|
|
 | | | |
- close
- close
- close
- close
| |||||||||
Cresud S.A.C.I.F. y A. 20-F 2006 Table of ContentsUNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 20-F
OR
For the fiscal year ended: June 30, 2006 OR
For the transition period from to Commission file number: 0-29190
CRESUD SOCIEDAD ANONIMA COMERCIAL INMOBILIARIA FINANCIERA Y AGROPECUARIA (Exact name of Registrant as specified in its charter) CRESUD INC. (Translation of Registrant’s name into English)
Republic of Argentina (Jurisdiction of incorporation or organization) Moreno 877, 23 Floor, (C1091AAQ) Buenos Aires, Argentina (Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Securities registered or to be registered pursuant to Section 12(g) of the Act: None Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None The number of outstanding shares of Common Stock of Cresud Sociedad Anónima Comercial, Inmobiliaria, Financiera y Agropecuaria as of June 30, 2006 was:
Indicate by check mark if the registrant is a well known seasoned issuer, as defined in Rule 405 of the Securities Act: ¨ Yes x No If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934. x Yes ¨ No Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (check one): Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Indicate by check mark which financial statement item the registrant has elected to follow. ¨ Item 17 x Item 18 If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No
Table of ContentsCRESUD SOCIEDAD ANÓNIMA COMERCIAL INMOBILIARIA FINANCIERA Y AGROPECUARIA
2
Table of Contents
3
Table of ContentsDISCLOSURE REGARDING FORWARD-LOOKING INFORMATION The Private Securities Litigation Reform Act of 1995 provides a “Safe Harbor” for forward looking statements. This annual report contains or incorporates by reference statements that constitute “forward-looking statements,” regarding the intent, belief or current expectations of our directors and officers with respect to our future operating performance. Such statements include any forecasts, projections and descriptions of anticipated cost savings or other synergies. Words such as “anticipate,” “expect,” “intend,” “plan,” “believe,” “seek,” “estimate,” variations of such words, and similar expressions are intended to identify such forward-looking statements. You should be aware that any such forward-looking statements are not guarantees of future performance and may involve risks and uncertainties, and that actual results may differ from those set forth in the forward-looking statements as a result of various factors (including, without limitations, the actions of competitors, future global economic conditions, market conditions, foreign exchange rates, and operating and financial risks related to managing growth and integrating acquired businesses), many of which are beyond our control. The occurrence of any such factors not currently expected by us would significantly alter the results set forth in these statements. Factors that could cause actual results to differ materially and adversely include, but are not limited to:
You should not place undue reliance on such statements, which speak only as of the date that they were made. Our independent public accountants have not examined or compiled the forward-looking statements and, accordingly, do not provide any assurance with respect to such statements. These cautionary statements should be considered in connection with any written or oral forward-looking statements that we might issue in the future. We do not undertake any obligation to release publicly any revisions to such forward-looking statements after filing of this Form to reflect later events or circumstances or to reflect the occurrence of unanticipated events.
4
Table of ContentsCERTAIN MEASURES AND TERMS As used throughout this Form 20-F, the terms “Cresud”, “Company”, “we”, “us”, and “our” refer to Cresud Sociedad Anónima Comercial, Inmobiliaria, Financiera y Agropecuaria, together with our consolidated subsidiaries, except where we make clear that such terms refer only to the parent company. In this Form 20-F, references to “Tons”, “tons” or “Tns.” are to metric tons, to “kgs” are to kilograms, to “ltrs” are to liters and “Hct” are to hectares. A metric ton is equal to 1,000 kilograms. A kilogram is equal to approximately 2.2 pounds. A metric ton of wheat is equal to approximately 36.74 bushels. A metric ton of corn is equal to approximately 39.37 bushels. A metric ton of soybean is equal to approximately 36.74 bushels. One gallon is equal to 3.7854 liter. One hectare is equal to approximately 2.47 acres. One kilogram of live weight beef cattle is equal to approximately 0.5 to 0.6 kilogram of carcass (meat and bones). PRESENTATION OF FINANCIAL AND CERTAIN OTHER INFORMATION In this annual report, references to “US$” and “U.S. Dollars” are to United States Dollars, and references to “Ps.”, “Peso” or “Pesos” are to Argentine Pesos. This annual report contains our audited consolidated financial statements as of June 30, 2006 and 2005 and for the years ended June 30, 2006, 2005 and 2004. Our consolidated financial statements have been audited by Price Waterhouse & Co. S.R.L. Buenos Aires Argentina, member firm of PricewaterhouseCoopers, a registered public accounting firm, whose report is included herein. Except as discussed in the following paragraph, we prepare our consolidated financial statements in Pesos and in conformity with the Generally Accepted Accounting Principles in Argentina (“Argentine GAAP”) and the regulations of the National Securities Commission (Comisión Nacional de Valores), which differ in certain significant respects from the Generally Accepted Accounting Principles in the United States of America (“U.S. GAAP”). Such differences involve methods of measuring the amounts shown in our financial statements, as well as additional disclosures required by U.S. GAAP and Regulation S-X of the U.S. Securities and Exchange Commission (“SEC”). See Note 17 to our consolidated financial statements contained elsewhere in this annual report for a description of the principal differences between Argentine GAAP and U.S. GAAP, as they relate to us, and a reconciliation to U.S. GAAP of net income and shareholders’ equity. As discussed in Note 3.k to our financial statements, contained elsewhere in this annual report, in order to comply with regulations of the Comisión Nacional de Valores, we recognized deferred income tax assets and liabilities on an undiscounted basis. This accounting practice represents a departure from generally accepted accounting principles in Argentina. However, such departure has not had a material effect on the accompanying financial statements. Additionally, as discussed in Note 2.c) to our consolidated financial statements, contained elsewhere in this annual report, after having considered inflation levels for the first months of 2003, on March 25, 2003, the Argentine government has repealed the provisions of the previous decree related to the inflation adjustment and has instructed the Comisión Nacional de Valores to issue the necessary regulations to preclude companies under its supervision from presenting price-level restated financial statements. Therefore, on April 8, 2003, the Comisión Nacional de Valores has issued a resolution providing for the discontinuance of inflation accounting as of March 1, 2003. We have complied with the Comisión Nacional de Valores resolution and we have accordingly recorded the effects of inflation until February 28, 2003. Comparative figures have also been restated until that date, using a conversion factor of 1.1232. On January 12, 2005 the Council of Economic Sciences of the City of Buenos Aires (Consejo Profesional de Ciencias Económicas de la Ciudad Autónoma de Buenos Aires, or “CPCECABA”) approved Technical Resolution No. 22 “Agricultural Activities” which establishes specific standards
