Regulation S GDR or a Master Rule 144A GDR, as the case may be, prior to the receipt of Shares (a “Pre-Release”). The Depositary may, pursuant to Condition 1.1, deliver Shares upon the receipt and cancellation of GDRs, which have been Pre-Released, whether or not such cancellation is prior to the termination of such Pre-Release or the Depositary knows that such GDR has been Pre-Released. The Depositary may receive GDRs in lieu of Shares in satisfaction of a Pre-Release. Each Pre-Release will be (a) preceded or accompanied by a written representation from the person to whom GDRs or Deposited Property are to be delivered (the “Pre-Releasee”) that such person, or its customer, (i) owns or represents the owner of the corresponding Deposited Properly or GDRs to be remitted (as the case may be), (ii) assigns all beneficial right, title and interest in such Deposited Property or GDRs (as the case may be) to the Depositary in its capacity as such and for the benefit of the Holders, (iii) will not take any action with respect to such GDRs or Deposited Property (as the case may be) that is inconsistent with the transfer of beneficial ownership (including without the consent of the Depositary, disposing of such GDRs or Deposited Property, as the case may be), other than in satisfaction of such Pre-Release, (b) at all times fully collateralised with cash or such other collateral as the Depositary determines in good faith will provide substantially similar liquidity and security, (c) terminable by the Depositary on not more than five (5) business days’ notice, and (d) subject to such further indemnities and credit regulations as the Depositary deems appropriate. The number of GDRs which are outstanding at any time as a result of Pre-Release will not normally represent more than thirty per cent. of the total number of GDRs then outstanding; provided, however, that the Depositary reserves the right to change or disregard such limit from time to time as it deems appropriate and may, with the prior written consent of the Company, change such limits for the purpose of general application. The Depositary will also set dollar limits with respect to such transactions hereunder with any particular Pre-Releasee hereunder on a case by case basis as the Depositary deems appropriate. The collateral referred to in sub-paragraph (b) above shall be held by the Depositary as security for the performance of the Pre-Releasee’s obligations in connection herewith, including the Pre-Releasee’s obligation to deliver Shares and/or other securities or GDRs upon termination of a transaction anticipated hereunder (and shall not, for the avoidance of doubt, constitute Deposited Property hereunder). The Depositary may retain for its own account any compensation received by it in connection with the foregoing, including without limitation, earnings on the collateral. The person to whom a Pre-Release of Rule 144A GDRs or Rule 144A Shares is to be made pursuant to this Condition 1.7 shall be required to deliver to the Depositary a duly executed and completed certificate substantially in the form set out in Schedule 4 Part A of the Deposit Agreement. The person to whom any Pre-Release of Regulation S GDRs or Regulation S Shares is to be made pursuant to this paragraph shall be required to deliver to the Depositary a duly executed and completed certificate substantially in the form set out in Schedule 3 of the Deposit Agreement.
112 2. SUSPENSION OF ISSUE OF GDRS AND OF WITHDRAWAL OF DEPOSITED PROPERTY The Depositary shall be entitled, at its reasonable discretion, at such times as it shall determine, to suspend the issue or transfer of GDRs (and the deposit of Shares) generally or in respect of particular Shares. In particular, to the extent that it is in its opinion practicable for it to do so, the Depositary will refuse to accept Shares for deposit, to execute and deliver GDRs or to register transfers of GDRs if it has been notified by the Company in writing that the Deposited Shares or GDRs or any depositary receipts representing Shares are listed on a U.S. Securities Exchange or quoted on a U.S. automated inter-dealer quotation system, unless accompanied by evidence satisfactory to the Depositary that any such Shares are eligible for resale pursuant to Rule 144A. Further, the Depositary may suspend the withdrawal of Deposited Property during any period when the Register, or the register of shareholders of the Company is closed or, generally or in one or more localities, suspend the withdrawal of Deposited Property or deposit of Shares if deemed necessary or desirable or advisable by the Depositary in good faith at any time or from time to time, in order to comply with any applicable law or governmental or stock exchange regulations or any provision of the Deposit Agreement or for any other reason. The Depositary shall (unless otherwise notified by the Company) restrict the withdrawal of Deposited Shares where the Company notifies the Depositary in writing that such withdrawal would result in ownership of Shares exceeding any limit under any applicable law, government resolution or the Company’s constitutive documents or would otherwise violate any applicable laws. 3. TRANSFER AND OWNERSHIP The GDRs are in registered form, each representing 0.25 Shares. Title to the GDRs passes by registration in the Register and accordingly, transfer of title to a GDR is effective only upon such registration. The Depositary will refuse to accept for transfer any GDRs if it reasonably believes that such transfer would result in violation of any applicable laws. The Holder of any GDR will (except as otherwise required by law) be treated by the Depositary and the Company as its beneficial owner for all purposes (whether or not any payment or other distribution in respect of such GDR is overdue and regardless of any notice of ownership, trust or any interest in it or any writing on, or theft or loss of any certificate issued in respect of it) and no person will be liable for so treating the Holder. Interests in Rule 144A GDRs represented by the Master Rule 144A GDR may be transferred to a person whose interest in such Rule 144A GDRs is subsequently represented by the Master Regulation S GDR only upon receipt by the Depositary of written certifications (in the forms provided in the Deposit Agreement) from the transferor and the transferee to the effect that such transfer is being made in accordance with Rule 903 or Rule 904 of Regulation S under the United States Securities Act of 1933, as amended (the “U.S. Securities Act”). There shall be no transfer of Regulation S GDRs by an owner thereof to a qualified institutional buyer as defined in Rule 144A under the U.S. Securities Act (each, a “QIB”) except in a transaction meeting the requirements of Rule 144A and unless such owner (i) withdraws Regulation S Shares from the Regulation S Facility in accordance with Clause 3.5 of the Deposit Agreement and (ii) instructs the Depositary to deliver the Shares so withdrawn to the account of the Custodian to be deposited into the Rule 144A Facility for issuance thereunder of Rule 144A GDRs to, or for the account of, such QIB. Issuance of Rule 144A GDRs shall be subject to the terms and conditions of the Deposit Agreement, including, with respect to the deposit of Shares and the issuance of Rule 144A GDRs, delivery of the duly executed and completed written certificate and agreement required under the Deposit Agreement by or on behalf of each person who will be the beneficial owner of such Rule 144A GDRs certifying that such person is a QIB and agreeing that it will comply with the restrictions on transfer set forth therein and to payment of the fees, charges and taxes provided therein. 4. CASH DISTRIBUTIONS Whenever the Depositary shall receive from the Company any cash dividend or other cash distribution on or in respect of the Deposited Shares (including any amounts received in the liquidation of the Company) or otherwise in connection with the Deposited Property, the Depositary shall, as soon as practicable, convert the same into United States dollars in accordance with Condition 8. The Depositary shall, if practicable in the opinion of the Depositary, give notice to the Holders of its receipt of such payment in accordance with Condition 23, specifying the amount per Deposited Share payable in respect of such dividend or distribution and the earliest date, determined by the Depositary, for transmission of such payment to Holders and shall as soon as practicable distribute any such amounts to the Holders in proportion to the number of Deposited Shares represented by the GDRs so held by them respectively, subject to and in accordance with the provisions of Conditions 9 and 11, PROVIDED THAT: (a) in the event that the Depositary is aware that any Deposited Shares are not entitled, by reason of the date of issue or transfer or otherwise, to such full proportionate amount, the amount so distributed to the relative Holders shall be adjusted accordingly; and
113 (b) the Depositary will distribute only such amounts of cash dividends and other distributions as may be distributed without attributing to any GDR a fraction of the lowest integral unit of currency in which the distribution is made by the Depositary, and any balance remaining shall be retained by the Depositary beneficially as an additional fee under Condition 16.1 (iv).
5. DISTRIBUTIONS OF SHARES Whenever the Depositary shall receive from the Company any distribution in respect of Deposited Shares which consists of a dividend or free distribution of Shares, the Depositary shall cause to be distributed to the Holders entitled thereto, in proportion to the number of Deposited Shares corresponding to the GDRs held by them respectively, additional GDRs corresponding to an aggregate number of Shares received pursuant to such distribution. Such additional GDRs shall be distributed by an increase in the number of GDRs corresponding to the Master GDRs, or by an issue of certificates in definitive registered form in respect of GDRs, according to the manner in which the Holders hold their GDRs; PROVIDED THAT, if and in so far as the Depositary deems any such distribution to all or any Holders not to be reasonably practicable (including, without limitation, due to the fractions which would otherwise result or to any requirement that the Company, the Custodian or the Depositary withhold an amount on account of taxes or other governmental charges) or to be unlawful, the Depositary shall (either by public or private sale and otherwise at its discretion, subject to all applicable laws and regulations) sell such Shares so received and distribute the net proceeds of such sale as a cash distribution pursuant to Condition 4 to the Holders entitled thereto.
6. DISTRIBUTIONS OTHER THAN IN CASH OR SHARES Whenever the Depositary shall receive from the Company any dividend or distribution in securities (other than Shares) or in other property (other than cash) on or in respect of the Deposited Property, the Depositary shall distribute or cause to be distributed such securities or other property to the Holders entitled thereto, in proportion to the number of Deposited Shares corresponding to the GDRs held by them respectively, in any manner that the Depositary may deem equitable and practicable for effecting such distribution; PROVIDED THAT, if and in so far as the Depositary deems any such distribution to all or any Holders not to be reasonably practicable (including, without limitation, due to the fractions which would otherwise result or to any requirement that the Company, the Custodian or the Depositary withhold an amount on account of taxes or other governmental charges) or to be unlawful, the Depositary shall deal with the securities or property so received, or any part thereof, in such way as the Depositary may determine to be equitable and practicable, including, without limitation, by way of sale (either by public or private sale and otherwise at its discretion, subject to all applicable laws and regulations) and shall (in the case of a sale distribute the resulting net proceeds as a cash distribution pursuant to Condition 4 to the Holders entitled thereto.
7. RIGHTS ISSUES If and whenever the Company announces its intention to make any offer or invitation to the holders of Shares to subscribe for or to acquire Shares, securities or other assets by way of rights, the Depositary shall as soon as practicable give notice to the Holders, in accordance with Condition 23, of such offer or invitation, specifying, if applicable, the earliest date established for acceptance thereof, the last date established for acceptance thereof and the manner by which and time during which Holders may request the Depositary to exercise such rights as provided below or, if such be the case, specifying details of how the Depositary proposes to distribute the rights or the proceeds of any sale thereof. The Depositary will deal with such rights in the manner described below: (i) if, and to the extent that the Depositary shall at its discretion, deem it to be lawful and reasonably practicable, the Depositary shall make arrangements whereby the Holders may, upon payment of the subscription price in Euro or other relevant currency together with such fees, taxes, duties, charges, costs and expenses as may be required under the Deposit Agreement and completion of such undertakings, declarations, certifications and other documents as the Depositary may reasonably require, request the Depositary to exercise such rights on their behalf with respect to the Deposited Shares and to distribute the Shares, securities or other assets so subscribed or acquired to the Holders entitled thereto by an increase in the numbers of GDRs corresponding to the Master GDRs or an issue of certificates in definitive registered form in respect of GDRs, according to the manner in which the Holders hold their GDRs, or
114 (ii) if, and to the extent that the Depositary shall at its discretion, deem it to be lawful and reasonably practicable, the Depositary will distribute such rights to the Holders entitled thereto in such manner as the Depositary may at its discretion determine, or (iii) if, and to the extent that the Depositary deems any such arrangement and distribution as is referred to in paragraphs (i) and (ii) above to all or any Holders not to be lawful and reasonably practicable (including, without limitation, due to the fractions which would otherwise result or to any requirement that the Company, the Custodian or the Depositary withhold an amount on account of taxes or other governmental charges) or to be unlawful, the Depositary (a) will, PROVIDED THAT Holders have not taken up rights through the Depositary as provided in (i) above, sell such rights (either by public or private sale and otherwise at its discretion subject to all applicable laws and regulations) or (b) may, if such rights are not transferable, in its discretion, arrange for such rights to be exercised and the resulting Shares or securities sold and, in each case, distribute the net proceeds of such sale as a cash distribution pursuant to Condition 4 to the Holders entitled thereto. (iv) (a) Notwithstanding the foregoing, in the event that the Depositary offers rights pursuant to Condition 7(i) (the “Primary GDR Rights Offering”), if authorised by the Company to do so, the Depositary may, in its discretion, make arrangements whereby in addition to instructions given by a Holder to the Depositary to exercise rights on its behalf pursuant to Condition 7(i), such Holder is permitted to instruct the Depositary to subscribe on its behalf for additional rights which are not attributable to the Deposited Shares represented by such Holder’s GDRs (“Additional GDR Rights”) if at the date and time specified by the Depositary for the conclusion of the Primary GDR Offering (the “Instruction Date”) instructions to exercise rights have not been received by the Depositary from the Holders in respect of all their initial entitlements. Any Holder’s instructions to subscribe for such Additional GDR Rights (“Additional GDR Rights Requests”) shall specify the maximum number of Additional GDR Rights that such Holder is prepared to accept (the “Maximum Additional Subscription”) and must be received by the Depositary by the Instruction Date. If by the Instruction Date any rights offered in the Primary GDR Rights Offering have not been subscribed by the Holders initially entitled thereto (“Unsubscribed Rights”), subject to Condition 7(iv)(c) and receipt of the relevant subscription price in Euro or other relevant currency, together with such fees, taxes, duties, charges, costs and expenses as it may deem necessary, the Depositary shall make arrangements for the allocation and distribution of Additional GDR Rights in accordance with Condition 7(iv)(b). (b) Holders submitting Additional GDR Rights Requests shall be bound to accept the Maximum Additional Subscription specified in such Additional GDR Request but the Depositary shall not be bound to arrange for a Holder to receive the Maximum Additional Subscription so specified but may make arrangements whereby the Unsubscribed Rights are allocated pro rata on the basis of the extent of the Maximum Additional Subscription specified in each Holder’s Additional GDR Rights Request. (c) In order to proceed in the manner contemplated in this Condition 7(iv), the Depositary shall be entitled to receive such opinions from Dutch counsel and U.S. counsel as in its discretion it deems necessary which opinions shall be in a form and provided by counsel satisfactory to the Depositary and at the expense of the Company and may be requested in addition to any other opinions and/or certifications which the Depositary shall be entitled to receive under the Deposit Agreement and these Conditions. For the avoidance of doubt, save as provided in these Conditions and the Deposit Agreement, the Depositary shall have no liability to the Company or any Holder in respect of its actions or omissions to act under this Condition 7(iv) and, in particular, the Depositary will not be regarded as being negligent, acting in bad faith, or in wilful default if it elects not to make the arrangements referred to in Condition 7(iv)(a). The Company has agreed in the Deposit Agreement that it will, unless prohibited by applicable law or regulation, give its consent to, and if requested use all reasonable endeavours (subject to the next paragraph) to facilitate, any such distribution, sale or subscription by the Depositary or the Holders, as the case may be, pursuant to Conditions 4, 5, 6, 7 or 10 (including the obtaining of legal opinions from counsel reasonably satisfactory to the Depositary concerning such matters as the Depositary may reasonably specify). If the Company notifies the Depositary that registration is required in any jurisdiction under any applicable law of the rights, securities or other property to be distributed under Condition 4, 5, 6, 7 or 10 or the securities to which such rights relate in order for the Company to offer such rights or distribute such
115 securities or other property to the Holders or owners of GDRs and to sell the securities corresponding to such rights, the Depositary will not offer such rights or distribute such securities or other property to the Holders or sell such securities unless and until the Company procures the receipt by the Depositary of an opinion from counsel reasonably satisfactory to the Depositary that a registration statement is in effect or that the offering and sale of such rights or securities to such Holders or owners of GDRs are exempt from registration under the provisions of such law. Neither the Company nor the Depositary shall be liable to register such rights, securities or other property or the securities to which such rights relate and they shall not be liable for any losses, damages or expenses resulting from any failure to do so. If at the time of the offering of any rights, at its discretion, the Depositary shall be satisfied that it is not lawful or practicable (for reasons outside its control) to dispose of the rights in any manner provided in paragraphs (i), (ii), (iii) and (iv) above, the Depositary shall permit the rights to lapse. The Depositary will not be responsible for any failure to determine that it may be lawful or feasible to make such rights available to Holders or owners of GDRs in general or to any Holder or owner of a GDR or Holders or owners of GDRs in particular.
8. CONVERSION OF FOREIGN CURRENCY Whenever the Depositary shall receive any currency other than United States dollars by way of dividend or other distribution or as the net proceeds from the sale of securities, other property or rights, and if at the time of the receipt thereof the currency so received can in the judgement of the Depositary be converted on a reasonable basis into United States dollars and distributed to the Holders entitled thereto, the Depositary shall as soon as practicable itself convert or cause to be converted by another bank or other financial institution, by sale or in any other manner that it may reasonably determine, the currency so received into United States dollars. If such conversion or distribution can be effected only with the approval or licence of any government or agency thereof, the Depositary shall make reasonable efforts to apply, or procure that an application be made, for such approval or licence, if any, as it may deem desirable. If at any time the Depositary shall determine that in its judgement any currency other than United States dollars is not convertible on a reasonable basis into United States dollars and distributable to the Holders entitled thereto, or if any approval or licence of any government or agency thereof which is required for such conversion is denied or, in the opinion of the Depositary, is not obtainable, or if any such approval or licence is not obtained within a reasonable period as determined by the Depositary, the Depositary may distribute such other currency received by it (or an appropriate document evidencing the right to receive such other currency) to the Holders entitled thereto to the extent permitted under applicable law, or the Depositary may in its discretion hold such other currency for the benefit of the Holders entitled thereto. If any conversion of any such currency can be effected in whole or in part for distribution to some (but not all) Holders entitled thereto, the Depositary may at its discretion make such conversion and distribution in United States dollars to the extent possible to the Holders entitled thereto and may distribute the balance of such other currency received by the Depositary to, or hold such balance for the account of, the Holders entitled thereto, and notify the Holders accordingly.
9. DISTRIBUTION OF ANY PAYMENTS 9.1 Any distribution of cash under Condition 4, 5, 6, 7 or 10 will be made by the Depositary to Holders on the record date established by the Depositary for that purpose (such date to be as close to the record date set by the Company as is reasonably practicable) and, if practicable in the opinion of the Depositary, notice shall be given promptly to Holders in accordance with Condition 23, in each case subject to any laws or regulations applicable thereto and (subject to the provisions of Condition 8) distributions will be made in United States dollars by cheque drawn upon a bank in New York City or, in the case of the Master GDRs, according to usual practice between the Depositary and Clearstream, Euroclear or DTC, as the case may be. The Depositary or the Agent, as the case may be, may deduct and retain from all moneys due in respect of such GDR in accordance with the Deposit Agreement all fees, taxes, duties, charges, costs and expenses which may become or have become payable under the Deposit Agreement or under applicable law or regulation in respect of such GDR or the relative Deposited Property. 9.2 Delivery of any securities or other property or rights other than cash shall be made as soon as practicable to the entitled Holders on the record date established by the Depositary for that purpose (such date to be as close to the record date set by the Company as is reasonably practicable), subject to any laws or regulations applicable thereto. If any distribution made by the Company with respect to the Deposited Property and received by the Depositary shall remain unclaimed at the end of three years from the first date upon which such distribution is made available to Holders in accordance with the Deposit Agreement, all rights of the
116 Holders to such distribution or the proceeds of the sale thereof shall be extinguished and the Depositary shall (except for any distribution upon the liquidation of the Company when the Depositary shall retain the same) return the same to the Company for its own use and benefit subject, in all cases, to the provisions of applicable law or regulation.
10. CAPITAL REORGANISATION Upon any change in the nominal or par value, sub-division, consolidation or other reclassification of Deposited Shares or any other part of the Deposited Property or upon any reduction of capital, or upon any reorganisation, merger or consolidation of the Company or to which it is a party (except where the Company is the continuing corporation), the Depositary shall as soon as practicable give notice of such event to the Holders and at its discretion may treat such event as a distribution and comply with the relevant provisions of Conditions 4, 5, 6 and 9 with respect thereto, or may execute and deliver additional GDRs in respect of Shares or may require the exchange of existing GDRs for new GDRs which reflect the effect of such change.
11. WITHHOLDING TAXES AND APPLICABLE LAWS 11.1 Payments to Holders of dividends or other distributions on or in respect of the Deposited Shares will be subject to deduction of Dutch and other withholding taxes, if any, at the applicable rates. 11.2 If any governmental or administrative authorisation, consent, registration or permit or any report to any governmental or administrative authority is required under any applicable law in The Netherlands in order for the Depositary to receive from the Company Shares or other securities to be deposited under these Conditions, or in order for Shares, other securities or other property to be distributed under Condition 4, 5, 6 or 10, or to be subscribed under Condition 7 or to offer any rights or sell any securities represented by such rights relevant to any Deposited Shares, the Company has agreed to apply for such authorisation, consent, registration or permit or file such report on behalf of the Holders within the time required under such laws. In this connection, the Company has undertaken in the Deposit Agreement, to the extent reasonably practicable, to take such action as may be required in obtaining or filing the same. The Depositary shall not be obliged to distribute GDRs representing such Shares, Shares, other securities or other property deposited under these Conditions or make any offer of any such rights or sell any securities corresponding to any such rights with respect to which such authorisation, consent, registration or permit or such report has not been obtained or filed, as the case may be, and shall have no duties to obtain (but shall where assistance is reasonably requested by the Company, and such assistance does not require the Depositary to take any action in conflict with market practice or in a capacity other than its capacity as Depositary, at the expense of the Company make reasonable endeavours to assist the Company to obtain) any such authorisation, consent, registration or permit, or to file any such report.
12. VOTING RIGHTS 12.1 Holders will have the right to instruct the Depositary with regard to the exercise of voting rights with respect to Deposited Shares in accordance with this Condition 12. The Company has agreed to notify the Depositary of any resolution to be proposed at a General Meeting of the Company and the Depositary will vote or cause to be voted the Deposited Shares in the manner set out in this Condition 12. The Company has agreed with the Depositary that it will promptly provide to the Depositary sufficient copies, as the Depositary may reasonably request, of notices of meetings of the shareholders of the Company and the agenda therefor as well as written requests containing voting instructions by which each Holder may give instructions to the Depositary to vote for or against each and any resolution specified in the agenda for the meeting, which the Depositary shall send to any person who is a Holder on the record date established by the Depositary for that purpose (which shall be the same as the corresponding record date set by the Company or as near as practicable thereto) as soon as practicable after receipt of the same by the Depositary in accordance with Condition 23. The Company has also agreed to provide to the Depositary appropriate proxy forms to enable the Depositary to procure the appointment of a representative to attend the relevant meeting and vote on behalf of the registered owner of the Deposited Shares. 12.2 In order for each voting instruction to be valid, the voting instructions form must be completed and duly signed by the respective Holder (or in the case of instructions received from the clearing systems should be received by authenticated SWIFT message) in accordance with the written request containing voting instructions and returned to the Depositary by such record date as the Depositary may specify.
117 12.3 The Depositary will exercise or cause to be exercised the voting rights in respect of the Deposited Shares so that a portion of the Deposited Shares will be voted for and a portion of the Deposited Shares will be voted against any resolution specified in the agenda for the relevant meeting in accordance with the voting instructions it has received. 12.4 If the Depositary is advised in the opinion referred to in Condition 12.7 below that it is not permitted by Dutch law to exercise the voting rights in respect of the Deposited Shares differently (so that a portion of the Deposited Shares may be voted for a resolution and a portion of the Deposited Shares may be voted against a resolution) the Depositary shall, if the opinion referred to in Condition 12.7 below confirms it to be permissible under Dutch law, calculate from the voting instructions that it has received from all Holders (x) the aggregate number of votes in favour of a particular resolution and (y) the aggregate number of votes opposed to such resolution and cast or cause to be cast in favour of or opposed to such resolution the number of votes representing the net positive difference between such aggregate number of votes in favour of such resolution and such aggregate number of votes opposed to such resolution. 12.5 The Depositary will only endeavour to vote or cause to be voted the votes attaching to Shares in respect of which voting instructions have been received, except that if no voting instructions are received by the Depositary (either because no voting instructions are returned to the Depositary or because the voting instructions are incomplete, illegible or unclear) from a Holder with respect to any or all of the Deposited Shares represented by such Holder’s GDRs on or before the record date specified by the Depositary, such Holder shall be deemed to have instructed the Depositary to give a discretionary proxy to a person designated by the Company with respect to such Deposited Shares, and the Depositary shall give a discretionary proxy to a person designated by the Company to vote such Deposited Shares, PROVIDED THAT no such instruction shall be deemed given, and no such discretionary proxy shall be given, with respect to any matter as to which the Company informs the Depositary (and the Company has agreed to provide such information in writing as soon as practicable) that (i) the Company does not wish such proxy to be given, or (ii) such matter materially and adversely affects the rights of holders of Shares. 12.6 If the Depositary is advised in the opinion referred to in Condition 12.7 below that it is not permissible under Dutch law or the Depositary determines that it is not reasonably practicable to vote or cause to be voted such Deposited Shares in accordance with Conditions 12.3, 12.4 or 12.5 the Depositary shall not vote or cause to be voted such Deposited Shares. 12.7 Where the Depositary is to vote in respect of each and any resolution in the manner described in Conditions 12.3, 12.4 or 12.5 above the Depositary shall notify the Chairman of the Company and appoint a person designated by him as a representative of the Depositary to attend such meeting and vote the Deposited Shares in the manner required by this Condition. The Depositary shall not be required to take any action required by this Condition 12 unless it shall have received an opinion from the Company’s legal counsel (such counsel being reasonably acceptable to the Depositary) at the expense of the Company to the effect that such voting arrangement is valid and binding on Holders under Dutch law and the statutes of the Company and that the Depositary is permitted to exercise votes in accordance with the provisions of this Condition 12 but that in doing so the Depositary will not be deemed to be exercising voting discretion. 12.8 By continuing to hold GDRs, all Holders shall be deemed to have agreed to the provisions of this Condition as it may be amended from time to time in order to comply with applicable Dutch law. 12.9 The Depositary shall not, and the Depositary shall ensure that the Custodian and its nominees do not, vote or attempt to exercise the right to vote that attaches to the Deposited Shares, other than in accordance with instructions given in accordance with this Condition.
13. DOCUMENTS TO BE FURNISHED, RECOVERY OF TAXES, DUTIES AND OTHER CHARGES The Depositary shall not be liable for any taxes, duties, charges, costs or expenses which may become payable in respect of the Deposited Shares or other Deposited Property or the GDRs, whether under any present or future fiscal or other laws or regulations, and such part thereof as is proportionate or referable to a GDR shall be payable by the Holder thereof to the Depositary at any time on request or may be deducted from any amount due or becoming due on such GDR in respect of any dividend or other distribution. In default thereof, the Depositary may for the account of the Holder discharge the same out of the proceeds of sale on any Stock Exchange on which the Shares may from time to time be listed, and subject to all applicable laws and regulations, of any appropriate number of Deposited Shares or other Deposited Property and subsequently pay any surplus to the Holder. Any such request shall be made by giving notice pursuant to Condition 23.
118 14. LIABILITY 14.1 In acting hereunder the Depositary shall have only those duties, obligations and responsibilities expressly specified in the Deposit Agreement and these Conditions, and, other than holding the Deposited Property for the benefit of Holders as bare trustee, does not assume any relationship of trust for or with the Holders or owners of GDRs or any other person. 14.2 Neither the Depositary, the Custodian, the Company, any Agent, nor any of their agents, officers, directors or employees shall incur any liability to any other of them or to any Holder or owner of a GDR or any other person with an interest in any GDRs if, by reason of any provision of any present or future law or regulation of The Netherlands or any other country or of any relevant governmental authority, or by reason of the interpretation or application of any such present or future law or regulation or any change therein, or by reason of any other circumstances beyond their control, or in the case of the Depositary, the Custodian, the Agent or any of their agents, officers, directors or employees by reason of any provision, present or future, of the constitutive documents of the Company, any of them shall be prevented, delayed or forbidden from doing or performing any act or thing which the terms of the Deposit Agreement or these Conditions provide shall or may be done or performed, nor shall any of them incur any liability to any Holder or owner of GDRs or any other person with an interest in any GDRs by reason of any exercise of, or failure to exercise, any voting rights attached to the Deposited Shares or any of them or any other discretion or power provided for in the Deposit Agreement. Any such party may rely on, and shall be protected in acting upon, any written notice, request, direction or other document believed by it to be genuine and to have been duly signed or presented (including a translation which is made by a translator believed by it to be competent or which appears to be authentic). 14.3 Neither the Depositary nor any Agent shall be liable (except for its own wilful default, negligence or bad faith or that of its agents, officers, directors or employees) to the Company or any Holder or owner of GDRs or any other person, by reason of having accepted as valid or not having rejected any certificate for Shares or GDRs or any signature on any transfer or instruction purporting to be such and subsequently found to be forged or not authentic or for its failure to perform any obligations under the Deposit Agreement or these Conditions. 14.4 The Depositary and its agents may engage or be interested in any financial or other business transactions with the Company or any of its subsidiaries or affiliates, or in relation to the Deposited Property (including without prejudice to the generality of the foregoing, the conversion of any part of the Deposited Property from one currency to another), may at any time hold or be interested in GDRs for its own account, and shall be entitled to charge and be paid all usual fees, commissions and other charges for business transacted and acts done by it as a bank, and not in the capacity of Depositary, in relation to matters arising under the Deposit Agreement (including, without prejudice to the generality of the foregoing, charges on the conversion of any part of the Deposited Property from one currency to another and on any sales of property) without accounting to Holders or any other person for any profit arising therefrom. 14.5 The Depositary shall endeavour to effect any such sale as is referred to or contemplated in Conditions 5, 6, 7, 10, 13 or 21 or any such conversion as is referred to in Condition 8 in accordance with the Depositary’s normal practices and procedures but shall have no liability (in the absence of its own wilful default, negligence or bad faith or that of its agents, officers, directors or employees) with respect to the terms of such sale or conversion or if such sale or conversion shall not be reasonably practicable. 14.6 The Depositary shall not be required or obliged to monitor, supervise or enforce the observance and performance by the Company of its obligations under or in connection with the Deposit Agreement or these Conditions. 14.7 The Depositary shall have no responsibility whatsoever to the Company, any Holders or any owner of GDRs, or any other person as regards any deficiency which might arise because the Depositary is subject to any tax in respect of the Deposited Property or any part thereof or any income therefrom or any proceeds thereof. 14.8 In connection with any proposed modification, waiver, authorisation or determination permitted by the terms of the Deposit Agreement, the Depositary shall not, except as otherwise expressly provided in Condition 22, be obliged to have regard to the consequence thereof for the Holders or the owners of GDRs or any other person.
119 14.9 Notwithstanding anything else contained in the Deposit Agreement or these Conditions, the Depositary may refrain from doing anything which could or might, in its opinion, be contrary to any law of any jurisdiction or any directive or regulation of any agency or state or which would or might otherwise render it liable to any person and the Depositary may do anything which is, in its opinion, necessary to comply with any such law, directive or regulation. 14.10 The Depositary may, in relation to the Deposit Agreement and these Conditions, act or take no action on the advice or opinion of, or any certificate or information obtained from, any lawyer, valuer, accountant, banker, broker, securities company or other expert whether obtained by the Company, the Depositary or otherwise and (subject to Condition 14.13 below) shall not be responsible or liable for any loss or liability occasioned by so acting or refraining from acting or relying on information from persons presenting Shares for deposit or GDRs for surrender or requesting transfers thereof. 14.11 Any such advice, opinion, certificate or information (as discussed in Condition 14.10 above) may be sent or obtained by letter, telex, facsimile transmission, telegram or cable and (subject to Condition 14.13 below) the Depositary shall not be liable for acting on any advice, opinion, certificate or information purported to be conveyed by any such letter, telex or facsimile transmission although (without the Depositary’s knowledge) the same shall contain some error or shall not be authentic. 14.12 The Depositary may call for and shall be at liberty to accept as sufficient evidence of any fact or matter or the expediency of any transaction or thing, a certificate, letter or other communication, whether oral or written, signed or otherwise communicated on behalf of the Company by a director of the Company or by a person duly authorised by a Director of the Company or such other certificate from persons specified in Condition 14.10 above which the Depositary considers appropriate and the Depositary shall not be bound in any such case to call for further evidence or be responsible for any loss or liability that may be occasioned by the Depositary acting on such certificate. 14.13 The Depositary shall have no obligation under the Deposit Agreement except to perform its obligations as are specifically set out therein without wilful default, negligence or bad faith. 14.14 The Depositary may delegate by power of attorney or otherwise to any person or persons or fluctuating body of persons, whether being a joint Depositary of the Deposit Agreement or not and not being a person to whom the Company may reasonably object, all or any of the powers, authorities and discretions vested in the Depositary by the Deposit Agreement and such delegation may be made upon such terms and subject to such conditions, including power to sub-delegate and subject to such regulations as the Depositary may in the interests of the Holders think fit, provided that no objection from the Company to any such delegation as aforesaid may be made to a person whose financial statements are consolidated with those of the Depositary’s ultimate holding company. Any delegation by the Depositary shall be on the basis that the Depositary is acting on behalf of the Holders and the Company in making such delegation. The Company shall not in any circumstances and the Depositary shall not (provided that it shall have exercised reasonable care in the selection of such delegate) be bound to supervise the proceedings or be in any way responsible for any loss, liability, cost, claim, action, demand or expense incurred by reason of any misconduct or default on the part of any such delegate or sub-delegate. However, the Depositary shall, if practicable and if so requested by the Company, pursue (at the Company’s expense and subject to receipt by the Depositary of such indemnity and security for costs as the Depositary may reasonably require) any legal action it may have against such delegate or subdelegate arising out of any such loss caused by reason of any such misconduct or default. The Depositary shall, within a reasonable time of any such delegation or any renewal, extension or termination thereof, give notice thereof to the Company. Any delegation under this Condition which includes the power to sub-delegate shall provide that the delegate shall, within a specified time of any sub-delegation or amendment, extension or termination thereof, give notice thereof to the Company and the Depositary. 14.15 The Depositary may, in the performance of its obligations hereunder, instead of acting personally, employ and pay an agent, whether a solicitor or other person, to transact or concur in transacting any business and do or concur in doing all acts required to be done by such party, including the receipt and payment of money. 14.16 The Depositary shall be at liberty to hold or to deposit the Deposit Agreement and any deed or document relating thereto in any part of the world with any banking company or companies (including itself) whose business includes undertaking the safe custody of deeds or documents or with any lawyer or firm of lawyers of good repute, and the Depositary shall not (in the case of deposit with itself, in the absence of its own negligence, wilful default, or bad faith or that of its agents, directors, officers or employees) be responsible for any losses, liability or expenses incurred in connection with any such deposit.
120 14.17 Notwithstanding anything to the contrary contained in the Deposit Agreement or these Conditions, the Depositary shall not be liable in respect of any loss or damage which arises out of or in connection with its performance or non-performance or the exercise or attempted exercise of, or the failure to exercise any of, its powers or discretions under the Deposit Agreement except to the extent that such loss or damage arises from the wilful default, negligence or bad faith of the Depositary or that of its agents, officers, directors or employees. 14.18 No provision of the Deposit Agreement or these Conditions shall require the Depositary to expend or risk its own funds or otherwise incur any financial liability in the performance of any of its duties or in the exercise of any of its rights or powers, if it shall have reasonable grounds for believing that repayment of such funds or adequate indemnity and security against such risk of liability is not assured to it. 14.19 For the avoidance of doubt, the Depositary shall be under no obligation to check, monitor or enforce compliance with any ownership restrictions in respect of GDRs or Shares under any applicable Dutch law as the same may be amended from time to time. Notwithstanding the generality of Condition 3, the Depositary shall refuse to register any transfer of GDRs or any deposit of Shares against issuance of GDRs if notified by the Company, or the Depositary becomes aware of the fact, that such transfer or issuance would result in a violation of the limitations set forth above. 14.20 No disclaimer of liability under the Securities Act is intended by any provision of the Deposit Agreement.
15. ISSUE AND DELIVERY OF REPLACEMENT GDRS AND EXCHANGE OF GDRS Subject to the payment of the relevant fees, taxes, duties, charges, costs and expenses and such terms as to evidence and indemnity as the Depositary may require, replacement GDRs will be issued by the Depositary and will be delivered in exchange for or replacement of outstanding lost, stolen, mutilated, defaced or destroyed GDRs upon surrender thereof (except in the case of the destruction, loss or theft) at the specified office of the Depositary or (at the request, risk and expense of the Holder) at the specified office of any Agent.
16. DEPOSITARY’S FEES, COSTS AND EXPENSES 16.1 The Depositary shall be entitled to charge the following remuneration and receive the following remuneration and reimbursement (such remuneration and reimbursement being payable on demand) from the Holders in respect of its services under the Deposit Agreement: (i) for the issue of GDRs (other than upon the issue of GDRs pursuant to the Offering) or the cancellation of GDRs upon the withdrawal of Deposited Property US$5.00 or less per 100 GDRs (or portion thereof) issued or cancelled; (ii) for issuing GDR certificates in definitive registered form in replacement for mutilated, defaced, lost, stolen or destroyed GDR certificates: a sum per GDR certificate which is determined by the Depositary to be a reasonable charge to reflect the work, costs and expenses involved; (iii) for issuing GDR certificates in definitive registered form (other than pursuant to (ii) above): the greater of US$1.50 per GDR certificate (plus printing costs) or such other sum per GDR certificate which is determined by the Depositary to be a reasonable charge to reflect the work plus costs (including but not limited to printing costs) and expenses involved; (iv) for receiving and paying any cash dividend or other cash distribution on or in respect of the Deposited Shares: a fee of US$0.02 or less per GDR for each such dividend or distribution; (v) in respect of any issue of rights or distribution of Shares (whether or not represented by GDRs) or other securities or other property (other than cash) upon exercise of any rights, any free distribution, stock dividend or other distribution US$5.00 or less per 100 outstanding GDRs (or portion thereof) for each such issue of rights, dividend or distribution; (vi) for transferring interests from and between the Regulation S Master GDR and the Rule 144A Master GDR: a fee of US$0.05 or less per GDR; (vii) a fee of US$0.02 or less per GDR for depositary services, which shall accrue on the last day of each calendar year and shall be payable as provided in paragraph (viii) below, provided however that no fee will be assessed under this provision to the extent a fee of US$0.02 per GDR was charged in such calendar year pursuant to paragraph (iv) above; and
121 (viii) any other charge payable by the Depositary, any of the Depositary’s agents, including the Custodian, or the agents of the Depositary’s agents, in connection with the servicing of Deposited Shares or other Deposited Property (which charge shall be assessed against Holders as of the date or dates set by the Depositary and shall be payable at the sole discretion of the Depositary by billing such Holders for such charge or deducting such charge from one or more cash dividends or other cash distributions; together with all expenses (including currency conversion expenses), transfer and registration fees, taxes, duties and charges payable by the Depositary, any Agent or the Custodian, or any of their agents, in connection with any of the above. 16.2 The Depositary is entitled to receive from the Company the fees, taxes, duties, charges, costs and expenses as specified in a separate agreement between the Company and the Depositary.
17. AGENTS 17.1 The Depositary shall be entitled to appoint one or more agents (the “Agents”) for the purpose, inter alia, of making distributions to the Holders. 17.2 Notice of appointment or removal of any Agent or of any change in the specified office of the Depositary or any Agent will be duly given by the Depositary to the Holders.
18. LISTING The Company has undertaken in the Deposit Agreement to use its best endeavours to maintain, so long as any GDR is outstanding, a listing for the GDRs on the Official List of the UK Listing Authority and admission to trading on the market for listed securities of the London Stock Exchange. For that purpose the Company will pay all fees and sign and deliver all undertakings required by the UK Listing Authority and the London Stock Exchange in connection with such listings. In the event that the listing on the Official List of the UK Listing Authority and admission to trading on the market for listed securities of the London Stock Exchange is not maintained, the Company has undertaken in the Deposit Agreement to use its best endeavours with the reasonable assistance of the Depositary (provided at the Company’s expense) to obtain and maintain a listing of the GDRs on any other internationally recognised stock exchange in Europe.
19. THE CUSTODIAN The Depositary has agreed with the Custodian that the Custodian will receive and hold (or appoint agents approved by the Depositary to receive and hold) all Deposited Property for the account and to the order of the Depositary in accordance with the applicable terms of the Deposit Agreement which include a requirement to segregate the Deposited Property from the other property of, or held by, the Custodian PROVIDED THAT the Custodian shall not be obliged to segregate cash comprised in the Deposited Property from cash otherwise held by the Custodian. The Custodian shall be responsible solely to the Depositary PROVIDED THAT, if and so long as the Depositary and the Custodian are the same legal entity, references to them separately in these Conditions and the Deposit Agreement are for convenience only and that legal entity shall be responsible for discharging both functions directly to the Holders and the Company The Custodian may resign or be removed by the Depositary by giving 90 days’ prior notice, except that if a replacement Custodian is appointed which is a branch or affiliate of the Depositary, the Custodian’s resignation or discharge may take effect immediately on the appointment of such replacement Custodian. Upon the removal of or receiving notice of the resignation of the Custodian, the Depositary shall promptly appoint a successor Custodian (approved (i) by the Company, such approval not to be unreasonably withheld or delayed, and (ii) by the relevant authority in The Netherlands, if any), which shall, upon acceptance of such appointment and the expiry of any applicable notice period become the Custodian. Whenever the Depositary in its discretion determines that it is in the best interests of the Holders to do so, it may, after prior consultation with the Company, terminate the appointment of the Custodian and, in the event of any such termination, the Depositary shall promptly appoint a successor Custodian (approved (i) by the Company, such approval not to be unreasonably withheld or delayed, and (ii) by the relevant authority in The Netherlands, if any), which shall, upon acceptance of such appointment, become the Custodian under the Deposit Agreement on the effective date of such termination. The Depositary shall notify Holders of such change immediately upon such change taking effect in accordance with Condition 23. Notwithstanding the foregoing, the Depositary may temporarily deposit the Deposited Property in a manner or a place other than as therein specified, PROVIDED THAT,
122 in the case of such temporary deposit in another place, the Company shall have consented to such deposit, and such consent of the Company shall have been delivered to the Custodian. In case of transportation of the Deposited Property under this Condition, the Depositary shall obtain appropriate insurance at the expense of the Company if and to the extent that the obtaining of such insurance is reasonably practicable and the premiums payable are of a reasonable amount.
20. RESIGNATION AND TERMINATION OF APPOINTMENT OF THE DEPOSITARY 20.1 The Company may terminate the appointment of the Depositary under the Deposit Agreement by giving at least 120 days’ prior notice in writing to the Depositary and the Custodian, and the Depositary may resign as Depositary by giving at least 120 days’ prior notice in writing to the Company and the Custodian. Within 30 days after the giving of either such notice, notice thereof shall be duly given by the Depositary to the Holders. The termination of the appointment or the resignation of the Depositary shall take effect on the date specified in such notice; PROVIDED THAT no such termination of appointment or resignation shall take effect until the appointment by the Company of a successor depositary under the Deposit Agreement and the acceptance of such appointment to act in accordance with the terms thereof and of these Conditions, by the successor depositary. The Company has undertaken in the Deposit Agreement to use its best endeavours to procure the appointment of a successor depositary with effect from the date of termination specified in such notice as soon as reasonably possible following notice of such termination or resignation. Upon any such appointment and acceptance, notice thereof shall be duly given by the Depositary to the Holders in accordance with Condition 23. 20.2 Upon the termination of appointment or resignation of the Depositary and against payment of all fees and expenses due to the Depositary from the Company under the Deposit Agreement, the Depositary shall deliver to its successor as depositary sufficient information and records to enable such successor efficiently to perform its obligations under the Deposit Agreement and shall deliver and pay to such successor depositary all property and cash held by it under the Deposit Agreement. The Deposit Agreement provides that, upon the date when such termination of appointment or resignation takes effect, the Custodian shall be deemed to be the Custodian thereunder for such successor depositary, and the Depositary shall thereafter have no obligation under the Deposit Agreement or the Conditions (other than liabilities accrued prior to the date of termination of appointment or resignation or any liabilities stipulated in relevant laws or regulations).
21. TERMINATION OF DEPOSIT AGREEMENT 21.1 Either the Company or the Depositary but, in the case of the Depositary, only if the Company has failed to appoint a replacement Depositary within 90 days of the date on which the Depositary has given notice pursuant to Condition 20 that it wishes to resign, may terminate the Deposit Agreement by giving 90 days’ prior notice to the other and to the Custodian. Within 30 days after the giving of such notice, notice of such termination shall be duly given by the Depositary to Holders of all GDRs then outstanding in accordance with Condition 23. 21.2 During the period beginning on the date of the giving of such notice by the Depositary to the Holders and ending on the date on which such termination takes effect, each Holder shall be entitled to obtain delivery of the Deposited Property relative to each GDR held by it, subject to the provisions of Condition 1.1 and upon compliance with Condition 1, payment by the Holder of the charge specified in Condition 16.1(i) and Clause 10.11(a) for such delivery and surrender, and payment by the Holder of any sums payable by the Depositary and/or any other expenses incurred by the Depositary (together with all amounts which the Depositary is obliged to pay to the Custodian) in connection with such delivery and surrender and otherwise in accordance with the Deposit Agreement. 21.3 If any GDRs remain outstanding after the date of termination, the Depositary shall as soon as reasonably practicable sell the Deposited Property then held by it under the Deposit Agreement and shall not register transfers, shall not pass on dividends or distributions or take any other action, except that it will deliver the net proceeds of any such sale, together with any other cash then held by it under the Deposit Agreement, pro rata to Holders of GDRs which have not previously been so surrendered by reference to that proportion of the Deposited Property which is represented by the GDRs of which they are the Holders. After making such sale, the Depositary shall be discharged from all obligations under the Deposit Agreement and these Conditions, except its obligation to account to Holders for such net proceeds of sale and other cash comprising the Deposited Property without interest.
123 22. AMENDMENT OF DEPOSIT AGREEMENT AND CONDITIONS All and any of the provisions of the Deposit Agreement and these Conditions (other than this Condition 22) may at any time and from time to time be amended by agreement between the Company and the Depositary in any respect which they may deem necessary or desirable. Notice of any amendment of these Conditions (except to correct a manifest error) shall be duly given to the Holders by the Depositary, and any amendment (except as aforesaid) which shall increase or impose fees payable by Holders or which shall otherwise, in the opinion of the Depositary, be materially prejudicial to the interests of the Holders (as a class) shall not become effective so as to impose any obligation on the Holders until the expiration of three months after such notice shall have been given. During such period of three months, each Holder shall be entitled to obtain, subject to and upon compliance with Condition 1, delivery of the Deposited Property relative to each GDR held by it upon surrender thereof, payment of the charge specified in Condition 16.1(i) for such delivery and surrender and otherwise in accordance with the Deposit Agreement and these Conditions. Each Holder at the time when such amendment so becomes effective shall be deemed, by continuing to hold a GDR, to approve such amendment and to be bound by the terms thereof in so far as they affect the rights of the Holders. In no event shall any amendment impair the right of any Holder to receive, subject to and upon compliance with Condition 1, the Deposited Property attributable to the relevant GDR. For the purposes of this Condition 22, an amendment shall not be regarded as being materially prejudicial to the interests of Holders if its principal effect is to permit the creation of GDRs in respect of additional Shares to be held by the Depositary which are or will become fully consolidated as a single series with the other Deposited Shares PROVIDED THAT temporary GDRs will represent such Shares until they are so consolidated.
23. NOTICES 23.1 Any and all notices to be given to any Holder shall be duly given if personally delivered, or sent by mail (if domestic, first class, if overseas, first class airmail) or air courier, or by telex or facsimile transmission confirmed by letter sent by mail or air courier, addressed to such Holder at the address of such Holder as it appears on the transfer books for GDRs of the Depositary, or, if such Holder shall have filed with the Depositary a written request that notices intended for such Holder be mailed to some other address, at the address specified in such request. 23.2 Delivery of a notice sent by mail or air courier shall be effective three days (in the case of domestic mail or air courier) or seven days (in the case of overseas mail) after despatch, and any notice sent by telex transmission, as provided in this Condition, shall be effective when the sender receives the answerback from the addressee at the end of the telex and any notice sent by facsimile transmission, as provided in this Condition, shall be effective when the intended recipient has confirmed by telephone to the transmitter thereof that the recipient has received such facsimile in complete and legible form. The Depositary or the Company may, however, act upon any telex or facsimile transmission received by it from the other or from any Holder, notwithstanding that such telex or facsimile transmission shall not subsequently be confirmed as aforesaid. 23.3 So long as GDRs are listed on the Official List of the UK Listing Authority and admitted for trading on the London Stock Exchange and the rules of the UK Listing Authority or the London Stock Exchange so require, all notices to be given to Holders generally will also be published in a leading daily newspaper having general circulation in the United Kingdom (which is expected to be the Financial Times).
24. REPORTS AND INFORMATION ON THE COMPANY 24.1 The Company has undertaken in the Deposit Agreement (so long as any GDR is outstanding) to furnish the Depositary with six copies in the English language (and to make available to the Depositary, the Custodian and each Agent as many further copies as they may reasonably require to satisfy requests from Holders) of:- (i) in respect of the financial year ending on 31 December 2004 and in respect of each financial year thereafter, the non-consolidated (and, if published for holders of Shares, consolidated) balance sheets as at the end of such financial year and the non-consolidated (and, if published for holders of Shares, consolidated) statements of income for such financial year in respect of the Company, prepared in conformity with generally accepted accounting principles in The Netherlands or International Financial Reporting Standards and reported upon by independent public accountants selected by the Company, as soon as practicable (and in any event within 180 days) after the end of such year;
124 (ii) if the Company publishes semi-annual financial statements for holders of Shares, such semi- annual financial statements of the Company, as soon as practicable, after the same are published and in any event no later than four months after the end of the period to which they relate; and (iii) if the Company publishes quarterly financial statements for holders of Shares, such quarterly financial statements, as soon as practicable, after the same are published, and in any event no later than 45 days after the end of the period to which they relate. 24.2 The Depositary shall upon receipt thereof give due notice to the Holders that such copies are available upon request at its specified office and the specified office of any Agent. 24.3 For so long as any of the GDRs remains outstanding and are “restricted securities” within the meaning of Rule 144(a)(3) under the United States Securities Act of 1933, as amended, if at any time the Company is neither subject to and in compliance with the reporting requirements of Section 13 or 15(d) of the United States Securities Exchange Act of 1934, as amended, nor exempt from such reporting requirements by complying with the information furnishing requirements of Rule 12g3-2(b) thereunder, the Company has agreed in the Deposit Agreement to supply to the Depositary such information, in the English language and in such quantities as the Depositary may, from time to time, reasonably request, as is required to be delivered to any Holder or beneficial owner of GDRs or to any holder of Shares or a prospective purchaser designated by such Holder, beneficial owner or holder pursuant to a Deed Poll executed by the Company in favour of such persons and the information delivery requirements of Rule 144A(d)(4) under the U.S. Securities Act of 1933, as amended, to permit compliance with Rule 144A thereunder in connection with resales of GDRs or Shares or interests therein in reliance on Rule 144A under the Securities Act and otherwise to comply with the requirements of Rule 144A(d)(4) under the Securities Act. Subject to receipt, the Depositary will deliver such information, during any period in which the Company informs the Depositary it is subject to the information delivery requirements of Rule 144A(d)(4), to any such holder, beneficial owner or prospective purchaser but in no event shall the Depositary have any liability for the contents of any such information.
25. COPIES OF COMPANY NOTICES The Company has undertaken in the Deposit Agreement to transmit to the Custodian and the Depositary in English on or before the day when the Company first gives notice, by mail, publication, or otherwise, to holders of any Shares or other Deposited Property, whether in relation to the taking of any action in respect thereof or in respect of any dividend or other distribution thereon or of any meeting or adjourned meeting of such holders or otherwise, such number of copies of such notice and any other material (which contains information having a material bearing on the interests of the Holders) furnished to such holders by the Company (or such number of English translations of the originals if the originals were prepared in a language other than English) in connection therewith as the Depositary may reasonably request. If such notice is not furnished to the Depositary in English, either by the Company or the Custodian, the Depositary shall, at the Company’s expense, arrange for an English translation thereof (which may be in such summarised form as the Depositary may deem adequate to provide sufficient information) to be prepared. Except as provided below, the Depositary shall, as soon as practicable after receiving notice of such transmission or (where appropriate) upon completion of translation thereof, give due notice to the Holders which notice may be given together with a notice pursuant to Condition 9.1, and shall make the same available to Holders in such manner as it may determine.
26. MONEYS HELD BY THE DEPOSITARY The Depositary shall be entitled to deal with moneys paid to it by the Company for the purposes of the Deposit Agreement in the same manner as other moneys paid to it as a banker by its customers and shall not be liable to account to the Company or any Holder or any other person for any interest thereon, except as otherwise agreed and shall not be obliged to segregate such moneys from other moneys belonging to the Depositary.
27. SEVERABILITY If any one or more of the provisions contained in the Deposit Agreement or in these Conditions shall be or become invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions contained therein or herein shall in no way be affected, prejudiced or otherwise disturbed thereby.
