Management report
Income statement

Net profit for 2010 stood at RUB 20.0bn, an 80% increase from the RUB 11.1bn we earned in 2009. EuroChem’s EBITDA for the reported period amounted to RUB 29.9bn, up 81% from the previous year.

Revenues

Driven by a recovery in prices and volumes, especially in the P segment, consolidated revenues increased by 33% in 2010 to RUB 97.8bn from RUB 73.6bn in 2009. The revenue contributions by all of the major segments of our business have been discussed in previous sections. Below we provide a summary of how segment revenues have developed over the past three years.

* Including revenue from segment ‘other’ and elimination of internal sales.

The recovery in revenues was especially pronounced in the Phosphate segment, which was more affected by the global economic downturn in 2009 than the Nitrogen segment. Nitrogen fertilizer consumption tends to remain more consistent through cycles due to the critical role it plays for plant growth and the necessity to regularly replenish this nutrient in most soils. Higher prices for iron ore, a co-product of the apatite mining process at Kovdorsky GOK, contributed to the Phosphate segment result as well, adding RUB 15.7bn to segment revenues and RUB 7.6bn to EBITDA. Distribution, while still a relatively small portion of our revenues, grew both on the economic recovery and on the continued expansion of our distribution network. Graphs illustrating global fertilizer price dynamics are available on this page, while EuroChem sales volumes by segment are provided on this page.

Cost of sales and gross margin

Cost of sales rose 17% in 2010 to RUB 50.2bn from RUB 42.9bn in 2009. This rise was slower than the 33% increase in revenues as nearly all of the major items in the cost structure grew at a slower pace than fertilizer prices and EuroChem’s sales during the year. The cost of sales structure is illustrated in the table below.

Materials and components used or resold, which traditionally accounts for just over 50% of our cost of sales (2010: 56%) increased 30% to RUB 28.4bn in 2010 from RUB 21.9bn in 2009. Gas prices for our nitrogen plants increased 26% and 25% to RUB 2,753/per 1,000m³ and RUB 2,920/per 1,000m³ at Nomoskovskiy Azot and Nevinomysskiy Azot, respectively. Overall gas costs for fertilizer production increased by 30% to RUB 2.8bn, or by 26% due to increased prices and by 4% due to increased volumes.

While natural gas prices in Russia continue to increase incrementally, we continue to enjoy a significant cost advantage over competitors in countries and regions with higher gas prices (Ukraine, Europe). Under the current price liberalization plans of the Russian government, which remain a topic of significant internal debate, domestic gas prices are eventually expected to equal netback prices from Europe, but cost advantages are expected to remain for Russian gas consumers by virtue of savings on transportation costs and the duty levied on natural gas exports, as illustrated in the table below:

Energy costs increased 22% to RUB 5.6bn in 2010 from RUB 4.6bn in 2009. This growth was primarily due to rising energy tariffs (19.9%) and, to a lesser degree, due to higher energy use resulting from increased production volumes (6.3%).

Labor costs (15% of COS in 2010) were up 14% to RUB 7.3bn in the reported period, from RUB 6.4bn a year earlier. This was due to a number of factors, including: a low base effect as a result of the reversal of bonus accrual in 2009, a one-time salary indexation in Q1 2010; and increased reserves created for payment of 2011 payroll tax (unified social tax) due to a planned rate increase from 26% in 2010 to 33% in 2011.

Source: EuroChem estimates.

Distribution, general and administrative and other operating expenses

Distribution costs increased 5% to RUB 17.8bn in 2010 (2009: RUB 16.9bn). This was primarily due to transportation costs, which accounted for 87% of the distribution costs line, increasing 8% from RUB 14.2bn in 2009 to RUB 15.4bn in 2010. A combination of factors contributed to the growth in transportation costs, including rising domestic rail transportation tariffs for the company’s products and increased volumes of transportation.

General and administrative (G&A) expenses increased 15% in 2010 to RUB 3.8bn from RUB 3.3bn in 2009. G&A labour costs, which account for 56% of G&A expenses, increased 31% year-on-year to RUB 2.1bn. As above, this increase was due to a one-time salary indexation in the first quarter of 2010 and higher bonus accruals for 2010.

EuroChem’s other operating expenses in 2010 amounted to RUB 17m, compared to other operating income of RUB 225m in 2009 as restored sponsorship activities returned to previous levels and foreign exchange gains (the main reason for the other operating income in 2009) were not as pronounced as in the previous period.

Operating profit and operating margin

Our operating profit margin for 2010 recovered to 27% from 15% in 2009, as increasing revenues outpaced the growth in costs above the operating line, and we were able to maintain some of the reductions in cost of sales and other expenses achieved through optimizations in 2009. Our EBITDA margin also rebounded to 31% for 2010 from 22% in 2009.

The following diagram analyzes the positive and negative influences of various components on our operating profit in 2010 relative to 2009:

Finance income and costs

Our finance income was significantly different in 2010 compared to 2009. We received only RUB 148m in gross dividend income from our shares in K+S AG in May 2010, compared to RUB 2,169m a year earlier. We earned RUB 1,407m mainly from the sale of shares in K+S during 2010, compared to income of RUB 967m a year earlier. We booked a financial foreign exchange loss of RUB 390m in 2010 vs. a gain of RUB 749m in 2009 as a result of translation of financial assets and liabilities denominated in foreign currency – loans, deposits with banks and borrowings given the slight depreciation of the rouble versus the US dollar which occurred in 2010.

Interest expense increased 4% year on year as we continued to pay down the USD 1.5bn syndicated pre-export facility obtained in October 2008, while securing several new facilities during the year (discussed on page this page).

Taxation

The Company’s consolidated effective tax rate for 2010 was 19.8% (2009: 19.2%; 2008: 24.2%), virtually equivalent to the statutory profit tax rate in Russia where most of the Company’s assets are located, which was set at 20% from 1 January 2009 (previously: 24%).