5
Table of Contentsrelated to our business. At the date of issuance of our consolidated financial statements, the Comisión Nacional de Valores has approved this standard, which is effective as from July 1, 2006. In the Company’s opinion, the resolution’s implementation will not affect the valuation of biological assets and it represents an improvement in the exposure. The results of cattle, grains and milk production shown in the financial statements in Schedule F are in accordance with this assessment. Since Argentine GAAP required companies to discontinue inflation adjustments only as from October 1, 2003, the application of the Comisión Nacional de Valores resolution represents a departure from generally accepted accounting principles. However, due to low inflation rates during the period from March to September 2003, such a departure has not had a material effect on the accompanying consolidated financial statements. Until February 28, 2003 our consolidated financial statements had been prepared on the basis of general price-level accounting which reflects changes in the purchasing power of the Peso in our historical financial statements using changes in the Argentine wholesale price index, as published by the National Institute of Statistics and Census (Instituto Nacional de Estadística y Censos, or “INDEC”), as follows:
As mentioned in Note 4.b) to our consolidated financial statements, as of June 30, 2006 we owned a 26.7% equity interest in IRSA. Also contained in this annual report are the consolidated financial statements of IRSA Inversiones y Representaciones Sociedad Anónima (“IRSA”), an equity invested, as of June 30, 2006 and 2005 and for the years ended June 30, 2006, 2005 and 2004, which have been audited by Price Waterhouse & Co. S.R.L. Buenos Aires Argentina, member firm of PriceWaterhouseCoopers, a registered public accounting firm, whose report is included herein. As of June 30, 2006, IRSA has a significant investment in Banco Hipotecario S.A. that accounts for approximately 9% of IRSA’s total consolidated assets. Except as discussed in the following paragraph, IRSA prepares its financial statements in Pesos and in conformity with Argentine GAAP and the regulation of the Comisión Nacional de Valores, which differ in certain significant respects from U.S. GAAP. Such differences involve methods of measuring the amounts shown in the consolidated financial statements, as well as additional disclosures required by U.S. GAAP and Regulation S-X of the SEC. See Note 27 to IRSA’s consolidated financial statements contained elsewhere in this annual report for a description of the main differences between Argentine GAAP and U.S. GAAP as they relate to IRSA, and a reconciliation with U.S. GAAP of net income and shareholders’ equity. As discussed in Note 3.m. to IRSA’s financial statements, contained elsewhere in this annual report, in order to comply with Comisión Nacional de Valores regulations, IRSA recognized deferred income tax assets and liabilities on a non-discounted basis. This accounting practice represents a departure from generally accepted accounting principles in Argentina. However, such departure has not had a material effect on the IRSA’s consolidated financial statements.
6
Table of ContentsAdditionally, as discussed in Notes 2.c. to IRSA’s financial statements, contained in this annual report, after considering inflation levels for the second half of 2002 and the first months of 2003, on March 25, 2003, the Argentine government repealed the provisions of the previous decree related to the inflation adjustment and instructed the Comisión Nacional de Valores to issue the necessary regulations to preclude companies under its supervision from presenting price-level restated financial statements. Therefore, on April 8, 2003, the Comisión Nacional de Valores issued a resolution providing for the discontinuance of inflation accounting as of March 1, 2003. IRSA complied with the Comisión Nacional de Valores resolution and accordingly recorded the effects of inflation until February 28, 2003. Comparative figures were restated until that date, using a conversion factor of 1.1232. Since Argentine GAAP required companies to discontinue inflation accounting only as from October 1, 2003, the application of the Comisión Nacional de Valores resolution represents a departure from generally accepted accounting principles. However, due to the low level of inflation rates during the period from March to September 2003, such a departure has not had a material effect on the IRSA’s consolidated financial statements. The CNV issued General Resolutions 485 and 487 on December 29, 2005 and January 26, 2006, respectively which adopted, with certain modifications, the new accounting standards previously issued by the Professional Council in Economic Sciences of the Autonomous City of Buenos Aries through its Resolution CD 93/2005. These standards are to be mandatorily applied for fiscal years or interim periods corresponding to fiscal years beginning as from January 1, 2006. The standards will be effective for the Company for the year ended June 30, 2007. The most significant change included in the accounting standards adopted by the CNV relates to the accounting treatment of differences between the tax basis and book basis of non-monetary items for deferred income tax calculation purposes when companies prepare price-level restated financial statements. The new accounting allows companies to treat these differences as either temporary or permanent differences. Accordingly, the Company will continue treating the differences between the tax basis and indexed book basis of non-monetary items as permanent for the year ended June 30, 2007. Certain amounts which appear in this annual report (including percentage amounts) may not sum due to rounding. You should not construe the translations as a representation that the amounts shown could have been, or could be, converted into U.S. Dollars at that or any other rate. References to fiscal years 2002, 2003, 2004, 2005 and 2006 are to the fiscal years ended June 30 of each such year. MARKET DATA Market data used throughout this annual report were derived from reports prepared by unaffiliated third-party sources. Such reports generally state that the information contained therein has been obtained from sources believed by such sources to be reliable. Certain market data which appear herein (including percentage amounts) may not sum due to rounding.