125 28. GOVERNING LAW 28.1 The Deposit Agreement and the GDRs are governed by and shall be construed in accordance with English law except that the certifications set forth in Schedule 3 and Schedule 4 to the Deposit Agreement and any provisions relating thereto shall be governed by and construed in accordance with the laws of the State of New York. The rights and obligations attaching to the Deposited Shares will be governed by Dutch law. The Company has submitted in respect of the Deposit Agreement and the Deed Poll to the jurisdiction of the English courts and the courts of the State of New York and any United States Federal court sitting in the Borough of Manhattan, New York City. The Company has also agreed in the Deposit Agreement, and the Deed Poll to allow, respectively, the Depositary and the Holders to elect that Disputes are resolved by arbitration. 28.2 The Company has irrevocably appointed Law Debenture Corporate Services Limited as its agent in England to receive service of process in any Proceedings in England based on the Deed Poll and appointed CT Corporation System as its agent in New York to receive service of process in any Proceedings in New York. If for any reason the Company does not have such an agent in England or New York as the case may be, it will promptly appoint a substitute process agent and notify the Holders and the Depositary of such appointment. Nothing herein shall affect the right to serve process in any other manner permitted by law. 28.3 The courts of England are to have jurisdiction to settle any disputes (each a “Dispute”) which may arise out of or in connection with the GDRs and accordingly any legal action or proceedings arising out of or in connection with the GDRs (“Proceedings”) may be brought in such courts. Without prejudice to the foregoing, the Depositary further irrevocably agrees that any Proceedings may be brought in any New York State or United States Federal court sitting in The Borough of Manhattan, New York City. The Depositary irrevocably submits to the non-exclusive jurisdiction of such courts and waives any objection to Proceedings in such courts whether on the ground of venue or on the ground that the Proceedings have been brought in an inconvenient forum. 28.4 These submissions are made for the benefit of each of the Holders and shall not limit the right of any of them to take Proceedings in any other court of competent jurisdiction nor shall the taking of Proceedings in one or more jurisdictions preclude the taking of Proceedings in any other jurisdictions (whether concurrently or not). 28.5 In the event that the Depositary is made a party to, or is otherwise required to participate in, any litigation, arbitration, or Proceeding (whether judicial or administrative) which arises from or is related to or is based upon any act or failure to act by the Company, or which contains allegations to such effect, upon notice from the Depositary, the Company has agreed to fully cooperate with the Depositary in connection with such litigation, arbitration or Proceeding. 28.6 The Depositary irrevocably appoints The Bank of New York, London Branch, (Attention: The Manager) of 48th Floor, One Canada Square, London E14 5AL as its agent in England to receive service of process in any Proceedings in England based on any of the GDRs. If for any reason the Depositary does not have such an agent in England, it will promptly appoint a substitute process agent and notify the Holders of such appointment. Nothing herein shall affect the right to serve process in any other manner permitted by law.
126 SUMMARY OF PROVISIONS RELATING TO THE GDRS WHILE IN MASTER FORM
The existing GDRs are, and the New GDRs will be, evidenced by (i) a single Master Regulation S GDR in registered form and (ii) a single Master Rule 144A GDR in registered form. The Master Regulation S GDR has been deposited with the Bank of New York, London Branch as a common depositary for Euroclear and Clearstream, Luxembourg and registered in the name of The Bank of New York Depository (Nominees) Limited. The Master Rule 144A has been registered in the name of Cede & Co as nominee for DTC and is held by The Bank of New York, London branch, as Custodian for DTC. The Master Regulation S GDR and Master Rule 144A GDR contain provisions which apply to the GDRs while they are in master form, some of which modify the effect of the conditions of the GDRs set out in this Prospectus. The following is a summary of certain of those provisions. Unless otherwise defined herein, the terms defined in the Conditions shall have the same meaning herein.
The Master GDRs will only be exchanged for certificates in definitive registered form representing GDRs in the circumstances descried in (i), (ii), (iii) or (iv) below in whole but not in part. The Depositary will irrevocably undertake in the Master GDRs to deliver certificates evidencing GDRs in definitive registered form in exchange for the Master GDR to the Holders within 60 days in the event that: (i) Euroclear or Clearstream, Luxembourg (in the case of the Master Regulation S GDR) or DTC, or any successor to DTC (in the case of the Master Rule 144A GDR) advises X5 in writing at any time that it is unwilling or unable to continue as depositary and a successor depositary is not appointed within 90 calendar days; or (ii) Euroclear or Clearstream, Luxembourg (in the case of the Master Regulation S GDR) or DTC (in the case of the Master Rule 144A GDR) is closed for business for a continuous period of 14 days (other than by reason of holiday, statutory or otherwise) or announces an intention permanently to cease business or does in fact do so, and, in each case, no alternative clearing system satisfactory to the Depositary is available within 45 days; or (iii) in the case of the Master Rule 144A GDR, DTC or any successor ceases to be a “clearing agency” registered under the Exchange Act; or (iv) The Depositary has determined that, on the occasion of the next payment in respect of the Master Regulation S GDR, the Depositary or its agent would be required to make any deduction or withholding from any payment in respect of the Master Regulation S GDR which would not be required were the Regulation S GDRs represented by certificates in definitive registered form, provided that the Depositary shall have no obligation to so determine or to attempt to so determine.
Any exchange shall be at the expense (including printing costs) of the relevant GDR holder.
A GDR evidenced by an individual definitive certificate will not be eligible for clearing and settlement through DTC, Euroclear or Clearstrearn, Luxembourg.
Upon any exchange of a Master GDR for certificates in definitive registered form or any exchange of interests between the Master Rule 144A GDR and the Master Regulation S GDR pursuant to Clause 4 of the Deposit Agreement, or any distribution of GDRs pursuant to Conditions 5, 7 or 10 or any reduction in the number of GDRs represented thereby following any withdrawal of Deposited Property pursuant to Condition 1, the relevant details shall be entered by the Depositary on the register maintained by the Depositary whereupon the number of GDRs represented by the relevant Master GDR shall be reduced or increased (as the case may be) for all purposes by the amount so exchanged and entered on the register, provided always that if the number of GDRs represented by a Master GDR is reduced to zero, the Master GDR shall continue in existence until the obligations of X5 under the Deposit Agreement and the obligations of the Depositary pursuant to the Deposit Agreement and the Conditions have terminated.
Payments, distributions and voting rights Payments of cash dividends and other amounts (including cash distributions) will, in the case of GDRs represented by the Master Regulation S GDR be made by the Depositary through Euroclear and Clearstream, Luxembourg and in the case of GDRs represented by the Master Rule 144A GDR, will be made by the Depositary through DTC, on behalf of persons entitled thereto upon receipt of funds therefore from X5. A free distribution or rights issue of Shares to the Depositary on behalf of the Holders will result in the record maintained by the Depositary being adjusted to reflect the enlarged number of GDRs represented by the Master GDR.
127 Holders of GDRs will have voting rights as set out in the Terms and Conditions of the GDRs.
Surrender of GDRs Any requirement in the Terms and Conditions of the GDRs relating to the surrender of a Regulation S GDR to the Depositary shall be satisfied by the production by Euroclear or Clearstream, Luxembourg and relating to the surrender of a Rule 144A GDR to the Depositary shall be satisfied by the production by DTC, on behalf of a person entitled to an interest therein, of such evidence of entitlement of such person as the Depositary may reasonably require, which is expected to be a certificate or other documents issued by Euroclear or Clearstream, Luxembourg, in the case of the Master Regulation S GDR, or by DTC in the case of the Master Rule 144A GDR. The delivery or production of any such evidence shall be sufficient evidence, in favour of the Depositary, any Agent and the Custodian of the title of such person to receive (or to issue instructions for the receipt of) all money or other property payable or distributable in respect of the Deposited Property represented by such GDRs.
Notices For as long as the Master Regulation S GDR is registered in the name of a nominee of the common depositary for Euroclear and Clearstream, Luxembourg and the Master Rule 144A GDR is registered in the name of DTC (or its nominee), notices to Holders may be given by the Depositary by delivery of the relevant notice to DTC, Euroclear and Clearstream, Luxembourg for communication to persons entitled thereto in substitution for delivery of notices in accordance with Condition 23. So long as GDRs are listed on the Official List and admitted for trading on the London Stock Exchange, and the UKLA or the London Stock Exchange so requires, notices shall also be published in a leading newspaper having general circulation in the UK (which is expected to be the Financial Times).
The Master GDRs shall be governed by and construed in accordance with English law.
128 TAXATION
The following summary of material tax consequences under the laws of The Netherlands, United Kingdom and United States of ownership of GDRs is based upon laws, regulations, decrees, rulings, income tax conventions (treaties), administrative practice and judicial decisions in effect at the date of this Prospectus. Legislative, judicial or administrative changes or interpretations may, however, be forthcoming that could alter or modify the statements and conclusions set forth herein. Any such changes or interpretations may be retroactive and could affect the tax consequences to GDR holders. This summary does not purport to be a legal opinion or to address all tax aspects that may be relevant to a GDR holder.
EACH PROSPECTIVE HOLDER IS URGED TO CONSULT THEIR TAX ADVISOR AS TO THE PARTICULAR TAX CONSEQUENCES TO SUCH HOLDER OF THE OWNERSHIP AND DISPOSITION OF GDRs, INCLUDING THE APPLICABILITY AND EFFECT OF ANY OTHER TAX LAWS OR TAX TREATIES, AND OF PENDING OR PROPOSED CHANGES IN APPLICABLE TAX LAWS AS OF THE DATE OF THIS OFFERING CIRCULAR, AND OF ANY ACTUAL CHANGES IN APPLICABLE TAX LAWS AFTER SUCH DATE.
DUTCH TAX CONSIDERATIONS General The following is a general summary of certain Dutch tax consequences in connection with the acquisition, ownership and transfer of GDRs. It does not purport to be a description of all Dutch tax considerations that may be relevant for a particular holder of GDRs. The summary is based upon the tax law of The Netherlands, including published regulations, rulings and court decisions in effect on the date of this Prospectus. The tax law is subject to change, which could apply retroactively and which could affect the continuing validity of this summary. We recommend investors and shareholders to consult their own tax advisers as to the Dutch tax consequences of the acquisition, ownership and transfer of GDRs, including, in particular, the application to their particular situations of the tax considerations discussed below. This summary assumes that X5 is a resident of The Netherlands for tax purposes, including for purposes of tax treaties concluded by The Netherlands. This summary further assumes that the ultimate beneficial owners of GDRs will be treated for Dutch tax purposes as absolute beneficial owners of the Shares represented by the GDRs , and references to GDRs should be read accordingly.
Dutch Withholding Tax Considerations This summary does not describe the tax consequences for a recipient of dividends for whom these dividends are exempt by virtue of the participation exemption, as set out in the Dutch Corporate Income Tax Act 1969 (Wet op de vennootschapsbelasting 1969). Dividends distributed by X5 are generally subject to withholding tax imposed by The Netherlands at a rate of 15%. The term “dividends” for this purpose includes, but is not limited to: (i) Distributions in cash or in kind, deemed and constructive distributions and repayments of paid-in capital not recognised for Dutch dividend withholding tax purposes; (ii) Liquidation proceeds, proceeds from the redemption of GDRs (or the underlying Shares) or, as a rule, consideration for the repurchase of GDRs (or the underlying Shares) by X5 in excess of the average paid-in capital recognised for Dutch dividend withholding tax purposes; (iii) The par value of GDRs (or the underlying Shares) issued to a GDR holder or an increase of the par value of GDRs (or the underlying Shares), as the case may be, to the extent that it does not appear that a contribution, recognised for Dutch dividend withholding tax purposes, has been made or will be made; and (iv) Partial repayment of paid-in capital, recognised for Dutch dividend withholding tax purposes, if and to the extent that there are net profits (zuivere winst), within the meaning of the Dividend Withholding Tax Act 1965 (Wet op de dividendbelasting 1965), unless (a) a General Meeting of Shareholders has resolved in advance to make such repayment and (b) the par value of GDRs (or the underlying Shares) concerned has been reduced in an equal amount by way of an amendment to the Articles.
The beneficial owner of a dividend who is, or who is deemed to be, or who has opted to be treated as, a resident of The Netherlands for Dutch income tax purposes or who is subject to tax in The Netherlands on a net
129 basis as a non-resident taxpayer can generally credit the withholding tax against his Dutch personal income tax or corporate income tax liability and is generally entitled to a refund of Dutch dividend withholding tax exceeding his aggregate Dutch income tax liability, provided certain conditions are met.
The beneficial owner of a dividend who is not, and who is not deemed to be, and who has not elected to be treated as, a resident of The Netherlands for Dutch income tax purposes and who is not subject to tax in The Netherlands on a net basis as a non-resident taxpayer and who is a resident of The Netherlands Antilles or Aruba under the provisions of the Tax Arrangement for the Kingdom of The Netherlands (Belastingregeling voor het Koninkrijk), or who is a resident of a country with which The Netherlands has concluded an income tax treaty under the provisions of that treaty may, depending on the terms of and subject to compliance with the procedures for claiming benefits under the Tax Arrangement for the Kingdom of The Netherlands or such income tax treaty, be eligible for a full or partial exemption from or a reduction or refund of Dutch dividend withholding tax. In addition, subject to certain conditions and based on Dutch legislation implementing the Parent Subsidiary Directive (Directive 90/435/EEG, as amended) an exemption from Dutch dividend withholding tax will generally apply to dividends beneficially owned by certain qualifying entities that are resident of another EU Member State and that hold an interest of at least 5 per cent. of the nominal paid-in capital or, in relation to certain jurisdictions, of the voting power in X5. Furthermore, certain entities resident in an EU Member State and not subject to tax on their profits in such EU Member State might be entitled to obtain a full refund of Dutch dividend withholding tax provided they would also not have been subject to Dutch corporate income tax if they would have been resident within The Netherlands.
A recipient of dividends will not be considered the beneficial owner of the dividends as this term is used in this paragraph if, as a consequence of a combination of transactions, a person other than the recipient wholly or partly benefits from the dividends, whereby such other person retains, directly or indirectly, an interest in the GDRs on which the dividends were paid and that other person is entitled to a credit, reduction or refund of dividend withholding tax that is less than that to which the recipient is entitled.
Generally, the dividend withholding tax will not be borne by X5, but will be withheld by X5 from the gross dividends paid on the GDRs.
Taxes on Income and Capital gains General The description of taxation set out in this section of this Prospectus is not intended for any holder of GDRs, who: • is an individual and for whom the income or capital gains derived from GDRs are attributable to employment activities the income from which is taxable in The Netherlands; • holds a Substantial Interest, or a deemed Substantial Interest in X5 (as defined below); • is an entity that is a resident or deemed to be a resident of The Netherlands and that is not subject to or is exempt, in whole or in part, from Dutch corporate income tax; • is an entity for which the income and/or capital gains derived in respect of GDRs are exempt under the participation exemption (as set out in the Dutch Corporate Income Tax Act 1969); or • is an investment institution (beleggingsinstelling) as defined in the Dutch Corporate Income Tax Act 1969.
Generally a holder of GDRs will have a substantial interest in X5 (a “Substantial Interest”) if he holds, alone or together with his partner, whether directly or indirectly, the ownership of, or certain other rights over, shares representing 5 % or more of our total issued and outstanding capital or of the issued and outstanding capital of any class of shares, or rights to acquire shares, whether or not already issued, that represent at any time 5% or more of our total issued and outstanding capital (or the issued and outstanding capital of any class of shares) or the ownership of certain profit participating certificates that relate to 5% or more of the annual profit and/or to 5% or more of our liquidation proceeds. A holder of GDRs will also have a Substantial Interest in X5 if one of certain relatives of that holder or of his partner has a Substantial Interest in us. If a holder of Shares does not have a Substantial Interest, a deemed Substantial Interest will be present if (part of) a Substantial Interest has been disposed of, or is deemed to have been disposed of, on a non-recognition basis.
130 Residents of the Netherlands Individuals An individual who is, or who is deemed to be, or who has elected to be treated as, a resident of The Netherlands for purposes of Dutch taxation (a “Dutch Resident Individual”) and who holds GDRs is subject to Dutch income tax on income and/or capital gains derived from GDRs at the progressive rate (up to 52%) if: (i) such individual has an enterprise or an interest in an enterprise, to which the GDRs are attributable; or (ii) the income or capital gains derived from the GDRs qualify as income from miscellaneous activities (resultaat uit overige werkzaamheden) within the meaning of Section 3.4 of the Income Tax Act 2001 (Wet inkomstenbelasting 2001), which include the performance of activities with respect to the GDRs that exceed regular, active portfolio management (normaal, actief vermogensbeheer).
If none of these two conditions apply to the Dutch Resident Individual, income and capital gains derived from the GDRs will be taxed at a flat rate of 30% on deemed income from savings and investments (inkomen uit sparen en beleggen) within the meaning of Section 5.1 of the Income Tax Act 2001 (Wet inkomstenbelasting 2001). This deemed income amounts to 4% of the average of the fair market value of all the assets (including the GDRs) and liabilities of the individual at the beginning and at the end of the calendar year, insofar the average exceeds a certain threshold.
Entities An entity that is resident or deemed to be resident in The Netherlands (a “Dutch Resident Entity”) will generally be subject to Dutch corporate income tax with respect to income and capital gains derived from GDRs. The Dutch corporate income tax rate is 20% for the first €40,000 of taxable income, 23% for the taxable income exceeding €40,000 but not exceeding €200,000 and 25.5%. for the taxable income exceeding €200,000 (rates for 2008).
Non-Residents of The Netherlands A person who is not a Dutch Resident Individual or Dutch Resident Entity (a “Non-Dutch Resident”) who holds GDRs is generally not subject to Dutch income or corporate income tax (other than dividend withholding tax described above) on the income and capital gains derived from GDRs, provided that: (i) such Non-Dutch Resident does not derive profits from an enterprise or deemed enterprise, whether as an entrepreneur (ondernemer) or pursuant to a co-entitlement to the net worth of such enterprise (other than as an entrepreneur or a shareholder) which enterprise is, in whole or in part, carried on through a permanent establishment or a permanent representative in the Netherlands and to which permanent establishment or permanent representative, as the case may be, GDRs are attributable or deemed attributable; (ii) such Non-Dutch Resident is neither entitled to a share in the profits of an enterprise nor co-entitled to the net worth of such enterprise effectively managed in the Netherlands, other than by way of the holding of securities or through an employment contract, to which enterprise GDRs or payments in respect of GDRs are attributable.; and (iii) in the case of a Non-Dutch Resident who is an individual, such individual does not derive income or capital gains from GDRs that are taxable as benefits from miscellaneous activities in the Netherlands (resultaat uit overige werkzaamheden in Nederland).
Gift, Estate and Inheritance Taxes No Dutch gift, estate or inheritance taxes will be levied on the transfer of GDRs by way of gift by or on the death of a holder, who neither is nor is deemed to be a resident of the Netherlands for the purpose of the relevant provisions, unless: • the transfer is construed as an inheritance or bequest, or as a gift made by or on behalf of a person who, at the time of the gift or death, is or is deemed to be a resident of the Netherlands for the purpose of the relevant provisions; • such holder at the time of the gift or his death has an enterprise or an interest in an enterprise which is carried on through a permanent establishment or a permanent representative in the Netherlands to which permanent establishment or permanent representative GDRs are attributable; or
131 • the holder of such GDRs is entitled to a share in the profits of an enterprise effectively managed in the Netherlands, other than by way of the holding of securities or through an employment contract, to which enterprise such GDRs are attributable.
For purposes of Dutch gift, estate and inheritance tax, an individual who is of Dutch nationality will be deemed to be a resident of the Netherlands if he has been a resident in the Netherlands at any time during the ten years preceding the date of the gift or his death. For purposes of Dutch gift tax, an individual who is not of Dutch nationality will be deemed to be resident of the Netherlands if he has been a resident in the Netherlands at any time during the 12 months preceding the date of the gift. For purposes of Dutch gift, estate and inheritance tax, if an individual, who at the time of the gift is not and is not deemed to be a resident of the Netherlands, dies within 180 days after the date of such gift, while being resident or deemed to be resident in the Netherlands, such gift is construed as an inheritance or bequest at the time of death of such holder.
Value Added Tax There is no Dutch value added tax payable by a holder of GDRs in respect of payments in consideration for the Offering and sale of GDRs.
Other Dutch Taxes There is no Dutch registration tax, capital tax, customs duty, stamp duty or any other similar tax or duty other than court fees payable in The Netherlands by a holder of GDRs in respect of or in connection with the execution, delivery and enforcement by legal proceedings (including any foreign judgement in the courts of The Netherlands) of GDRs.
UNITED KINGDOM TAX CONSIDERATIONS The comments below are of a general nature and are (save where otherwise stated) based on current UK tax law and published HM Revenue & Customs practice as of the date of this Prospectus, each of which is subject to change, possibly with retrospective effect. The summary only covers the principal UK tax consequences for the absolute beneficial owners of GDRs and any dividends paid in respect of them (in circumstances where the dividends paid are regarded for UK tax purposes as that person’s own income, and not the income of another person) who are resident and (in the case of individuals only) ordinarily resident and domiciled solely in the UK for tax purposes (“UK Holders”).
In addition, the summary: (a) only addresses the principal UK tax consequences for UK Holders who hold the GDRs as capital assets and does not address the tax consequences which may be relevant to certain other categories of UK Holders, for example, brokers, dealers or traders in shares, or securities; (b) does not address the UK tax consequences for UK Holders that are insurance companies, collective investment schemes, tax-exempt organisations, persons who benefit from special exemptions from UK taxation or persons connected with X5; (c) assumes that the UK Holder does not control or hold, and is not beneficially entitled to, either alone or together with one or more associated or connected persons, directly or indirectly, 10% or more of the share capital or voting power of X5; (d) assumes that the UK Holder acquires the New GDRs in the Offering; (e) assumes that the UK Holder is, for UK tax purposes, beneficially entitled to the Shares underlying the GDRs and to the dividends on those Shares; and (f) assumes that the UK Holder has not (and is not deemed to have) acquired the GDRs by virtue of an office or employment.
The following is intended only as a general guide and is not intended to be, nor should it be considered to be, legal or tax advice to any particular UK Holder. Potential investors should satisfy themselves as to the overall tax consequences, including, specifically, the consequences under UK tax law and HM Revenue & Customs practice, of the acquisition, ownership and disposal of GDRs in their own particular circumstances, by consulting their own tax advisers.
Taxation of Dividends UK Holders will, in general, be subject to UK income tax or UK corporation tax (as applicable) on the gross amount of any dividends paid on their GDRs.
As described above under “Dutch Tax Considerations,” when X5 pays dividends it will generally be required to withhold 15% of the gross amount of the dividends paid, and to account for that amount to the
132 Dutch tax authorities. This 15% Dutch withholding tax should generally be allowed as a credit against the UK tax liability of a UK Holder. However, any excess of such Dutch withholding tax over the UK tax payable on the aggregate amount of the dividend will generally not be refundable.
Under proposals contained in the Finance Bill 2008, certain changes to the taxation of UK resident individuals owning shares of non-UK resident companies would be introduced, with effect from 6 April 2008. If legislation is enacted in the manner that has been proposed, the non-payable one-ninth dividend tax credit that is currently available in respect of dividends paid by UK-resident companies will be extended to dividends from non-UK resident companies. Draft legislation in the Finance Bill 2008 is not yet law and may be subject to change.
Taxation of Capital Gains The issue of the New GDRs may, on the basis of published HMRC practice relating to open offers of shares, be treated in practice as if it were a reorganisation of the share capital of X5 for the purposes of the UK taxation of chargeable gains. Accordingly, to the extent a UK Holder takes up all or part of its Regular Entitlement, the New GDRs issued to it may be treated as the same asset, acquired at the same time as its existing holding of global depositary receipts (“Existing GDRs”). In that case, the subscription monies for so much of the UK Holder’s Regular Entitlement as that UK Holder chooses to take up would be added to the original cost of that UK Holder’s Existing GDRs for the purposes of the UK taxation of chargeable gains. However, the position is not free from doubt: prospective investors to whom “reorganisation” treatment is a material factor are particularly asked to consult their own professional advisers before deciding to take up any of their entitlement of New GDRs.
The receipt of Excess Proceeds by UK Holders may give rise to a chargeable gain, and the disposal or deemed disposal of GDRs by UK Holders may give rise to a chargeable gain or an allowable loss, for the purposes of UK taxation of capital gains (where the UK Holder is an individual) and UK corporation tax on chargeable gains (where the UK Holder is within the charge to UK corporation tax), depending on their circumstances and subject to any available allowance, exemption or relief.
In addition, individual UK Holders who dispose of their GDRs or receive a payment of Excess Proceeds while they are temporarily non-resident may, subject to certain conditions, be required to bring gains or losses (as the case may be) resulting from such disposal or receipt, into account for UK capital gains tax purposes in the tax year in which they again become resident or ordinarily resident in the UK. Any gains or losses in respect of currency fluctuations over the period of holding the GDRs would also be brought into account on a disposal.
For individual UK Holders, the principal factors that will determine the extent to which a gain will be subject to capital gains tax (“CGT”) are: (a) the extent to which they realise any other capital gains in the tax year in which the disposal takes place; (b) the extent to which they have incurred and not previously utilised capital losses in that or any earlier year; and (c) the extent to which the annual allowance of UK tax-free gains in the tax year in which the disposal takes place is available to such UK Holder to mitigate that gain (the “Annual Exemption”).
The Annual Exemption for individuals is £9,600 for the 2008-2009 tax year and, under current legislation, this exemption is, unless the UK Parliament decides otherwise, increased annually in line with the rate of increase in the retail price index (rounded up to the nearest £100).
Under proposals contained in the Finance Bill 2008, certain changes to the UK capital gains tax regime would be introduced with effect for disposals of capital assets by individuals occurring on or after 6 April 2008. If legislation is enacted in the manner that has been proposed, a single capital gains tax rate will be introduced (18% for the tax year 2008-2009) and certain reliefs that previously may have been available (such as taper relief and indexation allowance) will no longer be available. The proposals will not affect UK Holders within the charge to UK corporation tax. Draft legislation in the Finance Bill 2008 is not yet law and may be subject to change.
A UK Holder that is within the change to corporation tax with respect to its capital gains is entitled to an indexation allowance which applies to reduce capital gains to the extent that (broadly speaking) they arise due to inflation. Indexation allowance may reduce a chargeable gain but not create any allowable loss for UK corporation tax purposes.
133 Stamp Duty and Stamp Duty Reserve Tax No UK stamp duty or stamp duty reserve tax will be payable on the issue of the GDRs or their delivery into DTC, Euroclear and Clearstream.
No UK stamp duty or UK stamp duty reserve tax will be payable in respect of any dealings in the GDRs once they are issued into DTC, Euroclear and Clearstream where such transfer is effected in electronic book entry form in accordance with the procedures of DTC, Euroclear or Clearstream and not by any written instrument of transfer.
Inheritance Tax UK inheritance tax may be chargeable on the death of or, in certain circumstances, a gift of GDRs by, the owner of GDRs, where the owner is an individual who is domiciled or is deemed to be domiciled in the UK. For UK inheritance tax purposes, a transfer of assets at less than full market value may be treated as a gift and particular rules and rates apply to gifts where the donor reserves or retains some benefit.
UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS TO ENSURE COMPLIANCE WITH U.S. TREASURY DEPARTMENT CIRCULAR 230, HOLDERS ARE HEREBY NOTIFIED THAT: (A) ANY DISCUSSION OF UNITED STATES FEDERAL TAX ISSUES IN THIS PROSPECTUS IS NOT INTENDED OR WRITTEN TO BE RELIED UPON, AND CANNOT BE RELIED UPON, BY HOLDERS FOR THE PURPOSE OF AVOIDING PENALTIES THAT MAY BE IMPOSED ON HOLDERS UNDER THE INTERNAL REVENUE CODE; (B) SUCH DISCUSSION IS INCLUDED HEREIN BY THE COMPANY IN CONNECTION WITH THE PROMOTION OR MARKETING (WITHIN THE MEANING OF CIRCULAR 230) BY THE COMPANY OF THE TRANSACTIONS OR MATTERS ADDRESSED HEREIN; AND (C) HOLDERS SHOULD SEEK ADVICE BASED ON THEIR PARTICULAR CIRCUMSTANCES FROM AN INDEPENDENT TAX ADVISOR.
The following is a summary of certain U.S. federal income tax considerations that may be relevant to the purchase, ownership and disposition of New GDRs by a beneficial owner that is an Eligible Investor and that is, for U.S. federal income tax purposes, an individual who is a citizen or resident of the United States, a corporation created or organised in or under the laws of the United States or any political subdivision thereof or therein, or any other person that is subject to U.S. federal income tax on a net income basis in respect of its investment in New GDRs (a “U.S. Holder”). This summary is not a comprehensive discussion of all of the tax considerations that may be relevant to your decision to purchase, own or dispose of New GDRs. In particular, this discussion is directed only to U.S. Holders that will hold New GDRs as capital assets, and it does not address any special U.S. federal income tax considerations that may be applicable to U.S. Holders that are subject to special tax rules, including, without limitation, banks, brokers or dealers in securities or currencies, traders in securities electing to mark to market, financial institutions, life insurance companies, tax-exempt entities, partnerships, holders that own or are treated as owning 10% or more of our voting common shares, persons holding common shares or GDRs as part of a hedging or conversion transaction or a straddle, or persons whose functional currency is not the U.S. dollar.
If a partnership holds New GDRs, the tax treatment of a partner will generally depend upon the status of the partner and the activities of the partnership. A prospective investor who is a partner of a partnership holding New GDRs should consult its own tax advisor.
This summary is based on the Internal Revenue Code of 1986, as amended (the “Code”), its legislative history, existing and proposed regulations promulgated thereunder, published rulings, and court decisions, all as currently in effect. These laws are subject to change, possibly on a retroactive basis. X5 has not sought any ruling from the Internal Revenue Service (“IRS”) with respect to the statements made and the conclusions reached in the following summary, and there can be no assurance that the IRS will agree with such statements and conclusions.
Generally, U.S. Holders of New GDRs will be treated for U.S. federal income tax purposes as holding the Shares represented by the New GDRs, and no gain or loss will be recognised upon the exchange of Shares for New GDRs or the exchange of New GDRs for Shares.
Persons considering the purchase, ownership or disposition of New GDRs should consult their own tax advisors concerning the U.S. federal income tax consequences in light of their particular situations as well as any consequences arising under the laws of any other taxing jurisdiction.
134 Taxation of Dividends The gross amount of any cash distribution received by a U.S. Holder with respect to New GDRs (including the amount of any Dutch taxes withheld) generally will be treated as a dividend subject to U.S. federal income taxation as ordinary income. Any dividends paid in a currency other than U.S. dollars will be included in a U.S. Holder’s income in a U.S. dollar amount calculated by reference to the exchange rate in effect on the date of the Depositary’s receipt of the dividend, regardless of whether the payment is in fact converted into U.S. dollars on such date. If such a dividend is converted into U.S. dollars on the date of receipt, a U.S. Holder generally should not be required to recognise foreign currency gain or loss in respect of the dividend income. If such a dividend is not converted into U.S. dollars on the date of receipt, a U.S. Holder generally will have a basis in the non-U.S. currency equal to its U.S. dollar value on that date. A U.S. Holder also generally will be required to recognise foreign currency gain or loss realised on a subsequent conversion or other disposition of such currency, which will be treated as U.S.-source ordinary income or loss.
Dividends paid on New GDRs generally will constitute foreign-source income and will not be eligible for either the dividends received deduction available to U.S. corporate shareholders or the reduced tax rate applicable to “qualified dividend income” of non-corporate taxpayers.
Dividends received by U.S. Holders generally will constitute “passive category income” (or, in the case of certain U.S. Holders, “general category income”) for U.S. foreign tax credit purposes. Dutch tax withheld from dividends will be treated, up to any applicable reduced rates provided under the income tax treaty between The Netherlands and the United States, as a foreign income tax that, subject to generally applicable limitations under U.S. tax law, is eligible for credit against the U.S. federal income tax liability of U.S. Holders or, if they have elected to deduct such taxes, may be deducted in computing taxable income. U.S. Holders are not allowed foreign tax credits for withholding taxes imposed in respect of certain short-term or hedged positions in securities. U.S. Holders are urged to consult their tax advisors regarding the availability of the foreign tax credit under their particular circumstances.
Taxation of Capital Gains or Losses Sales or other taxable dispositions by U.S. Holders of New GDRs generally will give rise to U.S.-source capital gain or loss equal to the difference between the U.S. dollar value of the amount realised on the disposition and the U.S. Holder’s U.S. dollar tax basis in the New GDRs. Any such gain or loss generally will be long-term capital gain or loss (subject to taxation at reduced rates for non-corporate taxpayers) if the New GDRs were held for more than one year. The deductibility of capital losses is subject to limitations.
Taxation of Amounts Received Pursuant to the Rump Offering Although subject to significant uncertainty, it would appear that the receipt of Excess Proceeds by an Eligible Investor that is a U.S. Holder should be treated as foreign-source ordinary income for U.S. federal income tax purposes; however, it is possible that such proceeds would be treated instead as U.S.-source short- term capital gains. Eligible Investors that are U.S. Holders should consult their tax advisors with respect to the receipt of any Excess Proceeds in connection with the Rump Offering.
Backup Withholding and Information Reporting Payments in respect of New GDRs that are paid within the United States or through certain U.S.-related financial intermediaries are subject to information reporting and may be subject to backup withholding unless the U.S. Holder (i) is a corporation or other exempt recipient, or (ii) in the case of backup withholding, provides a taxpayer identification number and certifies that it has not lost its exemption from backup withholding. Holders of New GDRs that are not U.S. Holders generally are not subject to information reporting or backup withholding; however, any such holder may be required to provide a certification to establish its non-U.S. status in connection with payments received within the United States or from certain U.S.-related payors. Backup withholding is not an additional tax. The amount of backup withholding from a payment to you will be allowed as a credit against your U.S. federal income tax liability and may entitle you to a refund provided the required information is furnished to the IRS.
135 THE OFFERING
General This is an offering of up to 48,106,700 New GDRs, each representing one-quarter of a New Share, to holders of GDRs at the Record Date at the Subscription Price of US$21.37 per New GDR, consisting of a subscription price of US$21.32 and the Depositary’s issuance fee of US$0.05 per New GDR. Each GDR Right will entitle that holder to subscribe for one New GDR.
New GDRs Subject to all applicable securities laws, Eligible Holders at the Record Date may subscribe for New GDRs at the Subscription Price. Every nine GDRs an Eligible Holder holds immediately after the close of trading of GDRs on the Record Date will entitle that holder to subscribe for two New GDRs.
The Depositary will supply holders with this information in accordance with its usual procedures.
Commitments to Subscribe CTF has agreed to procure that (i) the Alfa Entities, which together own 43.05% of X5’s outstanding GDRs as at the date hereof, participate in the New GDR Offering to the full extent of their respective Regular Entitlements, and (ii) RBS, which owns 5.36% of X5’s outstanding GDRs as at the date hereof pursuant to a repurchase transaction with Luckyworth Limited participate to the full extent of its Regular Entitlement. Certain members of the Management Board and senior employees have also agreed to participate in the New GDR Offering to the full extent of their Regular Entitlements.
Record Date The Record Date for determining the holders of GDRs who may subscribe for New GDRs (subject to applicable securities laws) is immediately after the close of trading on the London Stock Exchange at on 18 April 2008.
Trading in New GDRs Applications have been made (i) to the UKLA to admit 48,106,700 New GDRs to the Official List; and (ii) to the London Stock Exchange plc for such New GDRs to be admitted to trading on the Regulated Market. Admission of the New GDRs issued in the New GDR Offering to the Official List and to trading on the Regulated Market is expected to take place on 7 May 2008 and with respect to the New GDRs issued in the Rump Offering, is expected to take place on 9 May 2008.
The security identification numbers of the GDRs offered hereby are as follows:
Regulation S GDRs ISIN: ...... US98387E2054 Regulation S GDRs CUSIP Number: ...... 98387E205 Rule 144A GDRs ISIN: ...... US98387E1064 Rule 144A GDRs CUSIP Number: ...... 98387E106 London Stock Exchange GDR trading symbol: ...... “FIVE”
GDR Subscription Period and Method of Exercise In order to subscribe for New GDRs, Eligible Investors must duly complete and timely submit a Subscription Card to the Depositary by facsimile transmission at the facsimile number or by e-mail in PDF format at the e-mail address specified in the Subscription Card no later than the Last GDR Subscription Day. A Form of Instruction will be sent by the Depositary to existing GDR holders who have certified that they are Eligible Investors. In addition, Eligible Investors will be required to remit funds to the Depositary in an amount equal to the Purchase Price prior to the Last GDR Subscription Day, calculated as the Subscription Price multiplied by the number of New GDRs subscribed for by an Eligible Investor.
Any Eligible Investor who holds GDRs through a financial intermediary wishing to subscribe for New GDRs should instruct the financial intermediary through which it holds its GDRs in accordance with the instructions received from it.
136 Once an Eligible Investor has returned its Subscription Card to the Depositary, it cannot revoke or modify that exercise. An Eligible Investor who has not validly subscribed for New GDRs by the end of the GDR Subscription Period will not be able to subscribe for New GDRs under the New GDR Offering.
Rump Offering New GDRs cannot be subscribed for under the New GDR Offering after the Last GDR Subscription Day, which is the end of the GDR Subscription Period.
After the GDR Subscription Period has ended, the Joint Bookrunners will, subject to the terms and conditions of the Underwriting Agreement, commence the Rump Offering, in which they will offer the Excess GDRs for sale. Subject to the terms and conditions of the Underwriting Agreement, the Joint Bookrunners have agreed to purchase the Excess GDRs at the Subscription Price.
X5 may also offer for sale all, or part, of its 3,769,113 GDRs held as Treasury Stock in the Rump Offering.
Excess Proceeds Upon completion of the Rump Offering, if the aggregate proceeds for the Excess GDRs offered and sold in the Rump Offering, after deduction of expenses related to procuring such sales (including any applicable taxes), if any, exceed the aggregate Subscription Price for such Excess GDRs, each Non-Subscribing Holder and Partially-Subscribing Holder will be entitled to receive, except as noted below, a part of the Excess Amount (being the Excess Proceeds) in cash from the Joint Bookrunners through the financial institution through which such holder holds GDRs, on a pro-rata basis calculated on the basis of Excess GDRs. Such Excess Proceeds will be made through the financial institution through which such holder holds its GDRs.
If any Excess Amount divided by the total number of Excess GDRs is less than US$0.01 per Excess GDR, no Excess Proceeds will be made to the Non-Subscribing Holders and Partially-Subscribing Holders and, instead, any Excess Amount will be for the benefit of the Joint Bookrunners and will be applied against their commissions. X5 will not be entitled to receive any Excess Amount, except with respect to the Treasury Stock hold by Pyaterochka.
The Excess Proceeds, if any, will be paid to the Non-Subscribing Holders and Partially-Subscribing Holders as soon as practicable after the closing of the Rump Offering and will be credited to those holders through the facilities of Euroclear, Clearstream and DTC. Payments will be made in U.S. dollars only, without interest and after the withholding of any applicable taxes.
If X5 has announced that an Excess Amount is available for payment to Non-Subscribing Holders and Partially-Subscribing Holders and a Non-Subscribing Holder or Partially-Subscribing Holder has not received payment thereof within a reasonable time following the closing of the Rump Offering, that holder should contact the financial institution through which it holds GDRs.
X5 cannot guarantee that the Rump Offering will take place. Should the Rump Offering take place, neither X5, the Depositary, the Joint Bookrunners nor any other person procuring subscriptions for Excess GDRs will be responsible for any lack of Excess Amount arising from any sale of the Excess GDRs in the Rump Offering.
New GDRs sold in the Rump Offering will be delivered to existing brokerage accounts of participating investors through DTC, Euroclear or Clearstream, on or about on or about 9 May 2008.
Share Offering X5 is concurrently granting to the Depositary, its sole shareholder of record, a right to subscribe for up to 12,026,675 New Shares. The Share Offering is being conducted on the basis that statutory pre-emptive rights have been disapplied by resolution of the Supervisory Board on 21 April 2008. As of the Record Date and the date of this Prospectus, The Bank of New York, in its capacity as Depositary, was, and is, the sole holder of record. The exercise price for Share Rights will be US$85.28 per New Share, which is equivalent to the Subscription Price less the Depositary issuance fee multiplied by four (the number of GDRs corresponding to each Share).
The Depositary will participate in the Share Offering only to the extent required to acquire a sufficient number of underlying New Shares to fulfil the allocation of New GDRs in the New GDR Offering.
137 SUBSCRIPTION AND SALE
The Offering consists of an international institutional offering of GDRs outside the United States in reliance on Regulation S and within the United States, an offering of GDRs to QIBs in private placement transactions exempt from the registration requirements of the Securities Act.
On 23 April 2008, X5 entered into the Underwriting Agreement with the Managers in respect of the Offering. Subject to the terms and conditions of the Underwriting Agreement, the Joint Bookrunners have severally agreed to purchase any remaining Excess GDRs (up to a maximum of 23,908,684 GDRs) in the proportions set out in the following table:
Joint Bookrunners Percentage of remaining Excess GDRs Citigroup Global Markets Limited ...... 33.33% Goldman Sachs International ...... 33.33% Alfa Capital Markets ...... 33.33%
The total expenses payable by X5 for the Offering, including the Managers’ commissions, are estimated to be approximately US$29.5 million.
Any resale of the Remaining New GDRs that are not sold in the Rump Offering by the Joint Bookrunners will be for their own account and not on behalf of X5.
The Co-Lead Managers have no obligation to underwrite any GDRs. The Joint Bookrunners do not have any obligation to purchase any New GDRs for which CTF and certain members of the Management Board and senior employees have agreed to subscribe or procure subscription.
The obligations of the Joint Bookrunners to purchase the Excess GDRs is subject to conditions, including accuracy of the representations and warranties of X5, satisfaction of covenants by X5, receipt of UKLA approval of the Prospectus and receipt of customary closing documents. The Underwriting Agreement also provides that the Joint Bookrunners have the right to terminate the Underwriting Agreement in certain circumstances.
If any Joint Bookrunners defaults in its obligation to purchase Excess GDRs, X5 has the right to substitute other Joint Bookrunners. If, after giving effect to any such arrangements, the aggregate number of Excess GDRs that remain unpurchased does not exceed 10% of the aggregate number of all New GDRs, then X5 has the right to require each non-defaulting Joint Bookrunners to subscribe for its pro rata share (based on the number of Excess GDRs that such Joint Bookrunners agreed to subscribe for under the Underwriting Agreement) of the Remaining New Shares of such defaulting Joint Bookrunners or Joint Bookrunners for which such arrangements have not been made up to a number of Excess GDRs that, in the aggregate with respect to all such non-defaulting Joint Bookrunners, does not exceed 10% of the aggregate number of all of the New GDRs. Alternatively, if, after giving effect to any such arrangements, the aggregate number of Excess GDRs that remains unpurchased exceeds 10% of the aggregate number of New GDRs, then the Underwriting Agreement will terminate. These arrangements could result in less than all of the New GDRs being purchased.
The Managers have no obligation to purchase Treasury Stock. The terms and conditions of any purchase and sale of Treasury Stock, if any, will be set forth in a pricing agreement, which will supplement the Underwriting Agreement.
Pursuant to the Underwriting Agreement, X5 has agreed to indemnify the Managers against certain liabilities. In addition, X5 has agreed to reimburse the Joint Bookrunners for certain of their expenses.
Some of the Managers and their respective affiliates have engaged, or may engage in the future, in investment banking and other commercial dealings in the ordinary course of business with X5. They have received customary fees and commissions for these transactions and services.
Investors wishing to enter into transactions in the GDRs sold in the Rump Offering prior to the closing of the Rump Offering, whether such transactions are effected on the London Stock Exchange or otherwise, should be aware that the closing of the Offering may not take place on 9 May 2008 or at all if certain conditions or events referred to in the Underwriting Agreement are not satisfied or waived or do not occur on or prior to such date. All such transactions will be of no effect if the offering does not become unconditional.
138 Lock-Up Arrangements Each of X5, CTF and certain Supervisory and Management Board members and senior employees, have agreed that for a period of 180 days after the Rump Offering Closing Date, it and its affiliates and subsidiaries will not and will procure that any person acting on its behalf will not, without the prior written consent of the Joint Bookrunners, offer, sell, contract to sell, pledge, charge, grant options over or otherwise dispose of (or publicly announce any such offer, sale, contract to sell, pledge, charge, option or disposal of), directly or indirectly (including by means of any hedging arrangement), any Shares (including in the form of GDRs) or securities convertible or exchangeable into or exercisable for any Shares (including in the form of GDRs) or warrants or other rights to purchase Shares (including in the form of GDRs) or enter into any transaction that is designed to, or might reasonably be expected to, result in the disposition (whether by actual disposition or effective economic disposition due to cash settlement or otherwise) of any Shares (including in the form of GDRs) held by the undersigned or any person acting on his or her behalf.
The lock-up agreement of the Company (contained in the Underwriting Agreement) does not prohibit issuances of GDRs upon exercise of outstanding stock options, issuances of stock options pursuant to plans existing on the date hereof and described in the Prospectus, issuances of Shares or GDRs to pay up to 25% of the consideration for the acquisition of Formata to the sellers or third parties who agree to become bound by the lock-up provision and sales of Treasury Shares in connection with the Rump Offering.
Subject to certain conditions, the lock-up agreement signed by CTF does not prohibit a pledge of 93,200,477 GDRs (the “Pledged GDRs”) by Cesaro Holdings Limited and Luckyworth Limited to an internationally recognised commercial lender or syndicate of internationally recognised commercial lenders as security in support of a credit facility with a principal amount of up to US$1,000,000,000, provided that the pledgee bank is not permitted to sell the Pledged GDRs except in certain events of default.
The lock-up agreements of the members of the Supervisory and Management Boards and certain members of senior management of X5 do not prohibit disposals of Shares or GDRs acquired after the date of the lock-up agreements, cash-less exercises of stock options and certain gifts and dispositions to trusts, provided that the recipient or trust agrees to be bound by the lock-up provision.
Marie-Carla Corporation N.V. and Tayleforth N.V. (entities associated with certain current and former Supervisory Board members), who together, hold 45,579,604 GDRs (representing a 21.06% interest in X5) have not entered into any lock-up arrangement.
139 SELLING AND TRANSFER RESTRICTIONS
Selling Restrictions Except to the extent indicated under “United Kingdom” below, no action has been taken or will be taken in any jurisdiction by the Managers or X5 that would permit a public offering of the Shares or GDRs, or possession or distribution of this Prospectus or any amendment or supplement thereto or any other offering or publicity material relating to the Shares or GDRs, in any country or jurisdiction where action for that purpose is required.
United States Accordingly, the Offer GDRs have not been offered or sold, and will not be offered or sold, by X5, in the Offering described herein, except (i) within the United States in reliance on exemptions from the registration requirements of the Securities Act to Eligible Investors who are QIBs who sign and return the Subscription Card, (ii) outside the United States to Eligible Holders in offshore transactions in reliance on Regulation S or (iii), in the case of Excess GDRs or Treasury Stock, to the Joint Bookrunners for offer and sale in the Rump Offering. Each Manager has represented and agreed in the Underwriting Agreement that it has not offered or sold, and will not offer or sell, the Offer GDRs except (a) other than in the Rump Offering, as set forth in (i) and (ii) above, and (b) in the Rump Offering, (1) within the United States to QIBs in reliance on Rule 144A or (2) outside the United States in offshore transactions in reliance on Regulation S.
European Economic Area In relation to each Relevant Member State, with effect from and including the date on which the Prospectus Directive is implemented in that Relevant Member State (the “Relevant Implementation Date”), an offer to the public in that Relevant Member State of any Securities may be made at any time with effect from and including the Relevant Implementation Date under the following exemptions under the Prospectus Directive, if they have been implemented in that Relevant Member State: (a) to legal entities which are authorised or regulated to operate in the financial markets or, if not so authorised or regulated, whose corporate purpose is solely to invest in securities; (b) to any legal entity which has two or more of (1) an average of at least 250 employees during the last financial year; (2) a total balance sheet of more than €43,000,000 and (3) an annual net turnover of more than €50,000,000, as shown in its last annual or consolidated accounts; or (c) in any other circumstances falling within Article 3(2) of the Prospectus Directive,
provided that no such offer of Securities shall require X5, the Depositary or any Manager to publish a prospectus pursuant to Article 3 of the Prospectus Directive or supplement a prospectus pursuant to Article 16 of the Prospectus Directive.
For the purposes of this provision, the expression an “offer to the public” in relation to any Securities in any Relevant Member State means the communication in any form and by any means of sufficient information on the terms of the offer and any Securities to be offered so as to enable an investor to decide to purchase any Securities, as the same may be varied in that Member State by any measure implementing the Prospectus Directive in that Member State.
United Kingdom Each Manager has represented, warranted and agreed that: (a) it has only communicated or caused to be communicated and will only communicate or cause to be communicated an invitation or inducement to engage in investment activity (within the meaning of Section 21 of the Financial Services and Markets Act 200 (the “FSMA”) received by it in connection with the issue or sale of any New GDRs which are the subject of the offering contemplated by this Prospectus (the “Securities”) in circumstances in which Section 21(1) of the FSMA does not apply to the Issuer; and (b) it has complied and will comply with all applicable provisions of the FSMA with respect to anything done by it in relation to the Securities in, from or otherwise involving the United Kingdom.
140 France No prospectus (including any amendment, supplement or replacement thereto) has been prepared in connection with the offering of the GDRs that has been approved by the Autorité des marchés financiers or by the competent authority of another State that is a contracting party to the Agreement on the European Economic Area and notified to the Autorité des marchés financiers; no GDRs have been offered or sold nor will be offered or sold, directly or indirectly, to the public in France; the prospectus or any other offering material relating to the GDRs have not been distributed or caused to be distributed and will not be distributed or caused to be distributed to the public in France; such offers, sales and distributions have been and shall only be made in France to persons licensed to provide the investment service of portfolio management for the account of third parties, qualified investors (investisseurs qualifiés) and/or a restricted circle of investors (cercle restreint d’investisseurs), in each case investing for their own account, all as defined in Articles L. 411-2, D. 411-1, D. 411-2, D. 411-4, D. 734-1, D.744-1, D. 754-1 and D. 764-1 of the Code monétaire et financier. The direct or indirect distribution to the public in France of any so acquired GDRs may be made only as provided by Articles L. 411-1, L. 411-2, L. 412-1 and L. 621-8 to L. 621-8-3 of the Code monétaire et financier and applicable regulations thereunder.
Russian Federation The Shares and New GDRs have not been registered under the law of the Russian Federation “On the Securities Market” and no statutory prospectus for Shares or New GDRs has been filed or registered with any securities regulatory authority of the Russian Federation. The Shares and New GDRs may not be advertised in the Russian Federation and should not be offered or sold or otherwise transferred and will not be offered or sold or otherwise transferred as part of their initial distribution or at any time thereafter to any persons (including legal entities) resident, incorporated, established or having their usual residence in the Russian Federation or to any person located within the territory of the Russian Federation unless and to the extent permitted under Russian law. No person should at any time carry out any activities in breach of the restrictions set out above.
Japan Each of the Managers has represented and agreed that it has not offered or sole and will not offer or sell any GDRs, directly or indirectly, in Japan or to or for the account of any resident of Japan except (A) pursuant to an exemption from the registration requirements of the Securities and Exchange Law of Japan and (B) in compliance with any other applicable requirements of Japanese law.
The New GDRs have not been, and will not be, registered under the Financial Instruments and Exchange Law of Japan (Law No. 25 of 1948, as amended, the “FIEL”) and disclosure under the FIEL has not been, and will not be, made with respect to the GDRs. Neither the GDRs, not any interest therein, may be offered, sold, resold or otherwise transferred, directly or indirectly, in Japan to, or for the account of, any resident of Japan, except pursuant to an exemption from the registration requirements of, and otherwise in compliance with, the FIEL and all other applicable laws, regulations and guidelines promulgated by the relevant Japanese governmental and regulatory authorities. As used in this paragraph, “resident of Japan” means any person resident in Japan, including any corporation or other entity organised under the laws of Japan.
Hong Kong The contents of this Prospectus have not been reviewed by any regulatory authority in Hong Kong. You are advised to exercise caution in relation to the New GDR Offering and/or the Rump Offering. If you are in any doubt about any of the contents of this Prospectus, you should obtain independent professional advice from your broker, bank manager, solicitor, professional accountant, financial advisor, or other professional advisor.
The GDRs have not been offered or sold and may not be offered or sold in Hong Kong, by means of any document other than (i) to “professional investors” as defined in the Securities and Futures Ordinance (Cap.571) of Hong Kong and any rules made under that ordinance; or (ii) in other circumstances which do not result in the document being a “prospectus” as defined in the Companies Ordinance (Cap.32) of Hong Kong or which do not constitute an offer to the public within the meaning of that ordinance. Further, no person shall issue or have in its possession for the purpose of issue, whether in Hong Kong or elsewhere, any advertisement, invitation or document relating to the GDRs, which is directed at, or the contents of which are likely to be accessed or read by, the public in Hong Kong (except if permitted to do so under the securities laws of Hong Kong) other than with respect to the GDRs which are or are intended to be disposed of only to persons outside Hong Kong or only to “professional investors” as defined in the Securities and Futures Ordinance (Cap.571) of Hong Kong and any
141 rules made under that ordinance. This Prospectus and the information contained herein may not be used other than by the person to whom it is addressed and may not be reproduced in any form or transferred to any person in Hong Kong. This New GDR Offering and/or the Rump Offering is not an offer for sale to the public in Hong Kong and it is not the intention of X5 that the GDRs be offered for sale to the public in Hong Kong.
Transfer Restrictions Each purchaser of Offer GDRs in the New GDR Offering or the Rump Offering may re-offer or re-sell the Offer GDRs they acquire only pursuant to exemptions from, or in transactions not subject to, the registration requirements of the Securities Act.
142 SETTLEMENT AND DELIVERY
Settlement Custodial and depositary links have been established between Euroclear and Clearstream, Luxembourg to facilitate the initial issue of the GDRs and cross-market transfers of the GDRs associated with secondary market trading.
Euroclear and Clearstream, Luxembourg Euroclear and Clearstream, Luxembourg each hold securities for participating organisations and facilitate the clearance and settlement of securities transactions between their respective participants through electronic book-entry changes in accounts of such participants. Euroclear and Clearstream, Luxembourg provide to their respective participants, among other things, services for safekeeping, administration, clearance and settlement of internationally-traded securities lending and borrowing. Euroclear and Clearstream, Luxembourg participants are financial institutions throughout the world, including underwriters, securities brokers and dealers, banks, trust companies, clearing corporations and certain other organisations. Euroclear and Clearstream, Luxembourg have established an electronic bridge between their two systems across which their respective customers may settle trades with each other. Indirect access to Euroclear or Clearstream, Luxembourg is also available to others, such as banks, brokers, dealers and trust companies which clear through or maintain a custodial relationship with a Euroclear or Clearstream, Luxembourg participant, either directly or indirectly.
Distributions of dividends and other payments with respect to book-entry interests in the GDRs held through Euroclear or Clearstream, Luxembourg will be credited, to the extent received by the Depositary, to the cash accounts of Euroclear or Clearstream, Luxembourg participants in accordance with the relevant system’s rules and procedures.
DTC DTC is a limited-purpose trust company organised under the laws of the State of New York, a “banking organisation” within the meaning of the New York Banking Law, a member of the United States Federal Reserve System, a “clearing corporation” within the meaning of the New York Uniform Commercial Code and a “clearing agency” registered pursuant to the provisions of Section 17A of the Exchange Act. DTC holds securities for DTC participants and facilitates the clearance and settlement of securities transactions between DTC participants through electronic computerised book-entry changes in DTC participants’ accounts. DTC participants include securities brokers and dealers, banks, trust companies, clearing corporations and certain other organisations. Indirect access to the DTC system is also available to others such as securities brokers and dealers, banks and trust companies that clear through or maintain a custodial relationship with a DTC participant, either directly or indirectly.
Holders of book-entry interests in the GDRs holding through DTC will receive, to the extent received by the Depositary, all distributions of dividends or other payments with respect to book-entry interests in the GDRs from the Depositary through DTC and DTC participants. Distributions in the United States will be subject to relevant U.S. tax laws and regulations.
Because DTC can act on behalf of DTC direct participants only, who in turn act on behalf of DTC indirect participants, the ability of beneficial owners who are indirect participants to pledge book-entry interests in the GDRs to persons or entities that do not participate in DTC, or otherwise take actions with respect to book-entry interests in the GDRs, may be limited.
Registration and Form Book-entry interests in the GDRs held through Euroclear and Clearstream, Luxembourg will be represented by the Master Regulation S GDR deposited with The Bank of New York, London Branch, as common depositary for Euroclear and Clearstream, Luxembourg and registered in the name of The Bank of New York Depository (Nominees) Limited. Book-entry interests in the GDRs held through DTC will be represented by the Master Rule 144A GDR registered in the name of Cede & Co, as nominee for DTC, which will be held by The Bank of New York, London branch as custodian for DTC. As necessary, the Depositary will adjust the amounts of GDRs on the relevant register to reflect the amounts of GDRs held through Euroclear, Clearstream, Luxembourg and DTC, respectively. Beneficial ownership in the GDRs will be held through financial institutions as direct and indirect participants in Euroclear, Clearstream, Luxembourg and DTC.
143 The aggregate holdings of book-entry interests in the GDRs in Euroclear, Clearstream, Luxembourg and DTC will be reflected in the book-entry accounts of each such institution. Euroclear, Clearstream, Luxembourg and DTC, as the case may be, and every other intermediate holder in the chain to the beneficial owner of book- entry interest in the GDRs, will be responsible for establishing and maintaining accounts for their participants and customers having interests in the book-entry interests in the GDRs. The Depositary will be responsible for maintaining a record of the aggregate holdings of GDRs registered in the name of the common depositary for Euroclear and Clearstream, Luxembourg and the nominee for DTC. The Depositary will be responsible for ensuring that payments received by it from X5 for holders holding through Euroclear or Clearstream, Luxembourg are credited to Euroclear or Clearstream, Luxembourg as the case may be, and the Depositary will also be responsible for ensuring that payments received by it from X5 for holders holding through DTC are received by DTC.
X5 will not impose any fees in respect of the GDRs; however, holders of book-entry interests in the GDRs may incur fees normally payable in respect of the maintenance and operation of accounts in Euroclear, Clearstream, Luxembourg or DTC and certain fees and expenses payable to the Depositary in accordance with the terms of the Deposit Agreement. See “Terms and Conditions of the Global Depositary Receipts.”
Global Clearance and Settlement Procedures Initial Settlement The GDRs will be in global form evidenced by the two Master GDRs. Purchasers electing to hold book- entry interests in GDRs through Euroclear or Clearstream, Luxembourg accounts will follow the settlement procedures applicable to depositary receipts. DTC participants acting on behalf of purchasers electing to hold book-entry interests in the GDRs through DTC will follow the delivery practices applicable to depositary receipts.
Secondary Market Trading For a description of the transfer restrictions relating to the GDRs, see “Subscription and Sale – Selling Restrictions.”
Trading between Euroclear and Clearstream, Luxembourg Participants Secondary market sales of book-entry interests in the GDRs held through Euroclear or Clearstream, Luxembourg to purchasers of book-entry interests in the GDRs through Euroclear or Clearstream, Luxembourg will be conducted in accordance with the normal rules and operating procedures of Euroclear or Clearstream, Luxembourg and will be settled using the normal procedures applicable to depositary receipts.
Trading between DTC Participants Secondary market sales of book-entry interests in the GDRs held through DTC will occur in the ordinary way in accordance with DTC rules and will be settled using the procedures applicable to depositary receipts, if payment is effected in U.S. dollars, or free of payment, if payment is not effected in U.S. dollars. Where payment is not effected in U.S. dollars, separate payment arrangements outside DTC are required to be made between the DTC participants.
Trading between a DTC Seller and Euroclear/Clearstream, Luxembourg Purchaser When book-entry interests in the GDRs are to be transferred from the account of a DTC participant to the account of a Euroclear or Clearstream, Luxembourg participant, the DTC participant must send to DTC a delivery free of payment instruction at least two business days prior to the settlement date. DTC will in turn transmit such instruction to Euroclear or Clearstream, Luxembourg, as the case may be, on the settlement date. Separate payment arrangements are required to be made between the DTC participant and the relevant Euroclear or Clearstream, Luxembourg participant. On the settlement date, DTC will debit the account of its DTC participant and will instruct the Depositary to instruct Euroclear or Clearstream, Luxembourg, as the case may be, to credit the relevant account of the Euroclear or Clearstream, Luxembourg participant, as the case may be. In addition, on the settlement date, DTC will instruct the Depositary to: (a) Decrease the amount of book-entry interests in the GDRs registered in the name of a nominee for DTC and represented by the Master Rule 144A GDR; and
144 (b) Increase the amount of book-entry interests in the GDRs registered in the name of the common nominee for Euroclear and Clearstream and represented by the Master Regulation S GDR.
Trading between a Clearstream, Luxembourg/Euroclear Seller and DTC Purchaser When book-entry interests in the GDRs are to be transferred from the account of a Euroclear or Clearstream, Luxembourg participant to the account of a DTC participant, the Euroclear or Clearstream, Luxembourg participant must send to Euroclear or Clearstream, Luxembourg a delivery free of payment instruction at least one business day prior to the settlement date. Separate payment arrangements are required to be made between the DTC participant and the relevant Euroclear or Clearstream, Luxembourg participant, as the case may be. On the settlement date, Euroclear or Clearstream, Luxembourg, as the case may be, will debit the account of its participant and will instruct the Depositary to instruct DTC to credit the relevant account of Euroclear or Clearstream, Luxembourg, as the case may be, and will deliver such book-entry interests in the GDRs free of payment to the relevant account of the DTC participant. In addition, Euroclear or Clearstream, Luxembourg, as the case may be, shall on the settlement date instruct the Depositary to: (a) Decrease the amount of the book-entry interests in the GDRs registered in the name of the common nominee and evidenced by the Master Regulation S GDR; and (b) Increase the amount of the book-entry interests in the GDRs registered in the name of a nominee for DTC and represented by the Master Rule 144A GDR.
General Although the foregoing sets forth the procedures of Euroclear, Clearstream, Luxembourg and DTC in order to facilitate the transfers of interests in the GDRs among participants of Euroclear, Clearstream, Luxembourg and DTC, none of Euroclear, Clearstream, Luxembourg or DTC are under any obligation to perform or continue to perform such procedures, and such procedures may be discontinued at any time.
None of the Managers, the Depositary, the Custodian or their respective agents will have any responsibility for the performance by Euroclear, Clearstream, Luxembourg or DTC or their respective participants of their respective obligations under the rules and procedures governing their operations.
145 INFORMATION RELATING TO THE DEPOSITARY
The Depositary is a state-chartered New York banking corporation and a member of the United States Federal Reserve System, subject to regulation and supervision principally by the United States Federal Reserve Board and the New York State Banking Department. The Depositary was constituted in 1784 in the State of New York. It is a wholly owned subsidiary of The Bank of New York Mellon Corporation, a New York bank holding company. The principal office of the Depositary is located at One Wall Street, New York, New York 10286, United States. Its principal administrative offices are located at 101 Barclay Street, 22 floor West, New York, New York 10286, United States. A copy of the Depositary’s Articles of Association, as amended, together with copies of The Bank of New York Mellon Corporation’s most recent financial statements and annual report are available for inspection at the Corporate Trust Office of the Depositary located at 101 Barclay Street, New York, NY 10286, United States and at The Bank of New York, One Canada Square, London E14 5AL, United Kingdom. The Depositary is validly incorporated.
LEGAL MATTERS
Certain legal matters under United States federal, New York and English law will be passed upon for X5 by Cleary Gottlieb Steen & Hamilton LLP, London, England. Certain legal matters under Dutch law will be passed upon for X5 by Cleary Gottlieb Steen & Hamilton LLP, Brussels, Belgium. Certain legal matters in connection with this Offering will be passed upon for the Joint Bookrunners with respect to the laws of the United Kingdom and the United States by Skadden, Arps, Slate, Meagher & Flom (UK) LLP, London, England and with respect to the laws of the Russian Federation by Skadden, Arps, Slate, Meagher & Flom LLP, Moscow, Russia. Certain legal matters under Dutch law will be passed upon for the Joint Bookrunners by Stibbe N.V., Amsterdam, The Netherlands.
INCORPORATION BY REFERENCE
The following sections of the 2006 Prospectus are incorporated by reference in and form part of this document: (a) the Perekrestok Holdings Limited consolidated financial statements for the financial year ended 31 December 2005 and associated notes and Independent Auditors’ Reports contained in pages 121-174 of the 2006 Prospectus; and (b) the Pyaterochka Holding N.V. consolidated financial statements for the financial year ended 31 December 2005 and associated notes and Independent Auditors’ Report contained in pages 73-105 of the 2006 Prospectus.
No other information contained in the 2006 Prospectus, including but not limited to the information incorporated by reference set out on page 222 of the 2006 Prospectus, shall form any part of this Prospectus.
146 LISTING AND GENERAL INFORMATION
1. It is expected that the New GDRs will be admitted to the Official List on or about 7 May 2008. Application has been made for the New GDRs to be traded on the Regulated Market of the London Stock Exchange. Prior to admission to the Official List, however, dealings will be permitted by the London Stock Exchange in accordance with its rules. Transactions will normally be effected for delivery on the third working day after the day of the transaction. 2. X5 was incorporated as a private company with limited liability (besloten vennootschap met beperkte aansprakelijkheid) under the laws of The Netherlands by notarial deed dated 13 August 1975 and is domiciled in The Netherlands. X5 is governed by and its securities were created under Dutch law. On 28 May 2004, it was converted into a public limited liability company (naamloze vennootschap) and its name was changed to “Pyaterochka Holding N.V.”. On 26 October 2006, Pyaterochka Holding N.V. changed its name to “X5 Retail Group N.V.”. X5 trades under the names “X5”, “Pyaterochka” and “Perekrestok”. The registered office of X5 and its domicile for tax purposes is Prins Bernhardplein 200, 1097 JB, Amsterdam, The Netherlands. X5’s headquarters for its Russian operations is at 28, bld. 4, Srednya, Kalitnikovskaya, Moscow, 109029, Russian Federation. X5’s headquarters for its Ukranian operations is at Building 5, 10A Dimitrova str., Kiev, Ukraine, 03150. The telephone numbers of X5’s registered office and its Russian and Ukranian headquarters are +31 70 310 5080, +7 495 662 8888 and +38 044 496 5533, respectively. X5 is registered in the commercial register of the Chamber of Commerce and Industry for Amsterdam under number 33143036. 3. X5 is a member of the Alfa Group Consortium by virtue of the shareholdings held by Luckyworth Limited and Cesaro Holdings Limited. As at 31 December 2007, the ultimate parent company of the Alfa Group Consortium was CTF, a company registered at Suite 2, 4 Irish Place, Gibraltar. 4. The names, country of incorporation and proportion of X5’s interest in each of its significant subsidiaries, as at 31 December 2007, are set out at note 7 of the X5 Consolidated Financial Statements for the year ended 31 December 2007. 5. X5 is not aware of any governmental, legal or arbitration proceedings (including any proceedings which are pending or threatened) during the 12 months prior to the date of this Prospectus which may have, or have had in the recent past, significant effects on X5 and/or its group’s financial position or profitability. 6. Copies of the following will be available for inspection and may be obtained free of charge, during regular business hours on any weekday, at the registered office of X5 for the duration of the Offering: (a) the articles of association of X5 (English translation); (b) the financial statements referred to in this Prospectus; (c) the 2006 Prospectus; and (d) this Prospectus. In addition, this Prospectus will be made available electronically at http://www.londonstockexchange.com/rns. 7. If definitive certificates are issued in exchange for the Master Regulation S GDRs and Master Rule 144A GDRs, X5 will appoint an agent in the United Kingdom or the United States, as appropriate. 8. The GDRs will be accepted for clearance through Euroclear, Clearstream and DTC. The ISIN for the Regulation S GDRs is US98387E2054 and the CUSIP number for the Regulation S GDRs is 98387E205. The ISIN for the Rule 144A GDRs is US98387E2054 and the CUSIP number for the Rule 144A GDRs is 98387E106. 9. There has been no significant change in X5’s financial or trading position since 31 December 2007 (the date of the latest audited financial statements). 10. On 21 April 2008, the Supervisory Board resolved to issue 12,026,675 New Shares and to exclude the pre-emptive rights of existing shareholders in respect of the issuance of such New Shares. The Supervisory Board has been authorised by the General Meeting of Shareholders on 5 November 2007 and 21 April 2008 as the corporate body to resolve until 21 October 2009 on (i) on the issuance of, and/or the grant of rights to subscribe for shares in X5’s share capital up to a maximum number of 30,000,000 shares and (ii) on the restriction or exclusion of any pre-emptive rights in connection therewith. For purposes of the Offering, X5 expects to issue the New Shares to the Depositary in part on 7 May 2008 and in part on 9 May 2008, following which, the Depositary is expected to issue immediately the corresponding New GDRs.
147 INDEX TO FINANCIAL STATEMENTS
X5 Consolidated Financial Statements for the year ended 31 December 2007 Page Directors’ Responsibility Statement ...... F-2 Independent Auditor’s Report ...... F-3 Consolidated Balance Sheet at 31 December 2007 ...... F-4 Consolidated Income Statement for the year ended 31 December 2007 ...... F-5 Consolidated Statement of Cash Flows for the year ended 31 December 2007 ...... F-6 Consolidated Statement of Changes In Equity for the year ended 31 December 2007 ...... F-7 Notes to Consolidated Financial Statements for the year ended 31 December 2007 ...... F-8
X5 Consolidated Financial Statements for the year ended 31 December 2006 Page Directors’ Responsibility Statement ...... F-51 Independent Auditor’s Report ...... F-52 Consolidated Balance Sheet at 31 December 2006 ...... F-53 Consolidated Income Statement for the year ended 31 December 2006 ...... F-54 Consolidated Statement of Cash Flows for the year ended 31 December 2006 ...... F-55 Consolidated Statement of Changes In Equity for the year ended 31 December 2006 ...... F-56 Notes to Consolidated Financial Statements for the year ended 31 December 2006 ...... F-57
F-1 DIRECTORS’ RESPONSIBILITY STATEMENT
The following statement, which should be read in conjunction with the independent auditors’ responsibilities stated in the independent auditors’ report, is made with a view to distinguishing the respective responsibilities of management and those of the independent auditors in relation to the consolidated financial statements of X5 Retail Group N.V. and its subsidiaries (the “Group”).
Management is responsible for the preparation of the consolidated financial statements that present fairly the financial position of the Group at 31 December 2007, and the results of its operations, cash flows and changes in shareholders’ equity for the year then ended, in compliance with International Financial Reporting Standards as adopted by the European Union.
In preparing the consolidated financial statements, management is responsible for: • Selecting suitable accounting principles and applying them consistently; • Making judgments and estimates that are reasonable and prudent; • Stating whether IFRS as adopted by the European Union and IFRS as issued by the International Accounting Standards Board have been followed, subject to any material departures disclosed and explained in the consolidated financial statements; and • Preparing the consolidated financial statements on a going concern basis, unless it is inappropriate to presume that the Group will continue in business for the foreseeable future.
Management is also responsible for: • Designing, implementing and maintaining an effective and sound system of internal controls, throughout the Group; • Maintaining proper accounting records that disclose, with reasonable accuracy at any time, the financial position of the Group, and which enable them to ensure that the consolidated financial statements of the Group comply with IFRS as adopted by the European Union and IFRS as issued by the International Accounting Standards Board; • Maintaining statutory accounting records in compliance with local legislation and accounting standards in the respective jurisdictions in which the Group operates; • Taking such steps as are reasonably available to them to safeguard the assets of the Group; and • Preventing and detecting fraud and other irregularities.
The consolidated financial statements for the year ended 31 December 2007 were approved on 10 April 2008 by:
Lev Khasis Evgeny Kornilov Chief Executive Officer Chief Financial Officer
F-2 ZAO PricewaterhouseCoopers Audit Kosmodamianskaya nab. 52/5 115054 Moscow Russian Federation Telephone +7 (495) 967 6000 Facsimile +7 (495) 967 6001
INDEPENDENT AUDITOR’S REPORT To the Management Board of X5 Retail Group N.V.: 1 We have audited the accompanying consolidated financial statements of X5 Retail Group N.V. and its subsidiaries (the “Group”) which comprise the consolidated balance sheet as at 31 December 2007 and the consolidated income statement, consolidated statement of changes in equity and consolidated cash flow statement for the year then ended and a summary of significant accounting policies and other explanatory notes.
Management’s Responsibility for the Financial Statements 2 Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards as adopted by the European Union. This responsibility includes: designing, implementing and maintaining internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error; selecting and applying appropriate accounting policies; and making accounting estimates that are reasonable in the circumstances.
Auditor’s Responsibility 3 Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with International Standards on Auditing. Those Standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material misstatement. 4 An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. 5 We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion 6 In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, the financial position of the Group as of 31 December 2007, and its financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards as adopted by the European Union.
10 April 2008 Moscow, Russian Federation
The firm is an authorized licensee of the tradename and logo of PricewaterhouseCoopers.
F-3 X5 RETAIL GROUP N.V. CONSOLIDATED BALANCE SHEET AT 31 DECEMBER 2007 (expressed in thousands of US Dollars, unless otherwise stated)
31 December 31 December Note 2007 2006 ASSETS Non-current assets Property, plant and equipment ...... 11 1,988,391 1,265,833 Investment property ...... 12 129,006 40,020 Goodwill ...... 13 2,934,216 2,629,046 Intangible assets ...... 14 523,533 492,259 Prepaid leases ...... 54,846 9,440 Loan originated to related parties ...... 9 – 5,250 Other non-current assets ...... 2,534 – Deferred tax assets ...... 31 28,357 18,626 5,660,883 4,460,474 Current assets Inventories of goods for resale ...... 15 325,036 208,576 Available for sale financial assets ...... 18 – 623 Derivative financial assets ...... 18 1,500 – Loans originated ...... 248 10,985 Current portion of non-current prepaid lease ...... 5,766 – Trade and other accounts receivable ...... 16 149,137 148,225 Current income tax receivable ...... 4,622 6,161 VAT and other taxes recoverable ...... 17 195,752 89,434 Cash ...... 10 179,496 167,988 861,557 631,992 Total assets ...... 6,522,440 5,092,466 EQUITY AND LIABILITIES Equity attributable to equity holders of the parent Share capital ...... 22 70,883 70,936 Share premium ...... 2,896,355 2,901,350 Cumulative translation reserve ...... 294,169 79,459 Accumulated deficit ...... (17,960) (161,708) Minority interests ...... 220 – Total equity ...... 3,243,667 2,890,037 Non-current liabilities Long-term borrowings ...... 20 1,464,684 949,123 Long-term finance lease payable ...... 21 1,181 2,913 Deferred tax liabilities ...... 31 214,101 177,604 Long-term deferred revenue ...... 3,221 4,117 Share-based payments liability ...... 30 43,208 – Other non-current liabilities ...... – 159 1,726,395 1,133,916 Current liabilities Trade accounts payable ...... 968,505 552,060 Short-term borrowings ...... 20 253,733 218,013 Share-based payments liability ...... 30 2,389 69,990 Short-term finance lease payables ...... 21 2,145 2,271 Interest accrued ...... 2,763 13,544 Short-term deferred revenue ...... 4,943 414 Current income tax payable ...... 33,303 11,511 Provisions and other liabilities ...... 19 284,597 200,710 1,552,378 1,068,513 Total liabilities ...... 3,278,773 2,202,429 Total equity and liabilities ...... 6,522,440 5,092,466
Lev Khasis Evgeny Kornilov Chief Executive Officer Chief Financial Officer 10 April 2008 10 April 2008 The accompanying Notes on pages F-10 to F-52 are an integral part of these consolidated financial statements.
F-4 X5 RETAIL GROUP N.V. CONSOLIDATED INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2007 (expressed in thousands of US Dollars, unless otherwise stated)
31 December 31 December Note 2007 2006 Revenue ...... 24 5,320,424 2,803,351 Cost of sales ...... (3,916,493) (2,041,702) Gross profit ...... 1,403,931 761,649 Selling, general and administrative expenses ...... (1,135,046) (630,817) Lease/sublease and other income ...... 26 68,032 36,879 Operating profit ...... 336,917 167,711 Finance costs ...... 27 (133,019) (62,952) Finance income ...... 27 7,230 1,432 Net foreign exchange gain ...... 28 31,545 14,083 Profit before tax ...... 242,673 120,274 Income tax expense ...... 31 (98,925) (36,062) Profit for the year ...... 143,748 84,212 Attributable to: Equity holders of the parent ...... 143,748 84,212 Profit for the year ...... 143,748 84,212 Basic earnings per share for profit attributable to the equity holders of the parent (expressed in USD per share) ...... 23 2.70 2.13 Diluted earnings per share for profit attributable to the equity holders of the parent (expressed in USD per share) ...... 23 2.69 2.12
Lev Khasis Evgeny Kornilov Chief Executive Officer Chief Financial Officer 10 April 2008 10 April 2008
The accompanying Notes on pages F-10 to F-52 are an integral part of these consolidated financial statements.
F-5 X5 Retail Group N.V. CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 2007 (expressed in thousands of US Dollars, unless otherwise stated)
31 December 31 December Note 2007 2006 Profit before tax ...... 242,673 120,274 Adjustments for: Depreciation and amortisation ...... 25 142,376 79,097 Loss / (gain) on disposal of property, plant and equipment ...... 137 (4,241) Loss on disposal of intangible assets ...... 35 38 Finance costs, net ...... 27 125,789 61,520 Impairment of trade and other accounts receivable ...... 25 1,369 4,073 Loss on disposal of subsidiaries ...... – 110 Share-based payments expense ...... 30 43,208 27,702 Amortisation of deferred expenses ...... 2,929 1,535 Loss on write-off of other long-term investments ...... – 400 Net foreign exchange gain ...... 28 (67,195) (14,083) Net cash from operating activities before changes in working capital ...... 491,321 276,425 Increase in trade and other accounts receivable ...... (65,107) (61,855) Increase in inventories ...... (77,041) (76,773) Increase in trade payable ...... 330,154 235,617 (Decrease) / Increase in other accounts payable ...... (48,234) 52,694 Net cash generated from operations ...... 631,093 426,108 Interest paid ...... (109,177) (63,843) Interest received ...... 3,380 687 Income tax paid ...... (97,824) (46,076) Net cash from operating activities ...... 427,472 316,876 Cash flows from investing activities Purchase of property, plant and equipment ...... 11 (620,233) (250,706) Purchase of investment property ...... 12 (9,173) (5,936) Non-current prepaid lease ...... (46,543) (6,836) Acquisition of subsidiaries, net of cash acquired ...... 8 (211,412) 227,932 Acquisition of other long-term investments ...... (211) (389) Short-term loans issued in connection with acquisitions ...... 8 (20,157) – Loans originated ...... – (11,608) Proceeds from sale of property, plant and equipment ...... 10,949 13,125 Proceeds from sale of investments available for sale ...... – 66 Purchase of intangible assets ...... 14 (1,987) (6,594) Net cash used in investing activities ...... (898,767) (40,946) Cash flows from financing activities Proceeds from short-term loans ...... 583,917 204,060 Repayment of short-term loans ...... (396,016) (207,232) Proceeds from long-term loans ...... 1,458,306 470,208 Repayment of long-term loans ...... (1,167,265) (225,186) Distribution to shareholders ...... – (300,000) Acquisition of treasury shares ...... (5,048) (76,534) Principal payments on finance lease obligations ...... (3,872) (3,491) Net cash from / (used in) financing activities ...... 470,022 (138,175) Effect of exchange rate changes on cash ...... 12,781 166 Net increase in cash ...... 11,508 137,921 Movements in cash Cash at the beginning of the year ...... 167,988 30,067 Net increase in cash ...... 11,508 137,921 Cash at the end of the year ...... 179,496 167,988
Lev Khasis Evgeny Kornilov Chief Executive Officer Chief Financial Officer 10 April 2008 10 April 2008 The accompanying Notes on pages F-10 to F-52 are an integral part of these consolidated financial statements.
F-6 X5 RETAIL GROUP N.V. CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 2007 (expressed in thousands of US Dollars, unless otherwise stated)
Attributable to the shareholders of the Company Retained Cumulative earnings / Total Number of Share Share translation (Accumulated shareholders’ Minority Note shares capital premium reserve deficit) equity interest Total Balance as at 1 January 2006 ...... 38,306,785 30 122,152 5,724 54,080 181,986 – 181,986 Translation movement ...... – – – 73,735 – 73,735 – 73,735 Profit for the year ...... – – – – 84,212 84,212 – 84,212 Total recognised income for the year ...... – – – 73,735 84,212 157,947 – 157,947 Reverse acquisition ...... 15,813,253 72,109 2,854,529 – – 2,926,638 – 2,926,638 Distribution to shareholders (Note 22) ...... – – – – (300,000) (300,000) – (300,000) Acquisition of treasury shares ...... (902,278) (1,203) (75,331) – – (76,534) – (76,534)
F-7 Balance as at 31 December 2006 ...... 53,217,760 70,936 2,901,350 79,459 (161,708) 2,890,037 – 2,890,037 Translation movement ...... – – – 214,710 – 214,710 – 214,710 Profit for the year ...... – – – – 143,748 143,748 – 143,748 Total recognised income for the year ...... – – – 214,710 143,748 358,458 – 358,458 Acquisition of treasury shares ...... (40,000) (53) (4,995) – – (5,048) – (5,048) Acquisition of subsidiaries ...... 8 – – – – – – 220 220 Balance as at 31 December 2007 ...... 53,177,760 70,883 2,896,355 294,169 (17,960) 3,243,447 220 3,243,667
Lev Khasis Evgeny Kornilov Chief Executive Officer Chief Financial Officer 10 April 2008 10 April 2008
The accompanying Notes on pages F-10 to F-52 are an integral part of these consolidated financial statements. X5 RETAIL GROUP N.V. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED 31 DECEMBER 2007 (expressed in thousands of US Dollars, unless otherwise stated) 1 PRINCIPAL ACTIVITIES AND THE GROUP STRUCTURE These consolidated financial statements are for the economic entity comprising X5 Retail Group N.V. (the “Company”) and its subsidiaries, as set out in Note 7 (the “Group”). These consolidated financial statements are prepared separately from the statutory accounts of the Company which are filed in authorities in the Netherlands. X5 Retail Group N.V. is a joint stock limited liability company established in August 1975 under the laws of the Netherlands. The principal activity of the Company is to act as a holding company for the group of companies that operate retail grocery stores. The Company’s address and tax domicile is Prins Bernhardplein 200, 1097 JB Amsterdam, the Netherlands. On 18 May 2006, the Company acquired 100% of Perekrestok Holdings Ltd., the parent company for the group of companies that operate stores under the “Perekrestok” brand (Note 8). Although legally X5 Retail Group N.V. is regarded as the parent and Perekrestok Holdings Ltd. is regarded as the subsidiary, Perekrestok Holdings Ltd. is identified as the acquirer under IFRS 3 “Business Combinations” and the acquisition of Perekrestok Holdings Ltd. is accounted for as a reverse acquisition (Note 2.1). Consequently, through the period ended 18 May 2006 consolidated statement of income and consolidated statement of cash flows relate only to the acquirer (Note 8). The main activity of the Group is the development and operation of grocery retail stores. As of 31 December 2007 and 31 December 2006 the Group operated a retail chain of soft-discount and supermarket stores under the brand names “Pyaterochka” and “Perekrestok” in major population centers in Russia, including but not limited to Moscow, St. Petersburg, Nizhniy Novgorod, Krasnodar, Kazan, Samara, Chelyabinsk, Ekaterinburg and Kiev, Ukraine with the following number of stores: 31 December 31 December 2007 2006 Supermarket Moscow ...... 105 101 N Novgorod ...... 18 16 Samara ...... 8 6 North-West ...... 19 17 Tatarstan ...... 5 2 Ukraine ...... 5 4 Central-Chernozem ...... 11 4 South ...... 8 6 179 156 Discounter Moscow ...... 309 222 N Novgorod ...... 18 – Samara ...... 5 – North-West ...... 244 204 Ekaterinburg ...... 34 25 Central-Chernozem ...... 15 – Chelyabinsk ...... 49 – 674 451 Hypermarket West Siberia ...... 1 1 Moscow ...... 4 4 N Novgorod ...... 2 1 Samara ...... 2 1 Tatarstan ...... 3 3 Central-Chernozem ...... 2 1 South ...... 1 1 15 12 Total stores ...... 868 619
F-8 In addition, as of 31 December 2007 the Group’s franchisees operated 680 stores under the “Pyaterochka” brand name and 8 stores under the “Perekrestok” brand name (31 December 2006: 605 and 10 respectively) in Russia and neighbouring countries, Kazakhstan and Ukraine.
The Group is a member of the Alfa Group Consortium. As of 31 December 2007 the Company’s immediate principal shareholders were Luckyworth Limited and Cesaro Holdings Limited owning 26.2% and 22.2% of total issued shares, respectively. The Group owns 942,278 (1.74%) of its shares (Note 22). As of 31 December 2007 the Company’s shares are listed on the London Stock Exchange in form of Global Depositary Receipts (GDRs), with each GDR representing an interest of 0.25 in an ordinary share. As of 31 December 2007 the ultimate parent company of the Group is CTF Holdings Ltd. (“CTF”), a company registered at Suite 2, 4 Irish Place, Gibraltar. CTF is under the common control of Mr Fridman, Mr Khan and Mr Kuzmichev (the “Shareholders”). None of the Shareholders individually controls and/or owns 50% or more in CTF.
2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The principal accounting policies applied in the preparation of these consolidated financial statements are set out below. These policies have been consistently applied to all years presented, unless otherwise stated.
2.1 Basis of preparation These consolidated financial statements for the year ended 31 December 2007 have been prepared in accordance with, and comply with International Financial Reporting Standards as adopted by the European Union. They have been prepared under the historical cost convention as modified by available-for-sale investments, derivative financial investments and share-based payments liability.
All International Financial Reporting Standards issued by the IASB and effective at the time of preparing these consolidated financial statements have been adopted by the European Union through the endorsement procedure established by the European Commission, with the exception of certain provisions of IAS 39, Financial Instruments: Recognition and Measurement, on portfolio hedging. Since the Group is not affected by the provisions regarding portfolio hedging that are not required by the EU-endorsed version of IAS 39, the accompanying consolidated financial statements comply with both International Financial Reporting Standards as adopted by the European Union and International Financial Reporting Standards issued by the IASB.
These consolidated financial statements are issued under the name of X5 Retail Group N.V. but represent a continuation of the consolidated financial statements of Perekrestok Holdings Ltd. accordingly: (a) the assets and liabilities of the legal subsidiary, i.e. Perekrestok Holdings Ltd., are recognised and measured at their pre-combination carrying amounts. The assets and liabilities of X5 Retail Group N.V. are recognised at their fair value at the date of acquisition; (b) the consolidated retained earnings and other equity balances recognised at the date of acquisition are the retained earnings and other equity balances of Perekrestok Holdings Ltd. immediately before the business combination; (c) the equity structure reflects the equity structure of X5 Retail Group N.V.; and (d) the comparative information presented in these consolidated financial statements is that of Perekrestok Holdings Ltd.
2.2 Accounting for the effects of inflation The Russian Federation was considered hyperinflationary prior to 1 January 2003. As a result, balances and transactions were restated for the changes in the general purchasing power of the Russian Rouble up to 31 December 2002 in accordance with IAS 29 (“Financial Reporting in Hyperinflationary Economies”). IAS 29 requires that the financial statements prepared in the currency of a hyperinflationary economy be stated in terms of the measuring unit current at the balance sheet date. As the characteristics of the economic environment of the Russian Federation indicate that hyperinflation has ceased effective from 1 January 2003, the Group does not apply the provisions of IAS 29 to assets acquired or revalued and liabilities incurred or assumed after that date. For other assets and liabilities, the amounts expressed in the measuring unit current at 31 December 2002 are treated as the basis for the carrying amounts in these consolidated financial statements.
F-9 2.3 Consolidated financial statements Subsidiaries are those companies and other entities (including special purpose entities) in which the Group, directly or indirectly, has the power to govern the financial and operating policies generally accompanying a shareholding of more than one half of the voting rights. The existence and effect of potential voting rights that are presently exercisable or presently convertible are considered when assessing whether the Group controls another entity. Subsidiaries are consolidated from the date on which control is transferred to the Group (acquisition date) and are de-consolidated from the date that control ceases.
Associates are entities over which the Group has significant influence, but not control, generally accompanying a shareholding of between 20 and 50 percent of the voting rights. Investments in associates are accounted for by the equity method of accounting and are initially recognised at cost. The carrying amount of associates includes goodwill identified on acquisition less accumulated impairment losses, if any. The Group’s share of the post-acquisition profits or losses of associates is recorded in the consolidated income statement, and its share of post-acquisition movements in reserves is recognised in reserves. When the Group’s share of losses in an associate equals or exceeds its interest in the associate, including any other unsecured receivables, the Group does not recognise further losses, unless it has incurred obligations or made payments on behalf of the associate.
The purchase method of accounting is used to account for the acquisition of subsidiaries. The cost of an acquisition is measured at the fair value of the assets given up, equity instruments issued and liabilities incurred or assumed at the date of exchange, plus costs directly attributable to the acquisition. The date of exchange is the acquisition date where a business combination is achieved in a single transaction. However, when a business combination is achieved in stages by successive share purchases, the date of exchange is the date of each exchange transaction; whereas the acquisition date is the date on which acquirer obtains control of the subsidiary.
The Group accounts for options to acquire subsidiaries in business combinations at cost.
Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination are measured at their fair values at the acquisition date.
The excess of the cost of acquisition over the fair value of the Group’s share in net assets of the acquiree at each exchange transaction represents goodwill. The excess of the acquirer’s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities acquired over cost (“negative goodwill”) is recognized immediately in the income statement.
Intercompany transactions, balances and unrealized gains on transactions between group companies are eliminated; unrealized losses are also eliminated unless the cost cannot be recovered. The Company and all of its subsidiaries use uniform accounting policies consistent with the Group’s policies.
2.4 Minority interest Minority interest is that part of the net results and of the net assets of a subsidiary, including the fair value adjustments, which is attributable to interests which are not owned, directly or indirectly, by the Company. Minority interest forms a separate component of the Group’s equity.
When the Group purchases a minority interest, the difference between its carrying amount and the amount paid to acquire it is recorded as goodwill. Gains or losses on disposal of a minority interest, determined as the difference between its carrying amount and proceeds received or receivable, are recorded in the statement of income.
2.5 Foreign currency translation and transactions (a) Functional and presentation currency Functional currency. The functional currency of each of the Group’s consolidated entities is the currency of the primary economic environment in which the entity operates. The functional currencies of the Group’s entities are the national currency of the Russian Federation, Russian Rouble (“RR”) and the national currency of Ukraine, Ukrainian Hryvnia (“UAH”). The Group’s presentation currency is the US Dollar (“USD”), which management believes is the most useful currency to adopt for users of these consolidated financial statements.
F-10 Translation from functional to presentation currency. The results and financial position of each Group entity (none of which have a functional currency that is the currency of a hyperinflationary economy) are translated into the presentation currency as follows: (i) assets and liabilities for each balance sheet presented are translated at the closing rates at the date of that balance sheet; (ii) income and expenses for each income statement are translated at average exchange rates (unless this average is not a reasonable approximation of the cumulative effect of the rates prevailing on the transaction dates, in which case income and expenses are translated at the dates of the transactions); and (iii) all resulting exchange differences are recognised as a separate component of equity as a cumulative translation reserve.
Goodwill and fair value adjustments arising on the acquisition of a foreign entity are treated as assets and liabilities of the foreign entity and translated at the closing rate. When a subsidiary is disposed of through sale, liquidation, repayment of share capital or abandonment of all, or part of, that entity, the exchange differences deferred in equity are reclassified to profit or loss.
(b) Transactions and balances Monetary assets and liabilities denominated in foreign currencies are translated into each entity’s functional currency at the official exchange rate of the Central Bank of Russian Federation (“CBRF”) at the respective balance sheet dates. Foreign exchange gains and losses resulting from the settlement of the transactions and from the translation of monetary assets and liabilities into each entity’s functional currency at period-end official exchange rates of the CBRF are recognized in profit or loss. Translation at period-end rates does not apply to non-monetary items.
At 31 December 2007, the official rate of exchange, as determined by the Central Bank of the Russian Federation, was USD 1 = RR 24.5462 (31 December 2006: USD 1 = RR 26.3311). Average rate for year ended 31 December 2007 was USD 1 = RR 25.577 (12 months 2006: USD 1 = RR 27.1852).
At 31 December 2007, the official rate of exchange, as determined by the Central Bank of Ukraine, was USD 1 = UAH 5.0500 (31 December 2006: USD 1 = UAH 5.0500). Average rate for 12 months 2007 was USD 1 = UAH 5.0500 (12 months 2006: USD 1 = UAH 5.0500).
2.6 Segment reporting A segment is a distinguishable component of the Group that is engaged either in providing products or services (business segment) or in providing products or services within a particular economic environment (geographical segment), which is subject to risks and rewards that are different from those of other segments. Segments with a majority of its revenue earned from sales to external customers and whose internal and external revenue or result or assets are ten percent or more of all segments are reported separately. The Group identifies business segments as its primary segment reporting format while geographical segments are its secondary segment reporting format.
2.7 Property, plant and equipment Property, plant and equipment are stated at cost less accumulated depreciation and provision for impairment, where required. Cost includes expenditure that is directly attributable to the acquisition or construction of the item. The Group does not capitalize borrowing costs but recognises them as an expense in the period in which they are incurred.
Costs of minor repairs and maintenance are expensed when incurred. Costs of replacing major parts or components of property, plant and equipment items are capitalised and the replaced parts are retired. Capitalised costs are depreciated over the remaining useful life of property, plant and equipment or part’s estimated useful life whichever is sooner.
At each reporting date management assesses whether there is any indication of impairment of property, plant and equipment. If any such indication exists, management estimates the recoverable amount, which is determined as the higher of an asset’s fair value less costs to sell and its value in use. The carrying amount is reduced to the recoverable amount and the impairment loss is recognised in the income statement. An impairment loss recognised for an asset in prior years is reversed if there has been a favourable change in circumstances affecting estimates used to determine the asset’s value in use or fair value less costs to sell.
F-11 Gains and losses on disposals determined by comparing the proceeds with the carrying amount are recognised in profit or loss.
Land is not depreciated. Depreciation on other items of property, plant and equipment is calculated using the straight-line method to allocate their cost to their residual values over their estimated useful lives. The depreciation periods, which approximate the estimated useful economic lives of the respective assets, are as follows:
Buildings ...... 20-50years Machinery and equipment ...... 5-10years Refrigerating equipment ...... 7-10years Vehicles ...... 5-7years Other ...... 3-5years
Leasehold improvements are capitalised when it is probable that future economic benefits associated with the improvements will flow to the Company and the cost can be measured reliably. The capitalised leasehold improvements are depreciated over their useful lives but not longer than the terms of the leases.
The residual value of an asset is the estimated amount that the Group would currently obtain from the disposal of the asset less the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life. The residual value of an asset is nil if the Group expects to use the asset until the end of its physical life. The assets’ residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date.
2.8 Investment property Investment property consists of buildings held by the Group to earn rental income or for capital appreciation, or both, and which are not occupied by the Group. The Group recognises the part of an owned shopping center that is leased to third party retailers as investment property, unless it represents an insignificant portion of the property and is used primarily to provide auxiliary services to retail customers not provided by the Group rather than to earn rental income. The Group uses the ratio of leased out space to total store space as criteria to distinguish investment property from Group-occupied property.
Investment properties are stated at cost less accumulated depreciation and provision for impairment, where required. If any indication exists that investment properties may be impaired, the Group estimates the recoverable amount as the higher of value in use and fair value less costs to sell. Subsequent expenditure is capitalised only when it is probable that future economic benefits associated with it will flow to the Group and the cost can be measured reliably. All other repairs and maintenance costs are expensed when incurred. If an investment property becomes owner-occupied, it is reclassified to property, plant and equipment, and its carrying amount at the date of reclassification becomes its deemed cost to be subsequently depreciated.
Depreciation on items of investment property is calculated using the straight-line method to allocate their cost to their residual values over their estimated useful lives. The depreciation periods, which approximate the estimated useful economic lives of the respective assets, are 20-50 years.
2.9 Intangible assets (a) Goodwill Goodwill represents the excess of the cost of an acquisition over the fair value of the acquirer’s share of the net identifiable assets, liabilities and contingent liabilities of the acquired subsidiary at the date of exchange. Goodwill on the acquisition of subsidiaries is presented as part of intangible assets in the consolidated balance sheet.
The Group tests goodwill for impairment at least annually and whenever there are indications that goodwill may be impaired. Goodwill is allocated to the cash-generating units, or groups of cash-generating units, that are expected to benefit from the synergies of the business combination. Such units or groups of units represent the lowest level at which the Group monitors goodwill and are not larger than a segment. Gains or losses on disposal of an operation within a cash generating unit to which goodwill has been allocated include the carrying amount of goodwill associated with the operation disposed of, generally measured on the basis of the relative values of the operation disposed of and the portion of the cash-generating unit which is retained.
F-12 (b) Lease rights Lease rights represent rights for favourable operating leases acquired in business combinations. Lease rights acquired in a business combination are recognised initially at fair value. Lease rights are amortised using the straight-line method over the lease term of the respective lease contracts – ranging from 10 to 20 years (15 on average).
(c) Brand and private labels Brand and private labels acquired in a business combination are recognised initially at fair value. Brand and private labels are amortised using the straight-line method over their useful lives:
Useful lives Brand ...... 20years Private labels ...... 5-8years
(d) Franchise agreements Franchise agreements represent rights to receive royalties. Franchise agreements acquired in a business combination are recognised initially at fair value. Franchise agreements are amortised using straight-line method over their useful lives that are, on average, ranging from 5 to 10 years (8 on average).
(e) Other intangible assets Expenditure on acquired patents, trademarks and licenses is capitalized and amortised using the straight-line method over their useful lives ranging from 3 to 4 years.
(f) Impairment of intangible assets Where an indication of impairment exists, the recoverable amount of any intangible asset, including goodwill, is assessed and, when impaired, the asset is written down immediately to its recoverable amount. Goodwill and intangible assets not yet available for use are tested for impairment at least annually and whenever impairment indicators exist.
2.10 Operating leases Leases of assets under which substantially all the risks and benefits of ownership are effectively retained by the lessor are classified as operating leases. Payments made under operating leases are charged to the income statement on a straight-line basis over the period of the lease.
An asset leased out by the Group under operating leases is included in investment property in the balance sheet, unless it represents an insignificant portion of property and is used primarily to provide auxiliary services to retail customers not provided by the Group, rather than to earn rental income. It is depreciated over its expected useful life on a basis consistent with similar fixed assets and investment property. Rental income is recognised in the income statement on a straight-line basis over the lease term.
The Group leases retail outlets under terms of fixed and variable lease payments. The variable lease payments depend on revenue earned by the respective retail outlets. The Group classifies variable lease payments as contingent rents unless the Group is virtually certain of the expected amount of the future lease payments in which case they are classified as minimum lease payments (Note 35).
Initial direct costs incurred by the Group in negotiating and arranging an operating lease including key money paid to lessors or previous tenants for entering into lease contracts are recognised as prepaid leases and expensed on a straight-line basis over the lease term.
2.11 Finance lease liabilities Where the Group is a lessee in a lease, which transfers substantially all the risks and rewards incidental to ownership to the Group, the leased assets are capitalized in property, plant and equipment at the commencement of the lease at the lower of the fair value of the leased asset and the present value of the minimum lease payments. Each lease payment is allocated between the liability and finance charges so as to achieve a constant rate on the finance balance outstanding. The corresponding rental obligations, net of future finance charges, are
F-13 included in borrowings. The interest cost is charged to the income statement over the lease period using the effective interest method. The assets acquired under finance leases as well as leasehold improvements are depreciated over their useful life or the lease term, if shorter and if the Group is not reasonably certain that it will obtain ownership by the end of the lease.
2.12 Trade receivables Trade receivables are initially recognised at their fair values and are subsequently carried at amortised cost using the effective interest method. A provision for impairment of receivables is established when there is objective evidence that the Group will not be able to collect all amounts due according to the original terms of the receivables. The Group determines that there is objective evidence of impairment by assessing groups of receivables against credit risk factors established based on historical loss experience for each group. Indications that the trade receivable may be impaired include financial difficulties of the debtor, likelihood of the debtor’s insolvency, and default or significant failure of payment. The amount of the provision is the difference between the asset’s carrying amount and the present value of the estimated future cash flows, discounted at the original effective interest rate. The amount of the provision is recognised in the income statement.
2.13 Inventories of goods for resale Inventories at warehouses and retail outlets are stated at the lower of cost and net realizable value. Cost comprises direct costs of goods, transportation and handling costs. Cost is determined by the first-in, first-out (FIFO) method. Net realizable value is the estimate of the selling price in the ordinary course of business, less selling expenses.
The Group provides for estimated inventory losses (shrinkage) between physical inventory counts on the basis of a percentage of cost of sales. The provision is adjusted to actual shrinkage based on regular inventory counts. The provision is recorded as a component of cost of sales.
2.14 Financial assets and liabilities The Group classifies its financial assets into the following measurement categories: at fair value through profit or loss, loans and receivables, held-to-maturity and available-for-sale investments. The classification depends on the purpose for which the financial assets were acquired. Management determines the classification of its financial assets at initial recognition and re-evaluates this designation at every reporting date, if required under IFRS. The Group designates investments as available-for-sale only when they fall outside the other categories of financial assets.
Initial recognition of financial instruments Financial assets at fair value through profit or loss are initially recorded at fair value. All other financial assets and liabilities are initially recorded at fair value plus transaction costs. Fair value at initial recognition is best evidenced by the transaction price. Subsequent to initial recognition, the fair values of financial instruments measured at fair value are bid prices quoted at active markets. A gain or loss on initial recognition is only recorded if there is a difference between fair value and transaction price which can be evidenced by other observable current market transactions in the same instrument or by a valuation technique whose inputs include only data from observable markets.
Impairment The Group reviews the carrying value of its financial assets on a regular basis. If the carrying value of an investment is greater than the recoverable amount, the Group records an impairment loss and reduces the carrying amount of assets by using allowance account. The Group does not reduce the carrying amount of impaired financial assets directly but rather uses an allowance account.
Derecognition of financial assets The Group derecognises financial assets when (i) the assets are redeemed or the rights to cash flows from the assets have otherwise expired or (ii) the Group has transferred substantially all the risks and rewards of ownership of the assets or (iii) the Group has neither transferred nor retained substantially all risks and rewards of ownership but has not retained control. Control is retained if the counterparty does not have the practical ability to sell the asset in its entirety to an unrelated third party without needing to impose additional restrictions on the sale.
F-14 Financial assets at fair value through profit or loss Financial assets at fair value through profit or loss are mainly derivatives.
Derivative financial instruments are recognised initially on a settlement date basis and subsequently remeasured at fair value. The Group generally acquires derivative financial instruments quoted at active markets and therefore subsequent remeasurement is based on active market quotations rather than valuation techniques. Gains and losses resulting from the fair value remeasurement are recognised in the consolidated income statement as fair value gains (losses) on financial instruments. Derivative financial instruments include foreign exchange contracts, forward rate agreements, interest rate swaps and currency options are carried as trading assets or liabilities at fair value through profit or loss. All derivative instruments are carried as assets when fair value is positive and as liabilities when fair value is negative. The Group does not apply hedge accounting.
Loans and receivables Loans and receivables are unquoted non-derivative financial assets with fixed or determinable payments other than those that the Group intends to sell in the near term. Loans receivable and other receivables are carried at amortised cost using the effective interest rate method. Receivables are written off only in case of debtor’s insolvency.
Available for sale Available for sale investments are carried at fair value. Interest income on available for sale debt securities is calculated using the effective interest method and recognised in profit or loss. Dividends on available-for-sale equity instruments are recognised in profit or loss when the Group’s right to receive payment is established. All other elements of changes in the fair value are deferred in equity until the investment is derecognised or impaired at which time the cumulative gain or loss is removed from equity to profit or loss.
Impairment losses are recognised in profit or loss when incurred as a result of one or more events (“loss events”) that occurred after the initial recognition of available-for-sale investments. A significant or prolonged decline in the fair value of an equity security below its cost is an indicator that it is impaired. The cumulative impairment loss – measured as the difference between the acquisition cost and the current fair value, less any impairment loss on that asset previously recognised in profit or loss – is removed from equity and recognised in profit or loss. Impairment losses on equity instruments are not reversed through profit or loss. If, in a subsequent period, the fair value of a debt instrument classified as available for sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognised in profit or loss, the impairment loss is reversed through the current period’s profit or loss.
Financial liabilities are classified according to the substance of the contractual arrangements entered into the following measurement categories: (a) financial derivatives and (b) other financial liabilities. Financial derivatives are carried at fair value with changes in value recognised in the consolidated income statement in the period in which they arise. Other financial are carried at amortised cost.
2.15 Cash Cash and cash equivalents include cash in hand, deposits held at call with banks, and other short-term highly liquid investments with original maturities of three months or less.
2.16 Provisions Provisions are recognised when the Group has a present legal or constructive obligation as a result of past events, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and a reliable estimate of the amount of the obligation can be made. Provisions are measured as the best estimate of the expenditure required to settle the present obligation at the balance sheet date.
2.17 Value added tax Value added tax related to sales is payable to tax authorities on the earliest of (a) collection of the receivables from customers or (b) delivery of the goods or services to customers. Input VAT is generally recoverable against sales VAT upon receipt of the VAT invoice. Input VAT on construction in progress can be reclaimed on receipt of VAT invoices for the particular stage of work performed or, if the construction in progress project can not be broken down into stages, on receipt of VAT invoices upon completion of the contracted work.
F-15 The tax authorities permit the settlement of VAT on a net basis. VAT related to sales and purchases which have not been settled at the balance sheet date (VAT deferred) is recognised in the balance sheet on a gross basis and disclosed separately as an asset and liability. Where a provision has been made for the impairment of receivables, the impairment loss is recorded for the gross amount of the debtor, including VAT.
2.18 Employee benefits Wages, salaries, bonuses, paid annual leave and sick leave are accrued in the period in which the associated services are rendered by the employees of the Group. The Group’s entities contribute to the Russian Federation’s state pension and social insurance funds in respect of its employees. These contributions are accrued when incurred. The Group’s commitment ends with the payment of these contributions.
2.19 Share-based payments The Group issues options to certain employees that give the employees the right to choose whether a share- based payment transaction is settled in cash or by issuing equity instruments.
Share-based payment transactions, or the components of such transactions, are accounted for as a cash- settled share-based payment transaction if, and to the extent that, the entity has incurred a liability to settle in cash or other assets, or as an equity-settled share-based payment transaction if, and to the extent that, no such liability has been incurred.
Share-based payments transactions are measured at the fair value of the compound financial instrument at the measurement date, taking into account the terms and conditions on which the rights to the cash or equity instruments were granted. The fair value is determined using the Black-Scholes pricing model. The expected life used in the model has been adjusted, based on management’s best estimate, for the effects of non-transferability, exercise restrictions and behavioral considerations.
A liability equal to the portion of the services received is recognised at the current fair value determined at each balance sheet date. The Group records an expense based on the fair value of options related to the shares expected to vest on a straight-line basis over the vesting period.