7
Table of ContentsItem 1. Identity of directors, Senior Management and Advisers This item is not applicable. Item 2. Offer statistics and expected timetable This item is not applicable. Item 3. Key information A. SELECTED CONSOLIDATED FINANCIAL DATA The following selected consolidated financial data has been derived from our consolidated financial statements as of the dates and for each of the periods indicated below. This information should be read in conjunction with and is qualified in its entirety by reference to our consolidated financial statements and the discussion in Operating and Financial Review and Prospects included elsewhere in this annual report. The selected consolidated statement of income data for the years ended June 30, 2006, 2005 and 2004 and the selected consolidated balance sheet data as of June 30, 2006 and 2005 have been derived from our consolidated financial statements included in this annual report which have been audited by Price Waterhouse & Co. S.R.L. Buenos Aires Argentina, member firm of PricewaterhouseCoopers, Buenos Aires, Argentina, registered public accounting firm. The consolidated statements of income data for the years ended June 30, 2003 and 2002 and the selected consolidated balance sheet data as of June 30, 2004, 2003 and 2002 have been derived from our audited consolidated financial statements that are not included herein. As discussed in Note 3 to our financial statements, contained in this annual report, on January 14, 2003, the Professional Council of Economic Sciences of the City of Buenos Aires and the Comisión Nacional de Valores approved, with certain amendments, Technical Resolutions (Resoluciones Técnicas) No. 16, 17, 18, 19 and 20 issued by the Argentine Federation of Professional Council of Economic Sciences (Federación Argentina de Consejos Profesionales en Ciencias Económicas, or “FACPCE”), which establish new accounting and disclosure principles under Argentine GAAP. We adopted such standards on July 1, 2002, except for Technical Resolution No. 20, which we adopted on July 1, 2003. On February 19, 2003, the CPCECABA enacted Technical Resolution No. 21 “Proportional Value – consolidation” of financial statements information to provide on “Related Parties”. We adopted such Technical Resolution on July 1, 2004. As required by Argentine GAAP, when issuing our 2003 Consolidated Financial Statements, we restated our prior year financial statements to give retroactive effect to the newly adopted accounting standards. On January 12, 2005 the Consejo Profesional de Ciencias Económicas de la Ciudad Autónoma de Buenos Aires (CPCECABA) approved RT No. 22 “Agricultural Activities” which establishes specific measurement and disclosure provisions related to the Company’s business. This standard was approved by the CNV and will be mandatory for fiscal years beginning on January 1, 2006. Accordingly, it will be effective for the Company’s fiscal year ended June 30, 2007. The adoption of the standard will not have a material effect on the valuation of biological assets. However, it will require additional disclosures. The CNV issued General Resolutions 485 and 487 on December 29, 2005 and January 26, 2006, respectively which adopted, with certain modifications, the new accounting standards previously issued by the Professional Council in Economic Sciences of the Autonomous City of Buenos Aries through its Resolution CD 93/2005. These standards are to be mandatorily applied for fiscal years or interim periods corresponding to fiscal years beginning as from January 1, 2006. The standards will be effective for the
8
Table of ContentsCompany for the year ended June 30, 2007. The most significant change included in the accounting standards adopted by the CNV relates to the accounting treatment of differences between the tax basis and book basis of non-monetary items for deferred income tax calculation purposes when companies prepare price-level restated financial statements. The new accounting allows companies to treat these differences as either temporary or permanent differences. Accordingly, the Company will continue treating the differences between the tax basis and indexed book basis of non-monetary items as permanent for the year ended June 30, 2007. Our financial statements are presented in Pesos. Except as discussed in the following paragraph, our financial statements are prepared in accordance with Argentine GAAP, which differs in certain significant respects from U.S. GAAP. Note 17 to our consolidated financial statements provides a description of the main differences between Argentine GAAP and U.S. GAAP affecting our net income and shareholders’ equity and a reconciliation to U.S. GAAP of net income reported under Argentine GAAP for the years ended June 30, 2006, 2005 and 2004, and of shareholders’ equity reported under Argentine GAAP as of June 30, 2006 and 2005. The differences involve methods of measuring the amounts shown in the financial statements as well as additional disclosures required by U.S. GAAP and Regulation S-X of the SEC. As discussed in Note 3.k to our financial statements, contained in this annual report, in order to comply with regulations of the Comisión Nacional de Valores, we recognized deferred income tax assets and liabilities on a non-discounted basis. This accounting practice represents a departure from generally accepted accounting principles in Argentina. However, we believe that such departure has not had a material effect on our financial statements. Additionally, as discussed in Note 2.d) to our consolidated financial statements, contained elsewhere in this annual report, after having considered inflation levels for the first months of 2003, on March 25, 2003, the Argentine government has repealed the provisions of the previous decree related to the inflation adjustment and has instructed the Comisión Nacional de Valores to issue the necessary regulations to preclude companies under its supervision from presenting price-level restated financial statements. Therefore, on April 8, 2003, the Comisión Nacional de Valores has issued a resolution providing for the discontinuance of inflation accounting as of March 1, 2003. We have complied with the Comisión Nacional de Valores resolution and we have accordingly recorded the effects of inflation until February 28, 2003. Comparative figures have also been restated until that date, using a conversion factor of 1.1232. Since Argentine GAAP required companies to discontinue inflation adjustments as from October 1, 2003, the application of the Comisión Nacional de Valores resolution represents a departure from generally accepted accounting principles. However, due to low inflation rates during the period from March to September 2003, we believe that such a departure has not had a material effect on the accompanying consolidated financial statements. Until February 28, 2003 our consolidated financial statements have been prepared on the basis of general price-level accounting which reflects changes in the purchasing power of the Peso in the historical financial statements using changes in the Argentine wholesale price index, as published by the Instituto Nacional de Estadística y Censos, as follows:
9
Table of Contentsreflecting the effect of holding monetary items; and
10
Table of Contents
11
Table of ContentsExchange Rates The following table sets forth, for the periods indicated, the high, low, average and period-end exchange rates for the purchase of U.S. Dollars expressed in nominal Pesos per U.S. Dollar. On November 30, 2006, the applicable Peso/U.S. Dollar exchange rate was Ps. 3.048 = US$ 1.00. The Federal Reserve Bank of New York does not report a noon buying rate for Pesos. Nominal Exchange Rates
Source: Banco de la Nación Argentina, Bloomberg Fluctuations in the exchange rate between the Peso and the U.S. Dollar may adversely affect our ability to service our Dollar-denominated debt and/or the U.S. Dollar value of our ADS. Since the repeal of the Convertibility Law in January 2002, the Peso has devaluated approximately 200% vis-à-vis the U.S. Dollar. We cannot assure you that further devaluations will not take place in the future. Inflation and further devaluation of the Argentine currency could materially and adversely affect our operating results. B. CAPITALIZATION AND INDEBTEDNESS This section is not applicable. C. REASONS FOR THE OFFER AND USE OF PROCEEDS This section is not applicable. D. RISK FACTORS You should consider the following risks associated with our business, taking into account the instability of the country in which we operate. We may also face additional risks and uncertainties that are not presently affecting us, or that we currently deem immaterial, which may materially impair our business. In general, investing in companies which operate in emerging markets such as Argentina is more risky than investing in companies which operate in more stable markets such as the United States.
12
Table of ContentsRisks Related to Argentina Argentina’s current growth and stabilization may not be sustainable. During 2001 and 2002, Argentina experienced a period of severe political, economic and social crisis. Although the economy has recovered significantly over the past three years, uncertainty remains as to whether the current growth and relative stability are sustainable. The Argentine economy remains fragile for the following reasons:
Substantially all of our operations, properties and customers are located in Argentina. As a result, our business is to a very large extent dependent upon the economic conditions prevailing in Argentina. Although the economic situation in Argentina has improved, instability is still prevalent and no assurance can be given that macroeconomic conditions in Argentina will not deteriorate again. Inflation may rise again, causing adverse effects on the Argentine real estate markets as well as the Argentine economy generally After several years of price stability, the devaluation of the Peso in January 2002 imposed pressures on the domestic price system that generated high inflation throughout 2002, before substantially stabilizing in 2003. However, inflationary pressures have since reemerged with consumer prices increasing by 6.1% per annum during 2004 and increasing by 12.3% in 2005. As of October 31, 2006, inflation had an annual increase of 10.5%. In the past, inflation has materially undermined the Argentine economy and the government’s ability to create conditions conducive to growth. A return to a high inflation environment could slow the rebound in the real estate market and may also undermine Argentina’s foreign competitiveness by diluting the effects of the Peso devaluation and negatively impacting the level of economic activity and employment. Argentina’s sovereign debt restructuring and the early prepayment to the International Monetary Fund (the “IMF”) may create certain additional uncertainties, and the Argentine government may face future litigation that could have an impact on Argentina’s ability to obtain financing from international markets and economic growth.
13
Table of ContentsAfter defaulting on over US$144.5 billion in external debt and as part of the debt restructuring process, the Argentine government consummated a debt exchange offer in the first quarter of 2005 with a rate of participation by bondholders of approximately 76% and an aggregate tendered amount of US$62.3 billion. The settlement of the debt exchange was completed on June 2, 2005 due to a delay resulting from legal action by certain bondholders who did not participate in the exchange offer that attempted to attach the tendered bonds. Despite the high levels of acceptance of the exchange offer, the amounts not tendered for exchange totaled approximately US$20 billion. Some bondholders in the United States, Italy and Germany filed legal actions against Argentina that are still pending resolution, and holdout creditors may initiate new suits in the future. Argentina’s past default and its failure to restructure completely its remaining sovereign debt and fully negotiate with holdout creditors may prevent the Argentine government from accessing the international capital markets for the foreseeable future. Moreover, after consummation of the exchange offer, Argentina’s sovereign debt is still significant and may inhibit economic growth and result in lower fiscal surpluses that could further restrict the ability to repay outstanding debt. Under these circumstances, we cannot assure you that the economy will not suffer additional shocks. Following settlement of Argentina’s sovereign debt restructuring, the “IMF” agreed to a one-year extension of Argentina’s scheduled repayment of debt due to the IMF and on December 15, 2005, the Argentine government announced its intention to prepay all of its outstanding debt with the IMF, totaling US$9.5 billion, using reserves available at the Central Bank. On January 3, 2006, the Argentine government made the prepayment of its outstanding debt with the IMF using foreign reserves of the Argentine Central Bank (“Central Bank”) that were in excess of the amounts necessary to support 100% of Argentina’s monetary base. The reduction of the Central Bank’s foreign-currency reserves may weaken Argentina’s ability to overcome economic deterioration, however, in October 2006 the Central Bank recovered the reserves level previous to the prepayment of its outstanding debt with the IMF. Without international private financing Argentina may not be able to finance its obligations, and financing from multilateral financial institutions may be limited or not available. This could also inhibit the ability of the Central Bank to adopt measures to combat inflation and could adversely affect Argentina’s economic growth and public finances, which could adversely affect our business, financial conditions or results of operations. In addition, without the restrictions on spending imposed by the IMF arrangement, Argentina may again experience significant government spending which could result in renewed inflation and other adverse economic consequences. The Peso has been subject to major devaluations in the past and may suffer significant fluctuations in the future creating uncertainty as to Argentina’s economic future what may have a material adverse effect on the results of our operations and financial condition. The economic policies of the Argentine government as well as any future depreciation of the Peso against the U.S. Dollar might have an adverse impact on our financial condition and the results of our operations. The Peso has been subject to major devaluations in the past and may suffer significant fluctuations in the future. Law No. 25,561, promulgated on January 6, 2002, called Public Emergency and Foreign Exchange Regime Reform Law (“Public Emergency Law”), put an end to over a decade of one-to-one parity between the U.S. Dollar and the Peso authorizing the Argentine government to set the exchange rate. Subsequent to the devaluation of the Peso in early 2002 and since the beginning of the economic crisis, there have been significant fluctuations in the value of the Peso causing repeated Central Bank interventions to stabilize the Peso through purchases and sales of U.S. Dollars. As of November 30, 2006, the exchange rate was Ps. 3.048 per U.S. Dollar. We collect substantially all of our revenues in Argentina, and as a result of the enactment of the Public Emergency Law, they are calculated and collected in Pesos. We cannot assure you that the policies to be implemented by the Argentine government in the future will stabilize the value of the Peso against foreign currencies. Therefore, the Peso may continue to be subject to significant fluctuations and
14
Table of Contentsfurther depreciations which might significantly and adversely affect our financial condition and the results of our operations. Further depreciation of the Peso would have particular impact on:
Government measures to preempt or respond to social unrest may adversely affect the Argentine economy During its crisis in 2001 and 2002, Argentina experienced social and political turmoil, including civil unrest, riots, looting, nationwide protests, strikes and street demonstrations. Despite Argentina’s ongoing economic recovery and relative stabilization, social and political tension and high levels of poverty and unemployment continue. Future government policies to avoid or address social unrest may include expropriation, nationalization, forced renegotiation or modification of existing contracts, suspension of the enforcement of creditors’ rights, new taxation policies, including royalty and tax increases and retroactive tax claims, and changes in laws and policies affecting foreign trade and investment. Such policies could destabilize the country and adversely and materially affect the economy, and thereby our business. Exchange controls and restrictions on transfers abroad and capital inflow restrictions have limited, and can be expected to continue to limit, the availability of international credit and may prevent us from servicing our foreign currency denominated debt obligations In 2001 and 2002, Argentina imposed exchange controls and transfer restrictions substantially limiting the ability of companies to retain foreign currency or make payments abroad. These restrictions have been substantially eased, including those requiring the Central Bank’s prior authorization for the transfer of funds abroad in order to pay principal and interest on debt obligations. However, Argentina may re-impose exchange control or transfer restrictions in the future, among other things, in response to capital flight or a significant depreciation of the Peso. In addition, the government issued Decree No. 616/2005 that established new controls on capital inflows that could result in less availability of international credit. Additional controls could have a negative effect on the economy and our business if imposed in an economic environment where access to local capital is substantially constrained. Moreover, in such event, restrictions on the transfers of funds abroad may impede our ability to make payments abroad and your ability to receive payments of principal and interest as a holder of notes. By contrast, according to Communication “C” 43075 dated September 26, 2005, inflows of foreign currency by a non-resident and to be applied to payment obligations under a purchase agreement (including installment payments) concerning real estate under construction may be registered as foreign direct investments, provided that certain conditions are met. Finally, Resolution No. 637/2005 from the Ministry of Economy and Production dated November 16, 2005 established that any inflow of foreign currency to the local exchange market used for the subscription of notes, bonds or participation certificates issued by the trustee of a trust, regardless of the channels in which they are traded (public or private offerings, or listings in self-regulated markets) is subject to the non-transferable deposit requirement established by Decree 616/2005 if such requirement would be deemed applicable to the acquisition of the underlying assets of the trust. See “Exchange Controls.”
15
Table of ContentsAlthough most capital outflow restrictions with regards to imports of goods, payment of interest, utilities, dividends and financial debts have been eliminated, there can be no assurance that the Central Bank will not reverse its position and once again restrict payments of principal and interest outside of Argentina. If more stringent restrictions are imposed by the Central Bank, we may be unable to make payments of principal and interest on our foreign currency-denominated debt obligations. If that were to occur, we would likely suffer payment defaults on our existing debt obligations, and such defaults would likely have a material adverse effect on our financial condition and prospects and our ability to service our external debt obligations. The Argentine economy could be adversely affected by economic developments in other global markets Financial and securities markets in Argentina are influenced, to varying degrees, by economic and market conditions in other global markets. Although economic conditions vary from country to country, investors’ perception of the events occurring in one country may substantially affect capital flows into and securities from issuers in other countries, including Argentina. The Argentine economy was adversely impacted by the political and economic events that occurred in several emerging economies in the 1990s, including Mexico in 1994, the collapse of several Asian economies between 1997 and 1998, the economic crisis in Russia in 1998 and the Brazilian devaluation in January 1999. In addition, Argentina continues to be affected by events in the economies of its major regional partners. Furthermore, the Argentine economy may be affected by events in developed economies which are trading partners or that impact the global economy. Shocks of a similar magnitude to the international markets in the future can be expected to affect adversely the Argentine economy and therefore our business. You may not be able to enforce your claims in Argentina. We are a corporation (sociedad anónima) organized under the laws of Argentina. Most of our shareholders, directors, members of our supervisory committee, members of our executive committee, officers and certain experts named herein reside principally in Argentina and substantially all of our assets are located in Argentina. Under Argentine law, enforcement of foreign judgments would be recognized provided that the requirements of Articles 517 through 519 of the National Code of Civil and Commercial Procedure are complied with, including, that the judgment does not violate principles of public policy of Argentine law, as determined by the Argentine courts. We cannot assure you that an Argentine court would not deem the enforcement of foreign judgments requiring us to make payments under the notes in foreign currency outside of Argentina to be contrary to Argentine public policy, if at that time there are legal restrictions prohibiting Argentine debtors from transferring foreign currency outside of Argentina to cancel indebtedness. Risks Related to Our Business We may face potential conflicts of interest relating to our principal shareholders. As of November 30, 2006 our largest shareholder, Mr. Eduardo S. Elsztain, was the beneficial owner of approximately 16% of our common shares. As of November 30, 2006, such beneficial ownership consists of 35,467,651 of our common shares owned by Inversiones Financieras del Sur S.A., a Uruguayan holding company, for which Mr. Eduardo S. Elsztain may be deemed beneficial owner by virtue of his voting power to control Inversiones Financieras del Sur S.A. Pursuant to a consulting agreement with Consultores Assets Management S.A. (formerly known as Dolphin Fund Management S.A.), we pay a management fee equal to 10% of our annual net income for certain agricultural advice and other administrative services. Eduardo Elsztain is the owner of 85% of the capital stock of Consultores Asset Management S.A., while our first vice-chairman of the board of directors, Saúl Zang, holds the other 15% of the capital stock.