At the date of settlement, the Group will remeasure the liability to its fair value. If the Group issues equity instruments on settlement rather than paying cash, the liability will be transferred directly to equity, as the consideration for the equity instruments issued.
2.20 Borrowings Borrowings are initially recognised at their fair value, net of transaction costs, and are subsequently stated at amortised cost; any difference between the proceeds (net of transaction costs) and the redemption value is recognised in the income statement over the period of the borrowings using the effective interest method. Borrowings are classified as current liabilities unless the Group has an unconditional right to defer settlement of the liability for at least 12 months after the balance sheet date.
2.21 Trade and other payables Trade and other payables are accrued when the counterparty performed its obligation under the contract and are carried at amortised cost using the effective interest method.
2.22 Share capital Ordinary shares are classified as equity. External costs directly attributable to the issue of new shares are shown as a deduction in equity from the proceeds. Any excess of the fair value of consideration received over the par value of shares issued is recognised as share premium.
2.23 Dividends Dividends are recognised as a liability and deducted from equity at the balance sheet date only if they are declared on or before the balance sheet date. Dividends are disclosed when they are proposed before the balance sheet date or proposed or declared after the balance sheet date but before the financial statements are authorised for issue.
F-16 2.24 Treasury shares Where any Group company purchases the Company’s equity share capital, the consideration paid, including any directly attributable incremental costs (net of income taxes) is deducted from equity attributable to the Company’s equity holders until the shares are cancelled, reissued or disposed of. Where such shares are subsequently sold or reissued, any consideration received, net of any directly attributable incremental transaction costs and the related income tax effects, is included in equity attributable to the Company’s equity holders.
2.25 Earnings per share Earnings per share are determined by dividing the profit or loss attributable to equity holders of the Company by the weighted average number of participating shares outstanding during the reporting period. Diluted earnings per share are calculated by adjusting the earnings and the number of shares for the effects of dilutive options.
For the purpose of calculating the weighted average number of ordinary shares outstanding during the period in which the reverse acquisition occurs:
• the number of ordinary shares outstanding from the beginning of that period to the acquisition date is the number of ordinary shares issued by the legal parent to the owners of the legal subsidiary • the number of ordinary shares outstanding from the acquisition date to the end of that period is the actual number of ordinary shares of the legal parent outstanding during that period.
2.26 Taxes Current income tax liabilities (assets) are measured in accordance with IAS 12, Income Taxes, based on legislation that is enacted or substantively enacted at the balance sheet date, taking into consideration applicable tax rates and tax exemptions.
Deferred income tax is provided, using the balance sheet liability method, for temporary differences arising between the tax bases of assets and liabilities and their carrying values for financial reporting purposes. 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. In accordance with the initial recognition exemption, deferred tax liabilities are not recorded for temporary differences on initial recognition of goodwill and subsequently for goodwill which is not deductible for tax purposes. Deferred tax assets and liabilities are measured at tax rates that are expected to apply to the period in which the asset is realised or the liability is settled, based on tax rates which are enacted or substantially enacted at the balance sheet date.
Taxes other than on income, interest and penalties are measured in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent. The Group provides against tax contingencies and the related interest and penalties where management can make a reliable estimate of the amount of the additional taxes that may be due. Provisions are maintained, and updated if necessary, for the period over which the respective tax positions remain subject to review by the tax and customs authorities, being 3 years from the year of filing. Upon expiry of the review period, the provisions are released and considered as a contingent liability until the accounting documentation maintenance period expires, being an additional 2 years (i.e. 5 years in total).
Liabilities for such taxes, interest and penalties are measured at the best estimate of the expenditure required to settle the present obligation at the balance sheet date (Notes 31 and 35).
2.27 Income and expense recognition Income and expenses are recognised on an accrual basis as earned or incurred. Recognition of the principal types of income and expenses is as follows:
(a) Revenue Revenue from the sale of goods through retail outlets is recognised at the point of sale. Revenue from franchisee fees is recognised based on contractual agreements over the term of the contracts. The up-front non-refundable franchisee fees received by the Group are deferred and recognised over the standard contractual term of 10 years. Revenue from advertising services is recognised based on contractual agreements. Revenues are measured at the fair value of the consideration received or receivable. Revenues are recognised net of value added tax.
F-17 The group launched a loyalty card scheme in 2007. Discounts earned by customers through loyalty cards, are recorded by the Group by allocating some of the consideration received from the initial sales transaction to the award credits and deferring the recognition of revenue. The allocation is made by the reference to the relative fair values of the components adjusted for expected forfeitures.
(b) Cost of sales Cost of sales include the purchase price of the products sold and other costs incurred in bringing the inventories to the location and condition ready for sale, i.e. retail outlets. These costs include costs of purchasing, storing, rent, salaries and transporting the products to the extent it relates to bringing the inventories to the location and condition ready for sale.
The Group receives various types of allowances from suppliers in the form of slotting fees, volume discounts, and other forms of payment. In accounting for supplier bonuses received by the Group, the Group determined that these bonuses are a reduction in prices paid for the product and are reported as part of the cost of sales.
Bonuses received from suppliers are recorded as a reduction in the price paid for the products and are recognised in cost of sales as the related inventory is sold. Bonuses receivable from suppliers in cash are presented as trade receivables.
(c) Interest income and expense Interest income and expense are recognised on an effective yield basis.
(d) Selling, general and administrative expenses Selling expenses consist of salaries and wages of stores employees, store expenses, rent or depreciation of stores, utilities, advertising costs and other selling expenses. General and administrative expenses include costs of salaries and wages of support office employees, rent and depreciation of support offices, impairment and amortisation charges of non-current charges and other general and administrative expenses. Selling, general and administrative expenses are recognised on an accrual basis as incurred. The Group recognised start-up costs of stores as an expense in the period in which they are incurred.
2.28 Impairment of non-current assets other than goodwill The Group periodically assesses whether there is any indication that non-current assets may be impaired. If any such indicators exist, the Group estimates the recoverable amount of the asset. Where it is not possible to estimate the recoverable amount of an individual asset, the Group estimates the recoverable amount of the cash generating unit to which it belongs. Individual stores are considered separate cash-generating units for impairment testing purposes. Impairment loss is recognised whenever the carrying amount of an asset or the related cash-generating unit exceeds its recoverable amount. Impairment losses are recognised in the income statement.
2.29 Fair value of assets and liabilities at the acquisition date In November 2006, the Group acquired Merkado Group. Fair values of assets and liabilities were determined as at the date of acquisition. Management subsequently revised the allocation of fair values. As a result of the revision the final value of identifiable net assets as at the date of acquisition decreased. After the completion of the purchase price allocation the aggregate fair value of the acquired net assets changed by USD 6,097 and amounted to USD 4,367 (Note 8). Also the Group separately disclosed acquired investment property of USD 21,888 in the Merkado net assets (Note 12).
2.30 Reclassifications Where necessary, corresponding figures have been adjusted to conform to changes in the presentation of the current year. The effect of reclassifications is as follows: • The Group has disclosed Investment property (Note 12) separately from property, plant and equipment. In the year ended 31 December 2006 investment property in the amount of USD 40,020 was reclassified from property, plant and equipment to a separate line in the balance sheet out of which USD 21,888
F-18 relates to acquisition of Merkado (Note 2.29). Besides the effect of investment property acquired as a result of the Merkado acquisition, the investment property business was not material in 2006 and therefore the Group started disclosing it separately only in 2007. • The Group changed the presentation of expenses reclassifying costs incurred in bringing the inventories to the location and condition ready for sale as cost of sales (Note 25). In the year ended 31 December 2006 expenses of USD 34,162 were reclassified from selling, general and administrative expenses to cost of sales.
Management of the Group believes that these reclassifications provide more relevant and meaningful information about the financial position of the Group.
As a consequence of the reclassifications the previously reported Balance Sheet and Income Statement for the year ended 31 December 2006 were changed.
Consolidated Balance Sheet
31 December 31 December 2006 2006 (adjusted) Property, plant and equipment ...... 1,265,833 1,311,950 Investment property ...... 40,020 – Goodwill ...... 2,629,046 2,622,949
Consolidated Income Statement
2006 2006 (adjusted) Cost of sales ...... (2,041,702) (2,007,540) Gross profit ...... 761,649 795,811 Selling, general and administrative expenses ...... (630,817) (664,979)
3 CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS IN APPLYING ACCOUNTING POLICIES The Group makes estimates and assumptions that affect the reported amounts of assets and liabilities within the next financial year. Estimates and judgements are continually evaluated and are based on management’s experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. Management also makes certain judgements, apart from those involving estimations, in the process of applying accounting policies. Judgements that have the most significant effect on the amounts recognised in the consolidated financial statements and estimates that can cause a significant adjustment to the carrying amount of assets and liabilities within the next financial year include:
Tax legislation. Russian tax, currency and customs legislation is subject to varying interpretations (Note 35).
Property, plant and equipment. The Group’s management determines the estimated useful lives and related depreciation charges for its plant and equipment (Note 11). This estimate is based on projected product lifecycles and technical requirements. Management will increase the depreciation charge where useful lives are less than previously estimated lives, or it will write-off or write-down technically obsolete or non-strategic assets that have been abandoned or reclassified as held for sale.
The Group periodically assesses whether there is any indication that property, plant and equipment may be impaired. In the current period no such indications exist and therefore no assets impairment testing was performed. In the opposite case, the Group estimates the recoverable amount of the asset or cash generating unit and if it is less than the carrying amount of an asset or cash generating unit an impairment loss is recognised in the income statement.
Fair value of lease rights. The Group’s management determines the fair value of lease rights acquired in business combinations. The assessment of the fair value of lease rights is based on the estimate of the market rates of the lease prepared by an independent valuation specialist (Note 14).
F-19 Inventory provisions. The Group provides for estimated inventory shrinkage on the basis of a historical shrinkage as a percentage of cost of sales (Note 15). This provision is adjusted at the end of each reporting period to reflect the historical trend of the actual physical inventory count results.
Provision for impairment of trade and other receivables. The Group determines an allowance for doubtful accounts receivable at the end of the reporting period (Note 16). In estimating an allowance for uncollectible accounts receivable the Group takes into account the historical collectibility of the outstanding accounts receivable balances supplemented by the judgement of management to exclude the impact of current conditions that did not affect past periods and to remove the effects of past conditions that do not exist currently.
Classification of VAT. The terms of recovery of VAT depends on the registration of certain property, plant and equipment (Note 17).
Fair value of franchise agreements. The Group’s management determines the fair value of franchise agreements acquired in business combinations. The assessment of the fair value of franchise agreements is based on the income method using discounted royalty payments during the period of the agreements (Note 14).
Fair value of brand and private labels. The Group’ management determines the fair value of brand and private labels acquired in business combinations. The assessment of the fair value of a brand is based on the income approach using the relief-from-royalty method. The assessment of fair value of private labels is based on either the income method using discounted annual savings for the remaining useful life of the labels or the cost method (Note 14).
Estimated impairment of goodwill. The Group tests goodwill for impairment at least annually. The recoverable amounts of cash-generating units have been determined based on the higher of fair value less costs to sell or on value-in-use calculations. These calculations require the use of estimates as further detailed in Note 13.
4 ADOPTION OF NEW AND REVISED STANDARDS AND INTERPRETATIONS Certain new standards and interpretations became effective for the Group from 1 January 2007. Unless otherwise described below, these new standards and interpretations do not significantly affect the Group’s consolidated financial statements: • IFRS 7 Financial Instruments: Disclosures and a complementary Amendment to IAS 1 Presentation of Financial Statements – Capital Disclosures). The IFRS introduces new disclosures to improve the information about financial instruments. Specifically, it requires disclosure of qualitative and quantitative information about exposure to risks arising from financial instruments, including specified minimum disclosures about credit risk, liquidity risk and market risk including sensitivity analysis to market risk. It replaces some of the requirements in IAS 32, Financial Instruments: Disclosure and Presentation. The Group added required disclosures to comply with IFRS 7 in these consolidated financial statements. • IFRIC 7, Applying the Restatement Approach under IAS 29 (effective from 1 January 2007). The Interpretation clarifies the application of IAS 29 in the reporting period in which hyperinflation is first identified. It states that IAS 29 should initially be applied as if the economy has always been hyperinflationary. It further clarifies calculation of deferred income taxes in the opening balance sheet restated for hyperinflation under with IAS 29. • IFRIC 8, Scope of IFRS 2 (effective from 1 January 2007). The interpretation states that IFRS 2 also applies to transactions in which the entity receives unidentifiable goods or services and that such items should be measured as the difference between the fair value of the share-based payment and the fair value of any identifiable goods or services received (or to be received). • IFRIC 9, Reassessment of Embedded Derivatives (effective for periods beginning on or after 1 June 2006 that is from 1 January 2007). The Interpretation clarifies that an entity should assess whether an embedded derivative should be accounted for separately from the host contract when the entity first becomes party to the contact. • IFRIC 10 “Financial Reporting and Impairment” (effective for periods beginning on or after 1 November 2006, that is from 1 January 2007). The interpretation clarifies that an entity should not reverse an impairment loss recognised in previous periods in respect of goodwill or an investment in a financial asset carried at cost. The interpretation is applicable for interim periods.
F-20 5 NEW ACCOUNTING PRONOUNCEMENTS Certain new standards and interpretations have been published that are mandatory for the Group’s accounting periods beginning on or after 1 January 2008 or later periods and which the Group has not early adopted:
IFRS 8, Operating Segments (effective for annual periods beginning on or after 1 January 2009). The standard applies to entities whose debt or equity instruments are traded in a public market or that file, or are in the process of filing, their financial statements with a regulatory organisation for the purpose of issuing any class of instruments in a public market. IFRS 8 requires an entity to report financial and descriptive information about its operating segments and specifies how an entity should report such information. The Group is currently assessing what impact the standard will have on segment disclosures in the consolidated financial statements.
Puttable financial instruments and obligations arising on liquidation – IAS 32 and IAS 1 Amendment (effective from 1 January 2009). The amendment requires classification as equity of some financial instruments that meet the definition of a financial liability. The Group does not expect the amendment to affect its consolidated financial statements.
IAS 23, Borrowing Costs (revised March 2007; effective for annual periods beginning on or after 1 January 2009). The revised IAS 23 was issued in March 2007. The main change to IAS 23 is the removal of the option of immediately recognising as an expense borrowing costs that relate to assets that take a substantial period of time to get ready for use or sale. An entity is, therefore, required to capitalise such borrowing costs as part of the cost of the asset. The revised standard applies prospectively to borrowing costs relating to qualifying assets for which the commencement date for capitalisation is on or after 1 January 2009. The Group is currently assessing the impact of the amended standard on its financial statements.
IAS 1, Presentation of Financial Statements (revised September 2007; effective for annual periods beginning on or after 1 January 2009). The main change in IAS 1 is the replacement of the income statement by a statement of comprehensive income which will also include all non-owner changes in equity, such as the revaluation of available-for-sale financial assets. Alternatively, entities will be allowed to present two statements: a separate income statement and a statement of comprehensive income. The revised IAS 1 also introduces a requirement to present a statement of financial position (balance sheet) at the beginning of the earliest comparative period whenever the entity restates comparatives due to reclassifications, changes in accounting policies, or corrections of errors. The Group expects the revised IAS 1 to affect the presentation of its financial statements but to have no impact on the recognition or measurement of specific transactions and balances.
IAS 27, Consolidated and Separate Financial Statements (revised January 2008; effective for annual periods beginning on or after 1 July 2009). The revised IAS 27 will require an entity to attribute total comprehensive income to the owners of the parent and to the non-controlling interests (previously “minority interests”) even if this results in the non-controlling interests having a deficit balance (the current standard requires the excess losses to be allocated to the owners of the parent in most cases). The revised standard specifies that changes in a parent’s ownership interest in a subsidiary that do not result in the loss of control must be accounted for as equity transactions. It also specifies how an entity should measure any gain or loss arising on the loss of control of a subsidiary. At the date when control is lost, any investment retained in the former subsidiary will have to be measured at its fair value. The Group is currently assessing the impact of the amended standard on its consolidated financial statements.
IFRS 3, Business Combinations (revised January 2008; effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after 1 July 2009). The revised IFRS 3 will allow entities to choose to measure non-controlling interests using the existing IFRS 3 method (proportionate share of the acquiree’s identifiable net assets) or on the same basis as US GAAP (at fair value). The revised IFRS 3 is more detailed in providing guidance on the application of the purchase method to business combinations. The requirement to measure at fair value every asset and liability at each step in a step acquisition for the purposes of calculating a portion of goodwill has been removed. Instead, goodwill will be measured as the difference at acquisition date between the fair value of any investment in the business held before the acquisition, the consideration transferred and the net assets acquired. Acquisition-related costs will be accounted for separately from the business combination and therefore recognised as expenses rather than included in goodwill. An acquirer will have to recognise at the acquisition date a liability for any contingent purchase consideration. Changes in the value of that liability after the acquisition date will be recognised in accordance with other applicable IFRSs, as appropriate, rather than by adjusting goodwill. The revised IFRS 3 brings into its scope business combinations involving only mutual entities and business combinations achieved by contract alone. The Group is currently assessing the impact of the amended standard on its consolidated financial statements.
F-21 Vesting Conditions and Cancellations – Amendment to IFRS 2, Share-based Payment (issued in January 2008; effective for annual periods beginning on or after 1 January 2008). The amendment clarifies that only service conditions and performance conditions are vesting conditions. Other features of a share-based payment are not vesting conditions. The amendment specifies that all cancellations, whether by the entity or by other parties, should receive the same accounting treatment. The Group is currently assessing the impact of the amended standard on its consolidated financial statements. IFRIC 13, ‘Customer loyalty programmes’ (issued in June 2007; effective for annual periods beginning on or after 1 July 2008). IFRIC 13 clarifies that where goods or services are sold together with a customer loyalty incentive (for example, loyalty points or free products), the arrangement is a multiple-element arrangement and the consideration receivable from the customer is allocated between the components of the arrangement using fair values. It is the policy of the Group to recognise deferred revenue on customer loyalty programme as a reduction of revenue, thus, this interpretation will have no impact on consolidated financial statements. Other new standards or interpretations. The Group has not early adopted the following other new standards or interpretations: • IFRIC 11, IFRS 2 – Group and Treasury Share Transactions (effective for annual periods beginning on or after 1 March 2007); • IFRIC 12, Service Concession Arrangements (effective for annual periods beginning on or after 1 January 2008); • IFRIC 14, IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction (effective for annual periods beginning on or after 1 January 2008). Unless otherwise described above, the new standards and interpretations are not expected to significantly affect the Group’s financial statements. All of the above new standards and interpretations are not yet adopted by the European Union except for IFRS 8 and IFRIC 11. 6 SEGMENT REPORTING The Group has the following business segments: Retail trade Other Group Year ended 31 December 2007 Sales – external ...... 5,295,091 25,333 5,320,424 Sales to other segments ...... – – – Total revenue ...... 5,295,091 25,333 5,320,424 Segment result ...... 424,505 19,390 443,895 Unallocated expenses ...... (106,978) Operating profit ...... 336,917 Finance costs, net ...... (125,789) Share of result of associates ...... – Unallocated expenses ...... 31,545 Profit before income tax ...... 242,673 Income tax expense ...... (98,925) Profit for the year ...... 143,748 Capital expenditure ...... 610,634 9,173 619,807 Depreciation and amortisation ...... 132,730 9,646 142,376 Doubtful debtors expense ...... 1,369 – 1,369 As at 31 December 2007 Segment assets ...... 6,291,212 192,823 6,484,035 Investment in associate ...... – Current and deferred tax assets ...... 28,357 Other unallocated assets ...... 10,048 Total assets ...... 6,522,440 Segment liabilities ...... 968,505 – 968,505 Current and deferred tax liability ...... 214,101 Other unallocated liabilities ...... 2,096,167 Total liabilities ...... 3,278,773
F-22 Retail trade Other Group Year ended 31 December 2006 Sales – external ...... 2,791,532 11,819 2,803,351 Sales to other segments ...... – – – Total revenue ...... 2,791,532 11,819 2,803,351 Segment result ...... 167,270 40,266 207,536 Unallocated expenses ...... (39,825) Operating profit ...... 167,711 Finance costs, net ...... (61,520) Share of result of associates ...... – Unallocated expenses ...... 14,083 Profit before income tax ...... 120,274 Income tax expense ...... (36,062) Profit for the year ...... 84,212 Capital expenditure ...... 250,706 5,936 256,642 Depreciation and amortisation ...... 73,750 5,347 79,097 Doubtful debtors expense ...... 4,073 – 4,073 As at 31 December 2006 Segment assets ...... 4,950,017 106,965 5,056,982 Investment in associate ...... – Current and deferred tax assets ...... 18,626 Other unallocated assets ...... 16,858 Total assets ...... 5,092,466 Segment liabilities ...... 552,060 – 552,060 Current and deferred tax liability ...... 177,604 Other unallocated liabilities ...... 1,472,765 Total liabilities ...... 2,202,429
The Group has the following geographical segments:
Russia Other Group Year ended 31 December 2007 Sales – external ...... 5,288,118 32,306 5,320,424 Capital expenditure ...... 616,018 3,789 619,807 As at 31 December 2007 Segment assets ...... 6,503,191 19,249 6,522,440
Year ended 31 December 2006 Sales – external ...... 2,776,748 26,603 2,803,351 Capital expenditure ...... 255,872 770 256,642 As at 31 December 2006 Segment assets ...... 5,055,598 36,868 5,092,466
F-23 7 SUBSIDIARIES Details of the Company’s significant subsidiaries at 31 December 2007 are as follows:
Ownership (%) Company Country Nature of operations 31 December 2007 31 December 2006 Agroaspekt OOO ...... Russia Retailing 100 100 Agroavto OOO ...... Russia Logistic operator 100 100 Agrostar ZAO ...... Russia Logistic operator 100 100 Agrotorg OOO ...... Russia Retailing 100 100 Aliance Service OOO ...... Russia Real estate 100 100 Alpegru Retail Properties Ltd...... Cyprus Real estate 100 100 Beta Estate OOO ...... Russia Real estate 100 100 Ceizer ZAO ...... Russia Real estate 100 100 Center SPAR Ukraine ZAT ...... Ukraine Retailing 100 100 Discount-Invest OOO ...... Russia Retailing 100 100 Elicon OOO ...... Russia Real estate 100 100 Metronom AG OOO ...... Russia Real estate 100 100 Orient Nedvizhimost OOO ...... Russia Real estate 100 100 Perekrestok-2000 OOO ...... Russia Retailing 100 100 Perekrestok Holdings Ltd...... Gibraltar Holding Company 100 100 Pyaterochka 2005 OOO ...... Russia Real estate 100 100 Pyaterochka Finance OOO ...... Russia Bonds issuer 100 100 Remtransavto ZAO ...... Russia Real estate 100 100 Rubin OOO TK ...... Russia Retailing 100 100 Set’ Roznichnoy Torgovli OOO . . . Russia Real estate 100 100 Sladkaya Zhizn N.N. OOO ...... Russia Retailing 100 100 Speak Global Ltd...... Cyprus Real estate and trade mark 100 100 Telprice OOO ...... Russia Real estate 100 100 TH Perekrestok ZAO ...... Russia Retailing 100 100 Ural-Agro-Torg OOO ...... Russia Retailing 51 26* Ural Retail OOO ...... Russia Retailing 51 100 Uzhnyi OOO ...... Russia Retailing 100 100
* control obtained from 1 January 2007 (Note 8)
8 ACQUISITION OF SUBSIDIARIES Pyaterochka On 18 May 2006, the Group acquired Pyaterochka Holding N.V. The acquisition was structured as follows: • On 12 April 2006 and on 18 May 2006 the shareholders of Perekrestok Holdings Ltd. acquired 2,467,917 and 12,068,115 ordinary voting shares of Pyaterochka Holding N.V., respectively, for a cash consideration of USD 1,178,000. • Pyaterochka Holding N.V. acquired 100% of the ordinary voting shares of Perekrestok Holdings Ltd. for 15,813,253 newly issued shares of Pyaterochka Holding N.V. and a cash consideration of USD 300,000.
On completion of the transaction, shareholders and other related parties of Perekrestok Holdings Ltd. obtained control over 56% of Pyaterochka Holding N.V. shares.
The cash consideration paid by Pyaterochka Holding N.V. for the shares of Perekrestok Holdings Ltd. is treated as a distribution of Perekrestok Holdings Ltd’s retained earnings to its shareholders.
In the year ended 31 December 2006 the acquired business of Pyaterochka contributed revenue of USD 1,291,074 and net profit of USD 63,542 from the date of acquisition. If the acquisition of Pyaterochka had occurred on 1 January 2006, the Group’s revenue for 2006 would have been USD 3,485,412 and the Group’s profit for 2006 would have been USD 102,239.
F-24 In estimating effect of Pyaterochka contribution to revenue and net profit of the Group it is assumed that depreciation and amortization of fair valued property, plant and equipment and intangibles was evenly charged throughout the year.
Details of assets and liabilities acquired and the related goodwill are as follows:
Acquiree’s carrying amount, IFRS Fair values Cash and cash equivalents ...... 327,504 327,504 Inventory of goods for resale ...... 58,750 58,750 Trade and other accounts receivable ...... 73,514 73,514 Intangible assets (Note 14) ...... 1,451 438,661 Property, plant and equipment (Note 11) ...... 524,873 638,209 Derivative financial asset ...... – – Long-term prepaid lease expenses ...... 4,589 – Deferred tax asset (Note 31) ...... 1,633 1,633 Other assets ...... 1,165 1,165 Short-term borrowings ...... (37,295) (37,295) Trade and other accounts payable ...... (257,307) (252,307) Provisions and liabilities for tax uncertainties (Note 35) ...... – (30,000) Long-term liability for share-based payments ...... (42,288) (42,288) Long-term borrowings ...... (544,034) (557,165) Non-current lease payable ...... (3,714) (3,714) Deferred tax liability (Note 31) ...... (9,110) (136,989) Net assets acquired ...... 99,731 479,678 Goodwill (Note 13) ...... 2,446,960 Total acquisition cost ...... 2,926,638 Net cash inflow arising from the acquisition ...... 327,504
The total acquisition cost is determined based on the published share price of the ordinary voting shares of Pyaterochka Holding N.V. on 12 April 2006, the exchange date, and represents the market capitalisation of Pyaterochka Holding N.V. on that date.
The non-cash component of the cost of acquisition of Pyaterochka was excluded from the consolidated statement of cash flows.
As a result of the business combination with Pyaterochka the Group obtained an option to acquire 100% of the shares of Formata Holding BV (a chain of hypermarkets operating under “Karusel” brand in Saint Petersburg). It is exercisable in the period from 1 January 2008 until 1 July 2008 at a price that is calculated based on the acquiree’s sales, EBITDA and debt. The Group has used multipliers to assign a fair value to the option rather than applying other valuation techniques. This is due to high volatility of the acquiree’s sales and EBITDA for the recent period that made the results of applying other valuation techniques highly dispersed. Due to significant uncertainties in estimation of the fair value which was also confirmed by an independent valuation specialist the Group concluded that the fair value of the option approximated zero at the acquisition date. Subsequently, the Group measures the option at cost.
Pyaterochka goodwill is justified by the following factors i) know how and developed technologies of Pyaterochka in retail business that contributed to the fact that it is one of the most profitable retailers in Russia, ii) qualified management team and staff of Pyaterochka, iii) expected cost and revenue synergies from the business combination, iv) business concentration v) business contacts acquired together with assets of Pyaterochka. Each of the factors contributed to the acquisition cost that results in the recognition of goodwill. However, these intangible assets are not separately recognised in the balance sheet of the Company because they are either not separable or there are no reliable bases for estimating their fair values.
Merkado In November 2006, the Group acquired 100% of the voting shares of OAO Merkado Group and OOO Metronom AG for USD 101,061. OAO Merkado Group and OOO Metronom AG operate 17 retail grocery stores in Moscow.
F-25 In the year ended 31 December 2006 the acquired business of Merkado contributed revenue of USD 16,596 and net loss of USD 3,260 from the date of acquisition. If the acquisition of Merkado had occurred on 1 January 2006, the Group’s revenue for 2006 would have been USD 2,869,407 and the Group’s profit for 2006 would have been USD 71,194. Estimates of contribution of revenue and profit to the Group are based on unaudited information derived from previous management accounts of Merkado.
In estimating effect of Merkado contribution to revenue and net profit of the Group it is assumed that depreciation and amortization of fair valued property, plant and equipment and intangibles was evenly charged throughout the year.
Details of assets and liabilities acquired and the related goodwill are as follows:
Acquiree’s carrying amount, Fair Russian GAAP* values Cash and cash equivalents ...... 1,488 1,489 Inventory of goods for resale ...... 6,823 3,611 Trade and other accounts receivable ...... 16,301 7,261 Intangible assets (Note 14) ...... 40,976 34,974 Property, plant and equipment (Note 11) ...... 29,730 93,870 Investment property (Note 12) ...... – 21,888 Other assets ...... 1,239 1 Short-term borrowings ...... (3,740) (3,740) Trade and other accounts payable ...... (12,245) (15,166) Provisions and liabilities for tax uncertainties (Note 35) ...... – (10,000) Long-term borrowings ...... (99,376) (99,376) Deferred tax liability (Note 31) ...... 434 (30,445) Net assets acquired ...... (18,370) 4,367 Goodwill (Note 13) ...... 96,694 Total acquisition cost ...... 101,061 Net cash outflow arising from the acquisition ...... 99,572
* Russian GAAP numbers are disclosed since IFRS financial statements were not prepared by the entities before acquisition.
The purchase consideration comprises cash and cash equivalents paid of USD 101,061.
For identification of fair values the Group engaged an independent valuation specialist. In estimating the fair values for the majority of Pyaterochka and Merkado’s property, plant and equipment direct references to observable prices in an active market were used (market approach). However, where there was no active market providing reliable information of prices for certain items of property, plant and equipment, then the depreciated replacement cost approach was applied. Fair values of intangible assets were determined using the replacement cost or discounted cash flows methods. These valuation techniques were used since there is no reliable information for market transactions.
Several intangible assets cannot be separately recognised in the balance sheet of the Company because they are either not separable or there are no reliable bases for estimating their fair values. These intangible assets contributed to the recognition of the Merkado goodwill: i) business concentration in Moscow region ii) qualified management team of Merkado iii) expected cost synergies from the business combination.
Under the purchase agreement, the Group has an indemnity for all costs in excess of USD 1,000 that the Group may suffer, including claims in respect of any tax liability or indebtedness arising out of any matter that occurred prior to the date of completion of the acquisition, 17 November 2006, up to a limit of USD 20,000. Furthermore, if the aggregate amount of claims made by the Group to the sellers exceeds USD 20,000 the Group has an option to sell back 100% of the voting shares of the Merkado Group to the former shareholders. Management estimates that the cost and fair value of the option on the date of acquisition is insignificant. The option expired by the end of 2007.
F-26 Chelyabinsk At 1 January 2007 the Group obtained control via contractual arrangements over OOO “Ural-Agro-Torg” and OOO “Leto”, entities of Chelyabinsk region. The Group increased its shareholding in OOO “Ural-Agro- Torg” and OOO “Leto” from 26% to 51% in exchange of 49% of shares of OOO “Ural-Retail” and OOO “Legion” (the fair value of the shares given as consideration to USD 220 as at the date of business combination).
In the year ended 31 December 2007 the acquired business of Chelyabinsk entities contributed revenue of USD 92,996 and net loss of USD 3,530 from the date of acquisition.
Details of assets and liabilities acquired and the related goodwill are as follows:
Acquiree’s carrying amount, Fair Russian GAAP* values Cash and cash equivalents ...... 1,699 1,699 Inventory of goods for resale ...... 4,441 4,296 Trade and other accounts receivable ...... 4,466 1,994 Intangible assets (Note 14) ...... – 486 Property, plant and equipment (Note 11) ...... 6,763 11,172 Derivative financial asset** ...... – 1,500 Deferred tax asset (Note 31) ...... – 694 Other assets ...... 1,101 – Short-term borrowings ...... (14,179) (12,974) Trade and other accounts payable ...... (8,558) (10,406) Deferred tax liability (Note 31) ...... – (1,217) Net assets acquired ...... (4,267) (2,756) Goodwill (Note 13) ...... 7,697 Total acquisition cost ...... 4,941 Net cash outflow arising from the acquisition ...... 3,242
* Russian GAAP numbers are disclosed since IFRS financial statements were not prepared by the entities before acquisition. ** under the Shareholders Agreement the Group also acquired an option to purchase the remaining 49% of the share capital of OOO “Ural- Agro-Torg” , OOO “Leto”, OOO “Ural-Retail” and OOO “Legion”.
The option is exercisable in the period from 1 January 2008 until 30 June 2009 at a price that is calculated based on the acquiree’s sales and debt. The Group considers change in the value of the option between the date of acquisition and the reporting date as insignificant.
The purchase consideration comprises cash and cash equivalents paid of USD 4,941.
The goodwill recognised is attributable to: i) the business concentration in Ural region and ii) expected cost synergies from the business combination.
Korzinka In November 2007 the Group acquired 100% shareholding in OOO “Uzhnyi” operating the largest and fastest growing retail chain in the Lipetsk region under “Korzinka” brand. The Group acquired 22 stores in total, of which 15 will be integrated into the Group’s discounter format, 6 into the supermarket format and one store will be added to the hypermarket network.
In the year ended 31 December 2007 the acquired business of Korzinka contributed revenue of USD 20,044 and net profit of USD 368 from the date of acquisition. If the acquisition of Korzinka had occurred on 1 January 2007, the Group’s revenue for 2007 would have been USD 5,464,530 and the Group’s profit for 2007 would have been USD 141,431. Estimates of contribution of revenue and profit to the Group are based on unaudited information derived from previous management accounts of Korzinka.
F-27 Details of assets and liabilities acquired and the related goodwill are as follows:
Acquiree’s carrying amount, Provisional Russian GAAP* values Cash and cash equivalents ...... 992 992 Inventory of goods for resale ...... 7,777 7,241 Trade and other accounts receivable ...... 9,129 8,993 Intangible assets (Note 14) ...... – 25,293 Property, plant and equipment (Note 11) ...... 23,562 37,289 Short-term borrowings ...... (7,098) (7,098) Trade and other accounts payable ...... (14,853) (15,027) Provisions and liabilities for tax uncertainties (Note 35) ...... – (7,883) Deferred tax liability (Note 31) ...... – (9,365) Net assets acquired ...... 19,509 40,435 Goodwill (Note 13) ...... 61,714 Total acquisition cost ...... 102,149 Net cash outflow arising from the acquisition ...... 92,308
* Russian GAAP numbers are disclosed since IFRS financial statements were not prepared by the entities before acquisition.
The Group assigned provisional values to net assets acquired. The Group will finalise the purchase price allocation within 12 month from the acquisition date.
The purchase consideration comprises cash and cash equivalents paid of USD 93,300 and deferred consideration of USD 8,849.
The goodwill recognised is attributable to: i) the business concentration in the Lipetsk region ii) expected synergetic effects and iii) favorable locations of retail outlets in Lipetsk city.
Strana Gerkulesia In December 2007 the Group acquired 100% of the voting shares of OOO “Rubin TK” and OOO “RPH Nedvizhimost” operating retail grocery stores in Moscow and in the Moscow region under “Strana Gerkulesia” brand. The Group acquired a total of 29 discount stores, of which 26 are operational and three are scheduled for opening in 2008. Five stores are located in Moscow, 16 stores operate close to Moscow and eight stores are located in other areas of the Moscow region and in Tver region.
In the year ended 31 December 2007 the acquired business of Strana Gerkulesia did not contribute revenue and net profit to the Group. If the acquisition of Strana Gerkulesia had occurred on 1 January 2007, the Group’s revenue for 2007 would have been USD 5,402,032 and the Group’s profit for 2007 would have been USD 143,046. Estimates of contribution of revenue and profit to the Group are based on unaudited information derived from previous management accounts of Strana Gerkulesia.
Details of assets and liabilities acquired and the related goodwill are as follows:
Acquiree’s carrying amount, Provisional Russian GAAP* values Cash and cash equivalents ...... 2,408 2,408 Investments available for sale ...... 34 – Inventory of goods for resale ...... 8,252 3,975 Trade and other accounts receivable ...... 29,754 5,467 Intangible assets (Note 14) ...... – 2,800 Property, plant and equipment (Note 11) ...... 3,748 26,825 Short-term borrowings ...... (6,347) (1,885) Trade and other accounts payable ...... (14,012) (10,547) Provisions and liabilities for tax uncertainties (Note 35) ...... – (7,677) Deferred tax liability (Note 31) ...... – (6,712) Net assets acquired ...... 23,837 14,654 Goodwill (Note 13) ...... 46,773 Total acquisition cost ...... 61,427 Net cash outflow arising from the acquisition ...... 59,019
* Russian GAAP numbers are disclosed since IFRS financial statements were not prepared by the entities before acquisition.
F-28 In estimating provisional values of property and lease rights direct references to observable prices in an active market are used (market approach).
The Group assigned provisional values to net assets acquired. The Group will finalise the purchase price allocation within 12 month from the acquisition date.
The purchase consideration comprises cash and cash equivalents paid of USD 37,903 and loan of USD 23,524 originated to OOO “Rubin TK” at the moment of acquisition.
The goodwill recognised is attributable to: i) the business concentration in Moscow region and its neighboring areas and ii) expected cost synergies from the business combination.
Other acquisitions In November the Group acquired several other companies. Their primary activity is operating of trade centers and earning rental income. No goodwill was recognised on these acquisitions. Details of assets and liabilities acquired are as follows:
In the year ended 31 December 2007 the acquired businesses of other acquisitions did not contribute significant revenue nor significant profit to the Group. If other acquisitions had occurred on 1 January 2007, the Group’s revenue and profit would have not changed significantly. Estimates of contribution of revenue and profit to the Group are based on unaudited information derived from previous management accounts of other acquired businesses.
Acquiree’s carrying amount, Provisional Russian GAAP* values Cash and cash equivalents ...... 2,984 2,984 Loans originated ...... 46 46 Inventory of goods for resale ...... 1 1 Trade and other accounts receivable ...... 2,923 2,923 Property, plant and equipment (Note 11) ...... 20,946 43,314 Investment property (Note 12) ...... – 77,524 Short-term borrowings ...... (14,603) (14,603) Trade and other accounts payable ...... (3,251) (3,250) Long-term borrowings ...... (1,418) (1,418) Deferred tax liability (Note 31) ...... – (22,287) Net assets acquired ...... 7,628 85,234 Total acquisition cost ...... 85,234 Net cash outflow arising from the acquisition ...... 56,843
* Russian GAAP numbers are disclosed since IFRS financial statements were not prepared by the entities before acquisition.
The Group assigned provisional values to net assets acquired. The Group will finalise the purchase price allocation within 12 month from the acquisition date.
The purchase consideration comprises cash and cash equivalents paid of USD 59,827 and loans receivable of USD 25,407 out of which USD 20,157 were issued in 2007 and USD 5,250 issued in 2005.
9 RELATED PARTY TRANSACTIONS Parties are generally considered to be related if one party has the ability to control the other party, is under common control or can exercise significant influence over the other party in making financial or operational decisions. In considering each possible related party relationship, attention is directed to the substance of the relationship, not merely the legal form. Related parties may enter into transactions which unrelated parties might not, and transactions between related parties may not be effected on the same terms, conditions and amounts as transactions between unrelated parties.
F-29 The nature of the relationships for those related parties with which the Group entered into significant transactions or had significant balances outstanding at 31 December 2007 are provided below. The ultimate controlling party is disclosed in Note 1.
Alfa Group The following transactions were carried out with members or management of Alfa Group:
Relationship 2007 2006 CTF Holdings Ltd...... Ultimate parent company Management services received ...... 1,315 890 OAO “Alfa-Bank” ...... Under common control Interest expense on loans received ...... 2,622 598 Bank charges ...... 495 256 Rent revenue ...... 208 – VimpelCom ...... Under significant influence of CTF Holdings Ltd. Communication services rendered by VimpelCom to the Group ...... 532 487 Commission for mobile phone payments processing rendered by the Group to VimpelCom ...... 633 489 Golden Telecom ...... Under significant influence of CTF Holdings Ltd. Communication services received ...... 2,010 1,645
Argonot and Argonot-B In November 2007 the Group acquired 100% in share capital of OOO”Argonot” and “Argont-B”. Their primary activity is operating of trade centers and earning rental income. No goodwill was recognised on these acquisitions. Details of assets and liabilities acquired are disclosed in Note 8. The purchase consideration comprises cash and cash equivalents paid of USD 39,556.
The consolidated financial statements include the following balances with members of the Alfa Group:
31 December 31 December 2007 2006 Cash and cash equivalents OAO “Alfa-Bank” ...... 10,684 20,173 Short-term loans payable OAO “Alfa-Bank” ...... 2,649 16,400 Receivable from related party VimpelCom ...... 102 109 Golden Telecom ...... 159 252 OAO “Alfa-Bank” ...... 225 – Other accounts payable VimpelCom ...... 18 6 CTF Holding Ltd...... – 256 Alfa-Bank The Group has an open credit line with Alfa-Bank. This credit line has a maximum limit of USD 150,000 and a floating interest rate. At 31 December 2007 the Group had USD 2,649 under this credit line at interest rate 9.88% p.a. (31 December 2006: 16,400) (Note 32) and therefore had available credit line of USD 147,351.
F-30 Other related parties The following transactions were carried out with other related parties controlled by management of the Group:
ZAO “Novye Roznichnye Technologii” The following transactions were carried out with ZAO “Novye Roznichnye Technologii”:
2007 2006 Operating lease expenses ...... 1,249 881 Communication services ...... 92 –
The consolidated financial statements include the following balances with ZAO “Novye Roznichnye Technologii”:
31 December 31 December 2007 2006 Accounts payable ...... 145 152
OOO “Rusel” and OOO “Rusel M” The following transactions were carried out with OOO “Rusel” and OOO “Rusel M”:
2007 2006 Outsourcing services provided by the Group ...... 66 1,549 Rental income received by the Group ...... 528 481
The consolidated financial statements include the following balances with OOO “Rusel” and OOO “Rusel M”:
31 December 31 December 2007 2006 Accounts receivable ...... 228 504
OOO “Media 5” and OOO “Media 5M” The following transactions were carried out with OOO “Media 5” and OOO “Media 5M”:
2007 2006 Advertising services provided by the Group ...... 238 3,325
The consolidated financial statements include the following balances with OOO “Media 5” and OOO “Media 5M”:
31 December 31 December 2007 2006 Loans and receivables ...... 52 115
The carrying value of loans and receivables approximates their fair value. Financial assets are not collateralised. None of the financial assets are either past due or impaired. The Group assesses credit quality of the investments as high.
OOO “Makromir” The following transactions were carried out with OOO “Makromir”:
Year ended 31 Year ended 31 December 2007 December 2006 Construction services provided to the Group ...... 1,512 761
F-31 The consolidated financial statements include the following balances with OOO “Makromir”:
31 December 2007 31 December 2006 Loans and receivables ...... 742 642
The carrying value of loans and receivables approximates their fair value. Financial assets are not collateralised. None of the financial assets are either past due or impaired. The Group assesses credit quality of the investments as high.
Donette Investments Limited At 31 December 2006 the Group recorded a long-term loan issued to Donette Investments Limited in the amount of USD 5,250 with an interest rate of 10% p.a. In 2007 the Group converted its loan into 30% in the share capital of Donette Investments Limited and subsequently purchased the remaining of 70% in the share capital. Provisional net assets of Donette Investments Limited acquired are USD 45,678 at the date of acquisition. No goodwill was recognised on this acquisition. The purchase consideration comprises cash and cash equivalents paid of USD 20,272 and loans receivable of USD 25,407. The details of the acquisition of Donette Investments Limited are disclosed in Note 8 as part of Other acquisitions.
Multiserve Holdings Limited The Group entered into an agreement with Multiserve Holdings Limited for payment of the commission directly attributable to acquisition of property, plant and equipment. The commission of USD 1,200 was paid upon completion of the mentioned transaction.
Key management personnel compensation Key management personnel compensation is disclosed in Note 29.
10 CASH
31 December 2007 31 December 2006 Cash in hand – Roubles ...... 12,197 6,207 Cash in hand – Ukrainian Hryvnia ...... 137 86 Bank current account – Roubles ...... 46,525 61,740 Bank current account – Ukrainian Hryvnia ...... 177 164 Bank current accounts and deposits – US Dollars ...... 2,741 32,075 Cash in transit – Roubles ...... 112,264 54,715 Cash in transit – Ukrainian Hryvnia ...... 754 354 Short term deposits and other cash equivalents ...... 4,701 12,647 179,496 167,988
The bank accounts represent current accounts with an effective interest rate of nil. Cash in transit is cash transferred from retail outlets to bank accounts and bank card payments being processed.
The Group assesses credit quality of outstanding cash and cash equivalents balances as high and considers that there is no significant individual exposure. Maximum exposure to credit risk at the reporting date is the carrying value of cash and bank balances.
F-32 11 PROPERTY, PLANT AND EQUIPMENT
Machinery Refrigera- Construc- and ting tion in Buildings equipment equipment Vehicles Other progress Total Cost: At 1 January 2006 ...... 212,996 80,375 23,522 2,002 12,022 50,165 381,082 Additions ...... 63,552 31,306 2,468 1,601 4,566 147,213 250,706 Transfers ...... 93,306 11,894 19,750 3,826 41,996 (170,772) – Assets from acquisitions (Note 8) . . . 463,298 12,880 40,048 5,951 32,789 177,113 732,079 Disposals ...... (13,529) (3,742) (476) (1,088) (2,003) (140) (20,978) Disposal of subsidiaries ...... – (121) – – (18) – (139) Translation movement ...... 35,687 9,157 3,822 398 3,157 5,499 57,720 At 31 December 2006 ...... 855,310 141,749 89,134 12,690 92,509 209,078 1,400,470 Additions ...... 144,547 825 4,363 1,143 16,675 443,081 610,634 Transfers ...... 350,347 31,082 23,614 14,453 12,327 (431,823) – Assets from acquisitions (Note 8) . . . 104,180 1,063 2,206 107 9,064 1,980 118,600 Disposals ...... (5,295) (971) (2,090) (277) (6,031) (2,407) (17,071) Translation movement ...... 81,098 12,534 7,272 2,237 6,609 14,088 123,838 At 31 December 2007 ...... 1,530,187 186,282 124,499 30,353 131,153 233,997 2,236,471 Accumulated depreciation: At 1 January 2006 ...... (24,389) (27,381) (9,844) (366) (6,159) – (68,139) Charge for the year ...... (20,231) (16,747) (6,029) (1,362) (14,430) – (58,799) Disposals ...... 1,453 3,225 302 326 52 – 5,358 Disposal of subsidiaries ...... – 120 – – 18 – 138 Translation movement ...... (4,184) (2,363) (1,298) (128) (5,222) – (13,195) At 31 December 2006 ...... (47,351) (43,146) (16,869) (1,530) (25,741) – (134,637) Charge for the year ...... (48,954) (22,504) (16,294) (1,354) (17,945) – (107,051) Disposals ...... 193 1,873 284 64 1,632 – 4,046 Translation movement ...... (3,105) (4,307) (609) (103) (2,314) – (10,438) At 31 December 2007 ...... (99,217) (68,084) (33,488) (2,923) (44,368) – (248,080) Net book value at 31 December 2007 ...... 1,430,970 118,198 91,011 27,430 86,785 233,997 1,988,391 Net book value at 31 December 2006 ...... 807,959 98,603 72,265 11,160 66,768 209,078 1,265,833 Net book value at 31 December 2005 ...... 188,607 52,994 13,678 1,636 5,863 50,165 312,943
Construction in progress predominantly relates to the development of stores through the use of sub-contractors.
The buildings are mostly located on leased land. Land leases with periodic lease payments are disclosed as part of commitments under operating leases (Note 35). Certain land leases are prepaid for the 49 year term. Such prepayments are presented as non-current prepaid leases in the balance sheet and amount to USD 54,846 (31 December 2006: USD 9,440).
F-33 The Group leases certain assets under finance leases (Note 21). At 31 December 2007 and 31 December 2006 the net book value of the property, plant and equipment held under finance lease arrangements was:
31 December 2007 31 December 2006 Gross book value: Vehicles ...... 3,106 2,699 Refrigerating equipment ...... 8,931 9,150 12,037 11,849 Accumulated depreciation: Vehicles ...... (608) (567) Refrigerating equipment ...... (2,842) (1,873) (3,450) (2,440) Net book value of property, plant and equipment obtained under finance lease arrangements ...... 8,587 9,409
Refer to Note 20 for property, plant and equipment pledged as collateral for borrowings.
12 INVESTMENT PROPERTY The Group held the following investment properties at 31 December 2007 and 31 December 2006:
2007 2006 Cost: Cost at 1 January ...... 41,446 12,166 Additions ...... 9,173 5,936 Assets from acquisitions (Note 8) ...... 77,524 21,888 Translation movement ...... 4,452 1,456 Cost at 31 December ...... 132,595 41,446 Accumulated depreciation: Accumulated depreciation at 1 January ...... (1,426) (511) Charge for the year ...... (1,976) (840) Translation movement ...... (187) (75) Accumulated depreciation at 31 December ...... (3,589) (1,426) Net book value at 31 December ...... 129,006 40,020 Net book value at 1 January ...... 40,020 11,655
Rental income from investment property amounted to USD 9,861(2006: USD 5,182). Direct operating expenses incurred by the Group in relation to investment property in the year ended 31 December 2007 were USD 6,158 (2006: USD 1,474).
Management estimates that the fair value of investment property at 31 December 2007 amounted to USD 179,065 (31 December 2006: USD 48,322).
Fair value represents the price at which a property could be sold to a knowledgeable, willing party and has generally been determined using the comparative valuation approach. The Group did not engage an independent valuation specialist to assess the fair value of investment properties.
F-34 13 GOODWILL Movements in goodwill arising on the acquisition of subsidiaries at 31 December 2007 and 31 December 2006 are:
2007 2006 Cost: Gross book value at 1 January ...... 2,629,046 24,153 Acquisition of subsidiaries (Note 8) ...... 116,184 2,543,654 Translation to presentation currency ...... 188,986 61,239 Gross book value at 31 December ...... 2,934,216 2,629,046 Accumulated impairment losses: Accumulated impairment losses at 1 January ...... – – Accumulated impairment losses at 31 December ...... – – Carrying amount at 31 December ...... 2,934,216 2,629,046 Carrying amount at 1 January ...... 2,629,046 24,153
Goodwill Impairment Test Goodwill is monitored for internal management purposes at the segment level being the retail trading in Russia (CGU).
Goodwill is tested for impairment at the CGU level by comparing carrying values of CGU assets including allocated goodwill to their recoverable amounts. The recoverable amount of CGU is determined as the higher of fair value less cost to sell or value in use.
Fair value less costs to sell The Group defines fair value less costs to sell of the CGU by reference to an active market, i.e. as a market capitalization of the Group on the London stock exchange, since the Group’s activities other than retail trade in Russia insignificantly affects the fair value. For indication purposes fair value less costs to sell of the CGU will be lower than its carrying amount if the share price falls below the level of USD 61 per share. The market capitalization of the Group at 31 December 2007 of USD 7,763,953 significantly exceeded the carrying amount of the CGU.
Value in use Discounted free cash flow approach, based on current acquisition valuation models, was utilized. For the period from 2007 until 2015 the free cash flows are based on the strategic plan as approved by key management. For the subsequent years, the data of the strategic plan are extrapolated based on the consumer price indices as obtained from external resources and based on key performance indicators inherent to the strategic plan. The projections are made in the reporting currency of the Group and discounted at the Group weighted average cost of capital, 12% in US dollar nominal terms. The Group’s management believes that all of its estimates are reasonable: they are consistent with the internal reporting and reflect management’s best estimates. As the result of the assessment no impairment charge was recognised.
Assumptions used for value-in-use calculations to which the recoverable amount is most sensitive were:
EBITDA growth rate ...... 18.3% Pre-tax discount rate ...... 12.0%
Based on the results of the calculations and the applied assumptions the Group concluded that no impairment charge was required. If in the discounted free cash flow model applied for the purpose of goodwill impairment testing the EBITDA growth decreased by 1% the Group would need to reduce the value in use of goodwill by USD 88,334. Also if in the discounted free cash flow model applied for the purpose of goodwill impairment testing the pre-tax discount rate increased by 50 basis points the Group would need to reduce the value in use amount of goodwill by USD 263,476.
F-35 The result of applying discounted cash flows model reflects expectations about possible variations in the amount and timing of future cash flows and is based on reasonable and supportable assumptions that represent management’s best estimate of the range of uncertain economic conditions.
Impairment Test The fair value less cost to sell significantly exceeded the value in use of the CGU and, thus, was taken as the recoverable amount for the purpose of the impairment test. The recoverable amount of CGU exceeded its carrying amount therefore no impairment was recognised.