16
Table of ContentsConflicts of interest between our management, our affiliates and us may arise in the performance of our respective business activities. Mr. Eduardo S. Elsztain is also the beneficial owner of approximately 26.5% of the common shares of IRSA, an Argentine company that currently owns approximately 61.5% of the common shares of its subsidiary Alto Palermo S.A. (“Alto Palermo”) whose CEO is Mr. Alejandro G. Elsztain, the CEO of Cresud. We cannot assure you that our principal shareholders will not limit or cause us to forego business opportunities that their affiliates may pursue or that their pursuit of other opportunities will be in our interest. Fluctuation in market prices for our agriculture products could adversely affect our financial condition and results of operations. Prices for cereals, oilseeds and by-products, like those of other commodities, can be expected to fluctuate significantly. The prices that we are able to obtain for our agriculture products from time to time depend on many factors beyond our control including:
From June 2005, to June 2006, prices in U.S. Dollars for soybeans dropped 8.75 %, the price of the corn increased in 11% and wheat increased 15.6%. (Source: CBOT- Bloomberg) Our financial condition and results of operations could be materially and adversely affected if the prices of grains and by-products were to decline below current levels. Our business is seasonal, and our revenues may fluctuate significantly depending on the growing cycle. As with any agribusiness enterprise, our business operations are predominantly seasonal in nature. The harvest and sale of crops (corn, soybean and sunflower) generally occurs from February to June. Wheat is harvested from December to January. Our operations and sales are affected by the growing cycle of the crops we process and by decreases during the summer in the price of the cattle we fatten. Therefore, our results of operations have varied significantly from period to period, and are likely to continue to vary, due to seasonal factors. Unpredictable weather conditions may have an adverse impact on crop and beef-cattle production. The occurrence of severe adverse weather conditions, especially droughts or floods, is unpredictable and may have a potentially devastating impact upon crop production and, to a lesser extent, beef-cattle production. The effect of severe adverse weather conditions may reduce yields in our farms or require higher levels of investment to maintain yields. As a result, we cannot assure you that severe future adverse weather conditions will not adversely affect our operating results and financial condition. Disease may strike our crops without warning potentially destroying some or all of our yields. The occurrence and effect of crop disease and pestilence can be unpredictable and devastating on crops, potentially rendering all or a substantial portion of the affected harvests. Even when only a
17
Table of Contentsportion of the crop is damaged, our results of operation could be adversely affected because all or a substantial portion of the production costs for the entire crop have been incurred. Although some crop diseases are treatable, the cost of treatment is high, and we cannot assure that such events in the future will not adversely affect our operating results and financial condition. Our cattle are subject to diseases. Diseases among our cattle herds, such as tuberculosis, brucellosis and foot-and-mouth disease, can have an adverse effect on milk production and fattening, rendering cows unable to produce milk or meat for human consumption. Outbreaks of cattle diseases may also result in the closure of certain important markets such as the United States to Argentine cattle products. Although we abide by national veterinary health guidelines, which include laboratory analyses and vaccination, to control diseases among the herds, especially foot-and-mouth disease, we cannot assure that future outbreaks of cattle diseases will not occur or that future outbreaks will not adversely affect our beef-cattle and milk sales, operating results and financial condition. Worldwide competition in the markets for our products could adversely affect our business and results of operations. We experience substantial worldwide competition in each of our markets and in many of our product lines. The market for cereals, oil seeds and by-products is highly competitive and also sensitive to changes in industry capacity, producer inventories and cyclical changes in the world’s economies, any of which may significantly affect the selling prices of our products and thereby our profitability. Argentina is more competitive in the oil-seed than in the cereal market. Due to the fact that many of our products are agricultural commodities, they compete in the international markets almost exclusively on the basis of price. Many other producers of these products are larger than us, and have greater financial and other resources. Moreover, many other producers receive subsidies from their respective countries that do not exist in Argentina. These subsidies may allow producers from other countries to produce at lower costs than us and/or endure periods of low prices operating losses for longer periods. Any increased competitive pressure with respect to our products could materially and adversely affect our financial condition and results of operations. If we are unable to maintain our relationship with our customers, particularly with the single customer who purchases our entire raw milk production each month, our business may be adversely affected. Though our cattle sales are diversified, we are and will continue to be significantly dependent on a number of third party relationships, mainly with our customers for crop and milk sales. We currently sell our entire raw milk production to one customer in Argentina. For fiscal year 2006, these sales represented 7% of our total revenues. There can be no assurance that this customer will continue to purchase our entire raw milk production or that, if it fails to do so, we could enter into satisfactory sale arrangements with new purchasers in the future. We sell our crop production mainly to exporters and manufacturers that process the raw materials to produce meal and oil, products that are sent to the export markets. The Argentine crop market is characterized by a few purchasers and a great number of sellers. Although most of the purchasers are international companies with strong financial conditions, we cannot assure you that this situation will remain the same in the future or that this market will not get more concentrated in the future. We may not be able to maintain or form new relationships with customers or others who provide products and services that are important to our business. Accordingly, we cannot assure you that our existing or prospective relationships will result in sustained business or the generation of significant revenues.
18
Table of ContentsWe do not maintain insurance on our crop storage facilities; therefore, if a fire or other disaster damages some or all of our harvest, we will not receive any compensation. We store a significant portion of our grain production during harvest due to the seasonal drop in prices that normally occurs at that time. Currently, we have approximately 15,341 tons of storage capacity at various farms and plan to further increase our storage capacity. We do not maintain insurance on our storage facilities. Although our storage capacity is in several different locations, and it is unlikely that a natural disaster affects all of our silos simultaneously, a fire or other natural disaster which damages the stored grain, particularly if such event occurs shortly after harvesting, could have an adverse effect on our operating results and financial condition. We may be exposed to material losses due to volatile crop prices since we hold significant uncovered futures and options positions to hedge our crop price risk. Due to the fact that we do not have 100% of our crops hedged, we are unable to have minimum price guarantees for all of our production and are exposed to significant risks associated with the level and volatility of crop prices. We are subject to fluctuations in crop prices which could result in receiving a lower price for our crops than our production cost. We are also subject to exchange rate risks related to our crops that are hedged, because our futures and options positions are valued in U.S. dollars, and thus are subject to exchange rate risk. If severe weather or any other disaster generates a lower crop production than the position already sold in the market, we may suffer material losses in the repurchase of the sold contracts. We may increase our crop price risk since we could have a long position in crop derivatives. In order to improve the use of land and capital allocation, we may have a long position in crops in addition to our own production. This strategy increases our crop price risk, generating material losses in a downward market. We do not intend to be exposed in a long derivative position in excess of 50% of our real production. We depend on our chairman and senior management. Our success depends, to a significant extent, on the continued employment of Eduardo S. Elsztain, our president and chairman of the board of directors, and Alejandro G. Elsztain, our chief executive officer. The loss of their services for any reason could have a material adverse effect on our business. Our future success also depends in part upon our ability to attract and retain other highly qualified personnel. We cannot assure you that we will be successful in hiring or retaining qualified personnel, or that any of our personnel will remain employed by us. We hold Argentine securities, which are more volatile than United States securities, and carry a greater risk of default. We currently have and in the past have had certain investments in Argentine government debt, corporate debt, and equity securities. In particular, we hold a significant interest in IRSA, an Argentine company that has suffered material losses, particularly during fiscal years 2001 and 2002. Although our holding of these investments, with the exception of IRSA, tends to be short term, investments in such securities involve certain risks, including:
19
Table of Contents
Some of the issuers in which we have invested and may invest, including the Argentine government, have in the past experienced substantial difficulties in servicing their debt obligations, which have led to the restructuring of certain indebtedness. We cannot assure that the issuers in which we have invested or may invest will not be subject to similar or other difficulties in the future which may adversely affect the value of our investments in such issuers. In addition, such issuers and, therefore, such investments, are generally subject to many of the risks that are described in this section, with respect to us, and, thus, could have little or no value. We could be adversely affected by our investment in IRSA if IRSA’s value decreases. As of June 30, 2006, we owned a 26.7% equity interest in IRSA representing an investment of Ps. 320.0 million through the purchase of shares and the conversion of Convertible Notes. In addition, as of such date, we owned IRSA’s Convertible Notes for a total amount of US$ 12.0 million and 32.96 millions warrants also. Consequently, as of June 30, 2006, our investment in IRSA amounted to Ps. 357.4 million, representing 41.05% of our total consolidated assets. Our investment in IRSA is subject to risks common to investments in commercial and residential properties in general, many of which are not within IRSA’s control. Any one or more of these risks might materially and adversely affect IRSA’s business, financial condition or results of operations. The yields available from equity investments in real estate depend on the level of sales or rental income generated and expenses incurred. In addition, other factors may affect the performance and value of a property adversely, including local economic conditions where the properties are located, macroeconomic conditions in Argentina and the rest of the world, competition from other real estate developers, IRSA’s ability to find tenants, tenant default or rescission of leases, changes in laws and governmental regulations (including those governing usage, zoning and real property taxes), changes in interest rates (including the risk that increased interest rates may result in decreased sales of lots in the residential development properties) and the availability of financing. IRSA may also be unable to respond effectively to adverse market conditions or may be forced to sell one or more of its properties at a loss because the real estate market is relatively illiquid. Certain significant expenditures, such as debt service, real estate taxes, and operating and maintenance costs, generally are not reduced in circumstances resulting in a reduction in income from the investment. It is possible that these or other factors or events will impair IRSA’s ability to respond to adverse changes in the performance of its investments, causing a material decline in IRSA’s financial condition or results of operations. During the fiscal year ended June 30, 2006, IRSA’s share price increased by 1.4% from Ps. 3.4, on June 30, 2005 to Ps. 3.45 on June 30, 2006. From fiscal year 2004 to fiscal year 2005 the price increased 55% from Ps. 2.2 to Ps. 3.4. Given the relative size of our investment in IRSA, any decline could continue to give us a material adverse effect on our financial condition and results of operations. The creation of new export taxes may have an adverse impact on our sales. In order to prevent inflation and variations in the exchange rate from adversely affecting prices of primary and manufactured products (including agricultural products), and to increase tax collections and reduce Argentina’s fiscal deficit, the Argentine government has imposed new taxes on exports. Pursuant to Resolution No. 11/02 of the Ministry of Economy and Production, as amended by Resolution 35/02, 160/2002, 307/2002 and 530/2002, effective as of March 5, 2002, the Argentine government imposed a 20%, 10% and 5% export tax on primary and manufactured products. On November 12, 2005, pursuant to Resolution No. 653/2005, the Ministry of Economy and Production increased 10% over the current 5% the taxes on beef-cattle exports.