14 INTANGIBLE ASSETS Intangible assets comprise the following:
Brand and private Franchise Software Lease labels agreements and other rights Total Cost: At 1 January 2006 ...... – – 1,280 19,138 20,418 Additions ...... – – 341 6,253 6,594 Acquisition of subsidiaries (Note 8) ...... 323,526 69,866 4,034 76,209 473,635 Disposals ...... – – (38) – (38) Translation movement ...... 7,689 1,660 241 3,216 12,806 At 31 December 2006 ...... 331,215 71,526 5,858 104,816 513,415 Additions ...... 310 – 450 – 760 Acquisition of subsidiaries (Note 8) ...... 1,017 – 70 27,492 28,579 Disposals ...... (93) – (154) – (247) Translation movement ...... 26,110 5,201 388 6,755 38,454 At 31 December 2007 ...... 358,559 76,727 6,612 139,063 580,961 Accumulated amortisation: At 1 January 2006 ...... – – (704) (674) (1,378) Charge for the year ...... (10,348) (4,507) (1,854) (2,749) (19,458) Translation movement ...... (86) (74) (122) (38) (320) At 31 December 2006 ...... (10,434) (4,581) (2,680) (3,461) (21,156) Charge for the year ...... (17,982) (7,670) (3,060) (4,637) (33,349) Disposals ...... – – 119 – 119 Translation movement ...... (1,709) (659) (258) (416) (3,042) At 31 December 2007 ...... (30,125) (12,910) (5,879) (8,514) (57,428) Net book value at 31 December 2007 ...... 328,434 63,817 733 130,549 523,533 Net book value at 31 December 2006 ...... 320,781 66,945 3,178 101,355 492,259 Net book value at 31 December 2005 ...... – – 576 18,464 19,040
15 INVENTORIES OF GOODS FOR RESALE Inventories as of 31 December 2007 and 31 December 2006 comprise the following:
31 December 2007 31 December 2006 Goods held for resale ...... 333,730 210,543 Less: provision for shrinkage ...... (8,694) (1,967) 325,036 208,576
Refer to Note 20 for goods pledged as collateral for borrowings.
Inventory shrinkage recognised as cost of sales in the consolidated income statement amounted to USD 74,436 (2006: USD 28,906).
F-36 16 TRADE AND OTHER ACCOUNTS RECEIVABLE
31 December 2007 31 December 2006 Trade accounts receivable ...... 61,881 38,442 Advances made to trade suppliers ...... 11,333 12,478 Other receivables ...... 25,259 32,411 Prepayments ...... 53,970 67,717 Accounts receivable for franchise services ...... 2,762 1,287 Receivables from related parties (Note 9) ...... 1,508 1,622 Provision for impairment of trade and other receivables ...... (7,576) (5,732) 149,137 148,225
All classes of receivables are categorized as loans and receivables under IAS 39 classification.
The carrying amounts of the Group’s trade and other receivables are primarily denominated in Russian Roubles.
Trade receivables There are balances of USD 8,935 that are past due but not impaired as at 31 December 2007.
The ageing of these receivables based on days outstanding is as follows:
31 December 2007 31 December 2006 2 - 6 months ...... 5,542 4,204 Over 6 months ...... 3,393 5,474 8,935 9,678
Movements on the provision for impairment of trade receivables are as follows:
2007 2006 At 1 January ...... (3,206) (293) Accrual of provision for receivables impairment ...... (3,871) (2,796) Release of provision for receivables impairment ...... 1,618 – Translation movement ...... (328) (117) At 31 December ...... (5,787) (3,206)
The creation and release of provision for impaired receivables have been included in general and administrative costs in the income statement.
The individually impaired trade receivables mainly relate to debtors that expect financial difficulties or there is likelihood of the debtor’s insolvency. It was assessed that a portion of the receivables is expected to be recovered.
The ageing of amounts receivable that are individually impaired based on days outstanding is as follows:
31 December 2007 31 December 2006 3 - 6 months ...... 281 2,040 Over 6 months ...... 5,991 3,716 6,272 5,756
For those receivables that are neither past due nor impaired the Group considers the credit quality as high. The maximum exposure to credit risk at the reporting date is the carrying amount of each class of receivable mentioned above. The Group does not hold any collateral as security.
F-37 Other receivables and receivables for franchise services There are balances of USD 14,857 that are past due but not impaired as at 31 December 2007.
The ageing of these receivables based on days outstanding is as follows:
31 December 2007 31 December 2006 2 - 6 months ...... 14,321 5,951 Over 6 months ...... 536 5,719 14,857 11,670
Movements on the provision for impairment of other receivables for the year ended 31 December 2007 are as follows:
2007 2006 At 1 January ...... (2,526) (1,263) Accrual of provision for receivables impairment ...... (962) (1,574) Release of provision for receivables impairment ...... 1,846 297 Translation movement ...... (147) 14 At 31 December ...... (1,789) (2,526)
The creation and release of provision for impaired receivables have been included in general and administrative costs in the income statement.
The individually impaired other receivables mainly relate to debtors that expect financial difficulties or there is likelihood of the debtor’s insolvency.
The ageing of amounts receivable that are individually impaired based on days outstanding is as follows:
31 December 2007 31 December 2006 3 - 6 months ...... 834 1,346 Over 6 months ...... 3,542 1,266 4,376 2,612
For those receivables that are neither past due nor impaired the Group considers the credit quality as high. The maximum exposure to credit risk at the reporting date is the carrying amount of each class of receivable mentioned above. The Group does not hold any collateral as security.
17 VAT AND OTHER TAXES RECOVERABLE
31 December 2007 31 December 2006 VAT recoverable ...... 194,264 85,771 Other taxes receivable ...... 1,488 3,663 195,752 89,434
VAT recoverable related to property, plant and equipment of USD 45,466 (31 December 2006: USD 54,202) is recorded within current assets because management expects it will be recovered within 12 months after the balance sheet date. Timing of the VAT refund depends on the registration of certain property, plant and equipment, therefore there are risks that recovering the balance may take longer than twelve months.
18 FINANCIAL ASSETS AND LIABILITIES Available-for-sale financial assets include the following:
31 December 2007 31 December 2006 Bank promissory notes ...... RUB – 623
Changes in the fair value of securities classified as available for sale were insignificant during the year ended 31 December 2007 (2006: nil).
F-38 Derivative financial instruments The Group recognised the following derivative financial instruments as at 31 December 2007:
Financial assets at fair value Financial liabilities at fair value through profit or loss through profit or loss 31 December 31 December 31 December 31 December 2007 2006 2007 2006 Call option for 49% share in subsidiaries (Note 8) ...... 1,500 – – – 1,500 – – –
The maturity of derivative financial instruments is as follows:
Assets Liabilities In 1 year or less ...... 1,500 –
None of the financial assets are either past due or impaired.
19 PROVISIONS AND OTHER LIABILITIES
31 December 2007 31 December 2006 Provisions and liabilities for tax uncertainties (Note 35) ...... 75,671 55,773 Taxes other than income tax ...... 38,727 21,836 Accrued salaries and bonuses ...... 81,680 61,366 Payables to landlords ...... 3,290 7,635 Other accounts payable and accruals ...... 32,205 16,675 Accounts payable for services received ...... 16,211 7,979 Accounts payable for property, plant and equipment ...... 11,458 20,005 Advances received ...... 25,355 9,441 284,597 200,710
There are no significant amounts of foreign accounts payable as at 31 December 2007.
20 BORROWINGS
Currency Interest rate, % p.a. 31 December 2007 31 December 2006 Short-term Current portion of Syndicated loan ...... USD LIBOR+2.25%/ – 112,000 2.5% Current portion of Perekrestok’s bonds ...... RR 8.15% 122 56,725 Commerzbank ...... USD LIBOR+1.4% 90,500 – Barclays Bank Plc ...... RR 6.50% 122,219 – Alfa-Bank ...... USD 9.88%/ 2,649 16,400 6.9%-7.52% UralSib Bank ...... USD 6.95% – 12,760 Raiffeisenbank ...... USD Mosprime + 15,991 – 1,2% Raiffeisenbank overdraft ...... RR 7.19%-7.34% – 6,266 Sberbank ...... RR 11.00% – 11,431 AKB BIN Bank ...... RR 16.00% – 2,279 Amsterdam Trade Bank N.V...... USD LIBOR + 6% 14,660 – Sberbank ...... RR 12.00% 1,222 – Sberbank ...... RR 12.20% 1,833 – Lipeczcombank ...... RR 13.00% 2,567 – Other ...... RR 1,970 152 253,733 218,013
F-39 Currency Interest rate, % p.a. 31 December 2007 31 December 2006 Long-term Syndicated loan** ...... USD LIBOR + 1,083,226 – 2.25% / 2.0% Syndicated loan ...... USD LIBOR 2.25% – 788,016 /2.5% Pyaterochka Finance’s bonds – 1st issue ...... RR 11.45% 2,956 60,667 Pyaterochka Finance’s bonds – 2nd issue ...... RR 9.30% 12,305 121,590 Perekrestok’s bonds ...... RR 8.15% – 56,725 Bank Petrocommerz ...... RR 11.00% – 90,850 X5 Finance bonds* ...... RR 7.60% 364,763 – Sberbank ...... USD 11.50% 1,422 – Other loans ...... RR 12 – Less: Current portion of Syndicated loan ...... USD LIBOR+2.25% – (112,000) /2.0% Current portion of Perekrestok’s bonds ...... RR 8.15% – (56,725) 1,464,684 949,123 Total borrowings ...... 1,718,417 1,167,136
* In July 2007 the Group placed RR 9,000 million (USD 350,172) bonds. The 7-year bonds pay semiannual coupons. Coupons 1 to 6 are equal and amount to 7.60% per annum, the rest to be defined by the Group later. The holders have right to ask for redemption of the bonds at par in 3 years. The funds raised by the bonds were used to refinance other outstanding bond issues of the Group. ** In December 2007 the Group raised syndicated a loan of USD 1,100,000 from a consortium of banks. The loan pays a margin of 2.25% per annum over LIBOR for the first year. Subsequently, the margin will move in accordance with a Net Debt/EBITDA grid with a maximum margin at the top of the grid of 2.0% per annum over LIBOR. LIBOR is repriced every quarter. The loan has a 3-year maturity. The Group has pledged as collateral for the syndicated loan 100% of voting shares, cash in the bank accounts and receivable accounts in its subsidiaries, including OOO “Agrotorg”, OOO “Agroaspekt”, Perekrestok Holdings Ltd., Alpegru Retail Properties Ltd., ZAO “TH “Perekrestok”, OOO “Perekrestok-2000”. The proceeds of the loan were used to refinance the bridge facility in the amount of USD 1,000,000 and for general corporate purposes.
All borrowings at 31 December 2007 are shown net of related transaction costs of USD 18,884 which are amortised over the term of loans using the effective interest method.
The Group maintains optimal capital structure by tracing certain capital requirements based on the ratios included as covenants into loan agreements (Note 33). The new bridge facility includes the following covenants: maximum level of Debt/EBITDA is 4.25, minimum level of EBITDA/Interest expense is 3, minimum level of EBITDAR/Fixed costs is 2.25 and maximum level of capital expenditure.
21 OBLIGATIONS UNDER FINANCE LEASES
The Group leases certain refrigerating equipment and vehicles under finance lease terms. The agreements expire in 2008-2009 and assume a transfer of ownership for the leased assets to the Group at the end of the lease term. The effective borrowing rate on lease agreements as of 31 December 2007 varies from 9.0% to 13.0% per annum on USD agreements and from 23.0% to 31.0% per annum on RR agreements. The fair value of the finance lease liability as of 31 December 2007 approximates its carrying amount.
Lease obligations of the Group as of 31 December 2007 and 31 December 2006 consisted of the following:
Present value of minimum lease Minimum lease payments payments 31 December 2007 31 December 2006 31 December 2007 31 December 2006 Amounts payable : Within one year ...... 2,653 3,261 2,145 2,271 In the second to fifth years inclusive ...... 1,355 3,879 1,181 2,913 4,008 7,140 3,326 5,184 Less: future finance charges ...... (682) (1,956) N/A N/A Present value of minimum lease payments ...... 3,326 5,184 3,326 5,184
F-40 22 SHARE CAPITAL As described in Note 2.1 the equity structure of the Group represents the equity structure of X5 Retail Group N.V. As of 1 January 2006 the Company had 38,306,785 ordinary shares issued and fully paid. The nominal par value of each ordinary share is EUR 1. The Company has only one class of ordinary shares. As part of the acquisition (Note 8) in April 2006 the Group issued an additional 15,813,253 ordinary shares.
During 2007 the Group repurchased 40,000 ordinary shares (2006: 902,278 ordinary shares repurchased) for general corporate purposes, including funding the employees’ share option program (ESOP) liabilities and potential acquisitions. As of 31 December 2007 the Group had 190,000,000 authorised ordinary shares of which 53,177,760 ordinary shares are outstanding. As of 31 December 2007 the fair value of outstanding shares amounted to USD 7,763,953 .
No dividends were paid or declared during the year ended 31 December 2007 or the year ended 31 December 2006 other than the USD 300,000 payment to former shareholders of Perekrestok Holdings Ltd. (Note 8).
23 EARNINGS PER SHARE Basic earnings per share are calculated by dividing the profit or loss attributable to equity holders of the Company by the weighted average number of ordinary shares in issue during the year, excluding treasury shares.
Earnings per share are calculated as follows:
2007 2006 Profit attributable to equity holders of the Parent ...... 143,748 84,212 Weighted average number of ordinary shares in issue ...... 53,214,212 39,492,210 Effect of share options granted to employees ...... 143,894 298,272 Weighted average number of ordinary shares for the purposes of diluted earnings per share ...... 53,358,106 39,790,482 Basic earnings per share for profit from continuing operations (expressed in USD per share) ...... 2.70 2.13 Diluted earnings per share for profit from continuing operations (expressed in USD per share) ...... 2.69 2.12
24 REVENUE
2007 2006 Revenue from sale of goods ...... 5,295,092 2,791,532 Revenue from franchise services ...... 12,507 7,050 Revenue from other services ...... 12,825 4,769 5,320,424 2,803,351
25 EXPENSES BY NATURE
2007 2006 Cost of product ...... 3,846,268 2,007,540 Staff costs (Note 29) ...... 556,255 302,552 Operating lease expenses ...... 184,635 107,157 Other store costs ...... 99,089 49,120 Depreciation and amortisation ...... 142,376 79,097 Utilities ...... 78,086 30,960 Other ...... 144,830 96,093 5,051,539 2,672,519
Operating lease expenses include USD 176,143 (2006: USD 105,799) of minimum lease payments and contingent rents of USD 8,492 (2006: USD 1,358).
Provision for impairment of trade and other receivables amounted to USD 1,369 during the year ended 31 December 2007 (2006: USD 4,073).
F-41 26 OPERATING LEASE INCOME The Group leases part of its store space to companies selling supplementary goods and services to customers. The lease arrangements are operating leases, the majority of which are short-term. The future minimum lease payments receivable under non-cancellable operating leases are as follows:
2007 2006 Not later than 1 year ...... 28,380 16,153 Later than 1 year and no later than 5 years ...... 17,820 6,782 Later than 5 years ...... 5,730 1,952 51,930 24,887
The rental income from operating leases recognised in the income statement amounted to USD 67,992 (2006: 35,268 USD). There were no contingent rents recognised in the income statement in the year ended 31 December 2007 (2006: nil).
27 FINANCE INCOME AND COSTS
2007 2006 Interest expense ...... 101,753 62,952 Interest income ...... (7,230) (1,432) Other finance costs, net ...... 31,266 – 125,789 61,520
Other finance costs include Pyaterochka Finance’s bonds redemption costs of USD 10,404 and transaction costs of USD 19,480 written-off to the income statement due to repayment of syndicated loans during the year.
28 NET FOREIGN EXCHANGE GAIN
2007 2006 Foreign exchange gains ...... 67,195 14,083 Mark-to-market result on foreign exchange collar ...... (35,650) – 31,545 14,083
The Group used the foreign exchange collar with leading banking institutions to mitigate foreign currency risks associated with syndicated loan. However management did not formally designate the foreign exchange collars as hedging instruments and did not apply hedge accounting.
29 STAFF COSTS
2007 2006 Wages and salaries ...... 449,496 254,544 Social security costs ...... 59,050 20,306 Share-based payments expense ...... 47,709 27,702 556,255 302,552
Key executive management personnel Key management personnel and members of the Supervisory Board of the Company receive compensation in the form of short-term employee benefits and share-based payments (Note 30). For the year ended 31 December 2007 key management personnel and members of the Supervisory Board of the Company were entitled to total short-term compensation of USD 8,217 (2006: USD 16,467), including bonuses of USD 4,437 (2006: USD 7,282) and share-based payments of USD 33,111 (2006: 6,321). The compensation is made up of annual remuneration and a performance bonus depending on operating results.
F-42 30 SHARE-BASED PAYMENTS In February and June 2007 the Group paid the cancellation fees related to the employee stock option program acquired in May 2006 with the acquisition of Pyaterochka Holding N.V. (Note 8). The amount of the cancellation fees outstanding at 31 December 2007 totaled to USD 2,389 (31 December 2006: USD 69,990) and will be paid out within a year of the balance sheet date.
In March 2007 the Group announced a new employee stock option program for its key executives and employees. The total number of share options is capped at 10,824,008 GDRs. Each option carries the right to one GDR. The program will run in four tranches that will be issued over the period to 19 May 2009. The vesting requirement of the program is the continued employment of participants.
The first and second tranches were approved for granting at 15 June 2007. The first tranche vests immediately and covers the period of service of option holders from 1 January 2007 to 15 June 2007. The second tranche will vest on 18 May 2008. The exercise price of the first grant is USD 18.00 per GDR. The exercise price of the second option tranche equals to USD 30.62 per GDR. Participants of the ESOP can exercise the share option at any time over the period from vesting till 18 November 2010.
In total, during the year ended 31 December 2007 the Group recognised expenses related to the ESOP in the amount of USD 47,708 (2006: USD 27,702). At 31 December 2007 the share-based payments liability amounted to USD 45,597 (31 December 2006: USD 69,990). Equity component was effectively zero at 31 December 2007 (2006: zero).
Details of the share options outstanding during year ended 31 December 2007 are as follows:
Number of Weighted average Weighted average share options exercise price, USD share price, USD Outstanding at the beginning of the year ...... – – Granted during the year ...... 4,198,000 26.4 Exercised during the year ...... (250,000) 18.0 36.0 Cancelled during the year ...... (365,000) 27.3 Outstanding at the end of the year ...... 3,583,000 26.9 Exercisable at 31 December 2007 ...... 1,145,000 18.0
The total intrinsic value of vested share options amounted to USD 21,183 as at 31 December 2007.
The fair value of services received in return for the share options granted to employees is measured by reference to the fair value of the share options granted which is determined at each reporting date. The estimate of the fair value of the services received is measured based on Black-Scholes model. Expected volatility is determined by calculating the historical volatility of the Group’s share price over the period since May 2006. Management assumes that holders will exercise the options on the expiry date of the options, being 18 November 2010, due to behavioral considerations. Other key inputs to the calculation of ESOP liability at 31 December 2007 were as follows:
GDR price at 31 December 2007 ...... 36.5 Expected volatility ...... 35.8% Risk-free interest rate ...... 5.44% Dividend yield ...... 0%
31 INCOME TAX
Year ended Year ended 31 December 2007 31 December 2006 Current income tax charge ...... 120,814 63,660 Deferred income tax benefit ...... (21,889) (27,598) Income tax charge for the year ...... 98,925 36,062
F-43 The theoretical and effective tax rates are reconciled as follows:
Year ended Year ended 31 December 2007 31 December 2006 Profit before taxation ...... 242,673 120,274 Theoretical tax at the effective statutory rates* ...... 58,242 28,856 Tax effect of items which are not deductible or assessable for taxation purposes: Effect of income taxable at rates different from standard statutory rates ...... (11,241) (15,688) Inventory shrinkage expenses ...... 33,862 6,937 Unrecognised tax loss carry forward for the year ...... 635 3,800 Share-based payments expenses ...... 9,952 – Other non-deductible expenses ...... 7,475 5,891 Provision for uncertain tax positions (Note 35) ...... – 6,266 Income tax charge for the year ...... 98,925 36,062
* Profit before taxation on Russian operations is assessed based on the statutory rate of 24%, profit before taxation on Ukrainian operations is assessed based on the statutory rate of 25%.
Deferred income tax Differences between financial reporting standards and taxation regulations give rise to certain temporary differences between the carrying value of certain assets and liabilities and their tax bases. The tax effect of the movement on these temporary differences is recorded at the rate of 24% for Russian operations and of 25% for Ukrainian operations.
Deferred tax assets and liabilities and the deferred tax charge in the income statement are attributable to the following items for the year ended 31 December 2007:
Recog- Deferred tax on nised in Credited business equity for 31 December to profit combinations translation 31 December 2006 and loss (Note 8) differences 2007 Tax effects of deductible temporary differences and tax loss carryforwards: Tax losses available for carry forward ...... – 16,341 – 372 16,713 Property, plant and equipment ...... 7,675 (676) – 530 7,529 Intangible assets ...... – 51 – 2 53 Accounts Receivable ...... 5,775 5,853 – 666 12,294 Liability for share based expenses ...... 16,284 (16,214) – 503 573 Other ...... 8,650 8,575 694 1,793 19,712 Gross deferred tax asset ...... 38,384 13,930 694 3,866 56,874 Less offsetting with deferred tax liabilities .... (19,758) (6,829) – (1,930) (28,517) Recognised deferred tax asset ...... 18,626 7,101 694 1,936 28,357 Tax effects of taxable temporary differences: Property, plant and equipment ...... (84,545) 4,151 (38,587) (5,822) (124,803) Intangible assets ...... (112,817) 13,080 (788) (7,562) (108,087) Accounts Receivable ...... – (3,222) – (76) (3,298) Other ...... – (6,050) (206) (174) (6,430) Gross deferred tax liability ...... (197,362) 7,959 (39,581) (13,634) (242,618) Less offsetting with deferred tax assets ...... 19,758 6,829 – 1,930 28,517 Recognised deferred tax liability ...... (177,604) 14,788 (39,581) (11,704) (214,101)
Temporary differences on unremitted earnings of certain subsidiaries amounted to USD 276,742 (2006: USD 162,573) for which the deferred tax liability was not recognised as such amounts are being reinvested for the foreseeable future.
F-44 The current portion of the deferred tax liability amounted to USD 23,289 (31 December 2006: USD 13,420), the current portion of the deferred tax asset amounted to USD 7,580 (31 December 2006: USD 17,467).
Management believes that future taxable profits in tax jurisdictions that suffered loss in current or preceding years will be available to utilise recognised in the current period deferred tax asset of USD 16,341 for the carryforward of unused tax loss.
Deferred tax assets and liabilities and the deferred tax charge in the income statement are attributable to the following items for the year ended 31 December 2006:
Recog- Deferred tax nised in Charged Deferred tax asset in equity for 31 December to profit on business disposed translation 31 December 2005 and loss combinations subsidiaries differences 2006 Tax effects of deductible temporary differences and tax loss carryforwards: Tax losses available for carry forward ...... 1,269 (1,343) – – 74 – Property, plant and equipment ..... – 3,468 4,090 – 117 7,675 Accounts Receivable ...... 3,001 1,245 1,170 – 359 5,775 Liability for share based expenses . . – 16,284 – – – 16,284 Other ...... (1,131) 2,591 6,710 (76) 556 8,650 Gross deferred tax asset ...... 3,139 22,245 11,970 (76) 1,106 38,384 Less offsetting with deferred tax liabilities ...... (3,139) (5,962) (10,337) 76 (396) (19,758) Recognised deferred tax asset .... – 16,283 1,633 – 710 18,626 Tax effects of taxable temporary differences: Property, plant and equipment ..... (14,764) 1,522 (68,718) – (2,585) (84,545) Intangible assets ...... (5,049) 3,831 (109,053) – (2,546) (112,817) Gross deferred tax liability ...... (19,813) 5,353 (177,771) – (5,131) (197,362) Less offsetting with deferred tax assets ...... 3,139 5,962 10,337 (76) 396 19,758 Recognised deferred tax liability ...... (16,674) 11,315 (167,434) (76) (4,735) (177,604)
32 FINANCIAL RISKS MANAGEMENT The risk management function within the Group is carried out in respect of financial risks (credit, market, geographical and liquidity rate), operational risks and legal risks. The primary objectives of the financial risk management function are to establish risk limits, and then ensure that exposure to risks stays within these limits. The operational and legal risk management functions are intended to ensure proper functioning of internal policies and procedures to minimise operational and legal risks.
Risk management is carried out by a central treasury department (Group Treasury). Group Treasury monitors and measures financial risks and undertakes steps to limit their influence on the Group’s performance. In this connection the Group uses certain derivative financial instruments to mitigate financial risk exposures. These instruments are primarily intended to cap risks associated with the most significant foreign currency denominated long-term borrowings.
(a) Market risk Currency risk The Group is exposed to foreign exchange risk arising from various currency exposures, primarily with respect to the US dollar. The Group has a substantial amount of foreign currency denominated long-term borrowings, and is thus exposed to foreign exchange risk (Note 20). Therefore the Group Treasury’s risk
F-45 management policy is primarily to hedge anticipated cash outflows associated with borrowings in US dollar. The Group used foreign exchange collars with leading banking institutions to hedge currency risks associated with syndicated loan (Note 20), however, there were none of these instruments at 31 December 2007. The loss on the foreign exchange collars amounted to USD 35,650 (Note 28). The new syndicated loan for USD 1,100,000 was hedged against currency risk in February 2008 (Note 20).
At 31 December 2007, if the Russian Rouble had weakened/strengthened by 5% against the US dollar with all other variables held constant, post-tax profit for the year would have been USD 34,426 (31 December 2006: USD 18,144) lower/higher, mainly as a result of foreign exchange losses/gains on US dollar denominated borrowings.
Interest rates risk As the Group has no significant interest-bearing assets, the Group’s income and operating cash inflows are substantially independent of changes in market interest rates.
The Group’s interest rate risk arises from borrowings. Borrowings issued at variable rates expose the Group to cash flow interest rate risk. It is the Group policy to manage cash flow interest rate risk by using floating-to-fixed interest rate swaps. Under the interest rate swaps, the Group agrees with other parties to exchange, at specified intervals (primarily quarterly), the difference between fixed contract rates and floating-rate interest amounts calculated by reference to the agreed notional amounts.
In 2007 the Group used an interest rate swap with leading banking institutions to hedge the interest rate of USD denominated loans. The effect of the swap on profit or loss of 2007 was insignificant. The new syndicated loan for USD 1,100,000 was hedged against interest rate risk in February 2008 (Note 20). However management did not formally designate interest rate swap as hedging instruments and did not apply hedge accounting.
As a result of using interest rate swaps change in market interest rates with all other variables held constant would not significantly affect post-tax profit of the Group. At 31 December 2007, if LIBOR at that date had been 50 basis points lower/higher with all other variables held constant, post-tax profit for the year would have been USD 1,362 (31 December 2006: USD 253 ) lower/higher.
(b) Credit risk Financial assets, which are potentially subject to credit risk, consist principally of cash and cash equivalents held in banks, trade and other receivables (Note 10 and Note 16). Due to the nature of its main activities (retail sales to individual customers) the Group has no significant concentration of credit risk. Cash is placed in financial institutions which are considered at the time of deposit to have minimal risk of default. The Group has policies in place to ensure that in case of credit sales of products and services to wholesales customers only those with an appropriate credit history are selected. Although collection of receivables could be influenced by economic factors, management believes that there is no significant risk of loss to the Group beyond the provision already recorded. In accordance with the Group treasury policies and exposure management practices, counterparty credit exposure limits are continually monitored and no individual exposure is considered significant.
(c) Liquidity risk Liquidity risk is defined as the risk that an entity will encounter difficulty in meeting obligations associated with financial liabilities. The Group is exposed to daily calls on its available cash resources. Liquidity risk is managed by the Group Treasury.
Management monitors monthly rolling forecasts of the group’s cash flows. The Group manages liquidity requirements by the use of both short- and long-term projections and by maintaining the availability of funding from an adequate amount of committed credit facilities.
F-46 The following is an analysis of the contractual undiscounted cash flows payable under financial liabilities and derivative assets and liabilities as at the balance sheet date at spot foreign exchange rates:
Year ended 31 December 2007
During 1 year In 1 to 3 years In 3 to 5 years After 5 years Borrowings ...... 374,030 1,665,661 – – Trade payables ...... 968,505 – – – Gross finance lease liabilities ...... 2,145 1,181 – – Other finance liabilities ...... 144,844 – – 1,489,524 1,666,842 – –
Year ended 31 December 2006
During 1 year In 1 to 3 years In 3 to 5 years After 5 years Borrowings ...... 315,256 1,057,716 – – Trade payables ...... 552,060 – – – Gross finance lease liabilities ...... 2,271 2,913 – – Other finance liabilities ...... 113,660 – – – 983,247 1,060,629 – –
At 31 December 2007 the Group has negative working capital of USD 690,820 (31 December 2006: USD 436,521) including short-term borrowings of USD 253,733 (31 December 2006: USD 218,013).
At 31 December 2007 the Group had available credit lines banks of USD 330,965 (31 December 2006: nil).
The Group plans to issue up to RUR 16 billion (USD 651,832 at spot foreign exchange rate) callable bonds in 2 tranches during 2008 to refinance the Group’s existing debt and fund its store expansion.
Management considers that the available credit lines and expected operating cash flows are sufficient to finance the Group’s current operations.
33 CAPITAL RISK MANAGEMENT The Group’s objectives when managing capital are to safeguard the Group’s ability to continue as a going concern in order to provide returns for shareholders and benefits for other stakeholders and to maintain an optimal capital structure to reduce the cost of capital. The Group manages total equity attributable to equity holders recognized under IFRS requirements.
Simultaneously, the Group maintains optimal capital structure by tracing certain capital requirements based on ratios. The ratios are maximum level of Debt/EBITDA, minimum level of EBITDA/Interest expense, minimum level of EBITDAR/Fixed costs and maximum level of capital expenditure. These ratios are included as covenants into new loan agreements (Note 20). The Group is in compliance with externally imposed capital requirements.
34 FAIR VALUE OF FINANCIAL INSTRUMENTS Fair value is the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation, and is best evidenced by an active quoted market price.
The estimated fair values of financial instruments have been determined by the Group using available market information, where it exists, and appropriate valuation methodologies. However, judgement is necessarily required to interpret market data to determine the estimated fair value. The Russian Federation continues to display some characteristics of an emerging market and economic conditions continue to limit the volume of activity in the financial markets. Market quotations may be outdated or reflect distress sale transactions and therefore not represent fair values of financial instruments. Management has used all available market information in estimating the fair value of financial instruments.
F-47 Financial assets carried at amortised cost. The fair value of floating rate instruments is normally their carrying amount. The estimated fair value of fixed interest rate instruments is based on estimated future cash flows expected to be received discounted at current interest rates for new instruments with similar credit risk and remaining maturity. Discount rates used depend on credit risk of the counterparty.
Carrying amounts of trade and other financial receivables approximate fair values.
Liabilities carried at amortised cost. The fair value of bonds is based on quoted market prices. Fair values of other liabilities are determined using valuation techniques. Carrying amounts of trade and other payables approximate fair values.
The fair value of X5 Finance bonds traded on the MICEX is determined based on active market quotations and amounted to USD 360,936 at 31 December 2007 (31 December 2006: nil). The carrying value of these bonds amounted to USD 364,763 at 31 December 2007 (31 December 2006: nil) (Note 20).
Derivative financial instruments. All derivative financial instruments are carried at fair value as assets when the fair value is positive and as liabilities when the fair value is negative. The fair value is determined based on quoted market prices or valuation techniques (Note 18).
35 COMMITMENTS AND CONTINGENCIES Commitments under operating leases At 31 December 2007, the Group operated 491 stores through rented premises (31 December 2006: 353). There are two types of fees in respect of operating leases payable by the Group: fixed and variable. For each store fixed rent payments are defined in the lease contracts and denominated in USD. The variable part of rent payments is predominantly denominated in RR and normally calculated as a percentage of turnover. Fixed rent payments constitute the main part of operating lease expenses of the Group as compared to the variable fees. Substantially all of the lease agreements have an option that enables the Group to cancel agreement at mutual concord of the parties involved.
The future minimum lease payments under non-cancellable operating leases of property are as follows (net of VAT):
31 December 2007 31 December 2006 During 1 year ...... 99,786 65,199 In 2 to 5 years ...... 276,653 184,936 Thereafter ...... 196,868 116,244 573,307 366,379
Capital expenditure commitments At 31 December 2007 the Group contracted for capital expenditure of USD 131,964 (net of VAT) (2006: USD 81,375).
Recent volatility in global financial markets. Since the second half of 2007 there has been a sharp rise in foreclosures in the US subprime mortgage market. The effects have spread beyond the US housing market as global investors have re-evaluated their exposure to risks, resulting in increased volatility and lower liquidity in the fixed income, equity, and derivative markets. However management assess that the Group’s financial position is not currently affected by the consequences of deterioration in the liquidity of the financial markets and their increased volatility.
Legal contingencies In the normal course of business the Group is involved in periodic legal cases. Management does not anticipate any material negative impact on the resolution of these cases.
Taxation environment Russian tax, currency and customs legislation is subject to varying interpretations, and changes, which can occur frequently. Management’s interpretation of such legislation as applied to the transactions and activity of
F-48 the Group may be challenged by the relevant regional and federal authorities. Recent events within the Russian Federation suggest that the tax authorities may be taking a more assertive position in their interpretation of the legislation and assessments, and it is possible that transactions and activities that have not been challenged in the past may be challenged as not having been in compliance with Russian tax laws applicable at the relevant time. In particular, the Supreme Arbitration Court issued guidance to lower courts on reviewing tax cases providing a systematic roadmap for anti-avoidance claims, and it is possible that this will significantly increase the level and frequency of tax authorities scrutiny. As a result, significant additional taxes, penalties and interest may be assessed. Fiscal periods remain open to review by the authorities in respect of taxes for three calendar years preceding the year of review. Under certain circumstances reviews may cover longer periods.
Russian transfer pricing legislation introduced on 1 January 1999 provides the possibility for tax authorities to make transfer pricing adjustments and impose additional tax liabilities in respect of all controllable transactions, provided that the transaction price differs from the market price by more than 20%. Controllable transactions include transactions with interdependent parties, as determined under the Russian Tax Code, and all cross-border transactions (irrespective of whether performed between related or unrelated parties), transactions where the price applied by a taxpayer differs by more than 20% from the price applied in similar transactions by the same taxpayer within a short period of time, and barter transactions. There is no formal guidance as to how these rules should be applied in practice. The arbitration court practice in this respect is contradictory.
Tax liabilities arising from inter-company transactions are determined using actual transaction prices. It is possible with the evolution of the interpretation of the transfer pricing rules in the Russian Federation and the changes in the approach of the Russian tax authorities, that such transfer prices could potentially be challenged in the future. Given the brief nature of the current Russian transfer pricing rules, the impact of any such challenge cannot be reliably estimated; however, it may be significant to the financial condition and operations of the entity.
Russian tax legislation does not provide definitive guidance in many areas. From time to time, the Group adopts interpretations of such uncertain areas that reduce the overall tax rate of the Group. As noted above, such tax positions may come under heightened scrutiny as a result of recent developments in administrative and court practices; the impact of any challenge by the tax authorities cannot be reliably estimated; however, it may be significant to the financial condition and operations of the entity.
Management regularly reviews the Group’s taxation compliance with applicable legislation, laws and decrees and current interpretations published by the authorities in the jurisdictions in which the Group has operations. Furthermore, management regularly assesses the potential financial exposure relating to tax contingencies for which the three years tax inspection right has expired but which, under certain circumstances, may be challenged by the regulatory bodies. From time to time potential exposures and contingencies are identified and at any point in time a number of open matters may exist. Management estimates that possible exposure in relation to profit tax and other non-profit tax risks such as inter-company transactions, VAT and employee related taxes, that are more than remote, but for which no liability is required to be recognised under IFRS, could be several times the additional accrued liabilities and provisions reflected on the balance sheet at that date (and potentially in excess of the Group’s profit before tax for the year). This estimation is provided for the IFRS requirement for disclosure of possible taxes and should not be considered as an estimate of the Group’s future tax liability. At the same time management has recorded liabilities for income taxes and provisions for taxes other than income taxes in the amount of USD 75,671 at 31 December 2007 (31 December 2006: USD 55,773) in these consolidated financial statements as their best estimate of the Group’s liability related to tax uncertainties as follows:
Balance at 1 January 2006 ...... 8,000 Increases due to acquisitions during the year recorded as part of the purchase price allocation (Note 8) ...... 40,000 Additional liabilities recorded during the year ...... 7,773 Reversals of prior year – accruals ...... – Balance at 31 December 2006 ...... 55,773 Increases due to acquisitions during the year recorded as part of the purchase price allocation (Note 8) ...... 15,560 Translation movement ...... 4,338 Balance at 31 December 2007 ...... 75,671
F-49 36 SUBSEQUENT EVENTS Due diligence of Karusel started The Group has sent an Option Notice (the Notice) to the shareholders of Formata Holding B.V. (Formata) on execution of its rights under a Call Option Agreement with respect to the purchase of 100% of the shares of Formata (the Option Shares). Formata owns the Karusel hypermarket chain. The Notice is irrevocable. Nevertheless, the acquisition of the Option Shares is conditional upon the completion by the Group to its satisfaction of due diligence on Formata and on receipt by the Group of any required regulatory, shareholder or third party approvals.
Following receipt of the Notice by Formata’s shareholders, the Group has begun carrying out due diligence on Formata’s legal, tax, financial, business, real estate standing, etc.
Completion of the Call Option, assuming the above conditions are fulfilled, must take place by the later of (i) 1 July 2008 or (ii) three months after the provision to the Group of the audited consolidated IFRS accounts for Formata for the year ended 31 December 2007.
The amount payable by the Group is calculated based on the acquiree’s sales, EBITDA and debt. No less than 75% of the Option Price is payable in cash, while the remaining amount can be settled by newly issued shares of the Group.
The financing structure for the potential acquisition of Formata is still being determined, with different forms of equity financing currently under consideration, including the possibility of granting existing GDR holders rights to subscribe for additional GDRs on a pro rata pre-emptive basis (subject to applicable legal requirements). To make possible equity financing options technically feasible, the Supervisory Board requires extended authority to approve the issuance of shares and the granting of rights to subscribe for shares. Should the Company decide to proceed with the acquisition, it anticipates to raise equity financing of approximately USD 1 billion in the first half of year 2008.
The approval of any secondary offering is within the competence of the General Meeting of Shareholders of the Company and as such will only be adopted in case of approval on the General Meeting of Shareholders.
Business combination in Perm region In March 2007 the Group signed an agreement to acquire 100% of the business and assets of Kama Retail company – a Pyaterochka franchisee in the Perm region, for a total consideration of approximately USD 18,000, including debt. The Company plans to close the deal in April 2008. The Group will acquire a total of 28 soft discounters in Perm and the Perm region with a selling area of 9.3 thousand sq.m. The total area of purchased stores is 19.9 thousand sq.m. The Group plans to assess fair value of assets and liabilities acquired as well as consideration paid to be used in purchase accounting of the business combination.
F-50 DIRECTORS’ RESPONSIBILITY STATEMENT
The following statement, which should be read in conjunction with the independent auditors’ responsibilities stated in the independent auditors’ report, is made with a view to distinguishing the respective responsibilities of management and those of the independent auditors in relation to the consolidated financial statements of X5 Retail Group N.V. and its subsidiaries (the “Group”).
Management is responsible for the preparation of the consolidated financial statements that present fairly the financial position of the Group at 31 December 2006, and the results of its operations, cash flows and changes in shareholders’ equity for the period of twelve months then ended, in compliance with International Financial Reporting Standards as adopted by the European Union.
In preparing the consolidated financial statements, management is responsible for: • Selecting suitable accounting principles and applying them consistently; • Making judgments and estimates that are reasonable and prudent; • Stating whether IFRS as adopted by the European Union and IFRS as issued by the International Accounting Standards Board have been followed, subject to any material departures disclosed and explained in the consolidated financial statements; and • Preparing the consolidated financial statements on a going concern basis, unless it is inappropriate to presume that the Group will continue in business for the foreseeable future.
Management is also responsible for: • Designing, implementing and maintaining an effective and sound system of internal controls, throughout the Group; • Maintaining proper accounting records that disclose, with reasonable accuracy at any time, the financial position of the Group, and which enable them to ensure that the consolidated financial statements of the Group comply with IFRS as adopted by the European Union and IFRS as issued by the International Accounting Standards Board; • Maintaining statutory accounting records in compliance with local legislation and accounting standards in the respective jurisdictions in which the Group operates; • Taking such steps as are reasonably available to them to safeguard the assets of the Group; and • Preventing and detecting fraud and other irregularities.
The consolidated financial statements for the period of the year ended 31 December 2006 were approved on 17 April 2007 by:
Lev Khasis Vitaliy Podolskiy Chief Executive Officer Chief Financial Officer
F-51 ZAO PricewaterhouseCoopers Audit Kosmodamianskaya nab. 52/5 115054 Moscow Russian Federation Telephone +7 (495) 967 6000 Facsimile +7 (495) 967 6001
INDEPENDENT AUDITOR’S REPORT
To the Management Board of X5 Retail Group N.V.:
We have audited the accompanying consolidated financial statements of X5 Retail Group N.V. Group and its subsidiaries (the “Group”) which comprise the consolidated balance sheet as at 31 December 2006 and the consolidated income statement, consolidated statement of changes in equity and consolidated statement of cashflows for the year then ended, and a summary of significant accounting policies and other explanatory notes.
Management’s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards as adopted by the European Union. This responsibility includes: designing, implementing and maintaining internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error; selecting and applying appropriate accounting policies; and making accounting estimates that are reasonable in the circumstances.
Auditor’s Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with International Standards on Auditing. Those Standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, the financial position of the Group as of 31 December 2006, and its financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards as adopted by the European Union.
Moscow, Russian Federation 17 April 2007
The firm is an authorized licensee of the tradename and logo of PricewaterhouseCoopers.
F-52 X5 RETAIL GROUP N.V. CONSOLIDATED BALANCE SHEET AT 31 DECEMBER 2006 (expressed in thousands of US Dollars, unless otherwise stated)
31 December 31 December Note 2006 2005 ASSETS Non-current assets Property, plant and equipment ...... 12 1,311,950 324,598 Goodwill ...... 13 2,622,949 24,153 Intangible assets ...... 14 492,259 19,040 Prepaid leases ...... 9,440 4,218 Loan to related party ...... 10 5,250 5,250 Deferred tax assets ...... 29 18,626 – 4,460,474 377,259 Current assets Inventories of goods for resale ...... 15 208,576 68,576 Available-for-sale financial assets ...... 623 – Loans receivable ...... 10,985 12 Trade and other accounts receivable ...... 16 148,225 24,528 VAT and other taxes recoverable ...... 17 95,595 59,084 Cash ...... 11 167,988 30,067 631,992 182,267 Total assets ...... 5,092,466 559,526 EQUITY AND LIABILITIES Equity attributable to equity holders of the parent Share capital ...... 21 70,936 30 Share premium ...... 2,901,350 122,152 Cumulative translation reserve ...... 79,459 5,724 (Accumulated deficit) / Retained earnings ...... (161,708) 54,080 Total equity ...... 2,890,037 181,986 Non-current liabilities Long-term borrowings ...... 19 949,123 144,089 Long-term finance lease payable ...... 20 2,913 – Deferred tax liabilities ...... 29 177,604 16,674 Long-term deferred revenue ...... 4,117 – Other non-current liabilities ...... 159 146 1,133,916 160,909 Current liabilities Trade accounts payable ...... 552,060 119,634 Short-term borrowings ...... 19 218,013 52,602 Share-based payments liability ...... 28 69,990 – Short-term finance lease payables ...... 20 2,271 – Interest accrued ...... 13,544 702 Payable to related parties ...... 10 414 2,758 Current income tax payable ...... 11,511 5,018 Other liabilities ...... 18 200,710 35,917 1,068,513 216,631 Total liabilities ...... 2,202,429 377,540 Total equity and liabilities ...... 5,092,466 559,526
Lev Khasis Vitaliy Podolskiy Chief Executive Officer Chief Financial Officer 17 April 2007 17 April 2007
The accompanying notes on pages F-61 to F-90 are an integral part of these consolidated financial statements.
F-53 X5 RETAIL GROUP N.V. CONSOLIDATED INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2006 (expressed in thousands of US Dollars, unless otherwise stated)
31 December 31 December Note 2006 2005 Revenue ...... 23 2,803,351 1,014,785 Cost of goods sold ...... (2,007,540) (749,197) Gross profit ...... 795,811 265,588 Operating expenses ...... 24 (669,219) (242,401) Gain from disposal of property, plant and equipment ...... 4,240 18,139 Lease/sublease and other income ...... 25 36,879 15,582 Operating profit ...... 167,711 56,908 Finance costs, net ...... 26 (61,520) (14,395) Net foreign exchange gain / (loss) ...... 14,083 (4,420) Profit before tax ...... 120,274 38,093 Income tax expense ...... 29 (36,062) (9,074) Profit for the year ...... 84,212 29,019 Attributable to: Equity holders of the parent ...... 84,212 29,132 Minority interest ...... – (113) Profit for the year ...... 84,212 29,019 Basic earnings per share for profit attributable to the equity holders of the Parent (expressed in USD per share) ...... 22 2.13 1.84 Diluted earnings per share for profit attributable to the equity holders of the Parent (expressed in USD per share) ...... 22 2.12 1.84
Lev Khasis Vitaliy Podolskiy Chief Executive Officer Chief Financial Officer 17 April 2007 17 April 2007
The accompanying notes on pages F-61 to F-90 are an integral part of these consolidated financial statements.
F-54 X5 RETAIL GROUP N.V. CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 2006 (expressed in thousands of US Dollars, unless otherwise stated) 31 December 31 December Note 2006 2005 Profit before tax ...... 120,274 38,093 Adjustments for: Depreciation and amortisation ...... 24 79,097 24,098 Gain on disposal of property, plant and equipment ...... (4,241) (18,139) Loss on disposal of intangible assets ...... 38 5 Inventory shrinkage ...... 15 28,906 11,476 Finance costs, net ...... 26 61,520 14,395 Impairment of trade and other accounts receivable ...... 24 4,073 1,746 Loss on disposal of subsidiaries ...... 9 110 220 Share-based payments expense ...... 27,28 27,702 – Amortisation of deferred expenses ...... 1,535 – Loss on write-off of other long-term investments ...... 400 – Net unrealised foreign exchange (gain) / loss ...... (14,083) 4,420 Net cash from operating activities before changes in working capital ...... 305,331 76,314 Decrease / (increase) in VAT recoverable ...... 8,475 (30,114) Increase in trade and other accounts receivable ...... (70,802) (17,564) Increase in inventories ...... (106,485) (28,296) Increase in trade accounts payable ...... 237,414 48,293 Increase in other accounts payable and deferred revenue ...... 53,096 11,957 Translation effect on working capital ...... (921) (713) Net cash generated from operations ...... 426,108 59,877 Interest paid ...... (63,843) (12,393) Administrative charges paid for loans received ...... – (2,886) Interest received ...... 687 177 Income tax paid ...... (46,076) (4,587) Net cash from operating activities ...... 316,876 40,188 Cash flows used in investing activities Purchase of property, plant and equipment ...... 12 (256,642) (147,903) Non-current prepaid lease ...... (6,836) (3,734) Acquisition of subsidiaries ...... 8 227,932 (20,138) Acquisition of other long-term investments ...... (389) – Proceeds from sale of property, plant and equipment ...... 13,125 8,608 Long-term loan to related party originated ...... 10 – (5,250) Loans originated ...... (11,608) – Proceeds from sale of investments available for sale ...... 66 1,186 Purchase of intangible assets ...... 14 (6,594) (246) Net cash used in investing activities ...... (40,946) (167,477) Cash flows from financing activities Proceeds from short-term loans ...... 204,060 487,923 Repayment of short-term loans ...... (207,232) (454,131) Proceeds from long-term loans ...... 470,208 146,262 Repayment of long-term loans ...... (225,186) (75,063) Distribution to shareholders ...... 8 (300,000) – Acquisition of treasury shares ...... 21 (76,534) – Principal payments on finance lease obligations ...... (3,491) – Net cash from financing activities ...... (138,175) 104,991 Effect of exchange rate changes on cash ...... 166 (253) Net increase / (decrease) in cash ...... 137,921 (22,551) Movements in cash ...... Cash at the beginning of the year ...... 30,067 52,618 Net increase / (decrease) in cash ...... 137,921 (22,551) Cash at the end of the year ...... 167,988 30,067
Lev Khasis Vitaliy Podolskiy Chief Executive Officer Chief Financial Officer 17 April 2007 17 April 2007 The accompanying Notes on pages F-61 to F-90 are an integral part of these consolidated financial statements.
F-55 X5 RETAIL GROUP N.V. CONSOLIDATED STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 2006 (expressed in thousands of US Dollars, unless otherwise stated)
Attributable to the shareholders of the Company Retained Cumulative earnings / Total Number of Share Share translation (Accumulated shareholders’ Minority Note shares* capital premium reserve deficit) equity interest Total Balance as at 1 January 2005 ...... 38,306,785 30 122,152 12,148 24,948 159,278 1,862 161,140 Translation movement ...... – – – (6,424) – (6,424) – (6,424) Profit for the year ...... – – – – 29,132 29,132 (113) 29,019 Total recognised income for the period ...... – – – (6,424) 29,132 22,708 (113) 22,595 Reduction of Minority interest as a result of the additional acquisition of Rathmine Holdings Limited shares ...... – – – – – – (1,749) (1,749) Balance as at 31 December 2005 ...... 38,306,785 30 122,152 5,724 54,080 181,986 – 181,986 Translation movement ...... – – – 73,735 – 73,735 – 73,735
F-56 Profit for the year ...... – – – – 84,212 84,212 – 84,212 Total recognised income for the period ...... 73,735 84,212 157,947 – 157,947 Reverse acquisition ...... 8 15,813,253 72,109 2,854,529 – – 2,926,638 – 2,926,638 Distribution to shareholders ...... 8 – – – – (300,000) (300,000) – (300,000) Acquisition of treasury shares ...... 21 (902,278) (1,203) (75,331) – – (76,534) – (76,534) Balance as at 31 December 2006 ...... 53,217,760 70,936 2,901,350 79,459 (161,708) 2,890,037 – 2,890,037
Lev Khasis Vitaliy Podolskiy Chief Executive Officer Chief Financial Officer 17 April 2007 17 April 2007
* The number of shares represents number of shares of X5 Retail Group N.V.
The accompanying Notes on pages F-61 to F-90 are an integral part of these consolidated financial statements. X5 RETAIL GROUP N.V. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEAR ENDED 31 DECEMBER 2006 (expressed in thousands of US Dollars, unless otherwise stated)
1 PRINCIPLE ACTIVITIES AND THE GROUP STRUCTURE These consolidated financial statements are for the economic entity comprising X5 Retail Group N.V. (the “Company”) and its subsidiaries, as set out in Note 7 (the “Group”), and are prepared as a continuation of the consolidated financial statements of Perekrestok Holdings Ltd. following the reverse acquisition (Note 2.1).
X5 Retail Group N.V. (before 27 October 2006 known as Pyaterochka Holding N.V.) is a joint stock limited liability company established in August 1975 under the laws of the Netherlands. The principal activity of the Company is to act as a holding company for the group of companies that operate retail grocery stores. The Company’s address and tax domicile is Prins Bernhardplein 200, 1097 JB Amsterdam, the Netherlands.
On 18 May 2006, the Company acquired 100% of Perekrestok Holdings Ltd., the parent company for the group of companies that operate stores under the “Perekrestok” brand (Note 8). Although legally X5 Retail Group N.V. is regarded as the parent and Perekrestok Holdings Ltd. is regarded as the subsidiary, Perekrestok Holdings Ltd. is identified as the acquirer under IFRS 3 “Business Combinations” and the acquisition of Perekrestok Holdings Ltd. is accounted for as a reverse acquisition (Note 2.1).
The main activity of the Group is the development and operation of grocery retail stores. As of 31 December 2006 and 31 December 2005 the Group operated “Pyaterochka” and “Perekrestok” retail chains in major population centers in Russia, including but not limited to Moscow, St. Petersburg, Nizhniy Novgorod, Krasnodar, Kazan, Samara, Ekaterinburg and Kiev, Ukraine with the following number of stores:
31 December 2006 31 December 2005 Under “Pyaterochka” name Moscow ...... 222 159 St. Petersburg ...... 204 167 Ekaterinburg ...... 25 21 451 347 Under “Perekrestok” name Moscow ...... 100 73 St. Petersburg ...... 17 9 N.Novgorod region ...... 17 14 Samara region ...... 7 6 South Russia region ...... 7 5 Ukraine ...... 4 4 Other ...... 16 9 168 120 Total stores ...... 619 467
In addition, as of 31 December 2006 the Group’s franchisees operated 605 stores under the “Pyaterochka” brand and 10 stores under the “Perekrestok” brand (31 December 2005: 404 and 8, respectively) in Russia and neighbouring countries, Kazakhstan and Ukraine.
The Group is a member of the Alfa Group Consortium. As of 31 December 2006 the Company’s principal shareholders were Luckyworth Limited and Cesaro Holdings Limited owning 32.4% and 22.2% of total issued shares, respectively. The Group owns 902,278 (1.76%) of its shares (Note 21). As of 31 December 2006 the Company’s shares are listed on the London Stock Exchange in form of Global Depositary Receipts (GDRs), with each GDR representing an interest of 0.25 in an ordinary share. As of 31 December 2006 the ultimate parent company of the Group is CTF Holdings Ltd. (“CTF”), a company registered at Suite 2, 4 Irish Place, Gibraltar and the parent entity of the Alfa Group Consortium. CTF is under the common control of Mr Fridman, Mr Khan and Mr Kuzmichev (the “Shareholders”). None of the Shareholders individually controls and/or owns 50% or more in CTF.
2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The principal accounting policies applied in the preparation of these consolidated financial statements are set out below. These policies have been consistently applied to all years presented, unless otherwise stated.
F-57 2.1 Basis of preparation These consolidated financial statements for the year ended 31 December 2006 have been prepared in accordance with, and comply with International Financial Reporting Standards as adopted by the European Union. Both X5 Retail Group N.V. and Perekrestok Holdings Ltd. previously prepared their financial statements under IFRS as issued by the IASB.
All International Financial Reporting Standards issued by the IASB and effective at the time of preparing these consolidated financial statements have been adopted by the European Union through the endorsement procedure established by the European Commission, with the exception of certain provisions of IAS 39, Financial Instruments: Recognition and Measurement, on portfolio hedging. These financial statements comply with IFRS and it is the Group’s intention, to the extent possible, to continue to comply with IFRS, as adopted by the European Union and as issued by the IASB since the Group is not affected by the hedging provisions.
These consolidated financial statements are issued under name of X5 Retail Group N.V. but represent a continuation of the consolidated financial statements of Perekrestok Holdings Ltd. accordingly: (a) the assets and liabilities of the legal subsidiary, i.e. Perekrestok Holdings Ltd., are recognised and measured at their pre-combination carrying amounts. The assets and liabilities of X5 Retail Group N.V. are recognised at their fair value at the date of acquisition; (b) the consolidated retained earnings and other equity balances recognised at the date of acquisition are the retained earnings and other equity balances of Perekrestok Holdings Ltd. immediately before the business combination; (c) the equity structure reflects the equity structure of X5 Retail Group N.V.; and (d) the comparative information presented in these consolidated financial statements is that of Perekrestok Holdings Ltd.
2.2 Accounting for the effects of inflation The Russian Federation was considered hyperinflationary prior to 1 January 2003. As a result, balances and transactions were restated for the changes in the general purchasing power of the Russian Rouble up to 31 December 2002 in accordance with IAS 29 (“Financial Reporting in Hyperinflationary Economies”). IAS 29 requires that the financial statements prepared in the currency of a hyperinflationary economy be stated in terms of the measuring unit current at the balance sheet date. As the characteristics of the economic environment of the Russian Federation indicate that hyperinflation has ceased effective from 1 January 2003, the Group does not apply the provisions of IAS 29 to assets acquired or revalued and liabilities incurred or assumed after that date. For other assets and liabilities, the amounts expressed in the measuring unit current at 31 December 2002 are treated as the basis for the carrying amounts in these consolidated financial statements.
2.3 Consolidated financial statements Subsidiaries are those companies and other entities (including special purpose entities) in which the Group, directly or indirectly, has the power to govern the financial and operating policies generally accompanying a shareholding of more than one half of the voting rights. The existence and effect of potential voting rights that are presently exercisable or presently convertible are considered when assessing whether the Group controls another entity. Subsidiaries are consolidated from the date on which control is transferred to the Group (acquisition date) and are de-consolidated from the date that control ceases.
The purchase method of accounting is used to account for the acquisition of subsidiaries. The cost of an acquisition is measured at the fair value of the assets given up, equity instruments issued and liabilities incurred or assumed at the date of exchange, plus costs directly attributable to the acquisition. The date of exchange is the acquisition date where a business combination is achieved in a single transaction. However, when a business combination is achieved in stages by successive share purchases, the date of exchange is the date of each exchange transaction; whereas the acquisition date is the date on which acquirer obtains control of the subsidiary.
Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination are measured at their fair values at the acquisition date.
The excess of the cost of acquisition over the fair value of the Group’s share in net assets of the acquiree at each exchange transaction represents goodwill. The excess of the acquirer’s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities acquired over cost (“negative goodwill”) is recognised immediately in profit or loss.
F-58 Intercompany transactions, balances and unrealised gains on transactions between group companies are eliminated; unrealised losses are also eliminated unless the cost cannot be recovered. The Company and all of its subsidiaries use uniform accounting policies consistent with the Group’s policies.
2.4 Minority interest Minority interest is that part of the net results and of the net assets of a subsidiary, including the fair value adjustments, which is attributable to interests which are not owned, directly or indirectly, by the Company. Minority interest forms a separate component of the Group’s equity.
When the Group purchases a minority interest, the difference between its carrying amount and the amount paid to acquire it is recorded as goodwill. Gains or losses on disposal of a minority interest, determined as the difference between its carrying amount and proceeds received or receivable, are recorded in the statement of income.
2.5 Foreign currency translation and transactions (a) Functional and presentation currency Functional currency. The functional currency of each of the Group’s consolidated entities is the currency of the primary economic environment in which the entity operates. The functional currencies of the Group’s entities are the national currency of the Russian Federation, Russian Rouble (“RR”) and the national currency of Ukraine, Ukrainian Hrynvia (“UAH”). The Group’s presentation currency is the US Dollar (“USD”), which management believes is the most useful currency to adopt for users of these consolidated financial statements.
Translation from functional to presentation currency. The results and financial position of each Group entity (none of which have a functional currency that is the currency of a hyperinflationary economy) are translated into the presentation currency as follows: (i) assets and liabilities for each balance sheet presented are translated at the closing rate at the date of that balance sheet; (ii) income and expenses for each income statement are translated at average exchange rates (unless this average is not a reasonable approximation of the cumulative effect of the rates prevailing on the transaction dates, in which case income and expenses are translated at the dates of the transactions); and (iii) all resulting exchange differences are recognised as a separate component of equity as a cumulative translation reserve.
Goodwill and fair value adjustments arising on the acquisition of a foreign entity are treated as assets and liabilities of the foreign entity and translated at the closing rate. When a subsidiary is disposed of through sale, liquidation, repayment of share capital or abandonment of all, or part of, that entity, the exchange differences deferred in equity are reclassified to profit or loss.
(b) Transactions and balances Monetary assets and liabilities denominated in foreign currencies are translated into each entity’s functional currency at the official exchange rate of the Central Bank of Russian Federation (“CBRF”) at the respective balance sheet dates. Foreign exchange gains and losses resulting from the settlement of the transactions and from the translation of monetary assets and liabilities into each entity’s functional currency at period-end official exchange rates of the CBRF are recognised in profit or loss. Translation at period-end rates does not apply to non-monetary items, including equity investments. Effects of exchange rate changes on the fair value of equity securities are recorded as part of the fair value gain or loss.
At 31 December 2006, the official rate of exchange, as determined by the Central Bank of the Russian Federation, was USD 1 = RR 26.3311 (31 December 2005: USD 1 = RR 28.7825). Average rate for 12 months 2006 was USD 1 = RR 27.1852 (12 months 2005: USD 1 = RR 28.2864).
At 31 December 2006, the official rate of exchange, as determined by the Central Bank of Ukraine, was USD 1 = UAH 5.0500 (31 December 2005: USD 1 = UAH 5.0500). Average rate for 12 months 2006 was USD 1 = UAH 5.0500 (12 months 2005: USD 1 = UAH 5.1160).
F-59 2.6 Segment reporting A segment is a distinguishable component of the Group that is engaged either in providing products or services (business segment) or in providing products or services within a particular economic environment (geographical segment), which is subject to risks and rewards that are different from those of other segments. Segments with a majority of its revenue earned from sales to external customers and whose internal and external revenue or result or assets are ten percent or more of all segments are reported separately.
2.7 Property, plant and equipment Property, plant and equipment are stated at cost less accumulated depreciation and provision for impairment, where required. Cost includes expenditure that is directly attributable to the acquisition or construction of the item.
Costs of minor repairs and maintenance are expensed when incurred. Costs of replacing major parts or components of property, plant and equipment items are capitalised and the replaced parts are retired. Capitalised costs are depreciated over the remaining useful life of property, plant and equipment or part’s estimated useful life whichever is sooner.
At each reporting date management assesses whether there is any indication of impairment of property, plant and equipment. If any such indication exists, management estimates the recoverable amount, which is determined as the higher of an asset’s fair value less costs to sell and its value in use. The carrying amount is reduced to the recoverable amount and the impairment loss is recognised in the income statement. An impairment loss recognised for an asset in prior years is reversed if there has been a change in the estimates used to determine the asset’s value in use or fair value less costs to sell.
Gains and losses on disposals determined by comparing the proceeds with the carrying amount are recognised in profit or loss.
Land is not depreciated. Depreciation on other items of property, plant and equipment is calculated using the straight-line method to allocate their cost to their residual values over their estimated useful lives. The depreciation periods, which approximate the estimated useful economic lives of the respective assets, are as follows:
Buildings ...... 20-50years Machinery and equipment ...... 5-10years Refrigerating equipment ...... 7-10years Vehicles ...... 5-7years Other ...... 3-5years
The residual value of an asset is the estimated amount that the Group would currently obtain from the disposal of the asset less the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life. The residual value of an asset is nil if the Group expects to use the asset until the end of its physical life. The assets’ residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date.
2.8 Intangible assets (a) Goodwill Goodwill represents the excess of the cost of an acquisition over the fair value of the acquirer’s share of the net identifiable assets, liabilities and contingent liabilities of the acquired subsidiary at the date of exchange. Goodwill on the acquisition of subsidiaries is presented as part of intangible assets in the consolidated balance sheet.
The Group tests goodwill for impairment at least annually and whenever there are indications that goodwill may be impaired. Goodwill is allocated to the cash-generating units, or groups of cash-generating units, that are expected to benefit from the synergies of the business combination. Such units or groups of units represent the lowest level at which the Group monitors goodwill and are not larger than a segment. Gains or losses on disposal of an operation within a cash generating unit to which goodwill has been allocated include the carrying amount of goodwill associated with the operation disposed of, generally measured on the basis of the relative values of the operation disposed of and the portion of the cash-generating unit which is retained.
F-60 (b) Lease rights Lease rights represent rights for favourable operating leases. Lease rights acquired in a business combination are recognised initially at fair value and acquired separately are recognised initially at cost. Lease rights are amortised using the straight-line method over the lease term of the respective lease contracts – on average over 10 years.
(c) Brand and private labels Brand and private labels acquired in a business combination are recognised initially at fair value. Brand and private labels are amortised using the straight-line method over their useful lives:
Useful lives Brand ...... 20years Private labels ...... 5-8years
(d) Franchise agreements Franchise agreements represent rights to receive royalties. Franchise agreements acquired in a business combination are recognised initially at fair value. Franchise agreements are amortised using straight-line method over their useful lives that are, on average, 10 years.
(e) Other intangible assets Expenditure on acquired patents, trademarks and licences is capitalised and amortised using the straight-line method over their useful lives that are, on average, 10 years.
(f) Impairment of intangible assets Where an indication of impairment exists, the recoverable amount of any intangible asset, including goodwill, is assessed and, when impaired, the asset is written down immediately to its recoverable amount. Goodwill and intangible assets not yet available for use are tested for impairment at least annually and whenever impairment indicators exist.
2.9 Operating leases Leases of assets under which all the risks and benefits of ownership are effectively retained by the lessor are classified as operating leases. Payments made under operating leases are charged to the income statement on a straight-line basis over the period of the lease.
Assets leased out under operating leases are included in property, plant and equipment in the balance sheet. They are depreciated over their expected useful lives on a basis consistent with similar fixed assets. Rental income is recognised in the income statement on a straight-line basis over the lease term.
2.10 Finance lease liabilities Where the Group is a lessee in a lease, which transfers substantially all the risks and rewards incidental to ownership to the Group, the leased assets are capitalised in property, plant and equipment at the commencement of the lease at the lower of the fair value of the leased asset and the present value of the minimum lease payments. Each lease payment is allocated between the liability and finance charges so as to achieve a constant rate on the finance balance outstanding. The corresponding rental obligations, net of future finance charges, are included in borrowings. The interest cost is charged to the income statement over the lease period using the effective interest method. The assets acquired under finance leases are depreciated over their useful life or the lease term, if shorter and if the Group is not reasonably certain that it will obtain ownership by the end of the lease.
2.11 Trade receivables Trade receivables are initially recognised at their fair values and are subsequently carried at amortised cost using the effective interest method. A provision for impairment of receivables is established when there is objective evidence that the Group will not be able to collect all amounts due according to the original terms of the receivables. The amount of the provision is the difference between the asset’s carrying amount and the present value of the estimated future cash flows, discounted at the original effective interest rate. The amount of the provision is recognised in the income statement.
F-61 2.12 Inventories of goods for resale Inventories at warehouses and retail outlets are stated at the lower of cost and net realisable value. Cost comprises direct costs of goods, transportation and handling costs. Cost is determined by the first-in, first-out (FIFO) method. Net realisable value is the estimate of the selling price in the ordinary course of business, less selling expenses.
The Group provides for estimated inventory losses (shrinkage) between physical inventory counts on the basis of a percentage of sales. The provision is adjusted at the end of each reporting period to reflect the historical trend of the actual physical inventory count results. The provision is recorded as a component of cost of goods sold.
2.13 Financial assets The Group classifies its financial assets into the following measurement categories: loans and receivables, held-to-maturity and available-for-sale investments. The classification depends on the purpose for which the financial assets were acquired. Management determines the classification of its financial assets at initial recognition and re-evaluates this designation at every reporting date, if required under IFRS.
Initial recognition of financial instruments Loans and receivables, held-to-maturity and available-for-sale investments are initially recorded at fair value plus transaction costs. Fair value at initial recognition is best evidenced by the transaction price. A gain or loss on initial recognition is only recorded if there is a difference between fair value and transaction price which can be evidenced by other observable current market transactions in the same instrument or by a valuation technique whose inputs include only data from observable markets.
All purchases and sales of financial assets that require delivery within the time frame established by regulation or market convention (“regular way” purchases and sales) are recorded at trade date, which is the date that the Group commits to deliver a financial asset. All other purchases and sales are recognised on the settlement date. The change in value between the commitment date and settlement date is not recognised for assets carried at cost or amortised cost; is recognised in profit or loss for trading investments; and is recognised in equity for assets classified as available for sale.
Derecognition of financial assets The Group derecognises financial assets when (i) the assets are redeemed or the rights to cash flows from the assets have otherwise expired or (ii) the Group has transferred substantially all the risks and rewards of ownership of the assets or (iii) the Group has neither transferred nor retained substantially all risks and rewards of ownership but has not retained control. Control is retained if the counterparty does not have the practical ability to sell the asset in its entirety to an unrelated third party without needing to impose additional restrictions on the sale.
Loans and receivables Loans and receivables are unquoted non-derivative financial assets with fixed or determinable payments other than those that the Group intends to sell in the near term.
Held-to-maturity Held-to-maturity classification includes quoted non-derivative financial assets with fixed or determinable payments and fixed maturities that the Group has both the intention and ability to hold to maturity. Management determines the classification of investment securities held to maturity at their initial recognition and reassesses the appropriateness of that classification at each balance sheet date.
Held-to-maturity investments are carried at amortised costs using the effective interest method, net of a provision for incurred impairment losses.
All other financial assets are included in the available-for-sale category.
F-62 Available for sale Available-for-sale investments are carried at fair value. Interest income on available for sale debt securities is calculated using the effective interest method and recognised in profit or loss. Dividends on available-for-sale equity instruments are recognised in profit or loss when the Group’s right to receive payment is established. All other elements of changes in the fair value are deferred in equity until the investment is derecognised or impaired at which time the cumulative gain or loss is removed from equity to profit or loss.
Impairment losses are recognised in profit or loss when incurred as a result of one or more events (“loss events”) that occurred after the initial recognition of available-for-sale investments. A significant or prolonged decline in the fair value of an equity security below its cost is an indicator that it is impaired. The cumulative impairment loss – measured as the difference between the acquisition cost and the current fair value, less any impairment loss on that asset previously recognised in profit or loss – is removed from equity and recognised in profit or loss. Impairment losses on equity instruments are not reversed through profit or loss. If, in a subsequent period, the fair value of a debt instrument classified as available for sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognised in profit or loss, the impairment loss is reversed through the current period’s profit or loss.
2.14 Supplier bonuses The Group receives various types of allowances from suppliers in form of slotting fees, volume discounts and other forms of payment that effectively reduce the cost of goods purchased from the supplier or the cost of promotional activities conducted by the Group for the benefit of the supplier.
Bonuses received from suppliers are recorded as a reduction in the price paid for the products and are recognised in cost of goods sold as the related inventory is sold.
2.15 Cash Cash comprises cash in hand and deposits held on call with banks which are carried at amortised cost.
2.16 Provisions Provisions are recognised when the Group has a present legal or constructive obligation as a result of past events, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and a reliable estimate of the amount of the obligation can be made.
2.17 Value added tax Value added tax related to sales is payable to tax authorities on the earliest of (a) collection of the receivables from customers or (b) delivery of the goods or services to customers. Input VAT is generally recoverable against sales VAT upon receipt of the VAT invoice. Input VAT on construction in progress can be reclaimed on receipt of VAT invoices for the particular stage of work performed or, if the construction in progress project can not be broken down into stages, on receipt of VAT invoices upon completion of the contracted work.
The tax authorities permit the settlement of VAT on a net basis. VAT related to sales and purchases which have not been settled at the balance sheet date (VAT deferred) is recognised in the balance sheet on a gross basis and disclosed separately as an asset and liability. Where a provision has been made for the impairment of receivables, the impairment loss is recorded for the gross amount of the debtor, including VAT.
2.18 Employee benefits Wages, salaries, bonuses, paid annual leave and sick leave are accrued in the year in which the associated services are rendered by the employees of the Group. The Group’s entities contribute to the Russian Federation’s state pension and social insurance funds in respect of its employees. These contributions are accrued when incurred. The Group’s commitment ends with the payment of these contributions.
2.19 Share-based payments The Group issues options to certain employees that give the employees the right to choose whether a share- based payment transaction is settled in cash or by issuing equity instruments.
F-63 Share-based payment transactions, or the components of such transactions, are accounted for as a cash- settled share-based payment transaction if, and to the extent that, the entity has incurred a liability to settle in cash or other assets, or as an equity-settled share-based payment transaction if, and to the extent that, no such liability has been incurred.
Share-based payment transactions are measured at the fair value of the compound financial instrument at the measurement date, taking into account the terms and conditions on which the rights to the cash or equity instruments were granted. The fair value is determined using the Black-Scholes pricing model. The expected life used in the model has been adjusted, based on management’s best estimate, for the effects of non-transferability, exercise restrictions and behavioural considerations.
A liability equal to the portion of the services received is recognised at the current fair value determined at each balance sheet date. The Group records an expense, based on its estimates of the difference between the market price and the strike price related to the shares expected to vest, on a straight-line basis over the vesting period.
At the date of settlement, the Group will remeasure the liability to its fair value. If the Group issues equity instruments on settlement rather than paying cash, the liability will be transferred directly to equity, as the consideration for the equity instruments issued.
2.20 Borrowings Borrowings are initially recognised at their fair value, net of transaction costs, and are subsequently stated at amortised cost; any difference between the proceeds (net of transaction costs) and the redemption value is recognised in the income statement over the period of the borrowings using the effective interest method. Borrowings are classified as current liabilities unless the Group has an unconditional right to defer settlement of the liability for at least 12 months after the balance sheet date.
2.21 Trade and other payables Trade and other payables are accrued when the counterparty performed its obligation under the contract and are carried at amortised cost using the effective interest method.
2.22 Share capital Ordinary shares are classified as equity. External costs directly attributable to the issue of new shares are shown as a deduction in equity from the proceeds. Any excess of the fair value of consideration received over the par value of shares issued is recognised as share premium.
2.23 Dividends Dividends are recognised as a liability and deducted from equity at the balance sheet date only if they are declared before or on the balance sheet date. Dividends are disclosed when they are proposed before the balance sheet date or proposed or declared after the balance sheet date but before the financial statements are authorised for issue.
2.24 Income taxes Income taxes payable are provided for on the basis of estimates of the tax liability for the year, taking into consideration applicable tax rates and tax exemptions.
Deferred income tax is provided, using the balance sheet liability method, for temporary differences arising between the tax bases of assets and liabilities and their carrying values for financial reporting purposes. 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. In accordance with the initial recognition exemption, deferred tax liabilities are not recorded for temporary differences on initial recognition of goodwill and subsequently for goodwill which is not deductible for tax purposes. Deferred tax assets and liabilities are measured at tax rates that are expected to apply to the period in which the asset is realised or the liability is settled, based on tax rates which are enacted or substantially enacted at the balance sheet date. The Group provides against tax contingencies and the related interest and penalties where management can make a reliable
F-64 estimate of the amount of the additional taxes that may be due. Provisions are maintained, and updated if necessary, for the period over which the respective tax positions remain subject to review by the tax and customs authorities, being 3 years from the year of filing. Upon expiry of the review period, the provisions are released and considered as a contingent liability until the accounting documentation maintenance period expires, being an additional 2 years (i.e. 5 years in total).
Liabilities for such taxes, interest and penalties are calculated based on management’s best estimate of the obligations, in accordance with the rates set out in the respective laws in effect at the balance sheet date (Notes 29 and 31).
2.25 Income and expense recognition Income and expenses are recognised on an accrual basis as earned or incurred. Recognition of the principal types of income and expenses is as follows:
(a) Revenue Revenue from the sale of goods through retail outlets is recognised at the point of sale. Revenue from franchisee fees is recognised based on contractual agreements over the term of the contracts. The up-front non-refundable franchisee fees received by the Group are deferred and recognised over the standard contractual term of 10 years. Revenue from advertising services is recognised based on contractual agreements. Revenues are measured at the fair value of the consideration received or receivable.
Discounts earned by customers through loyalty cards, are recorded by the Group as a reduction of the sales price at the time of the sale. Revenues are recognised net of value added tax;
(b) Cost of goods sold Cost of goods sold comprises the purchase price of goods sold reduced by the amount of suppliers’ bonuses that relate to the goods sold;
(c) Interest income and expense Interest income and expense are recognised on an effective yield basis;
(d) Operating expenses Operating expenses are recognised on an accrual basis as incurred.
2.26 Earnings per share Earnings per share are determined by dividing the profit or loss attributable to equity holders of the Company by the weighted average number of participating shares outstanding during the reporting period. Diluted earnings per share are calculated by adjusting the earnings and the number of shares for the effects of dilutive options.
2.27 Treasury shares Where any Group company purchases the Company’s equity share capital, the consideration paid, including any directly attributable incremental costs (net of income taxes) is deducted from equity attributable to the Company’s equity holders until the shares are cancelled, reissued or disposed of. Where such shares are subsequently sold or reissued, any consideration received, net of any directly attributable incremental transaction costs and the related income tax effects, is included in equity attributable to the Company’s equity holders.
3 CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS IN APPLYING ACCOUNTING POLICIES The Group makes estimates and assumptions that affect the reported amounts of assets and liabilities within the next financial year. Estimates and judgements are continually evaluated and are based on management’s experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. Management also makes certain judgements, apart from those involving estimations, in the process of applying accounting policies. Judgements that have the most significant effect on the amounts
F-65 recognised in the consolidated financial statements and estimates that can cause a significant adjustment to the carrying amount of assets and liabilities within the next financial year include:
Estimated impairment of goodwill. The Group tests goodwill for impairment at least annually. The recoverable amounts of cash-generating units have been determined based on the higher of fair value less costs to sell or on value-in-use calculations. These calculations require the use of estimates as further detailed in Note 13.
Tax legislation. Russian tax, currency and customs legislation is subject to varying interpretations (Note 31).
Market interest rate in related party transactions. In the normal course of business the Group enters into transactions with related parties. Financial instruments are initially recognised based on their fair values. Judgement is applied in determining if transactions are priced at market or non-market interest rates, where there is no active market for such transactions. The basis for judgement is the pricing for similar types of transactions with unrelated parties and effective interest rate analyses (Note 10).
Useful lives of property, plant and equipment. The Group’s management determines the estimated useful lives and related depreciation charges for its plant and equipment (Note 12). This estimate is based on projected product lifecycles and technical requirements. Management will increase the depreciation charge where useful lives are less than previously estimated lives, or it will write-off or write-down technically obsolete or non-strategic assets that have been abandoned or reclassified as held for sale.
Fair value of lease rights. The Group’s management determines the fair value of lease rights received. The assessment of the fair value of lease rights is based on the estimate of the market rates of the lease prepared by an independent valuation specialist.
Accounting for property generating incidental lease income. The Group leases out a portion of each store to provide auxiliary services to retail customers which are not provided by the Group (Note 25). The purpose of the leases is to satisfy the full scope of customers’ needs rather than earn rental income. The Group accounts for the leased property in accordance with IAS 16 “Property, plant and equipment”.
Accounting for rent expense. The Group leases retail outlets under terms of fixed and variable lease payments. The variable lease payments depend on revenue earned by the respective retail outlets. The Group classifies variable lease payments as contingent rents unless the Group is virtually certain of the expected amount of the future lease payments in which case they are classified as minimum lease payments (Note 31).
Supplier bonuses. The Group receives various types of allowances from suppliers in the form of slotting fees, volume discounts, and other forms of payment. In accounting for supplier bonuses received by the Group, the Group determined that these bonuses are a reduction in prices paid for the product and should, therefore, be reported as part of the cost of sales.
Inventory provisions. The Group provides for estimated inventory shrinkage on the basis of a historical shrinkage as a percentage of sales (Note 15). This provision is adjusted at the end of each reporting period to reflect the historical trend of the actual physical inventory count results.
Provision for impairment of trade and other receivables. The Group determines an allowance for doubtful accounts receivable at the end of the reporting period (Note 16). In estimating an allowance for uncollectible accounts receivable the Group takes into account the historical collectibility of the outstanding accounts receivable balances supplemented by the judgement of management to exclude the impact of current conditions that did not affect past periods and to remove the effects of past conditions that do not exist currently.
Classification of VAT . Recovery of VAT depends on the registration of certain property, plant and equipment (Note 17).
Fair value of franchise agreements. The Group’ management determines the fair value of franchise agreements acquired in business combinations. The assessment of the fair value of franchise agreements is based on the income method using discounted royalty payments during the period of the agreements.
Fair value of brand and private labels. The Group’ management determines the fair value of brand and private labels acquired in business combinations. The assessment of the fair value of a brand is based on the income approach using the relief-from-royalty method. The assessment of fair value of private labels is based on either the income method using discounted annual savings for the remaining useful life of the labels or the cost method.
F-66 Valuation of Karusel option. As a result of the business combination with Pyaterochka the Group obtained an option to acquire 100% of the shares of Formata Holding BV (a chain of hypermarkets operating under “Karusel” brand in Saint Petersburg) at zero cost. The value of the option depends on the operating results of Formata Holding BV. Due to the uncertainties involved in estimating certain qualitative and quantitative characteristics of the option, and the lack of reliable financial information, the Group has not ascribed any value to the option either on acquisition or at the balance sheet date (Note 8).
4 ADOPTION OF NEW AND REVISED STANDARDS AND INTERPRETATIONS Certain new standards and interpretations became effective for the Group from 1 January 2006. None of the new or amended standards or interpretations are relevant to the Group’s operations and their adoption has not resulted in any significant changes to the Group’s accounting policies. The standards and interpretations that became effective from 1 January 2006 are: • Amendment to IAS 19, ‘Actuarial gains and losses, group plans and disclosures’, effective for annual periods beginning on or after 1 January 2006. • Amendments to IAS 39, ‘The fair value option’, ‘Cash flow hedge accounting of forecast intragroup transactions’ and ‘Financial guarantee contracts’ (including related amendment to IFRS 4) effective for annual periods beginning on or after 1 January 2006. • Amendment to IAS 21, ‘Net investment in a foreign operation’, effective for annual periods beginning on or after 1 January 2006. • Amendments to IFRS 1, ‘First-time adoption of International Financial Reporting Standards effective for annual periods beginning on or after 1 January 2006 • IFRS 6, ‘Exploration for and evaluation of mineral resources’, including related subsequent amendment to IFRS 6 and to IFRS 1, effective for annual periods beginning on or after 1 January 2006. • IFRIC 4, ‘Determining whether an arrangement contains a lease’, effective for annual periods beginning on or after 1 January 2006. • IFRIC 5, ‘Rights to interests arising from decommissioning, restoration and environmental rehabilitation funds’, effective for annual periods beginning on or after 1 January 2006. • IFRIC 6, ‘Liabilities arising from participating in a specific market – waste electrical and electronic equipment’, effective for annual periods beginning on or after 1 December 2005.
5 NEW ACCOUNTING PRONOUNCEMENTS Certain new standards and interpretations have been published that are mandatory for the Group’s accounting periods beginning on or after 1 January 2007 or later periods and which the entity has not early adopted: • IFRIC 7, ‘Applying the Restatement Approach under IAS 29’, effective for annual periods beginning on or after 1 March 2006. Management does not expect the interpretation to be relevant for the Group; • IFRIC 8, ‘Scope of IFRS 2’, effective for annual periods beginning on or after 1 May 2006. Management does not expect the interpretation to be relevant for the Group; • IFRIC 9, ‘Reassessment of Embedded Derivatives’, effective for annual periods beginning on or after 1 June 2006. Management believes that this interpretation should not have a significant impact on the Group’s operations. • IFRIC 11, ‘IFRS 2 – Group and treasury share transactions’, effective for annual periods beginning on or after 1 March 2007. Management believes that this interpretation should not have a significant impact on the Group’s operations. • IFRIC 12, ‘Service concession arrangements’, effective for the annual periods beginning on or after 1 January 2008. Management believes that this interpretation should not have a significant impact on the Group’s operations. • IFRS 7, ‘Financial instruments: Disclosures’, effective for annual periods beginning on or after 1 January 2007. and a complementary Amendment to IAS 1 ‘Presentation of Financial Statements – Capital Disclosures’ , effective for annual periods beginning on or after 1 January 2007. The Group is currently evaluating the potential impact of the IFRS 7 and the amendment to IAS 1 on the financial statement presentation.
F-67 • IFRS 8, ‘Operating segments’, effective for annual periods beginning on or after 1 January 2009. The Group is currently evaluating the potential impact of the IFRS 8 on the financial statement presentation. • IFRIC 10, ‘Interim financial reporting and impairment’, effective from 1 November 2006 • IAS 23 (revised), ‘Borrowing costs’, effective for annual periods beginning on or after 1 January 2009. The Group is currently evaluating the potential impact of the IAS 23 (revised) on the financial statement presentation.
IFRS 8, IFRIC 10, IFRIC 11, IFRIC 12 and IAS 23 (revised) are not yet adopted by the European Union.
Unless otherwise described above, these new standards and interpretations are not expected to significantly affect the Group’s consolidated financial statements.
6 SEGMENT REPORTING The Group has one reportable business segment (retail trade) and one reportable geographical segment (Russia). Management has not presented segment information in a separate note as it believes such information has already been disclosed in Group’s consolidated financial statements.
7 SUBSIDIARIES Details of the Company’s significant subsidiaries at 31 December 2006 are as follows:
Ownership (%) Company Country Nature of operations 31 December 2006 31 December 2005 Speak Global Ltd...... Cyprus Trade mark owner and 100 – property management OOO Agroaspekt ...... Russia Retailing 100 – OOO Agroavto ...... Russia Logistic operator 100 – ZAO Remtransavto ...... Russia Real estate 100 – OOO Pyaterochka 2005 ...... Russia Real estate 100 – OOO Set’ Roznichnoy Torgovli .... Russia Real estate 100 – OOO Telprice ...... Russia Real estate 100 – OOO Alliance Service ...... Russia Real estate 100 – OOO Agrotorg ...... Russia Retailing 100 – ZAO Agrostar ...... Russia Logistic operator 100 – ZAO Ceizer ...... Russia Real estate 100 – OOO Beta Estate ...... Russia Real estate 100 – OOO Pyaterochka Finance ...... Russia Bonds issuer 100 – OOO Elicon ...... Russia Real estate 100 – OOO Ural Retail ...... Russia Retailing 100 – OOO Legion ...... Russia Real estate 100 – Perekrestok Holdings Ltd...... Gibraltar Holding Company 100 100 ZAO TH Perekriostok ...... Russia Retailing 100 100 OOO Perekriostok-2000 ...... Russia Retailing 100 100 OOO Discount-Invest ...... Russia Retailing 100 100 OOO Retailtorg NK ...... Russia Real estate 100 100 Rathmine Holdings Ltd ...... Cyprus Holding Company 100 100 ZAT Center SPAR Ukraine ...... Ukraine Retailing 100 100 Alpegru Retail Properties Ltd...... Cyprus Real estate 100 100 OOO Sladkaya Zhizn N.N...... Russia Retailing 100 100 OOO Metronom AG ...... Russia Retailing 100 – OOO X5 Finance ...... Russia Bonds issuer 100 –
F-68 8 ACQUISITION OF SUBSIDIARIES Pyaterochka On 18 May 2006, the Group acquired Pyaterochka Holding N.V. The acquisition was structured as follows: • On 12 April 2006 and on 18 May 2006 the shareholders of Perekrestok Holdings Ltd. acquired 2,467,917 and 12,068,115 ordinary voting shares of Pyaterochka Holding N.V., respectively, for a cash consideration of USD 1,178,000. • Pyaterochka Holding N.V. acquired 100% of the ordinary voting shares of Perekrestok Holdings Ltd. for 15,813,253 newly issued shares of Pyaterochka Holding N.V. and a cash consideration of USD 300,000.
On completion of the transaction, shareholders and other related parties of Perekrestok Holdings Ltd. obtained control over 56% of Pyaterochka Holding N.V. shares. Accordingly, the transaction is accounted for as a reverse acquisition of Pyaterochka Holding N.V. by Perekrestok Holdings Ltd. (Note 2.1).
The cash consideration paid by Pyaterochka Holding N.V. for the shares of Perekrestok Holdings Ltd. is treated as a distribution of Perekrestok Holdings Ltd’s retained earnings to its shareholders.
Details of assets and liabilities acquired and the related goodwill are as follows:
Acquiree’s carrying amount, IFRS Fair values Cash and cash equivalents ...... 327,504 327,504 Inventory of goods for resale ...... 58,750 58,750 Trade and other accounts receivable ...... 73,514 73,514 Intangible assets (Note 14) ...... 1,451 438,661 Property, plant and equipment ...... 524,873 638,209 Long-term prepaid lease expenses ...... 4,589 – Deferred tax asset ...... 1,633 1,633 Other assets ...... 1,165 1,165 Short-term borrowings ...... (37,295) (37,295) Trade and other accounts payable ...... (257,307) (252,307) Provisions for tax contingencies (Note 31) ...... – (30,000) Long-term liability for share-based payments ...... (42,288) (42,288) Long-term borrowings ...... (544,034) (557,165) Non-current lease payable ...... (3,714) (3,714) Deferred tax liability ...... (9,110) (136,989) Net assets acquired ...... 99,731 479,678 Goodwill (Note 13) ...... 2,446,960 Total acquisition cost ...... 2,926,638 Net cash inflow arising from the acquisition ...... 327,504
The total acquisition cost is determined based on the published share price of the ordinary voting shares of Pyaterochka Holding N.V. on 12 April 2006, the exchange date, and represents the market capitalisation of Pyaterochka Holding N.V. on that date.
The non-cash component of the cost of acquisition of Pyaterochka was excluded from the consolidated statement of cash flows.
The allocation of the purchase price was completed by 31 December 2006, however, the goodwill is allocated to cash-generating units expected to benefit from the business combination on a provisional basis (Note 13). The provisional fair values assigned to the acquired net assets reported in the consolidated interim financial statements for the six months ended 30 June 2006 were USD 99,731. After the completion of the purchase price allocation the aggregate fair value of the acquired net assets changed by USD 379,947 and amounted to USD 479,678.
As a result of the business combination with Pyaterochka the Group obtained an option to acquire 100% of the shares of Formata Holding BV (a chain of hypermarkets operating under “Karusel” brand in Saint Petersburg) for
F-69 zero cost. It is exercisable in the period from 1 January 2008 until 1 July 2008 at a price that is calculated based on the acquiree’s sales, EBITDA and debt. The Group made reasonable efforts to measure the value of the option at the reporting date using various valuation techniques. However, management of the Group believes that uncertainties arising in measuring qualitative and quantitative characteristics of the option and the lack of reliable information do not allow a reasonable valuation of the option. Therefore, since the value of the option can not be measured reliably the Group has not ascribed any value to the option at acquisition or at the balance sheet.
Pyaterochka goodwill is justified by the following factors i) know how and developed technologies of Pyaterochka in retail business that contributed to the fact that it is one of the most profitable retailers in Russia, ii) qualified management team and staff of Pyaterochka, iii) expected cost and revenue synergies from the business combination, iv) business concentration v) business contacts acquired together with assets of Pyaterochka. Each of the factors contributed to the acquisition cost that results in the recognition of goodwill. However, these intangible assets are not separately recognized in the balance sheet of the Company because they are either not separable or there are no reliable bases for estimating their fair values.
Merkado In November 2006, the Group acquired 100% of the voting shares of OAO Merkado Group and OOO Metronom AG for USD 101,061. OAO Merkado Group and OOO Metronom AG operate 17 retail grocery stores in Moscow.
Details of assets and liabilities acquired and the related goodwill are as follows:
Acquiree’s carrying amount, Russian GAAP Fair values Cash and cash equivalents ...... 1,488 1,489 Inventory of goods for resale ...... 6,823 3,611 Trade and other accounts receivable ...... 16,301 7,261 Intangible assets (Note 14) ...... 40,976 34,974 Property, plant and equipment ...... 29,730 121,855 Other assets ...... 1,239 1 Short-term borrowings ...... (3,740) (3,740) Trade and other accounts payable ...... (12,245) (15,166) Provisions for tax contingencies (Note 31) ...... – (10,000) Long-term borrowings ...... (99,376) (99,376) Deferred tax liability ...... 434 (30,445) Net assets acquired ...... (18,370) 10,464 Goodwill (Note 13) ...... 90,597 Total acquisition cost ...... 101,061 Net cash outflow arising from the acquisition ...... 99,572
The allocation of the purchase price was completed, however, the goodwill is allocated to cash-generating units on provisional basis (Note 13).
For identification of fair values the Group engaged ZAO Neo Centre, an independent valuation specialist. In estimating the fair values for the majority of Pyaterochka and Merkado’s property, plant and equipment direct references to observable prices in an active market were used (market approach). However, where there was no active market providing reliable information of prices for certain items of property, plant and equipment, then the depreciated replacement cost approach was applied. Fair values of intangible assets were determined using the replacement cost or discounted cash flows methods. These valuation techniques were used since there is no reliable information for market transactions.
Several intangible assets cannot be separately recognized in the balance sheet of the Company because they are either not separable or there are no reliable bases for estimating their fair values. These intangible assets contributed to the recognition of the Merkado goodwill: i) business concentration in Moscow region ii) qualified management team of Merkado iii) expected cost synergies from the business combination.
Under the purchase agreement, the Group has an indemnity for all costs in excess of USD 1,000 that the Group may suffer, including claims in respect of any tax liability or indebtedness arising out of any matter that
F-70 occurred prior to the date of completion of the acquisition, 17 November 2006, up to a limit of USD 20,000. Furthermore, if the aggregate amount of claims made by the Group to the sellers exceeds USD 20,000 the Group has an option to sell back 100% of the voting shares of the Merkado Group to the former shareholders. The option may be exercised by the Group not later than 31 December 2007. Management estimates that the cost and fair value of the option on the date of acquisition and at the year-end are insignificant. The acquired business of Pyaterochka contributed revenue of USD 1,291,074 and net profit of USD 63,542 from the date of acquisition. The acquired business of Merkado contributed revenue of USD 16,599 and net loss of USD 3,481 from the date of acquisition. If the acquisitions had occurred on 1 January 2006, the Group’s results for the year ended 31 December 2006 would have been substantially as follows: Group, not including Pyaterochka Pyaterochka Total Group Holding N.V. Holding N.V. Merkado 12 months operations operations operations* 2006 Revenue ...... 1,495,678 1,973,138 82,652 3,551,468 Cost of goods sold ...... (1,057,855) (1,444,298) (59,815) (2,561,968) Gross profit ...... 437,823 528,840 22,837 989,500 Operating expenses ...... (379,986) (402,849) (32,059) (814,894) Including: Staff costs ...... (163,780) (224,705) (16,529) (405,014) Third party services ...... (96,795) (63,715) (6,046) (166,556) Operating lease expenses ...... (66,668) (59,383) (4,580) (130,631) Depreciation and amortisation ...... (33,261) (34,072) (3,596) (70,929) Taxes other than income tax ...... (7,878) (5,806) (536) (14,220) Other operating expenses ...... (11,604) (15,168) (772) (27,544) Gain from disposal of property, plant and equipment ...... 2,885 3,171 20 6,076 Lease/sublease and other income ...... 24,984 14,785 4,017 43,786 Operating profit ...... 85,706 143,947 (5,185) 224,468 Finance costs, net ...... (37,082) (32,759) (9,997) (79,838) Net foreign exchange gain ...... 5,194 9,532 140 14,866 Profit before tax ...... 53,818 120,720 (15,042) 159,496 Income tax expense ...... (20,755) (34,708) (1,236) (56,699) Profit for the period ...... 33,063 86,012 (16,278) 102,797 Attributable to: Equity holders of the parent ...... 33,063 86,012 (16,278) 102,797 Minority interest ...... – – – – Profit for the period ...... 33,063 86,012 (16,278) 102,797
* unaudited information derived from previous management accounts.
9 DISPOSAL OF SUBSIDIARIES During the year ended 31 December 2006 the Group disposed of its subsidiaries ZAO STD-Holding and ZAO Credo-Estate: STD-Holding Credo-Estate Total Assets disposed Cash ...... 13 – 13 Trade and other accounts receivable ...... 45 6 51 Property, plant and equipment (Note 12) ...... 1 – 1 Deferred tax asset ...... 76 – 76 Liabilities disposed Other accounts payable ...... – (29) (29) Net assets / (liabilities) disposed ...... 135 (23) 112 Consideration received ...... (1) (1) (2) Loss / (gain) on disposal of subsidiaries ...... 134 (24) 110
F-71 10 RELATED PARTY TRANSACTIONS Parties are generally considered to be related if one party has the ability to control the other party, is under common control or can exercise significant influence over the other party in making financial or operational decisions. In considering each possible related party relationship, attention is directed to the substance of the relationship, not merely the legal form. Related parties may enter into transactions which unrelated parties might not, and transactions between related parties may not be effected on the same terms, conditions and amounts as transactions between unrelated parties. The nature of the relationships for those related parties with which the Group entered into significant transactions or had significant balances outstanding at 31 December 2006 are provided below.
Alfa Group The following transactions were carried out with members of Alfa Group: Relationship 2006 2005 CTF Holdings Ltd...... Ultimate parent company Management services received ...... 890 816 OAO “Alfa-Bank” ...... Under common control Interest expense on loans received ...... 598 1,604 Bank charges ...... 256 41 VimpelCom ...... Under significant influence of CTF Holdings Ltd. Communication services rendered by VimpelCom to the Group ...... 487 159 Commission for mobile phone payments processing rendered by the Group to VimpelCom ...... 489 933 Golden Telecom ...... Under significant influence of CTF Holdings Ltd. Communication services received ...... 1,645 435 The consolidated financial statements include the following balances with members of the Alfa Group: 31 December 2006 31 December 2005 Cash and cash equivalents OAO “Alfa-Bank” ...... 20,173 5,442 Short-term loans payable OAO “Alfa-Bank” ...... 16,400 – Receivable from related party VimpelCom ...... 109 35 Golden Telecom ...... 252 451 Other accounts payable VimpelCom ...... 6 1 CTF Holding Ltd...... 256 –
Alfa-Bank The Group has an open credit line with Alfa-Bank. This credit line has a maximum limit of USD 150,000 and a floating interest rate. At 31 December 2006 the annual interest rate on this credit line was 6.9%-7.52% p.a. (31 December 2005: 8.75%). At 31 December 2006 the Group had utilised USD 40,000 of this credit line (31 December 2005: nil) (Note 31) and therefore had available credit lines of USD 110,000. Vimpelcom and Golden Telecom are not related parties of the Group under IAS 24, however, management of the Group has decided to disclose transactions and balances with these companies due to the significant influence of CTF Holdings Ltd.
Other related parties The following transactions were carried out with other related parties controlled by management of the Group: ZAO “Novye Roznichnye Technologii” The following transactions were carried out with ZAO “Novye Roznichnye Technologii”: 2006 2005 Operating lease expenses ...... 881 458
F-72 The consolidated financial statements include the following balances with ZAO “Novye Roznichnye Technologii”:
31 December 2006 31 December 2005 Accounts payable ...... 152 531
OOO “Rusel” and OOO “Rusel M” The following transactions were carried out with OOO “Rusel” and OOO “Rusel M”:
2006 2005 Outsourcing services provided by the Group ...... 1,549 – Rental income received by the Group ...... 481 –
The consolidated financial statements include the following balances with OOO “Rusel” and OOO “Rusel M”:
31 December 2006 31 December 2005 Accounts receivable ...... 504 –
OOO “Media 5” and OOO “Media 5M” The following transactions were carried out with OOO “Media 5” and OOO “Media 5M”:
2006 2005 Advertising services provided by the Group ...... 3,325 –
The consolidated financial statements include the following balances with OOO “Media 5” and OOO “Media 5M”:
31 December 2006 31 December 2005 Accounts receivable ...... 115 –
OOO “Makromir” The following transactions were carried out with OOO “Makromir”:
2006 2005 Construction services provided to the Group ...... 761 –
The consolidated financial statements include the following balances with OOO “Makromir”:
31 December 2006 31 December 2005 Accounts receivable ...... 642 –
OOO “Firma Sladkaya Zhizn” OOO “Firma Sladkaya Zhizn” was one of the significant suppliers of goods for resale for the Group and was affiliated with one of the minority shareholders, who was also a member of the senior management of the Group. With effect from the beginning of 2006 this company was excluded from related parties as the individual resigned from management and is no longer a shareholder.
The following transactions were carried out with OOO “Firma Sladkaya Zhizn”:
2006 2005 Purchase of goods for resale ...... – 34,383
The consolidated financial statements include the following balances with OOO “Firma Sladkaya Zhizn”:
31 December 2006 31 December 2005 Accounts receivable ...... – 20 Trade accounts Payable ...... – 2,226
F-73 Donette Investments Limited As at 31 December 2006 the Group has a long-term loan issued to Donette Investments Limited in the amount of USD 5,250 with an interest rate of 10% p.a. (31 December 2005: USD 5,250). The loan was initially recognised at fair value and is subsequently carried at amortized cost. As of 31 December 2006 the fair value of the loan approximates its carrying amount. The loan matures in 2014.
Key management personnel compensation Key management personnel compensation is disclosed in Note 27.
11 CASH 31 December 2006 31 December 2005 Cash in hand – Roubles ...... 6,207 2,557 Cash in hand – Ukrainian Hryvnia ...... 86 115 Bank current account – Roubles ...... 61,740 6,487 Bank current account – Ukrainian Hryvnia ...... 164 138 Bank current accounts and deposits – US Dollars ...... 32,075 614 Cash in transit – Roubles ...... 67,362 19,794 Cash in transit – Ukrainian Hryvnia ...... 354 362 167,988 30,067
The bank accounts represent current accounts with an effective interest rate of nil. Cash in transit is cash transferred from retail outlets to bank accounts and bank card payments being processed.
12 PROPERTY, PLANT AND EQUIPMENT Machinery and Refrigerating Construction Buildings equipment equipment Vehicles Other in progress Total Cost: At 1 January 2005 ...... 160,198 47,509 17,740 930 7,676 27,777 261,830 Additions ...... 5,989 17,537 5,936 1,026 1,823 115,592 147,903 Transfers ...... 65,113 17,367 468 69 2,844 (85,861) – Assets from acquisitions ...... 2,902 838 456 85 510 5 4,796 Disposals ...... (1,276) (217) (213) (53) (366) (6,023) (8,148) Disposal of subsidiaries ...... – (33) (59) – (12) – (104) Translation movement ...... (7,764) (2,626) (806) (55) (453) (1,325) (13,029) At 31 December 2005 ...... 225,162 80,375 23,522 2,002 12,022 50,165 393,248 Additions ...... 69,488 31,306 2,468 1,601 4,566 147,213 256,642 Transfers ...... 93,306 11,894 19,750 3,826 41,996 (170,772) – Assets from acquisitions (Note 8) ...... 487,297 14,388 41,005 5,951 34,310 177,113 760,064 Disposals ...... (13,529) (3,742) (476) (1,088) (2,003) (140) (20,978) Disposal of subsidiaries (Note 9) ...... – (121) – – (18) – (139) Translation movement ...... 37,143 9,157 3,822 398 3,157 5,499 59,176 At 31 December 2006 ...... 898,867 143,257 90,091 12,690 94,030 209,078 1,448,013 Accumulated depreciation: At 1 January 2005 ...... (19,788) (17,744) (7,512) (248) (4,926) – (50,218) Charge for the period ...... (7,103) (10,574) (2,674) (164) (2,546) – (23,061) Disposals ...... 211 205 7 20 521 – 964 Disposal of subsidiaries ...... – 37 – – 7 – 44 Translation movement ...... 1,780 695 335 26 785 – 3,621 At 31 December 2005 ...... (24,900) (27,381) (9,844) (366) (6,159) – (68,650) Charge for the period ...... (21,071) (16,747) (6,029) (1,362) (14,430) – (59,639) Disposals ...... 1,453 3,225 302 326 52 – 5,358 Disposal of subsidiaries (Note 9) ...... – 120 – – 18 – 138 Translation movement ...... (4,259) (2,363) (1,298) (128) (5,222) – (13,270) At 31 December 2006 ...... (48,777) (43,146) (16,869) (1,530) (25,741) – (136,063) Net book value at 31 December 2006 .... 850,090 100,111 73,222 11,160 68,289 209,078 1,311,950 Net book value at 31 December 2005 .... 200,262 52,994 13,678 1,636 5,863 50,165 324,598 Net book value at 1 January 2005 ...... 140,410 29,765 10,228 682 2,750 27,777 211,612
F-74 Construction in progress predominantly relates to the development of stores through the use of sub-contractors.
The buildings are mostly located on leased land. Land leases with periodic lease payments are disclosed as part of commitments under operating leases (Note 31). Certain land leases are prepaid for the 49 year term. Such prepayments are presented as non-current prepaid leases in the balance sheet and amount to USD 52,022 (31 December 2005: USD 4,218).
The Group leases certain assets under finance leases (Note 20). At 31 December 2006 and 31 December 2005 the net book value of the property, plant and equipment held under finance lease arrangements was:
31 December 2006 31 December 2005 Gross book value: Vehicles ...... 9,150 – Refrigerating equipment ...... 2,699 – 11,849 – Accumulated depreciation: Vehicles ...... (1,873) – Refrigerating equipment ...... (567) – (2,440) – Net book value of property, plant and equipment obtained under finance lease arrangements ...... 9,409 –
Refer to Note 19 for property, plant and equipment pledged as collateral for borrowings.
13 GOODWILL Movements in goodwill arising on the acquisition of subsidiaries are:
2006 2005 Gross book value at 1 January ...... 24,153 15,619 Accumulated impairment losses at 1 January ...... – – Carrying amount at 1 January ...... 24,153 15,619 Acquisition of subsidiaries (Note 8) ...... 2,537,557 9,095 Impairment loss ...... – – Translation to presentation currency ...... 61,239 (561) Carrying amount at 31 December ...... 2,622,949 24,153 Gross book value at 31 December ...... 2,622,949 24,153 Accumulated impairment losses at 31 December ...... – – Carrying amount at 31 December ...... 2,622,949 24,153
Goodwill Impairment Test Goodwill is allocated to cash-generating units (CGUs) which represent the lowest level within the Group at which the goodwill is monitored by management and which are not larger than a segment as follows:
Acquisition of Number subsidiaries Translation of stores 31 December 2006 (Note 8) movement 31 December 2005 Pyaterochka operations* ...... 444 2,504,794 2,446,960 57,834 – Merkado operations* ...... 17 92,145 90,597 1,548 – Operations in Moscow, Russia ...... 3 3,006 – 256 2,750 Operations in Nizhniy Novgorod, Russia .... 14 12,807 – 1,089 11,718 Operations in Yaroslavl, Russia ...... 4 5,762 – 491 5,271 Operations in Samara, Russia ...... 1 246 – 21 225 Operations in Kiev, Ukraine ...... 4 4,189 – – 4,189 2,622,949 2,537,557 61,239 24,153
* Goodwill is allocated on provisional basis (Note 8).
F-75 Goodwill has been tested for impairment at the CGU level by comparing carrying values of CGU assets including allocated goodwill to their recoverable amounts.
For goodwill arising from acquisitions prior to this reporting period Assumptions used for value-in-use calculations to which the recoverable amount is most sensitive were:
2006 2005 EBITDA growth rate ...... 1%p.a. 1% p.a. Pre-tax discount rate ...... 10%p.a. 14% p.a.
Based on the results of the calculations and the applied assumptions the Group concluded that no impairment charge was required. If the EBITDA actually declined by 17% annually the Group would need to reduce the carrying amount of goodwill by USD 48. If the pre-tax discount rate increased to 31% p.a. the Group would need to reduce the carrying amount of goodwill by USD 100.
Goodwill arising from Pyaterochka operations The recoverable amount of Pyaterochka operations was determined as the higher of fair value less cost to sell or value in use. The fair value less cost to sell was defined by reference to an active market, i.e. market capitalization of the Group on the London stock exchange at 31 December 2006. Market capitalization of Pyaterochka operations was defined as part of the market capitalization of the Group, pro-rated between Pyaterochka operations and Perekrestok operations based on EBITDA for the year ended 31 December 2006. The fair value less cost to sell significantly exceeded the value in use of Pyaterochka operations and, thus, was taken as the recoverable amount for the purpose of the impairment test. The recoverable amount of Pyaterochka operations exceeded its carrying amount therefore no impairment was recognised.
Goodwill arising from Merkado operations The recoverable amount of Merkado operations was determined as the higher of fair value less cost to sell or value in use. However due to the relatively insignificant value of Merkado assets acquired at the end of the year the value in use approach is used in testing the Merkado goodwill for impairment. More particularly, a discounted free cash flow approach, based on current acquisition valuation models, was utilized.
The Group engaged Neo Centre, an independent valuation specialist, in order to assess the level of impairment of goodwill on the Merkado operations. For the period from 2007 until 2015 the free cash flows are based on the strategic plan as approved by key management. For the subsequent years, the data of the strategic plan are extrapolated based on the consumer price indices as obtained from external resources and based on key performance indicators inherent to the strategic plan. The projections are made in the reporting currency of the Group and discounted at the Group weighted average cost of capital, 10% in US dollar nominal terms. The Group’s management believes that all of its estimates are reasonable: they are consistent with the internal reporting and reflect management’s best estimates. As the result of the assessment no impairment charge was recognised.
Assumptions used for value-in-use calculations to which the recoverable amount is most sensitive were:
2006 EBITDA growth rate ...... 9%p.a. Pre-tax discount rate ...... 10%p.a.
If the EBITDA of Merkado operations actually declined by 7% annually the Group would need to reduce the carrying amount of goodwill by USD 14,710. If the pre-tax discount rate increased to 14% p.a. the Group would need to reduce the carrying amount of goodwill by USD 17,627.
F-76 14 INTANGIBLE ASSETS Intangible assets comprise the following:
Brand and private Franchise Software Lease labels agreements and other rights Total Cost: At 1 January 2005 ...... – – 1,148 – 1,148 Additions ...... – – 246 15,864 16,110 Acquisition of subsidiaries ...... – – 45 3,131 3,176 Disposals ...... – – (120) – (120) Translation movement ...... – – (39) 143 104 At 31 December 2005 ...... – – 1,280 19,138 20,418 Additions ...... – – 341 6,253 6,594 Acquisition of subsidiaries (Note 8) ...... 323,526 69,866 4,034 76,209 473,635 Disposals ...... – – (38) – (38) Translation movement ...... 7,689 1,660 241 3,216 12,806 At 31 December 2006 ...... 331,215 71,526 5,858 104,816 513,415 Accumulated amortisation: At 1 January 2005 ...... – – (472) – (472) Charge for the period ...... – – (365) (672) (1,037) Disposals ...... – – 115 – 115 Translation movement ...... – – 18 (2) 16 At 31 December 2005 ...... – – (704) (674) (1,378) Charge for the period ...... (10,348) (4,507) (1,854) (2,749) (19,458) Translation movement ...... (86) (74) (122) (38) (320) At 31 December 2006 ...... (10,434) (4,581) (2,680) (3,461) (21,156) Net book value at 31 December 2006 ...... 320,781 66,945 3,178 101,355 492,259 Net book value at 31 December 2005 ...... – – 576 18,464 19,040 Net book value at 1 January 2005 ...... – – 676 – 676
15 INVENTORIES OF GOODS FOR RESALE Inventories as of 31 December 2006 and 31 December 2005 comprise the following:
31 December 2006 31 December 2005 Goods held for resale ...... 210,543 70,165 Less: provision for shrinkage ...... (1,967) (1,589) 208,576 68,576
Refer to Note 19 for goods pledged as collateral for borrowings.
Inventory shrinkage recognised as cost of goods sold in the consolidated income statement amounted to USD 28,906 (2005: USD 11,476).
16 TRADE AND OTHER ACCOUNTS RECEIVABLE
31 December 2006 31 December 2005 Trade accounts receivable ...... 38,442 13,392 Advances made to trade suppliers ...... 51,985 1,313 Other receivables ...... 29,641 4,694 Deferred expenses and prepayments ...... 28,210 6,191 Accounts receivable for franchise services ...... 1,287 – Accounts receivable for sales of property, plant and equipment . . . 2,770 7 Receivables from related parties (Note 10) ...... 1,622 486 Provision for impairment of trade and other receivables ...... (5,732) (1,555) 148,225 24,528
F-77 17 VAT AND OTHER TAXES RECOVERABLE
31 December 2006 31 December 2005 VAT recoverable ...... 85,771 58,628 Income tax receivable ...... 6,161 – Other taxes receivable ...... 3,663 456 95,595 59,084
VAT recoverable related to property, plant and equipment of USD 54,202 (31 December 2005: USD 26,493) is recorded within current assets because management expects it will be recovered within 12 months after the balance sheet date. Timing of the VAT refund depends on the registration of certain property, plant and equipment, therefore there are risks that recovering the balance may take longer than twelve months.
18 OTHER LIABILITIES
31 December 2006 31 December 2005 Taxes other than income tax ...... 21,836 7,175 Provision for tax contingencies (Note 31) ...... 55,773 8,000 Accrued salaries and bonuses ...... 61,366 14,742 Payables to landlords ...... 7,635 1,236 Other accounts payable and accruals ...... 16,675 4,764 Accounts payable for services received ...... 7,979 – Accounts payable for property, plant and equipment ...... 20,005 – Advances received ...... 9,441 – 200,710 35,917
The increase in provisions for tax contingencies is attributable to income taxes (Note 29) and Value Added Taxes.
19 BORROWINGS
Interest 31 December 31 December Currency rate, % p.a. 2006 2005 Short-term Current portion of Syndicated loan* ...... USD LIBOR + 2.25% 112,000 – Current portion of Perekrestok’s bonds** ...... RR 8.15% 56,725 51,715 Alfa-Bank ...... USD 6.9% - 7.52% 16,400 – UralSib Bank ...... USD 6.95% 12,760 – UralSib Bank ...... USD 7.40% – 750 Raiffeisenbank overdraft ...... RR 7.19% - 7.34% 6,266 – Sberbank ...... RR 11.00% 11,431 – AKB BIN Bank ...... RR 16.00% 2,279 – Other ...... RR – 152 137 218,013 52,602 Long-term Syndicated loan* ...... USD LIBOR + 2.25%/ 788,016 – 2.50% Pyaterochka Finance’s bonds – 1st issue*** ...... RR 11.45% 60,667 – Pyaterochka Finance’s bonds – 2nd issue*** ...... RR 9.30% 121,590 – Perekrestok’s bonds** ...... RR 8.15% 56,725 51,715 Bank Petrocommerce ...... RR 11.00% 90,850 – Old syndicated loan (USD part) ...... USD LIBOR+3% – 70,176 Old syndicated loan (Euro part) ...... Euro EURLIBOR+3 – 73,913 Less: Current portion of Syndicated loan* ...... USD LIBOR + 2.25% (112,000) – Current portion of Perekrestok’s bonds** ...... RR 8.15% (56,725) (51,715) 949,123 144,089 Total borrowings ...... 1,167,136 196,691
F-78 * In May 2006 the Company raised USD 800,000 from a consortium of banks. The loan is divided into two tranches as follows: USD 450,000 for three years bearing interest at LIBOR plus 2.25%, repayable as follows: USD 112,000 on each of the 18th, 24th and 30th month of the loan and a final payment of USD 114,000 on maturity, i.e. in May 2009. Of the USD 450,000, USD 300,000 was paid to Perekrestok Holdings Limited shareholders as part of the acquisition of Pyaterochka Holding N.V. (Note 8) and USD 150,000 was utilised to refinance existing debt of the Group. USD 350,000 bearing interest at LIBOR plus 2.5% and increasing to LIBOR plus 3% after one year and has a three-year maturity. This portion of the loan is being used to finance the future development of the combined Group. The full amount of the second tranche was utilised as at 31 December 2006.
The syndicated loan at 31 December 2006 is shown net of related transaction costs of USD 11,984 (31 December 2005: nil), which are amortised over the term of the loan using the effective interest method. LIBOR rate is repriced every quarter.
The Group has pledged as collateral for the syndicated loan 100% of voting shares in its subsidiaries, including Speak Global Ltd., OOO Agrotorg, OOO Agroaspect, Perekrestok Holdings Ltd., Alpegru Retail Properties Ltd., ZAO TH “Perekriostok”, OOO Perekriostok-2000, ZAO Ceizer, ZAO Remtransavto.
** In July 2005 the Group issued Russian Rouble denominated bonds in the amount of RR 1,500 million (USD 52,217 at the time of issue). The bonds have a maturity of 3 years. Coupon income is payable twice a year. The interest rate for the first and second coupon is 8.15% p.a. The interest rates on further coupon payments will be determined by management of the Group based on current market conditions and these interest rates will be announced in July 2007. The bond holders have a right to redeem the bonds in July 2007, therefore all the bonds are classified as a current liability in these consolidated financial statements. The bond origination costs amounted to USD 400. They reduced the amount of bonds drawn down and are amortised over the estimated life of the bonds. *** Pyaterochka Finance’s rouble-denominated bonds, issue 1 and 2, were acquired by the Group in course of the acquisition (Note 8). • The first series of bonds was issued by Pyaterochka Finance in March 2005. The aggregate nominal value of the first issue amounted to RR 1,500 million (USD 56,967 as of 31 December 2006). The first series of bonds has a maturity of five years and bears interest at a fixed rate of 11.45% per annum. Interest is payable every six months. • The second series of bonds was issued by Pyaterochka Finance in December 2005. The aggregate nominal value of the second issue amounted to RR 3,000 million (USD 113,934 as of 31 December 2006). The second series of bonds has a maturity of five years and bears interest at a fixed rate of 9.3% per annum. Interest is payable every six months.
Under borrowing agreements with Bank Petrocommerce and Sberbank, the Group has pledged property, plant and equipment with a net book value of USD 170,418 (31 December 2005: nil) and goods held for resale with a carrying value of USD 30,095 (31 December 2005: nil).
Compliance with covenants. The Group is subject to certain covenants on its borrowings and, at 31 December 2006, was in compliance with those covenants. Non-compliance with such covenants would have negative consequences for the Group including an increase in the cost of borrowings and, potentially, a declaration of default.
Loans received and repaid after the reporting date are described in Note 32.
Maturity of non-current borrowings:
31 December 2006 31 December 2005 1 to 3 years ...... 676,016 144,089 3 to 5 years ...... 273,107 – More than 5 years ...... – – 949,123 144,089
F-79 20 OBLIGATIONS UNDER FINANCE LEASES The Group leases certain refrigerating equipment and vehicles under finance lease terms. The agreements expire in 2007-2009 and assume a transfer of ownership for the leased assets to the Group at the end of the lease term. The effective borrowing rate on lease agreements as of 31 December 2006 varies from 9.0% to 11.0% per annum on USD agreements and from 24.0% to 31.0% per annum on RR agreements. The fair value of the finance lease liability as of 31 December 2006 approximates its carrying amount.
Lease obligations of the Group as of 31 December 2006 and 31 December 2005 consisted of the following:
Present value of minimum Minimum lease payments lease payments 31 December 31 December 31 December 31 December 2006 2005 2006 2005 Amounts payable : Within one year ...... 3,261 – 2,271 – In the second to fifth years inclusive ...... 3,879 – 2,913 – 7,140 – 5,184 – Less: future finance charges ...... (1,956) – N/A N/A Present value of minimum lease payments ...... 5,184 – 5,184 –
21 SHARE CAPITAL As described in Note 2.1 the equity structure of the Group represents the equity structure of X5 Retail Group N.V.. As of 1 January 2006 the Company had 38,306,785 ordinary shares issued and fully paid. The nominal par value of each ordinary share is EUR 1. The Company has only one class of ordinary shares. Because the acquisition (Note 8) is accounted for as a reverse acquisition of Pyaterochka Holding N.V. by Perekrestok Holdings Ltd., the comparative amount of share capital of USD 30 as at 31 December 2005 reflects the share capital of Perekrestok Holdings Ltd. (Note 2.1).
As part of the acquisition (Note 8) in April 2006 the Group issued an additional 15,813,253 ordinary shares.
During the year 2006 the Group repurchased 902,278 ordinary shares for general corporate purposes, including funding the employees’ share option program (ESOP) liabilities and potential acquisitions. As of 31 December 2006 the Group had 190,000,000 authorised ordinary shares of which 53,217,760 ordinary shares are outstanding. As of 31 December 2006 the fair value of outstanding shares amounted to USD 5,534,647.
No dividends were paid or declared during the year ended 31 December 2006 or the year ended 31 December 2005 other than the USD 300,000 payment to former shareholders of Perekrestok Holdings Ltd. as disclosed in Note 8.
22 EARNINGS PER SHARE Basic earnings per share are calculated by dividing the profit or loss attributable to equity holders of the Company by the weighted average number of ordinary shares in issue during the year, excluding treasury shares.
Earnings per share are calculated as follows:
31 December 2006 31 December 2005 Profit attributable to equity holders of the Parent ...... 84,212 29,132 Weighted average number of ordinary shares in issue ...... 39,492,210 15,813,253 Weighted average number of ordinary shares for the purposes of diluted earnings per share ...... 39,790,482 15,813,253 Basic earnings per share for profit from continuing operations (expressed in USD per share) ...... 2.13 1.84 Diluted earnings per share for profit from continuing operations (expressed in USD per share) ...... 2.12 1.84
F-80 23 REVENUE
2006 2005 Revenue from sale of goods ...... 2,791,532 1,012,667 Revenue from franchise services ...... 7,050 647 Revenue from other services ...... 4,769 1,471 2,803,351 1,014,785
24 OPERATING EXPENSES
2006 2005 Staff costs (Note 27) ...... 302,552 105,208 Third party services ...... 142,201 58,366 Operating lease expenses ...... 107,157 40,661 Depreciation and amortisation (Notes 12, 14) ...... 79,098 24,098 Taxes other than income tax ...... 12,069 5,178 Other operating expenses ...... 26,142 8,890 669,219 242,401
Operating lease expenses include USD 105,799 (2005: USD 39,251) of minimum lease payments and contingent rents of USD 1,358 (2005: USD 1,410).
Provision for impairment of trade and other receivables amounted to USD 4,073 during the year ended 31 December 2006 (31 December 2005: USD 1,746).
25 OPERATING LEASES
The Group leases part of its retail space in stores to companies selling supplementary goods and services to customers. The lease arrangements are operating leases, the majority of which are short-term. The future minimum lease payments receivable under non-cancellable operating leases are as follows:
31 December 2006 31 December 2005 Not later than 1 year ...... 16,153 6,547 Later than 1 year and no later than 5 years ...... 6,782 198 Later than 5 years ...... 1,952 – 24,887 6,745
The rental income from operating leases recognised in the income statement amounted to USD 35,268 (2005: USD 11,469). There were no contingent rents recognised in the income statement in 2006 (2005: nil).
26 FINANCE INCOME AND COSTS
2006 2005 Interest expense ...... 62,952 14,572 Interest income ...... (1,432) (177) 61,520 14,395
27 STAFF COSTS
2006 2005 Wages and salaries ...... 254,544 93,361 Social security costs ...... 20,306 11,847 Share-based payments expense ...... 27,702 – 302,552 105,208
F-81 Key executive management personnel Key management personnel and members of the Supervisory Board of the Company receive compensation in the form of short-term employee benefits and share-based payments (Note 28). For 2006 key management personnel and members of the Supervisory Board of the Company were entitled to total short-term compensation of USD 12,556 (2005: USD 5,652), including bonuses of USD 3,562 (2005: USD 3,648) and share-based payments of USD 6,321 (2005: nil). The compensation is made up of an annual remuneration and a performance bonus depending on operating results.
28 SHARE-BASED PAYMENTS With the acquisition of Pyaterchka Holding N.V., the Group acquired a liability for share-based payments of USD 42,288 (Note 8). Pyaterochka Holding N.V. approved this employee stock option program (ESOP) for certain of its key employees with options granted on 16 August 2005 and 2 December 2005 on a total of 6,129,088 GDRs. Terms of the arrangement provided an employee with the choice of whether the transaction will be settled in cash or by issuing equity instruments. Each option equaled a Global Depository Receipt. Options were exercisable at a fixed price equal to EUR 0.25 per GDR (approximately USD 0.30). The vesting period varied from 3 to 5 years. 1,436,505 of the total options were attached with vesting conditions other than length of service, such as: (i) the development of the EBITDA; (ii) the development of costs and expenses and/or (iii) other parameters. Options lapsed if they remain unexercised after a period of one year from the date of vesting.
On 2 November 2006, with the agreement of the stock option holders the Supervisory Board approved the ESOP cancellation by which the existing stock options would be terminated and the beneficiaries would receive a one-off cash payment. As a result, the ESOP cancellation liability required the compensation of USD 65,568 which implies approximately USD 11 per GDR and related auxillary expenses of USD 4,422. A liability of USD 69,990 was recorded at the year-end and will be payable in the first half of 2007. In total during the year ended 31 December 2006 the Group recognised expenses related to the ESOP in the amount of USD 27,702 (2005: nil). The Group has no future liabilities under this ESOP.
In March 2007 the Group announced a new employee stock option program for its key executives and employees (See Note 32).
Details of the share options outstanding during the year are as follows: Number of Weighted average share options exercise price, USD Outstanding at the acquisition date (Note 8) ...... 6,129,088 0.30 Granted during the year ...... – – Cancelled during the year ...... (6,129,088) 0.30 Outstanding at the end of the period ...... – –
29 INCOME TAX Year ended 31 December 2006 2005 Current income tax charge ...... 63,660 7,075 Deferred income tax (benefit) / charge ...... (27,598) 1,999 Income tax charge for the year ...... 36,062 9,074
The theoretical and effective tax rates are reconciled as follows: Year ended 31 December 2006 2005 Profit before taxation ...... 120,274 38,093 Theoretical tax at the effective statutory rates* ...... 28,856 9,449 Tax effect of items which are not deductible or assessable for taxation purposes: Effect of income taxable at rates different from standard statutory rates ...... (15,688) (10,871) Inventory shrinkage expenses ...... 6,937 2,754 Other non-deductible expenses ...... 9,691 4,257 Provision for tax contingencies (Note 31) ...... 6,266 3,485 Income tax charge for the year ...... 36,062 9,074
F-82 * Profit before taxation on Russian operations is assessed based on the statutory rate of 24%, profit before taxation on Ukrainian operations is assessed based on the statutory rate of 25%.
Deferred income tax Differences between financial reporting standards and taxation regulations give rise to certain temporary differences between the carrying value of certain assets and liabilities and their tax bases. The tax effect of the movement on these temporary differences is recorded at the rate of 24% for Russian operations and of 25% for Ukrainian operations.
Deferred tax assets and liabilities and the deferred tax charge in the income statement are attributable to the following items for the year ended 31 December 2006:
Deferred Deferred tax tax asset Recognised in Credited on business in disposed equity 31 December to profit combinations subsidiaries for translation 31 December 2005 and loss (Note 8) (Note 9) differences 2006 Tax effects of deductible temporary differences and tax loss carryforwards: Tax losses available for carry forward ...... 1,269 (1,343) – – 74 – Property, plant and equipment . . . – 3,468 4,090 – 117 7,675 Accounts Receivable ...... 3,001 1,245 1,170 – 359 5,775 Liability for share based expenses ...... – 16,284 – – – 16,284 Other ...... (1,131) 2,591 6,710 (76) 556 8,650 Gross deferred tax asset ...... 3,139 22,245 11,970 (76) 1,106 38,384 Less offsetting with deferred tax liabilities ...... (3,139) (5,962) (10,337) 76 (396) (19,758) Recognised deferred tax asset .. – 16,283 1,633 – 710 18,626 Tax effects of taxable temporary differences: Property, plant and equipment . . . (14,764) 1,522 (68,718) – (2,585) (84,545) Intangible assets ...... (5,049) 3,831 (109,053) – (2,546) (112,817) Gross deferred tax liability ..... (19,813) 5,353 (177,771) – (5,131) (197,362) Less offsetting with deferred tax assets ...... 3,139 5,962 10,337 (76) 396 19,758 Recognised deferred tax liability ...... (16,674) 11,315 (167,434) (76) (4,735) (177,604)
Temporary differences on unremitted earnings of certain subsidiaries amounted to USD 162,573 (31 December 2005: USD 1,510) for which the deferred tax liability was not recognised as such amounts are reinvested for the foreseeable future.
Current portion of deferred tax liability amounted to USD 13,420 (31 December 2005: USD 3,800), current portion of deferred tax asset amounted to USD 17,467 (31 December 2005: nil)
F-83 Deferred tax assets and liabilities and the deferred tax charge in the income statement are attributable to the following items for the year ended 31 December 2005: Deferred Recognised in Charged Deferred tax tax asset equity 31 December to profit on business in disposed for translation 31 December 2004 and loss combinations subsidiaries differences 2005 Tax effects of deductible temporary differences and tax loss carryforwards: Tax losses available for carry forward . . 1,471 (152) – – (50) 1,269 Accounts Receivable ...... 795 2,600 – (28) (366) 3,001 Other ...... (140) (1,046) – – 55 (1,131) Gross deferred tax asset ...... 2,126 1,402 – (28) (361) 3,139 Less offsetting with deferred tax liabilities ...... (2,126) (1,402) 28 361 (3,139) Recognised deferred tax asset ...... –– – – – – Tax effects of taxable temporary differences: Property, plant and equipment ...... (15,563) 772 (678) – 705 (14,764) Intangible assets ...... (143) (4,173) (783) – 50 (5,049) Gross deferred tax liability ...... (15,706) (3,401) (1,461) – 755 (19,813) Less offsetting with deferred tax assets ...... 2,126 1,402 – (28) (361) 3,139 Recognised deferred tax liability ..... (13,580) (1,999) (1,461) (28) 394 (16,674)
30 FINANCIAL RISKS Credit risk Financial assets, which are potentially subject to credit risk, consist principally of cash and cash equivalents held in banks, trade and other receivables. Due to the nature of its main activities (retail sales to individual customers) the Group has no significant concentration of credit risk. Cash is placed in financial institutions which are considered at the time of deposit to have minimal risk of default. The Group has policies in place to ensure that in case of credit sales of products and services to wholesales customers only those with an appropriate credit history are selected. Although collection of receivables could be influenced by economic factors, management believes that there is no significant risk of loss to the Group beyond the provision already recorded.
Foreign exchange and interest rates risk The Group has a substantial amount of foreign currency denominated long-term borrowings, and is thus exposed to foreign exchange risk (Note 19). The Group uses an interest rate swap with HSBC to hedge the interest rate and a foreign exchange collar with ABN Amro Bank to hedge foreign currency risks. As a result, Libor has been fixed at 5 per cent p.a. for the lifetime of the Syndicated loan (Note 19), and the foreign exchange collar at 32.4 and 23.85 RUR/USD. Management did not formally designate the interest rate swap and the foreign exchange collar as hedging instruments and did not applied hedge accounting.
Fair values The fair value of bonds traded on the MICEX is determined based on market quotations and amounted to USD 237,221 at 31 December 2006 (31 December 2005: USD 52,193). The carrying value of these bonds amounted to USD 238,982 at 31 December 2006 (31 December 2005: USD 51,715) (Note 19).
In assessing the fair value of non-traded financial instruments the Group uses a variety of methods including estimated discounted value of future cash flows, and making assumptions that are based on market conditions existing at each balance sheet date.
The carrying amounts of financial assets and liabilities with short-term maturity are assumed to approximate their fair values. At 31 December 2006 and 31 December 2005, the fair value of long-term borrowings was estimated by discounting the future contractual cash flows at the current market interest rate available to the Group for similar financial instruments. This fair value was not materially different from the carrying amount for the borrowings.
F-84 Liquidity risk At 31 December 2006 the Group has negative working capital of USD 436,521 (31 December 2005: USD 34,364). As described in the Note 19, the whole carrying amount of Perekrestok’s bonds of USD 56,725 is classified as a current liability but in fact a significant proportion will probably be carried forward to 2008 if the interest rates set in July 2007 are competative.
Furthermore, at 31 December 2006 the Group had available credit lines with Alfa-Bank (Note 10) of USD 110,000 (31 December 2005: nil).
Management considers that the available credit lines and expected operating cash flows are sufficient to finance the Group’s current operations.
The Group plans to issue 25 billion RUR callable bonds in 3 tranches during 2007 – early 2008 to refinance the Group’s existing debt and fund its store expansion.
31 COMMITMENTS AND CONTINGENCIES Commitments under operating leases At 31 December 2006, the Group operated 353 stores through rented premises (31 December 2005: 73). There are two types of fees in respect of operating leases payable by the Group: fixed and variable. For each store fixed rent payments are defined in the lease contracts and predominantly denominated in USD. The variable part of rent payments is predominantly denominated in RR and normally calculated as a percentage of turnover.
The future minimum lease payments under non-cancellable operating leases of property are as follows (net of VAT): 2006 2005 During 1 year ...... 65,199 30,897 In 2 to 5 years ...... 184,936 101,676 Thereafter ...... 116,244 106,914 366,379 239,487
Capital expenditure commitments At 31 December 2006 the Group had contracted for capital expenditure of USD 96,022 (including VAT) (31 December 2005: USD 25,483).
Taxation environment Russian tax, currency and customs legislation is subject to varying interpretations, and changes, which can occur frequently. Management’s interpretation of such legislation as applied to the transactions and activity of the Group may be challenged by the relevant regional and federal authorities. Recent events within the Russian Federation suggest that the tax authorities may be taking a more assertive position in their interpretation of the legislation and assessments, and it is possible that transactions and activities that have not been challenged in the past may be challenged. In particular, the Supreme Arbitration Court issued guidance to lower courts on reviewing tax cases providing a systematic roadmap for anti-avoidance claims, and it is possible that this will significantly increase the level and frequency of tax authorities scrutiny. As a result, significant additional taxes, penalties and interest may be assessed. Fiscal periods remain open to review by the authorities in respect of taxes for three calendar years preceding the year of review. Under certain circumstances reviews may cover longer periods.
Russian transfer pricing legislation introduced on 1 January 1999 provides the possibility for tax authorities to make transfer pricing adjustments and impose additional tax liabilities in respect of all controllable transactions, provided that the transaction price differs from the market price by more than 20%.
Controllable transactions include transactions with interdependent parties, as determined under the Russian Tax Code, and all cross-border transactions (irrespective of whether performed between related or unrelated parties), transactions where the price applied by a taxpayer differs by more than 20% from the price applied in similar transactions by the same taxpayer within a short period of time, and barter transactions. There is no formal guidance as to how these rules should be applied in practice. The arbitration court practice with this respect is contradictory.
Tax liabilities arising from intercompany transactions are determined using actual transaction prices. It is possible with the evolution of the interpretation of the transfer pricing rules in the Russian Federation and the changes in the approach of the Russian tax authorities, that such transfer prices could potentially be challenged in
F-85 the future. Given the brief nature of the current Russian transfer pricing rules, the impact of any such challenge cannot be reliably estimated; however, it may be significant to the financial condition and operations of the entity.
Russian tax legislation does not provide definitive guidance in many areas. From time to time, the Group adopts interpretations of such uncertain areas that reduce the overall tax rate of the Group. As noted above, such tax positions may come under heightened scrutiny as a result of recent developments in administrative and court practices; the impact of any challenge by the tax authorities cannot be reliably estimated; however, it may be significant to the financial condition and operations of the entity.
Management regularly reviews the Group’s taxation compliance with applicable legislation, laws and decrees and current interpretations published by the authorities in the jurisdictions in which the Group has operations. Furthermore, management regularly assesses the potential financial exposure relating to tax contingencies for which the 3 years tax inspection right has expired but which, under certain circumstances, may be challenged by regulatory bodies. From time to time potential exposures and contingencies are identified and at any point in time a number of open matters may exist. Management has recorded provisions and contingent liabilities of USD 55,773 (31 December 2005: USD 8,000) in these consolidated financial statements as their best estimate of potential liabilities arising from such tax contingencies. However, the range of potential exposures has not been disclosed to avoid prejudicing the Group’s position. Management has taken active steps to reduce the possibility of such risks in the future.
During the year the Group recorded USD 40,000 of provisions for tax contingencies arising from business combinations (Note 8) and recorded additional tax provisions of USD 7,773.
32 SUBSEQUENT EVENTS Announcement of a new Employee stock option program In March 2007 the Group announced the launch of a new employee stock option program (ESOP) for its key executives and employees. Under the terms of the plan, its beneficiaries may be granted options to acquire the economic benefit in, or receive the cash value of, a certain number of GDRs.
The total number of share options is capped at 10,824,000 GDRs. The program will run through to 18 May 2010. The options will be granted in four equal tranches, issued over a period of four years (2007 through 2010) with immediate vesting for the first grant, an 11 month vesting for the second grant and a one year vesting for the third and fourth grant. The exercise price of the first grant will be USD 18 per GDR (the share price at the date of the merger on 18 May 2006), the exercise price of the consequent three option tranches will be equal to the average market value of the shares represented in GDRs during 30 days prior to the vesting date of each of these options.
The total number of participants is not limited and is expected to vary during its lifetime, but it is anticipated to cover about one hundred top employees and managers of the Company.
The approval of the ESOP is within the competence of the General Meeting of Shareholders of the Company. As such, the ESOP will only officialy and legaly be adopted in case of approval on the General Meeting of Shareholders.
Settlement of Merkado’s debts Metronom AG’s mortgage loans provided by Petrokommerz, Sberbank and Binbank which were outstanding in total amount of USD 104,522 as at 31 December 2006 and bore interest rates of 11 to 16 per cent p.a., were refinanced with other lenders at the end of January 2007.
Announcement of secondary offering In April 2007 the Supervisory Board approved the management proposal to make a secondary public offering of the Group’s new ordinary shares during 2007 to raise USD 1,000,000 to finance potential M&A deals and organic growth plans. The approval of any secondary offering is within the competence of the General Meeting of Shareholders of the Company and as such will only be adopted in case of approval on the General Meeting of Shareholders.
Business combination in Ekaterinburg and Chelyabinsk In April 2007 the Group restructured its operations in Ekaterinburg and Chelyabinsk (Russia) by means of creation of a merger with a local franchisee. As the result, the Group received 51% of the new company and the owner of Pyaterochka franchises received 49%, which the Group agreed to purchase out in 2008 (24%) and in 2009 (25%).
F-86 ANNEXURE INDEX TO FORMATA CONSOLIDATED FINANCIAL STATEMENTS
Formata Holding B.V. Consolidated Financial Statements for the year ended 31 December 2007 Page Statement of Management’s Responsibilities ...... A-2 Independent Auditors’ Report ...... A-3 Consolidated Income Statement for the year ended 31 December 2007 ...... A-4 Consolidated Balance Sheet as of 31 December 2007 ...... A-5 Consolidated Statement of Changes In Shareholders’ Equity for the year ended 31 December 2007 ...... A-6 Consolidated Statement of Cash Flows for the year ended 31 December 2007 ...... A-7 Notes to Consolidated Financial Statements for the year ended 31 December 2007 ...... A-8
A-1 FORMATA HOLDING B.V. AND ITS SUBSIDIARIES (DOING BUSINESS AS KARUSEL GROUP) STATEMENT OF MANAGEMENT’S RESPONSIBILITIES FOR THE PREPARATION AND APPROVAL OF THE CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED 31 DECEMBER 2007
The following statement, which should be read in conjunction with the independent auditors’ responsibilities stated in the independent auditors’ report, is made with a view to distinguishing the respective responsibilities of management and those of the independent auditors in relation to the consolidated financial statements of Formata Holding B.V. and subsidiaries (the “Group”).
Management is responsible for the preparation of the consolidated financial statements that present fairly the financial position of the Group as of 31 December 2007, and the results of its operations, cash flows and changes in shareholders’ equity for the year then ended, in compliance with International Financial Reporting Standards (“IFRS”).
In preparing the consolidated financial statements, management is responsible for: • selecting suitable accounting principles and applying them consistently; • making judgments and estimates that are reasonable and prudent; • stating whether IFRS have been followed, subject to any material departures disclosed and explained in the consolidated financial statements; and • preparing the consolidated financial statements on a going concern basis, unless it is inappropriate to presume that the Group will continue in business for the foreseeable future.
Management is also responsible for: • designing, implementing and maintaining an effective and sound system of internal controls, throughout the Group; • maintaining proper accounting records that disclose, with reasonable accuracy at any time, the financial position of the Group, and which enable them to ensure that the consolidated financial statements of the Group comply with IFRS; • maintaining statutory accounting records in compliance with local legislation and accounting standards in the respective jurisdictions in which the Group operates; • taking such steps as are reasonably available to them to safeguard the assets of the Group; and • preventing and detecting fraud and other irregularities.
The consolidated financial statements for the year ended 31 December 2007 were approved by management on 7 March 2008:
On behalf of the Management:
M.Lapin D.Lepekha Chief Executive Officer Chief Financial Officer
7 March 2008
A-2 ZAO Deloitte & Touche CIS Business Center “Mokhovaya” 4/7 Vozdvizhenka St., Bldg. 2 Moscow, 125009 Russia Tel: +7 (095) 787 0600 Fax: +7 (095) 787 0601 www.deloitte.ru
INDEPENDENT AUDITORS’ REPORT To the Supervisory Board and Shareholders of Formata Holding B.V.: We have audited the accompanying consolidated financial statements of Formata Holding B.V. and its subsidiaries (‘the Group’), which comprise the consolidated balance sheet as of 31 December 2007, the consolidated income statement, the consolidated statements of changes in equity and cash flows for the year then ended and a summary of significant accounting policies and other explanatory notes.
Management’s responsibility for the financial statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards. This responsibility includes: designing, implementing and maintaining internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error; selecting and applying appropriate accounting policies; and making accounting estimates that are reasonable in the circumstances.
Auditor’s responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with International Standards on Auditing. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Group as of 31 December 2007, and the results of its consolidated financial performance and its cash flows for the year then ended in accordance with International Financial Reporting Standards.
7 March 2008
Member of Audit • Tax • Consulting • Financial Advisory • Deloitte Touche Tohmatsu
A-3 FORMATA HOLDING B.V. AND ITS SUBSIDIARIES (DOING BUSINESS AS KARUSEL GROUP) CONSOLIDATED INCOME STATEMENT FOR THE YEAR ENDED 31 DECEMBER 2007
Notes 2007 2006 ‘000 USD ‘000 USD REVENUE ...... 6 831,117 360,618 COST OF SALES ...... (624,388) (275,098) GROSS PROFIT ...... 206,729 85,520 Rental income ...... 11,314 6,415 Selling, general and administrative expenses ...... 7 (172,372) (74,198) OPERATING INCOME ...... 45,671 17,737 Other non-operating gains (losses) ...... 8 (1,446) 752 Net finance costs ...... 9 (12,276) (8,467) Foreign exchange (loss)/gain, net ...... (124) (3,508) PROFIT BEFORE INCOME TAX ...... 31,825 13,530 INCOME TAX ...... 10 (11,953) (3,617) NET PROFIT ...... 19,872 9,913 Basic and diluted earnings per share (expressed in USD per share) ...... 11 1.92 1.64
On behalf of the Management:
M.Lapin D.Lepekha Chief Executive Officer Chief Financial Officer
7 March 2008
The notes on pages F-99 to F-120 form an integral part of these consolidated financial statements.
A-4 FORMATA HOLDING B.V. AND ITS SUBSIDIARIES (DOING BUSINESS AS KARUSEL GROUP) CONSOLIDATED BALANCE SHEET AS OF 31 DECEMBER 2007
Notes 2007 2006 ‘000 USD ‘000 USD ASSETS NON-CURRENT ASSETS: Property, plant and equipment ...... 12 509,280 377,542 Long-term leasehold property assets ...... 17,122 9,502 Long-term loans ...... 13 16 10,663 Deferred tax assets ...... 10 7,713 3,180 534,131 400,887 CURRENT ASSETS: Inventories ...... 14 92,528 62,709 Receivables and prepayments ...... 15 62,555 82,480 Non-current assets classified as held for sale ...... 8 – 20,769 Other current assets ...... 16 13,377 6,707 Cash and cash equivalents ...... 17 110,035 28,992 278,495 201,657 TOTAL ASSETS ...... 812,626 602,544 SHAREHOLDERS’ EQUITY AND LIABILITIES SHAREHOLDERS’ EQUITY: Share capital ...... 18 133,077 133,077 Additional paid-in capital ...... 59,637 59,637 Retained earnings ...... 31,943 12,071 Translation reserve ...... 28,065 13,938 252,722 218,723 NON-CURRENT LIABILITIES: Long-term borrowings ...... 19 108,056 198,487 Deferred tax liabilities ...... 10 9,844 2,685 117,900 201,172 CURRENT LIABILITIES: Trade accounts payable ...... 231,271 108,319 Short-term borrowings ...... 19 139,359 30,784 Current income tax payable ...... 303 185 Other payables and accrued expenses ...... 20 71,071 43,361 442,004 182,649 TOTAL SHAREHOLDERS’ EQUITY AND LIABILITIES ...... 812,626 602,544
The notes on pages F-99 to F-120 form an integral part of these consolidated financial statements.
A-5 FORMATA HOLDING B.V. AND ITS SUBSIDIARIES (DOING BUSINESS AS KARUSEL GROUP) CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY FOR THE YEAR ENDED 31 DECEMBER 2007
Retained Share Capital Share Capital earnings/ Total of Formata of Hirsova Additional Loans from (Accumulated Translation shareholders’ Notes Holding B.V. Trading Ltd. paid-in capital shareholders losses) reserve equity ‘000 USD ‘000 USD ‘000 USD ‘000 USD ‘000 USD ‘000 USD ‘000 USD Balance as of 1 January 2006 before change in presentation of Hirsova Trading Ltd...... 25 2 59,635 132,977 2,420 (3,345) 191,714 Contribution of Hirsova Trading Ltd ...... 2 – (2) 2 – – – – Balance as of 1 January 2006 after change in presentation of Hirsova Trading Ltd...... 25 – 59,637 132,977 2,420 (3,345) 191,714 Accrual of interest on shareholders’ loans ...... – – – 75 – – 75 Conversion of shareholders’ loans into new shares of Formata Holding B.V...... 18 133,052 – – (133,052) – – – A-6 Net profit ...... – – – – 9,913 – 9,913 Translation adjustment ...... – – – – (262) 17,283 17,021 Balance as of 31 December 2006 ...... 133,077 – 59,637 – 12,071 13,938 218,723 Net profit ...... – – – – 19,872 – 19,872 Translation adjustment ...... – – – – – 14,127 14,127 Balance as of 31 December 2007 ...... 133,077 – 59,637 – 31,943 28,065 252,722
The notes on pages F-99 to F-120 form an integral part of these consolidated financial statements. FORMATA HOLDING B.V. AND ITS SUBSIDIARIES (DOING BUSINESS AS KARUSEL GROUP) CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 2007
2007 2006 ‘000 USD ‘000 USD OPERATING ACTIVITIES: Profit before income tax ...... 31,825 13,530 Adjustments for: Depreciation of property, plant and equipment (Note 12) ...... 24,114 10,575 Amortization of long-term leasehold property assets (Note 7) ...... 388 197 (Gain)/loss on disposal of property, plant and equipment (Note 8) ...... (1,173) 70 (Gain)/loss on disposal of non-current assets classified as held for sale (Note 8) . . 2,619 (752) Net finance costs ...... 12,276 8,467 Foreign exchange loss/(gain) ...... 1,090 (339) Operating cash flow before movements in working capital ...... 71,139 31,748 Increase in inventories ...... (29,819) (45,822) Decrease/(increase) in receivables and prepayments ...... 19,925 (56,110) Increase in other current assets ...... (6,670) (6,707) Increase in trade accounts payable ...... 122,952 76,561 Increase in current income tax payable ...... 118 185 Increase in other payables and accrued expenses ...... 33,276 22,576 Cash provided by operations ...... 210,921 22,431 Interest paid ...... (31,291) (12,032) Income tax paid ...... (10,687) (3,071) Net cash provided by operating activities ...... 168,943 7,328 INVESTING ACTIVITIES Purchase of property, plant and equipment ...... (123,737) (173,476) Purchase of long-term leasehold property assets ...... (8,008) (344) Long-term loans issued ...... – (10,130) Proceeds from disposal of property, plant and equipment ...... 3,718 – Proceeds from disposal of non-current assets classified as held for sale ...... 9,947 9,433 Interest received ...... 154 47 Proceeds from repayment of long-term loans ...... 10,647 – Net cash used in investing activities ...... (107,279) (174,470) FINANCING ACTIVITIES: Repayment of short-term borrowings, net ...... (26,148) (8,950) Proceeds from long-term loans ...... 43,418 71,553 Proceeds from bonds issuance ...... – 113,503 Net cash provided by financing activities ...... 17,270 176,106 Effect of exchange rate changes on cash and cash equivalents ...... 2,109 (258) NET INCREASE IN CASH AND CASH EQUIVALENTS ...... 78,934 8,964 CASH AND CASH EQUIVALENTS, beginning of the year ...... 28,992 20,286 CASH AND CASH EQUIVALENTS, end of the year ...... 110,035 28,992 NON-CASH TRANSACTIONS Conversion of loans and interest into share capital (see Note 18) ...... – 133,052
The notes on pages F-99 to F-120 form an integral part of these consolidated financial statements.
A-7 FORMATA HOLDING B.V. AND ITS SUBSIDIARIES (DOING BUSINESS AS KARUSEL GROUP) NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FOR YEAR ENDED 31 DECEMBER 2007
1. GENERAL INFORMATION Formata Holding B.V. (the “Company”) is a limited liability company established on 7 May 2004 under the laws of the Netherlands. The principal activity of the Company is to act as a holding and finance company for the group of companies that operate under the “Karusel” brand in St.Petersburg, Leningrad region, Moscow region, Nizhniy Novgorod, Izhevsk and Volgograd (hereafter – the “Group”). All of the Company’s subsidiaries are wholly-owned, registered under the laws of the Russian Federation and had no significant operations prior to establishment of the Company. One Company’s subsidiary, Hirsova Trading, which held Karusel trade mark, is registered in Cyprus.
The principal shareholders of Formata Holding B.V. are Puritani Corporation N.V. with 51.28% shareholding and Overture Corporation N.V. with 48.72% shareholding, the companies established under the laws of the Netherlands Antilles. The ultimate beneficial interests are held indirectly by Mr. A. Rogachev, Mr. A. Girda, Ms. T. Franus and Mr. I. Vidiaev through Puritani Corporation N.V. and Overture Corporation N.V. Mr. A. Rogachev is the beneficial owner of the controlling stake in the Group.
The Group’s principal business activities are within the Russian Federation. As of 31 December 2007 and 2006 “Karusel” retail chain operated in St. Petersburg, Leningrad region, Moscow region, Nizhniy Novgorod, Izhevsk and Volgograd under the brand name “Karusel” with the following number of hypermarkets:
31 December 31 December 2007 2006 St. Petersburg ...... 13 12 Leningrad region ...... 2 2 Moscow region ...... 4 3 Nizhniy Novgorod ...... 1 1 Izhevsk ...... 1 1 Volgograd ...... 1 – Total ...... 22 19
The Group is also involved in development activities such as securing land rights, preparation of sites and construction of facilities for the Group’s future hypermarkets.
The address of the Company’s registered office is Prins Bernhardplein 200, 1097 JB Amsterdam, the Netherlands. The primary operating office of the Group is located at Leninskiy prospect 98, 198332, St. Petersburg, Russia.
The average number of employees of the Group (including outsourced personnel) for the years ended 31 December 2007 and 2006 were 7,311 and 4,837, respectively.
The accompanying consolidated financial statements were approved by management and authorized for issue on 7 March 2008.
2. PRESENTATION OF FINANCIAL STATEMENTS Basis of Presentation – These consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”) under the historical cost convention. The principal accounting policies applied in the preparation of these consolidated financial statements are set out below. These policies have been consistently applied to all the periods presented unless otherwise stated.
Formata Holding B.V. maintains its accounting records in US Dollars (“USD”) in accordance with the accounting and reporting regulations of the Netherlands. Hirsova Trading Ltd. maintains its accounting records in USD in accordance with the accounting and reporting regulations of Cyprus. All other operating subsidiaries of the Group maintain their accounting records in Russian Roubles (“RUR”) in accordance with the accounting and reporting regulations of the Russian Federation. Russian statutory accounting principles and procedures differ
A-8 substantially from those generally accepted under IFRS. Accordingly, the consolidated financial statements, which have been prepared using the Group’s statutory accounting records, reflect adjustments necessary for such financial statements to be presented in accordance with IFRS.
Before 2007 the Group presented its financial statements on a combined and consolidated basis, including Hirsova Trading Ltd., a company under common control with Formata Holding B.V. In December 2007 the shareholders of the Group contributed their 100% interest in the shares of Hirsova Trading Ltd. to the Company. Accordingly, the comparative information for the year ended 31 December 2006 included as part of these consolidated financial statements is presented as if this contribution was made as of 1 January 2006.
Going Concern – The attached consolidated financial statements were prepared by the Group’s management on a going concern basis, based on the assumption that the Group will continue its activities for the foreseeable future and has no intention or obligation to discontinue or significantly curtail the scope of its activities, and therefore all its obligations will be settled in the due course of business.
The Group continues to expand its retail chain by obtaining additional premises and constructing new hypermarkets. The Group’s expansion is partially financed with short-term borrowings and trade and other payables, which resulted in a net current liabilities position of approximately USD 163.5 million at 31 December 2007. Management’s efforts to improve the Group’s liquidity position concentrate primarily on prolonging and refinancing the existing liabilities and obtaining long-term financing from both existing and new lenders so as to match capital expenditure with long-term finance. Management believes that the Group’s available borrowing capacity, operating cash flows and shareholder support, if necessary, will provide adequate resources to fund its liabilities for the next year. In addition, management believes that if the Group’s efforts are not successful that it will be able to modify its capital expenditure plans in order to meet its liabilities.
Use of Estimates and Assumptions – The preparation of the consolidated financial statements in conformity with IFRS requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Due to the inherent uncertainty in making those estimates, actual results reported in future periods could differ from such estimates.
Functional and Presentation Currency – The functional currency of the parent company Formata Holding B.V. is the USD. The Group presents these financial statements in USD. The functional currency of the Russian operating entities of the Group and Hirsova Trading Ltd. is RUR. RUR is not a fully convertible currency outside the territory of the Russian Federation. The translation of RUR denominated assets and liabilities into USD for the purpose of these consolidated financial statements does not indicate that the Group could or will in the future realize or settle in USD the translated values of these assets and liabilities.
The translation of the financial statements of operating subsidiaries to the Group’s presentation currency is done in accordance with the requirements of International Accounting Standard (IAS) 21 (Revised 2003) “The Effects of Changes in Foreign Exchange Rates”. In accordance with IAS 21, assets and liabilities for all balance sheets presented are translated at the closing rate existing at the date of each balance sheet presented; income and expense items for all periods presented are translated at the exchange rates existing at the dates of the transactions or a rate that approximates the actual exchange rates (usually, the average rate for a period) and all exchange differences resulting from translation are recognized directly in shareholders equity as translation reserve. Cash flows are translated using the exchange rates existing at the dates of the significant transactions or at the average rate for a period. Resulting differences are presented separately as effect of exchange rate changes on cash and cash equivalents.
The closing rates used for preparation of these consolidated financial statement as of 31 December 2007 and 2006 were 24.55 RUR/1 USD and 26.33 RUR/1 USD, respectively. The average rates for 2007 and 2006 were 25.55 RUR/1 USD and 27.14 RUR/1 USD, respectively.
Business and geographic segments – the Group has only one reportable business and geographic segment thus segment reporting information as required by IAS 14 “Segment Reporting” has not been provided.
Comparative information and corrections – some comparative figures were reclassified, where necessary, to conform to changes in the presentation of the current period. Specifically, the Group has made the following reclassifications in the balance sheet as of 31 December 2006: • Land with a carrying value of USD 20,769 thousand which was previously included in inventory is now presented in the balance sheet separately as non-current assets classified as held for sale;
A-9 • USD 9,405 thousand has been reclassified from long-term leasehold property assets to assets in the course of construction within property, plant and equipment; • Property under development held for sale to related parties of USD 6,707 thousand which was previously included in inventory is now presented in the balance sheet separately as other current assets; • USD 6,416 thousand has been reclassified from long-term loans to property, plant and equipment, in order to correctly reflect the purchase of land which occurred prior to 31 December 2006; • USD 1,613 thousand has been reclassified from land and buildings within property, plant and equipment to long-term leasehold property assets in line with the Group’s policy for classification of purchased leasehold rights described in these financial statements; • Deferred tax assets and deferred tax liabilities were offset by USD 561 thousand.
3. ADOPTION OF NEW AND REVISED INTERNATIONAL FINANCIAL REPORTING STANDARDS The Group has adopted the following new or revised standards and interpretations issued by International Accounting Standards Board and the International Financial Reporting Interpretations Committee (the IFRIC) which become effective for the Group’s annual consolidated financial statement for the year ended 31 December 2007: • IFRS 7 “Financial Instruments: Disclosures”; • IAS 1 Amendment – “Capital Disclosures”; • IFRIC 7 “Applying the Restatement Approach under IAS 29 “Financial Reporting in Hyperinflationary Economies”; • IFRIC 8 “Scope of IFRS 2”; • IFRIC 9 “Reassessment of Embedded Derivatives”; • IFRIC 10 “Interim Financial Reporting and Impairment”.
The adoption of the new or revised standards and interpretations did not have any effect on the Financial position or performance of the Group.
As a result of adoption of IAS 1 – “Capital Disclosures” new disclosures were added about the Group’s objectives, policies and processes for managing capital; qualitative data about what the Group regards as capital; and compliance with any capital requirements imposed on the Group.
As a result of adoption of IFRS 7 – “Financial Instruments: Disclosures” these consolidated financial statements now include expanded disclosures regarding the Group’s financial instruments and the nature and extent of risks arising from those financial instruments.
At the date of authorization of this financial information, the following new standards and interpretations were in issue, but not yet effective, and which the Group has not early adopted: • IFRS 8 “Operating Segments”; • IAS 23 “Borrowing Costs (revised)”; • IFRS 3 “Business Combinations” – Comprehensive revision on applying the acquisition method, and consequential amendments to IAS 27 “Consolidated and Separate Financial Statements”, IAS 31 “Interests in Joint Ventures”; • IAS 1 “Presentation of Financial Statements” – Comprehensive revision including requiring a statement of comprehensive income; • IAS 1 “Presentation of Financial Statements” – Amendments relating to disclosure of puttable instruments and obligations arising on liquidation; • IAS 32 “Financial Instruments: Presentation” – Amendments relating to puttable instruments and obligations arising on liquidation; • IFRIC 11 “IFRS 2: Group and Treasury Share Transactions “; • IFRIC 12 “Service Concession Arrangements”;
A-10 • IFRIC 13 “Customer Loyalty Programmes”; • IFRIC 14 “IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements their Interaction”.
IFRS 8 shall be applied for annual periods beginning on or after 1 January 2009. This IFRS supersedes IAS 14 “Segment reporting” and requires identification of operating segments on the basis of internal reports that are regularly reviewed by the chief operating decision maker in order to allocate resources to the segment and assess its performance. The Group is currently assessing what impact the new Standard will have on disclosures in its consolidated financial statements.
IAS 23 (revised) shall be applied for annual periods beginning on or after 1 January 2009. The revision to IAS 23 removes the option of immediately recognizing as an expense borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset. A qualifying asset is one that takes a substantial period of time to get ready for use or sale. An entity is, therefore, required to capitalize such borrowing costs as part of the cost of the asset. Management considers that this revision of IAS 23 is unlikely to have any impact on the Group’s results of operations and financial position as it already applies an accounting policy of capitalizing qualifying borrowing costs (see Summary of significant accounting policies – Borrowing costs).
IFRIC 13 gives guidance on the accounting by entities that grant loyalty award credits (such as ‘points’ or travel miles) to customers who buy other goods or services or participate in similar customer loyalty programmes for their customers. The Group’s loyalty cards currently issued to its customers do not accumulate any award points. Consequently, the Group does not expect that the adoption of IFRIC 13 will result in any significant impact on its financial statements. This Interpretation is effective for periods beginning on or after 1 January 2008.
IFRIC 11, IFRIC 12, and IFRIC 14 shall be applied for annual periods beginning on or after 1 March 2007, 1 January 2008, and 1 January 2008, respectively.
Revisions and amendments to IFRS 3, IAS 1, IAS 27, IAS 31, IAS 32 shall be applied for annual periods beginning on or after 1 July 2009.
The Group is in the process of making its assessment of the likely impact of all of these new and revised IFRSs. So far, it has concluded that while the adoption of IFRS 8 may result in some new disclosures, other new and revised IFRS pronouncements listed above are unlikely to have a significant impact on the Group’s results of operations and financial position.
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation – These consolidated financial statements include the consolidated accounts of Formata Holding B.V. and its subsidiaries.
All intra-group transactions, balances, income and expenses are eliminated on consolidation.
Subsidiaries are those companies (including special purpose entities) in which the Group, directly or indirectly, has an interest of more than one half of the voting rights or otherwise has power to govern the financial and operating policies so as to obtain economic benefits. The existence and effect of potential voting rights that are presently exercisable or presently convertible are considered when assessing whether the Group controls another entity. Subsidiaries are consolidated from the date on which control is transferred to the Group (acquisition date) and are de-consolidated from the date that control ceases.
The Group’s consolidated financial statements are prepared using uniform accounting policies.
Foreign Currencies Transactions – Transactions in currencies other than the functional currency are initially recorded at the rates of exchange prevailing on the dates of the transactions. Monetary assets and liabilities denominated in such currencies are translated at the rates prevailing on the balance sheet date.
Foreign exchange gains and losses resulting from the settlement of the transactions and from the translation of monetary assets and liabilities into each Group companies’ functional currency at year-end exchange rates are recognised in profit or loss.
A-11 Business Combinations – The acquisition of subsidiaries is accounted for using the purchase method. The cost of the acquisition is measured at the aggregate of the fair values, at the date of exchange, of assets given, liabilities incurred or assumed, and equity instruments issued by the Group in exchange for control of the acquiree, plus any costs directly attributable to the business combination.
Acquisition of subsidiaries from entities under common control, whether paid by cash, shares, or any other consideration, is measured at the book value of assets and liabilities acquired in the financial statements of those entities.
Revenue Recognition and Supplier’s Bonuses – The Group generates and recognizes sales to retail customers at the point of sale in its hypermarkets. Revenues are measured at the fair value of the consideration received or receivable.
Revenue generated from renting out space to third party trading outlets within the Group’s hypermarkets is recognized in the end of each month, in accordance with the terms of each lease agreement. Rental agreements are concluded with the lessees for the term of 11 months. Rental agreements can be cancelled by tenant at a two month notice and by lessor at a five days notice.
Revenues are shown net of value added tax (VAT) and discounts.
The Group receives various types of allowances from suppliers in the form of slotting fees, volume discounts and other forms of payment that effectively reduce the cost of goods purchased from the supplier or the cost of promotional activities conducted by the Group that benefit the supplier. Bonuses received from suppliers are presumed to be reduction in prices paid for the product and are recognized in cost of sales as the related inventory is sold.
Property, Plant and Equipment – Property, plant and equipment are stated at purchase and construction cost less accumulated depreciation.
Capitalized cost includes major expenditures for improvements and replacements. All other repair and maintenance expenditures are charged to income statement as incurred.
Land owned by the Group is not depreciated. Deprecation of other items of property, plant and equipment is computed under the straight-line method to allocate their cost, less residual values, to income statement over their estimated useful lives, as follows:
Buildings ...... 20-50 years Refrigerating Equipment ...... 7-10 years Vehicles ...... 5-7years Other Equipment ...... 3-25 years
The residual value of an asset is the estimated amount that the Group would currently obtain from disposal of the asset less the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life. The residual value of an asset is nil if the Group expects to use the asset until the end of its physical life. The assets’ residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date.
Assets in the course of construction comprise costs directly related to the construction of property, plant and equipment including an appropriate allocation of directly attributable variable overheads that are incurred in construction, and capitalized borrowing costs. Depreciation of these assets, on the same basis as for other property assets, commences in the next month following the month in which the assets are put into operation. Assets in the course of construction are reviewed regularly to determine whether its carrying value is fairly stated and whether appropriate provision for impairment should be made.
The loans provided by the Group to certain entities which are established to administer construction projects for the Group are classified as assets in the course of construction. The Group normally acquires full ownership of such entities on completion of construction. The Group does not control those entities until it acquires full ownership.
The gain or loss arising on disposal or retirement of an asset is determined as the difference between the sales proceeds and the carrying amount of the asset and is recognized in the consolidated income statement.
A-12 Operating Leases – Where the Group is a lessee in a lease which does not transfer substantially all the risks and rewards incidental to ownership from the lessor to the Group, the total lease payments, including those on expected termination, are charged to profit or loss on a straight-line basis over the period of the lease.
Long-term Leasehold Property Assets – Long-term leasehold property assets comprise capitalized up-front payments for lease of land under hypermarkets which are in operation or where the construction is completed. The Group typically acquires the right to use land on a temporary basis during the construction stage of each new store. Once the construction of a new store is complete the Group may either acquire the full ownership of land relating to this store or enter into a fixed term lease with a local city or regional government which is normally limited to 49 years. Investments in acquiring lease rights are presented as part of assets in the course of construction until the construction stage is compete, at which point they are either included in the cost of owned land or reclassified in long term leasehold property assets presented separately in the Group’s balance sheet. Long-term leasehold property assets are amortized over the term of the lease. Amortization of long-term leasehold property assets commences when the fixed long-term lease agreement is signed.
Impairment of Tangible Non-current Assets – At each balance sheet date, the Group reviews the carrying amounts of its tangible assets to determine whether there is any indication that those assets have suffered an impairment loss. If any such indication exists, the recoverable amount of the asset is estimated in order to determine the extent of the impairment loss (if any). Where it is impossible to estimate the recoverable amount of an individual asset, the Group estimates the recoverable amount of the cash-generating unit to which the asset belongs. Recoverable amount is the higher of an asset’s net selling price and its value in use, which is the present value of estimated future cash flows expected to arise from the continuing use of an asset and from its disposal at the end of its useful life.
If the recoverable amount of an asset (or cash-generating unit) is estimated to be less than its carrying amount, the carrying amount of the asset (or cash-generating unit) is reduced to its recoverable amount. Impairment losses are recognized as an expense immediately.
Where an impairment loss subsequently reverses, the carrying amount of the asset (cash generating unit) is increased to the revised estimate of its recoverable amount, but so that the increased carrying amount does not exceed the carrying amount that would have been determined had no impairment loss been recognized for the asset (cash generating unit) in prior years. A reversal of an impairment loss is recognized immediately in the income statement.
No impairment loss was recognized for the years ended 31 December 2007 and 31 December 2006.
Inventories – Inventories are stated at the lower of cost or net realizable value. Cost of inventory comprises direct cost of goods, transportation and handling costs less supplier’s bonuses. Cost of inventory is determined on the weighted average method. Net realizable value represents the estimated selling price less all estimated costs to be incurred in marketing, selling and distribution.
The Group conducts continuous physical counts of inventory and any shrinkage identified is recognized immediately. The Group provides for estimated inventory losses (shrinkage) between physical inventory counts on the basis of a percentage of inventory balance. The provision is adjusted at the end of each reporting period to reflect the trend of the actual losses.
Assets Transferable to Related Parties – The Group entered into investment agreements with related parties which provide for a transfer of title for a part of hypermarket’s space to these related parties upon completion of construction and registration of title. Expenditure relating to the part of hypermarket under construction to be transferred is recorded within other current assets while advances received from these related parties are recorded as prepayments under investment agreements within payables to related parties. The Group receives payment for the assets transferred which approximate the costs incurred. Any resulting gains and losses realized at the time of a transfer are recognized as other gains and losses in the income statement.
Non-current Assets Classified as Held for Sale – Non-current assets and disposal groups are classified as held for sale if their carrying amount will be recovered principally through a sale transaction rather than through continuing use. This condition is regarded as met only when the sale is highly probable and the asset (or disposal group) is available for immediate sale in its present condition. Management must be committed to the sale, which should be expected to qualify for recognition as a completed sale within one year from the date of classification.
Non-current assets (and disposal groups) classified as held for sale are measured at the lower of their previous carrying amount and fair value less costs to sell.
A-13 Long-term Loans Receivable – Long-term loans receivable are stated at amortized costs after provision for impairment. Long-term loans provided by the Group at interest rates substantially different from the market rate are discounted using the appropriate market rate at inception. Gain or loss resulting from discounting is recognized in the manner appropriate to the circumstances: as capital contribution or deduction from equity, if the loans are to the entities under common control; as adjustment to assets or liabilities, if intended to compensate non-market terms of other transactions; or in the income statement, in all other circumstances.
Receivables and Prepayments – Receivables are recorded at original invoice amount less provision made for impairment of these receivables. A provision for impairment of receivables is established when there is objective evidence that the Group will not be able to collect all amounts due according to the original terms of receivables. The amount of the provision is recognised in the income statement.
Cash and cash equivalents – Cash and cash equivalents includes cash in hand, cash in transit, cash held on current bank accounts and deposits held at call with banks.
Borrowings – Borrowings are recognized initially at cost, which is the fair value of the proceeds received, net of transaction costs incurred. In subsequent periods, borrowings are stated at amortized cost using the effective yield method; any difference between fair value of the proceeds (net of transaction costs) and the redemption amount is recognized as interest expense over the period of the borrowings.
Borrowing Costs – Borrowing costs directly attributable to the acquisition, construction or production of qualifying assets, which are assets that necessarily take a substantial period of time to get ready for their intended use or sale, are added to the cost of those assets, until such time as the assets are substantially ready for their intended use or sale. All other borrowing costs are recognized as an expense in the period in which they are incurred.
Trade and Other Payables – Liabilities for trade and other short-term amounts payable are stated at their nominal value.
Provisions for liabilities and charges – Provisions for liabilities and charges are recognized when the Group has a present legal or constructive obligation as a result of past events, and it is probable that an outflow of resources will be required to settle the obligation, and a reliable estimate of the amount can be made. 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 recognized even if the likelihood of an outflow with respect to any one item included in the same class of obligations may be small.
Where the Group expects a provision to be reimbursed, for example under an insurance contract, the reimbursement is recognized as a separate asset but only when the reimbursement is virtually certain.
Value Added Tax on Purchases and Sales – Value added taxes (VAT) related to sales are payable to the tax authorities on an accrual basis upon sales of goods and services. Input VAT is reclaimable against sales VAT upon purchases. The tax authorities permit settlement of VAT on a net basis. VAT related to sales and purchases which have not been settled at the balance sheet date is recognized in the consolidated balance sheet on a gross basis. Where provision has been made against debtors deemed to be uncollectible, a bad debt expense is recorded for the gross amount of the debtor, including VAT.
Income Taxes – Income taxes for the Group entities have been computed in accordance with the laws of the respective jurisdictions. They are based on the results for the year as adjusted for items that are non-assessable or non-tax deductible. Income tax expense includes any adjustments to provisions in respect of management’s estimates of additional amounts payable as a result of disputes with the tax authorities over the Group’s compliance with tax legislation.
Deferred tax is accounted for using the balance sheet liability method in respect of temporary differences arising from differences between the carrying amount of assets and liabilities in the consolidated financial statements and the corresponding tax basis used in the computation of taxable profit.
Deferred tax liabilities are generally recognized for all taxable temporary differences and deferred tax assets are recognized to the extent that it is probable that taxable profits will be available against which deductible temporary differences can be utilized. Deferred tax assets and liabilities are offset when they relate to income taxes levied by the same taxation authority and the Group intends to settle its tax assets and liabilities on a net basis.
A-14 Deferred tax is calculated at rates that are expected to apply to the period when the asset is realized or the liability is settled. It is charged or credited to the consolidated income statement, except when it relates to items credited or charged directly to equity, in which case the deferred tax is also dealt with in equity.
Retirement Benefit Costs – The operating entities of the Group contribute to the Russian Federation state pension, medical and social insurance and employment funds on behalf of all its current employees. Any related expenses are recognized in the consolidated income statement as incurred.
Dividends – Dividends are recognized at the date they are declared by the shareholders in general meeting. Equity legally distributable by the Group is based on amounts available for distribution in accordance with applicable legislation and as reflected in the statutory financial statements of the individual entities that make up the Group. These amounts may differ significantly from the amounts calculated on the basis of IFRS.
5. CRITICAL ACCOUNTING JUDGEMENTS AND KEY SOURCES OF ESTIMATION UNCERTAINTY In the application of the Group’s accounting policies, which are described in note 4 above, management is required to make judgments, estimates and assumptions about the carrying amounts of assets and liabilities that are not readily apparent from other sources. The estimates and associated assumptions are based on historical experience and other factors that are considered to be relevant. Actual results may differ from these estimates.
The estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimate is revised if the revision affects only that period, or in the period of the revision and future periods if the revision affects both current and future periods.
Judgments that have the most significant effect on the amounts recognized in these consolidated financial statements and estimates that can cause a significant adjustment to the carrying amount of assets and liabilities within the next financial year include:
Recognition of Supplier Bonuses – In accounting for supplier bonuses received by the Group the Group makes an assumption that all such supplier bonuses are related to the performance of the Group in the reporting period.
The amount of bonuses received during 2007 and 2006 was USD 72,535 thousand and USD 27,313 thousand, respectively, the amount of bonuses allocated to the inventory balance as of 31 December 2007 and 2006 was USD 9,255 thousand and USD 4,665 thousand, respectively.
Recognition of Revenue from Sale of Discount Cards – the Group sells to its customers discount cards that enable them to buy products at special discounted prices. The Group recognizes revenue from the sale of these cards as sale of goods at the point of sale as it is not offering any long term service obligations to the holders of the cards. The costs of issuing the cards are also not deferred and recognized immediately in the income statement. During the year ended 31 December 2007 the Group recognized approximately USD 1,600 thousand of revenue from the sale of discount cards (USD 1,500 thousand for the year ended 31 December 2006).
Useful Lives of Property, Plant and Equipment – The estimation of the useful lives of items of property, plant and equipment is a matter of judgment based on the experience with similar assets. The future economic benefits embodied in the assets are consumed principally through use. However, other factors, such as technical or commercial obsolescence and wear and tear, often result in the diminution of the economic benefits embodied in the assets. Management assesses the remaining useful lives in accordance with the current technical conditions of the assets and estimated period during which the assets are expected to earn benefits for the Group. The following primary factors are considered: (a) expected usage of the assets; (b) expected physical wear and tear, which depends on operational factors and maintenance program; and (c) technical or commercial obsolescence arising from changes in market conditions.
Leases Renewal Assumption – It is presumed that the initial land leases contracted for 2-5 years will be either renewed for up to 49 years at completion of construction of stores, or the Group will purchase the respective land plots. Thus, any capitalized up-front payments for lease of land are presumed to have useful life not shorter than the duration of subsequent long term leases (currently, not shorter than 25 years). Should the Group fail to renew the initial land lease contracts, or to purchase the respective land plots, leasehold rights would have to be written off at the end of the initial lease term.
A-15 Compliance with Tax Legislation – Russian tax, currency and customs legislation is subject to frequent changes and varying interpretations. Management’s interpretation of such legislation in applying it to business transactions of the Group may be challenged by the relevant regional and federal authorities enabled by law to impose fines and penalties. Recent events in the Russian Federation suggest that the tax authorities are taking a more assertive position in their interpretation of the legislation and assessments and as a result, it is possible that the transactions that have not been challenged in the past may be challenged. Fiscal periods remain open to review by the tax authorities in respect of taxes for the three calendar years preceding the year of tax review. Under certain circumstances reviews may cover longer periods. While the Group believes it has provided adequately for all tax liabilities based on its understanding of the tax legislation, the above facts may create additional financial risks for the Group (see Note 23).
6. REVENUE The Group’s hypermarkets are located in St. Petersburg, Leningrad region, Moscow region, Nizhniy Novgorod, Izhevsk and Volgograd.
The following table provides an analysis of the Group’s sales by geographical areas where the products and services are sold.
2007 2006 ‘000 USD ‘000 USD St. Petersburg and Leningrad region ...... 588,080 290,071 Moscow region ...... 172,259 45,225 Nizhniy Novgorod ...... 43,932 24,546 Izhevsk ...... 16,784 776 Volgograd ...... 10,062 – 831,117 360,618
7. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses for the year ended 31 December consisted of the following:
2007 2006 ‘000 USD ‘000 USD Payroll expenses ...... 84,926 36,709 Depreciation of property, plant and equipment ...... 24,114 10,575 Temporary power generation for hypermarkets ...... 18,069 4,471 Advertising and promotional expenses ...... 9,744 4,661 Packaging and raw materials ...... 8,874 3,508 Taxes, other then income tax ...... 5,937 1,723 Operating lease expenses (rent) ...... 4,655 4,198 Security services ...... 4,126 1,779 Repair and maintenance ...... 2,467 880 Bank charges ...... 1,406 472 Audit and consulting fees ...... 991 814 Telecommunication ...... 898 416 Amortization of long-term leasehold property assets ...... 388 197 Bad debt expense ...... 231 620 Transportation ...... 42 51 Other expenses ...... 5,504 3,124 Total ...... 172,372 74,198
A significant portion of the Group’s operational and accounting personnel is outsourced from two external staff management companies. The related outsourcing fees paid by the Group are shown within the payroll expenses.
Expenses relating to temporary power generation for hypermarkets include operating lease expenses incurred on leasing power generating equipment, maintenance costs of such equipment and the cost of diesel fuel. These expenses are incurred before a hypermarket is switched on to a permanent electrical power network
A-16 connection. These expenses are stated net of compensation received from construction companies for delays in connecting new hypermarkets to permanent networks.
The total operating lease expenses of the Group for the year ended 31 December 2007 amounted to USD 17,089 thousand (2006: USD 8,230 thousand).
8. OTHER NON-OPERATING GAINS AND LOSSES During the year ended 31 December 2007 the Group completed a sale of certain non-core real estate assets, such as plots of land which were considered not suitable as a place for construction of the Group’s stores.
The net loss for the year ended 31 December 2007 includes a loss of USD 2,619 thousand on disposal of a land plot which was classified as non-current asset held for sale and had a carrying value of USD 20,769 thousand as of 31 December 2007. The original purchase price paid by the Group to acquire this land plot and consideration received by the Group on subsequent disposal denominated in USD were substantially the same in USD terms and the loss was primarily attributed to the devaluation of USD against RUR.
Also, included in the net loss for the year ended 31 December 2007 is a gain of USD 1,173 thousand on disposal of another land plot which had a carrying value of USD 2,546 thousand and was included in property, plant and equipment as of 31 December 2006.
9. NET FINANCE COSTS Finance costs for the years ended 31 December consisted of the following:
2007 2006 ‘000 USD ‘000 USD Interest expense ...... (12,772) (8,965) Interest income ...... 496 47 Effect of discounting originated loans to market rates on initial recognition ...... – 451 Total ...... (12,276) (8,467)
10. INCOME TAX The statutory tax rate effective in the Russian Federation, the location of the majority of the Group’s entities, was 24% in the year ended 31 December 2007. The Group companies registered in other countries are paying income taxes in their respective jurisdictions.
The taxable profits of Formata Holding B.V., an entity incorporated in the Netherlands, are taxed at a rate of 31.5% for the year ended 31 December 2007. The taxable profits of Hirsova Trading Ltd., an entity incorporated in Cyprus, are taxed at 10% for the year ended 31 December 2007.
The Group’s total income tax expense is as follows:
2007 2006 ‘000 USD ‘000 USD Current tax ...... 9,327 3,550 Deferred tax ...... 2,626 67 Total income tax expense ...... 11,953 3,617
The amount of income tax expense for the period is different from that which would be obtained by applying the statutory income tax rate to the profit before income tax. Below is a reconciliation of theoretical income tax at 24% to the actual expense recorded in the consolidated income statement:
2007 2006 ‘000 USD % ‘000 USD % Profit before income tax ...... 31,825 13,530 Theoretical income tax at Russian statutory rate of 24% ...... 7,638 24% 3,247 24% Adjustments due to: Effect of different tax rate of the Company operating in other jurisdiction ...... (235) 1% (1,109) 8% Tax effect of expenses that are not deductible in determining taxable profit ..... 4,550 14% 1,479 11% Income tax expense ...... 11,953 37% 3,617 27%
A-17 Deferred taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for tax purposes.
The tax effect of temporary differences that give rise to the deferred tax assets and liabilities as of 31 December is summarized as follows:
2007 2006 ‘000 USD ‘000 USD Deferred tax assets Difference between tax and book value of inventory ...... 2,240 1,373 Asset recognized with respect to tax losses carried forward ...... 4,829 1,393 Other ...... 644 414 Total ...... 7,713 3,180 Deferred tax liabilities Difference between tax and book value of property, plant and equipment ...... (9,844) (2,685) Total ...... (9,844) (2,685)
As of 31 December 2007 the aggregate amount of temporary differences associated with undistributed earnings of subsidiaries, amounted to USD 97,024 thousand (2006: USD 76,351 thousand). The tax effect of such differences calculated at a tax rate of 5%, as established in the double-tax treaty between the Russian Federation and the Netherlands, and at a Russian statutory withholding tax rate of 9%, where transfers of profits have to be first made between the Russian legal entities of the Group, has amounted to USD 12,532 thousand as of 31 December 2007 (2006: USD 10,392 thousand). No deferred tax liability has been recognized in respect of these differences, since the Group does not have an intention to distribute such earnings in the near future, and also such statutory earnings exceed the consolidated retained earnings of the Group of USD 31,943 thousand as of 31 December 2007 (2006: USD 12,071 thousand).
11. EARNINGS PER SHARE Basic earnings per share are calculated by dividing the profit or loss attributable to equity holders of the Company by the weighted average number of ordinary shares in issue during the year, excluding treasury shares.
Earning per share are calculated as follows:
2007 2006 ‘000 USD ‘000 USD Net profit for the year ...... 19,872 9,913 Weighted average number of ordinary shares in issue (Note 18) ...... 10,376,225 6,027,493 Basic and diluted earnings per share for profit (expressed in USD per share) ..... 1.92 1.64
A-18 12. PROPERTY, PLANT AND EQUIPMENT
Assets in the Land and Refrigerating Other course of buildings equipment Vehicles equipment construction Total ‘000 USD ‘000 USD ‘000 USD ‘000 USD ‘000 USD ‘000 USD Cost As of 31 December 2005 ...... 71,711 5,421 506 11,467 116,303 205,408 Additions ...... 84,954 – – – 78,052 163,006 Disposals ...... – – – (71) – (71) Transfers ...... 32,946 4,281 1,081 36,314 (74,622) – Translation adjustment ...... 10,135 640 80 2,168 10,382 23,405 As of 31 December 2006 ...... 199,746 10,342 1,667 49,878 130,115 391,748 Additions ...... 38,576 – – – 88,410 126,986 Disposals ...... (2,546) – – (180) – (2,726) Transfers ...... 1,871 10,326 71 51,055 (63,323) – Translation adjustment ...... 16,079 1,175 124 5,711 10,489 33,578 As of 31 December 2007 ...... 253,726 21,843 1,862 106,464 165,691 549,586 Accumulated depreciation As of 31 December 2005 ...... (428) (186) (69) (2,420) – (3,103) Charge for the year ...... (2,766) (935) (207) (6,667) – (10,575) Eliminated at disposals ...... – – – 1 – 1 Translation adjustment ...... (124) (46) (13) (346) – (529) As of 31 December 2006 ...... (3,318) (1,167) (289) (9,432) – (14,206) Charge for the year ...... (6,850) (2,475) (346) (14,443) – (24,114) Eliminated at disposals ...... – – – 34 – 34 Translation adjustment ...... (522) (186) (36) (1,276) – (2,020) As of 31 December 2007 ...... (10,690) (3,828) (671) (25,117) – (40,306) Net book value As of 31 December 2006 ...... 196,428 9,175 1,378 40,446 130,115 377,542 As of 31 December 2007 ...... 243,036 18,015 1,191 81,347 165,691 509,280
For the years ended 31 December 2007 and 2006 borrowing costs capitalized and included in the costs of property, plant and equipment amounted to USD 10,900 thousand and USD 4,797 thousand, respectively.
As of 31 December 2007 and 2006 property, plant and equipment with a net book value of USD 154,353 thousand and USD 20,951 thousand, respectively, were pledged to secure certain loans granted to the Group.
Assets in the course of construction as of 31 December consisted of the following:
2007 2006 ‘000 USD ‘000 USD Assets in the course of construction ...... 80,406 47,559 Advance payments for assets in the course of construction ...... 44,866 55,333 Up-front payments for lease of land related to assets in the course of construction ...... 27,891 15,848 Advanced payments to related parties for assets in the course of construction (Note 21) .... 12,528 11,375 Total ...... 165,691 130,115
Up-front payments for lease of land represent the cost of acquiring rights to lease land necessary to commence construction of the Group’s hypermarkets.
13. LONG-TERM LOANS Long-term loans as of 31 December 2007 and 2006 consisted of the loans in RUR to the companies previously engaged in development of land plots, which are no longer intended for own use. The loans were issued in 2004-2006 at interest rate of 0.2%-15.1% and were maturing in 2011. At the borrowers’ initiative, the loans were early repaid in 2007.
A-19 14. INVENTORIES Inventories as of 31 December consisted of the following:
2007 2006 ‘000 USD ‘000 USD Goods in hypermarkets ...... 92,606 62,745 Less: shrinkage provision ...... (78) (36) Total ...... 92,528 62,709
Inventory shrinkage recognized as cost of sales in 2007 amounted to USD 5,921 thousand (2006: USD 2,104 thousand).
15. RECEIVABLES AND PREPAYMENTS Receivables and prepayments as of 31 December consisted of the following:
2007 2006 ‘000 USD ‘000 USD VAT reimbursable ...... 49,856 40,007 Accounts receivable for long-term assets disposal ...... – 23,094 Other receivables and prepayments ...... 9,585 17,322 Other taxes receivable ...... 2,641 1,109 Receivables from related parties (Note 21) ...... 1,301 1,441 Advances paid ...... 525 544 Provision for doubtful other receivables and prepayments ...... (1,353) (1,037) Total ...... 62,555 82,480
The receivable of USD 23,094 thousand for the sale of land lease rights made in 2006, was fully collected in 2007.
Management considers that the carrying amount of receivables and prepayments approximates their fair value.
Movements in the provision for doubtful receivables are as follows:
2007 2006 ‘000 USD ‘000 USD Balance at the beginning of the year ...... 1,037 364 Increase in allowance for doubtful receivables ...... 658 985 Amounts recovered during the year ...... (427) (365) Translation adjustment ...... 85 53 Balance at the end of the year ...... 1,353 1,037
16. OTHER CURRENT ASSETS Other current assets as of 31 December consisted of the following:
2007 2006 ‘000 USD ‘000 USD Assets transferable to related parties (Note 21) ...... 13,377 6,707 Total ...... 13,377 6,707
Other current assets represent expenditure on construction of premises transferable to LLC Makromir and LLC Grand Prix, related parties of the Group. Respective prepayments from LLC Makromir and LLC Grand Prix have been included in prepayments received for construction work within payables to related parties (see Note 21).
A-20 17. CASH AND CASH EQUIVALENTS Cash and cash equivalents as of 31 December consisted of the following:
2007 2006 ‘000 USD ‘000 USD Cash in banks, RUR accounts ...... 53,979 20,290 Bank deposits at call, RUR ...... 34,229 – Bank deposits at call, USD ...... 4,440 – Cash in transit, RUR ...... 15,671 7,029 Cash in banks, foreign currency accounts, USD ...... 31 136 Cash in banks, foreign currency accounts, EUR ...... 99 64 Cash in hand, RUR ...... 1,586 1,473 Total ...... 110,035 28,992
Cash in transit represents cash collected by the bank from the Group’s hypermarkets as of the end of 31 December 2007 and 2006 and not deposited into the current bank accounts as of such dates.
Deposits at call were held with the following banks as of 31 December 2007: Sberbank, Bank VTB North- West (Promstroybank), Fortis Bank (Nederland) N.V.
18. CAPITAL As of 31 December 2007 the authorized share capital of Formata Holding B.V. consisted of EUR 300,000,000 divided into 30,000,000 shares of EUR 10 each.
Number of Nominal shares issued par value and fully paid 2007 2006 ‘000 USD ‘000 USD Formata Holding B.V...... EUR10 10,376,225 133,077 133,077
During 2006 the Group’s shareholders, Puritani Corporation N.V. and Overture Corporation N.V., converted loans with a principal amount of USD 132,977 thousand and USD 75 thousand of interest accrued thereon into additional ordinary shares in Formata Holding B.V. The increase of share capital was registered on 2 June 2006.
During 2007 and 2006 the Group did not pay or declare any dividends.
Distributable earnings are determined in accordance with legislation of the Group’s companies residence.
In December 2007 the shareholders of the Company contributed their entire interest in the shares of Hirsova Trading Ltd to the Company. As a result of this non-cash capital contribution additional paid-in capital of the Company was increased by USD 2 thousand, representing the nominal value of the share capital of Hirsova Trading Ltd. For the description of the change in presentation of the financial statements as a result of this transaction see Basis of Presentation in Note 2.
19. LONG-TERM AND SHORT-TERM BORROWINGS Long-term borrowings as of 31 December comprise the following:
Currency Annual interest rate 2007 2006 ‘000 USD ‘000 USD Bonds (Karusel Finance 01, ISIN: RU000A0JNNC7) . . . RUR 9.75% – 113,503 Sberbank ...... RUR 11-16% 56,373 43,354 Raiffeisenbank ...... RUR 1-month 29,054 13,140 MOSPRIME + 2.25% Gazprombank ...... RUR 13.5-14.5% 14,938 20,344 Bank VTB North-West (Promstroybank) ...... RUR 12-14% 7,691 8,146 108,056 198,487
A-21 Short-term borrowings as of 31 December are presented by the following:
Annual interest Currency rate 2007 2006 ‘000 USD ‘000 USD Bonds (Karusel Finance 01, ISIN: RU000A0JNNC7) ...... RUR 9.75% 121,802 – Loan from Sberbank, current portion ...... 9,143 1,771 Loan from Gasprombank, current portion ...... 6,885 2,656 Loan from Promstroybank, current portion ...... 1,047 209 Loan from Raiffeisenbank, current portion ...... 482 – Short-term loans from related parties (Note 21) ...... – 26,148 Total ...... 139,359 30,784
Summary of borrowing arrangements Bonds – On 1 August 2006, LLC Karusel Finance, a 99.99% owned subsidiary of LLC Kaizer, issued 7-year ruble-denominated bonds with a total nominal value RsUR 3 billion. The coupon rate for the first two years, determined through an auction, is 9.75% per annum. Interest on bonds is payable every six months. A coupon for the remaining five years until repayment will be determined at an auction to be held in September 2008. Although the majority of bonds are not expected to be claimed by their holders for repayment in September 2008, as the bond holders are effectively entitled to a put option at the time a coupon rate is reset, bonds have been classified as short-term as of 31 December 2007.
Credit line from Promstroybank – In July 2006 the Group entered into a credit line agreement with Promstroybank for RUR 220,000 thousand (the outstanding balances were equivalent to USD 8,738 and 8,355 thousand as of 31 December 2007 and 2006, respectively). Loan borrowed under this facility is secured by the Group’s 100% interest in LLC Avtoport. In accordance with loan agreement LLC Avtoport shall pledge building of a hypermarket under construction as soon as title to this building is duly registered. Equipment with carrying value of USD 1,581 thousand was pledged to collateralize the outstanding balance as of 31 December 2007. The loan bears interest of 12.5% per annum and matures in 2013.
Credit lines from Raiffeisenbank – In December 2006 the Group entered into a credit line agreement with Raiffeisenbank for RUR 346,000 thousand (an equivalent of USD 13,140 thousand as of 31 December 2006). The loan borrowed under this facility was fully re-paid in 2007.
In May and July 2007 the Group entered into two credit line agreements with Raiffeisenbank for RUR 225,000 and 1,125,000 thousand (the outstanding balances under these credit lines were equivalent to USD 9,166 and 20,370 thousand as of 31 December 2007, respectively). Loans borrowed under these credit facility arrangements are secured by two hypermarket buildings with a carrying value of USD 4,039 and USD 20,709 thousand, respectively, and a plot of land with carrying value of USD 1,746 thousand as of 31 December 2007. The loans bear interest at Mosprime + 3.1% per annum and mature in 2013.
Loans and credit lines from Sberbank – In September 2004 the Group entered into a loan agreement with Sberbank for RUR 180,000 thousand (the outstanding balances were equivalent to USD 7,334 and 6,836 thousand as of 31 December 2007 and 2006, respectively). The loan is secured by the Group’s 100% interest in LCC Matrix and a collateral of assets in the course of construction with a carrying value of USD 8,001 thousand as of 31 December 2007. The loan bears interest of 16% per annum and matures in 2011.
In 2005 the Group entered into a loan agreement with Sberbank for RUR 200,000 thousand (the outstanding balances were equivalent to USD 7,192 and 7,596 thousand as of 31 December 2007 and 2006, respectively). The loan is secured by the Group’s 100% interest in LCC Emitel and a collateral of assets in the course of construction with a carrying value of USD 8,688 thousand as of 31 December 2007. The loan bears interest of 11.61% per annum and matures in 2012.
In February and December 2006 the Group entered into three credit line agreements with Sberbank for RUR 545,915, 275,000 and 430,000 thousand, respectively (the outstanding balances under these credit lines were equivalent to USD 21,607, 10,873 and 14,953 thousand as of 31 December 2007, and equivalent to USD 20,711, 9,982 thousand and Nil as of 31 December 2006, respectively). The loans borrowed under these facilities were secured by the Group’s 100% stake in LCC Krasnoborskoye, LCC Dalnevostochny and LLC Kollontay, by
A-22 a plot of land with carrying value of USD 8,766 thousand as of 31 December 2007 and by a collateral of assets in the course of construction with a carrying value of USD 57,900 thousand as of 31 December 2007. The loans bear 12%, 11% and 11%, respectively, and mature in 2013.
In February 2007 the Group entered into a credit line agreement with Sberbank for RUR 235,000 thousand (the outstanding balances under this credit line was USD 3,557 thousand as of 31 December 2007). The loan borrowed under this facility is secured by the Group’s 100% interest in LCC Kaizer-Ural and a collateral of assets in the course of construction with a carrying value of USD 10,258 thousand as of 31 December 2007. The loan bears interest of 11% per annum and matures in 2015.
Credit line from Gazprombank – In January and March 2006 the Group entered into credit line agreements with Gazprombank for RUR 292,317 and 313,305 thousand (the outstanding balances under these credit lines were USD 10,247 and 11,576 thousand as of 31 December 2007, and USD 11,101 and 11,899 thousand as of 31 December 2006, respectively). The loans borrowed under these facilities are secured by the Group’s stake in LCC Ukatan, by 100% interest in LLC Stalebetona, by a land plot with a carrying value of USD 5,474 thousand as of 31 December 2007, and a collateral of assets in the course of construction with carrying value of USD 27,191 thousand as of 31 December 2007. The loans bear interest of 11.5% and mature in 2011.
The total unused credit facility available under the above arrangements with Promstroybank, Raiffeisenbank, Sberbank and Gazprombank was USD 33,378 and 16,793 thousand as of 31 December 2007 and 2006, respectively.
20. OTHER PAYABLES AND ACCRUED EXPENSES Other payables and accrued expenses as of 31 December consisted of the following:
2007 2006 ‘000 USD ‘000 USD Payables to related parties (Note 21) ...... 27,927 14,496 Accrued payroll expense ...... 11,041 4,372 Taxes payable ...... 5,193 2,973 Advances received ...... 5,519 12,425 Payables for assets in the course of construction ...... 3,249 836 Interest payable ...... 3,698 3,186 Other payables ...... 14,444 5,073 Total ...... 71,071 43,361
21. TRANSACTIONS WITH RELATED PARTIES As of 31 December 2007 and 2006 and for the years then ended, the Group had the following balances with related parties:
2007 2006 ‘000 USD ‘000 USD ASSETS Prepayments issued for construction works ...... 12,528 11,375 Other current assets – Assets transferable to related parties ...... 13,377 6,707 Accounts receivable (Note 15) ...... 1,301 1,441 LIABILITIES Prepayments received for Assets transferable to related parties (Note 20) ..... 27,149 12,599 Accounts payable (Note 20) ...... 778 1,897 Short-term borrowings ...... – 26,148
Purchases from related parties for the years ended 31 December 2007 and 2006 comprised of the following:
2007 2006 ‘000 USD ‘000 USD Purchases from related parties Purchases of construction services ...... 43,138 3,763 Compensations for construction services ...... (2,114) – Purchases of outsourcing services ...... 408 1,540 Operating lease expenses ...... 186 481 Purchases of goods and other services ...... 260 260
A-23 Prepayments Issued for Construction Works – In 2006 and 2007 the Group has entered into several agreements with related parties for construction services: LLC Makromir, LLC ICAR, LLC Grand Prix and LLC LEK. Beneficiary owner of controlling interest in the Group has control, joint control or is able to exercise significant influence over these entities. The amounts represent advances paid by the Group for construction services and included in the assets in the course of construction balance.
Assets Transferable to Related Parties – In 2006 and 2007 the Group has also entered into several investment agreements with LLC Makromir and LLC Grand Prix to act as a co-investor in construction of hypermarkets of the Group. On completion of construction and registration of property titles, the title for parts of the hypermarket space and other property under development will be transferred to LLC Macromir and LLC Grand Prix.
Short-term Borrowings – In December 2005 and February 2006, the Group received loans from Technibel Worldwide Ltd. for USD 19,000 thousand and from Tassa Development Ltd. for USD 12,000 thousand and USD 10,000 thousand to finance the Group’s capital expenditures. Technibel Worldwide Ltd. and Tassa Development Ltd. are parties related to the ultimate beneficiaries of the Group. The loans were bearing an interest of 16% per annum and where repaid in March 2007 before their scheduled maturity. Interest expense for the years ended 31 December 2007 and 2006 was USD 530 thousand and USD 3,060 thousand, respectively.
Purchases of Goods and Services – in 2006-2007 the Group used the rent, outsourcing and other services from X5 Retail Group N.V., a party related by means of common ownership.
Compensation of Key Management Personnel – The remuneration of the directors and officers of the Group for the year ended 31 December was as follows:
2007 2006 ‘000 USD ‘000 USD Payroll ...... 362 295 Bonuses ...... 3,827 1,316 4,189 1,611
22. COMMITMENTS Capital Expenditure Commitments – In 2006 and 2007 the Group entered into several investment agreements for the construction of hypermarkets in St. Petersburg. The amount of commitments under these agreements as of 31 December 2007 and 2006 were USD 30,699 and USD 14,477 thousand, respectively.
Operating Lease Commitments – Where the Group is the lessee, the future minimum lease payments under non-cancellable operating leases of property were as follows (net of VAT):
2007 2006 ‘000 USD ‘000 USD Not later than 1 year ...... 1,202 810 Later than 1 year and not later than 5 years ...... 7,234 6,994 Later than 5 years ...... 53,180 54,622 61,616 62,426
Certain adjustments to the above minimum lease payments are expected once the land tax rates are amended by the local authorities.
23. FINANCIAL INSTRUMENTS (a) Capital risk management The Group manages its capital to ensure that entities in the Group will be able to continue as a going concern while maximizing the return to stakeholders through the optimization of the debt and equity balance. The primary focus of the Group to achieve this objective is to minimize the risks and costs associated with its loan portfolio. The Group uses a combination of bonds issued, long-term loans, short-term loans and supplier payables to meet its capital needs.
A-24 While the Group has not established any formal policies regarding debt to equity ratios, the Group reviews the capital needs of the Group periodically to determine actions to balance its overall capital structure through shareholders’ capital contributions or new share issues, return of capital to shareholders as well as the issue of new debt or the redemption of existing debt.
(b) Significant accounting policies Details of the significant accounting policies and methods adopted, including the criteria for recognition, the basis of measurement and the basis on which income and expenses are recognized, in respect of each class of financial asset, financial liability and equity instrument are disclosed in note 4 to these consolidated financial statements.
(c) Categories of financial instruments
2007 2006 ‘000 USD ‘000 USD Financial assets Loans and receivables (including cash) ...... 172,081 121,591 Available-for-sale financial assets ...... 13,377 27,476 Financial liabilities At amortized cost ...... (544,238) (368,526)
(d) Market risk The Group’s activities expose it primarily to the financial risks in foreign currency exchange rates (see (e) below) and interest rates (see (f) below). These risks include market risk (including currency risk, fair value interest rate risk and price risk), credit risk, liquidity risk and cash flow interest rate risk.
(e) Foreign currency risk management The Group is exposed to foreign currency risk on balances that are denominated in currencies other than the functional currency of its operating entities. The Group’s exposure to foreign currency risk is not currently significant as majority of its borrowings and operating transactions are denominated in Russian Roubles.
The Group is mainly exposed to changes in exchange rate of US Dollars. At 31 December, if the Russian Rouble had weakened/strengthened by 10% against the US Dollar with all the other variables held constant, post-tax profit for the year would have been USD 343 thousand (31 December 2006: USD 2,392) lower/higher.
(f) Interest rate risk management The Group is exposed to interest rate risk. Borrowings issued at variable rates expose the Group to cash flow interest rate risk. The Group’s future cash flows are also exposed to the change in interest rates due to the fact that a portion of the Group’s borrowings are short-term and would need to be refinanced in the next 12 months. Additionally, the Group is exposed to changes in the interest rate payable on the corporate bonds which is to be determined in September 2008 as described in Note 19. The Group does not hedge against these risks. The Group intends to finance its operations in the future using predominantly fixed-rate long-term borrowings.
The following table demonstrates the sensitivity to a reasonably possible change in interest rates, with all other variables held constant, of the Group’s profit before tax (through the impact on floating rate borrowings). This assumes that year end debt levels are constant over the year. There is no impact on the Group’s equity.
Increase / Annualized (decrease) effect on profit in basis points before tax 2006 changes in the floating interest rates ...... 100 (1,985) (100) 1,985 2007 changes in the floating interest rates ...... 100 (2,298) (100) 2,298
Borrowings obtained at fixed rates expose the Group to fair value interest rate risk. The fair value of bonds traded on MICEX is determined based on active quotations and amounted to USD 121,729 and USD 113,592 thousand as of 31 December 2007 and 2006, respectively.
A-25 (g) Credit risk management Credit risk is the risk that a counterparty may default or not meet its obligations to the Group on a timely basis, leading to financial loss to the Group. Financial assets, which are potentially subject to credit risk, consist principally of cash in bank accounts and cash in transit, loans and receivables. The Group minimizes its exposure to this risk by ensuring that credit risk is spread across a number of counterparties. Credit is only extended to counterparties undergoing strict approval procedures. In case of delivery of equipment the prepayments made by the Group are generally limited to 30 percent of the contract amount and the final payment is provided after delivery is complete.
The Group trades only with recognized, creditworthy third parties who are registered in the Russian Federation. It is the Group’s policy that all customers who are granted credit terms have a history of purchases from the Group. The Group also requires these customers to provide certain documents such as incorporation documents and financial statements. In addition, receivable balances are monitored on an ongoing basis with the result that the Group’s exposure to bad debts is not significant.
(h) Fair value of financial instruments Except for the fair value of bonds issued by the Group (see (f) above) the fair value of financial assets and liabilities approximates is their financial statement carrying values.
(i) Liquidity risk management The Group’s objective is to maintain a continuity of funding and flexibility through the use of bank overdrafts and bank loans. Each year the Group analyzes its funding needs and anticipated cashflows, so that it can determine its funding needs. The Group uses long-term instruments (loans and borrowings) to cover a significant proportion of its capital needs. The Group uses short-term loans and bank overdrafts to cover base liquidity needs.
The table below summarizes the maturity profile of the Group’s financial liabilities at 31 December 2007 based on contractual undiscounted cash flows of the financial liabilities based on the earliest date on which the Group can be required to pay. The table includes both interest and principal cash flows. When the amount payable is not fixed for the entire term of the instrument, such as variable rate interest payments and coupon rate on bonds, the amounts disclosed in the table are determined by reference to the conditions existing (e.g. MOSPRIME index) at the balance sheet date:
Less than More than 31 December 2007 3 months 3-12 months 1-5 years 5 years Total Borrowings – principal ...... – 139,359 100,518 7,538 247,415 Borrowings – interest ...... 6,200 18,601 71,260 9,225 105,286 Trade payables ...... 231,271 – – – 231,271 Other payables and accrued expenses ...... 19,931 45,621 – – 65,552 Total ...... 257,402 203,581 171,778 16,763 649,524
Less than More than 31 December 2006 3 months 3-12 months 1-5 years 5 years Total Borrowings – principal ...... 306 30,478 187,592 10,895 229,271 Borrowings – interest ...... 3,946 11,656 81,584 23,702 120,888 Trade payables ...... 108,319 – – – 108,319 Other payables and accrued expenses ...... 10,531 32,830 – – 43,361 Total ...... 123,102 74,964 269,176 34,597 501,839
24. OPERATING ENVIRONMENT AND CONTINGENCIES Operating and Regulatory Environment – Although in recent years there has been a general improvement in economic conditions in Russia, the Russian Federation continues to display certain characteristics of a transitional economy. These include, but are not limited to, currency controls and convertibility restrictions, relatively high level of inflation (according to the government’s statistical data consumer price inflation for the years ended 31 December 2007 and 2006 was 11.9% and 9%, respectively) and continuing efforts by the government to implement structural reforms. As a result laws and regulations affecting businesses continue to change rapidly.
A-26 Taxation – Tax laws in Russia are subject to frequent changes and varying interpretations. Management’s interpretation of such legislation in applying it to business transactions of the Group may be challenged by the relevant regional and federal authorities enabled by law to impose fines and penalties. Recent events within the Russian Federation suggest that the tax authorities are taking a more assertive position in its interpretation of the legislation and assessments and as a result, it is possible that the transactions that have not been challenged in the past may be challenged. Fiscal periods remain open to review by the tax authorities in respect of taxes for the three calendar years preceding the year of tax review. Under certain circumstances reviews may cover longer periods. While the Group believes it has provided adequately for all tax liabilities based on its understanding of the tax legislation, the above facts may create additional financial risks for the Group.
Management regularly reviews the Group’s taxation compliance with applicable legislation, laws and decrees and current interpretations published by the authorities in the jurisdictions in which the Group has operations. Furthermore, Management regularly assesses the potential financial exposure relating to tax contingencies for which the 3 years tax inspection right has expired but which, under certain circumstances, may be challenged by regulatory bodies. From time to time potential exposures and contingencies are identified and at any point in time a number of open matters may exist. As of 31 December 2007 the Group recorded a provision for potential tax liabilities of USD 100 thousand (2006: USD 180 thousand) which it considers probable of occurring.
Effective from 1 January 2006 the Article 269 of the Russian Tax Code was amended to require a reduction of the deductible amount of interest on loans, and an accrual of additional income tax liability, when the respective borrowings are classified as debt controlled by a foreign related party. Such controlled debt includes debt to Russian legal entities which are related to a foreign legal entity, through direct or indirect ownership of over 20% of the taxpayer’s capital. Practical implementation of these rules and availability of interpretative guidance published by the tax authorities is limited. The Group is also not aware of any arbitration court practice on the matter. The Group has not made any provision for the potential tax impact of intra-Group transactions which may fall under these rules. Given the short period of application of the current Russian thin capitalization rules, the impact of any challenge of the Group’s position by the tax authorities regarding the effect of certain intra-Group borrowings on the total tax liabilities of the Group is uncertain. However, the impact of this as well as other potential tax risks that are more than remote on the financial position and operations of the Group may be significant. The range of potential exposures in relation to income tax and other taxes that are more than remote, but for which no liability is recognized under IFRS, is not disclosed to avoid prejudicing the Group’s position.
Insurance – The insurance industry in the Russian Federation is in the process of development and many forms of insurance protection common in developed markets are not yet generally available in Russia. The Group does not fully cover many risks that a group of a similar size and nature operating in a more economically developed country would insure. Management understands that until the Group obtains adequate insurance coverage there is a risk that the loss or destruction of certain assets could have an adverse effect on the Group’s operations and financial position.
Environmental matters – The enforcement of environmental regulation in the Russian Federation is evolving and the enforcement posture of government authorities is continually being reconsidered. The Group periodically evaluates its obligations under environmental regulations. As obligations are determined, they are recognised immediately. Potential liabilities, which might arise as a result of changes in existing regulations, civil litigation or legislation, cannot be estimated but could be material. In the current enforcement climate under existing legislation, management believes that there are no significant liabilities for environmental damage.
A-27 25. SUBSIDIARIES Details of the Company’s major subsidiaries which undertake significant activities as of 31 December 2007 are as follows:
Proportion of ownership Place of incorporation interest Name of subsidiary (or registration) and operation (%) Principal activity LLC Rusel ...... Russia, St. Petersburg 100% Trade operator in St. Petersburg and Leningrad region LLC Kaizer ...... Russia, St. Petersburg 100% Property management and logistics LLC Matrix ...... Russia, St. Petersburg 100% Property ownership and letting in St. Petersburg LLC Krasnoborskoye ...... Russia, St. Petersburg 100% Property ownership and letting in St. Petersburg LLC Emitel ...... Russia, St. Petersburg 100% Property ownership and letting in St. Petersburg LLC Ukatan ...... Russia, St. Petersburg 100% Property ownership and letting in St. Petersburg LLC Stalebeton ...... Russia, St. Petersburg 100% Property ownership and letting in St. Petersburg LLC Avtoport ...... Russia, St. Petersburg 100% Property ownership and letting in St. Petersburg LLC Dalnevostochny ...... Russia, St. Petersburg 100% Property ownership and letting in St. Petersburg LLC Kollontay ...... Russia, St. Petersburg 100% Property ownership and letting in St. Petersburg LLC Land invest ...... Russia, St. Petersburg 100% Property ownership and letting in St. Petersburg LLC Sportivny ...... Russia, St. Petersburg 100% Property ownership and letting in St. Petersburg LLC Inzhstroy NN ...... Russia, Nizhniy Novgorod 100% Property ownership and letting in Nizhniy Novgorod LLC Region proekt ...... Russia, Volgograd 100% Property ownership and letting in Volgograd LLC Kaizer-Izhevsk ...... Russia, Izhevsk 100% Property ownership and letting in Izhevsk LLC Kaizer-Ural ...... Russia, St. Petersburg 100% Property ownership in Ekaterinburg LLC Forum ...... Russia, St. Petersburg 100% Property ownership and letting in St. Petersburg LLC Karusel-Finance ...... Russia, St. Petersburg 100% Issuer of Bonds (Note 19) LLC Rusel M ...... Russia, Moscow region 100% Trade operator in Moscow region, Izhevsk, Nizhniy Novgorod and Volgograd LLC Union Stroy ...... Russia, Moscow region 100% Property management and logistic LLC Oblast Fill 5 ...... Russia, Moscow region 100% Property ownership and letting in Moscow region LLC Gipertrade ...... Russia, Moscow region 100% Property ownership and letting in Moscow region LLC Artvey ...... Russia, Moscow region 100% Property ownership and letting in Moscow region LLC Format-M ...... Russia, Moscow region 100% Property ownership and letting in Moscow region LLC Fili oblast 2 ...... Russia, Moscow region 100% Property ownership and letting in Moscow region Hirsova Trading Ltd...... Cyprus 100% Karusel trade mark owner till December 2007
A-28 Additionally, as part of its capital investments in construction of new hypermarkets the Group routinely acquires 100% ownership in entities which hold land ownership rights and are engaged in hypermarket construction activities using financing of LLC Kaizer and LLC Union Stroy. These entities are to be subsequently legally merged into the Group’s operating companies when the construction phase is completed.
26. SUBSEQUENT EVENTS In 2007 the shareholders of the Group established a group of companies consisting of a holding company Donson B.V. incorporated in the Netherlands and its Russian subsidiaries, to carry out development activities which comprise of searching and acquisition of land plots and construction of hypermarkets. Donson B.V. owns 100% of equity in Russian subsidiaries representing special purpose entities, which hold title or lease rights to use land plots located in several cities across Russia.
In the first quarter of 2008 Kaizer LLC, a Group company, entered into a number of investment agreements with Russian subsidiaries of Donson B.V. for construction of five hypermarkets in Yaroslavl, Volzhsky (Volgograd region), Lipetsk, Ramenskoye and Zelenograd (Moscow region) during 2009-2010. The Group’s capital commitments under these agreements are estimated to be approximately USD 223,000 thousand. Additionally, in the first quarter of 2008 the Group entered into a preliminary investment agreement with Russian subsidiaries of Donson B.V. for the building of 15 hypermarkets during 2010-2012 in a number of Russian cities, including Yaroslavl, Nizhniy Novgorod and Klin (Moscow region). Under these investment agreements the Russian subsidiaries of Donson B.V. will acquire land plots, collect all permits and build hypermarkets for the Group. The Group will finance these projects in accordance with respective investment agreements and based on the agreed payment schedule.
Additionally, subsequent to 31 December 2007, Formata Holding B.V. issued a public irrevocable offer to repurchase Russian corporate bonds to be issued by Hyperfinance LLC in the second quarter of 2008. In accordance with the offer, Formata Holding B.V. will have to arrenge the redemption of all bonds including the accumulated interest in case of default of the issuer in the first year from the date of placement. The total nominal value of bonds is RUR 5 bln with a maturity of five years. Russian subsidiaries of the Group – Rusel LLC and Kaizer LLC, have issued guarantees on these bonds until their maturity, which cover both the principal amount and the interest.
A-29 ISSUER
X5 RETAIL GROUP N.V. Prins Bernhardplein 200 1097 JB, Amsterdam The Netherlands
JOINT BOOKRUNNERS
Citigroup Global Markets Limited Goldman Sachs International Alfa Capital Holdings (Cyprus) Citigroup Centre, Canada Square 133 Fleet Street Limited, London Branch Canary Wharf London, EC4A 2BB City Tower London, E14 5LB United Kingdom 40 Basinghall Street United Kingdom London, EC2V 5DE United Kingdom
LEGAL ADVISORS TO THE ISSUER
As to English and United States As to Russian law: As to Dutch law: federal and New York law:
Cleary Gottlieb Steen & Hamilton Cleary Gottlieb Steen & Hamilton Cleary Gottlieb Steen & Hamilton LLP, London LLP, Moscow LLP, Brussels City Place House, CGS&H Limited Liability Company Rue de la Loi, 57 55 Basinghall Street Paveletskaya Square 2/3 1040 Brussels London, EC2V 5EH Moscow, 115054 Belgium United Kingdom Russian Federation
LEGAL ADVISORS TO THE MANAGERS
As to English and United States law: As to Russian law: As to Dutch law:
Skadden, Arps, Slate, Meagher & Skadden, Arps, Slate, Meagher & Stibbe N.V. Flom (UK) LLP Flom LLP Stibbetoren 40 Bank Street, Canary Wharf Ducat Place III, Gasheka Street 6 Strawinskylaan 2001 London E14 5DS Moscow 125047 1077 ZZ Amsterdam United Kingdom Russian Federation The Netherlands
INDEPENDENT AUDITORS TO THE ISSUER FOR THE YEARS ENDED 2007 AND 2006 AND PEREKRESTOK HOLDINGS LIMITED AUDITORS FOR THE YEAR ENDED 2005
ZAO PricewaterhouseCoopers Audit 52 Kosmodamianskaya Nab., Bld. 5 Moscow 115054 Russian Federation
DEPOSITARY
The Bank of New York 101 Barclay Street 22nd Floor New York New York 10286 United States of America
Printed by RRDonnelley 42910