20
Table of ContentsExport taxes might have a material and adverse effect on our sales. We produce exportable goods, and, therefore, an increase in export taxes is likely to result in a decrease in our products’ price, and, therefore, may result in a decrease to our sales. We cannot guarantee the impact of those or any other future measures that might be adopted by the Argentine government on our financial condition and result of operations. Government intervention in our markets may have a direct impact on our prices. The Argentine government has set certain industry market conditions and prices in the past. In order to prevent a substantial increase in the price of basic products as a result of inflation, the Argentine government is adopting an interventionist policy. In March 2002, the Argentine government fixed the price for milk after a conflict among producers and the government. During 2005, the Argentine government adopted measures in order to increase the domestic availability of beef and reduce domestic prices. The withholding rate was increased and a minimum weight requirement for animals to be slaughtered was established. In March 2006, the foreign sales of cattle beef cuts were momentarily suspended. The latter measure was softened once prices decreased. There can be no assurance that the Argentine government will not interfere in other areas by setting prices or regulating other market conditions. Accordingly, we cannot assure you that we will be able to freely negotiate all our products’ prices in the future or that the prices or other market conditions that the Argentine government might impose will allow us to freely negotiate the price of our products. The Investment Company Act may limit our future activities. Under Section 3(a)(3) of the Investment Company Act of 1940, as amended, an investment company is defined in relevant part to include any company that owns or proposes to acquire investment securities that have a value exceeding 40% of such company’s unconsolidated total assets (exclusive of U.S. government securities and cash items). Investments in minority interests of related entities as well as majority interests in consolidated subsidiaries which themselves are investment companies are included within the definition of “investment securities” for purposes of the 40% limit under the Investment Company Act. Companies that are investment companies within the meaning of the Investment Company Act and that do not qualify for an exemption from the provisions of such Act, are required to register with the Securities and Exchange Commission and are subject to substantial regulations with respect to capital structure, operations, transactions with affiliates and other matters. In the event such companies do not register under the Investment Company Act, they may not, among other things, conduct public offerings of their securities in the United States or engage in interstate commerce in the United States. Moreover, even if we desired to register with the Commission as an investment company, we could not do so without an order of the Commission because we are a non-U.S. corporation, and it is unlikely that the Commission would issue such an order. In recent years we have made a significant minority investment in the capital stock of IRSA, an Argentine company engaged in a range of real estate activities. As of June 30, 2006, we owned approximately 26.7% of IRSA’s outstanding shares, and our total investment in IRSA represented approximately 41.05% of our total assets. Although we believe we are not an “investment company” for purposes of the Investment Company Act, our belief is subject to substantial uncertainty, and we cannot give you any assurance that we would not be determined to be an “investment company” under the Investment Company Act. We believe we may be exempted from a registration as an investment company under the Investment Company Act so long as we do not offer or sell securities in the United States or to U.S. persons while our status under the Investment Company Act remains uncertain. Accordingly, due to the uncertainty regarding our status under the Investment Company Act, we may not be able to offer and sell securities in the United States or to U.S. persons. The United States capital markets have historically
21
Table of Contentsbeen an important source of funding for us, and our future financing ability may be adversely affected by a lack of access to the United States capital markets. If an exception under the Investment Company Act is unavailable to us in the future and we desire to access the U.S. capital markets, our only recourse would be to file an application to the SEC for an exemption from the provisions of the Investment Company Act, which is a lengthy and highly uncertain process. Moreover, if we offer and sell securities in the United States or to U.S. persons and we were deemed to be an investment company and not exempted from the application of the Investment Company Act, contracts we enter into in violation of, or whose performance entails a violation of, the Investment Company Act, including any such securities, may not be enforceable against us. Risks Related to our American Depositary Shares and the Shares Shares eligible for sale could adversely affect the price of our shares and American Depositary Shares The market prices of our common shares and American Depositary Shares (“ADS”) could decline as a result of sales by our existing shareholders of common shares or American Depositary Shares in the market, or the perception that these sales could occur. These sales also might make it difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate. The American Depositary Shares are freely transferable under U.S. securities laws, including shares sold to our affiliates. Inversiones Financieras del Sur S.A., which as of November 30, 2006 owned approximately 16.0% of our common shares (or approximately 35,467,651 common shares which may be exchanged for an aggregate of 3,546,765 American Depositary Shares), is free to dispose of any or all of its common shares or American Depositary Shares at any time in its discretion. Sales of a large number of our common shares and/or American Depositary Shares would likely have an adverse effect on the market price of our common shares and the American Depositary Shares. We are subject to certain different corporate disclosure requirements and accounting standards than domestic issuers of listed securities in the United States. There is less publicly available information about the issuers of securities listed on the Buenos Aires Stock Exchange than information publicly available about domestic issuers of listed securities in the United States and certain other countries. In addition, all listed Argentine companies must prepare their financial statements in accordance with Argentine GAAP which differs in certain significant respects from U.S. GAAP. For this and other reasons, the presentation of Argentine financial statements and reported earnings may differ from that of companies in other countries in this and other respects. We are exempted from the rules under the Exchange Act prescribing the furnishing and content of proxy statements, and our officers, directors and principal shareholders are exempted from the reporting and short-swing profit recovery provisions contained in Section 16 of the Exchange Act. Investors may not be able to effect service of process within the U.S., limiting their recovery of any foreign judgment. We are a publicly held corporation (sociedad anónima) organized under the laws of Argentina. Most of our directors and our senior managers, and most of our assets are located in Argentina. As a result, it may not be possible for investors to effect service of process within the United States upon us or such persons or us or to enforce against them in United States courts judgments obtained in such courts predicated upon the civil liability provisions of the United States federal securities laws. We have been advised by our Argentine counsel, Zang, Bergel & Viñes, that there is doubt as to whether the Argentine courts will enforce to the same extent and in as timely a manner as a U.S. or foreign court, an
22
Table of Contentsaction predicated solely upon the civil liability provisions of the United States federal securities laws or other foreign regulations brought against such persons or against us. If we are considered to be a passive foreign investment company for United States federal income tax purposes, United States holders of our equity securities would suffer negative consequences Based on the current and projected composition of our income and the valuation of our assets we do not believe we were a Passive Foreign Investment Company (“PFIC”) for United States federal income tax purposes for the tax year ending June 30, 2006, and we do not currently expect to become a PFIC, although there can be no assurance in this regard. The determination of whether we are a PFIC is made annually. Accordingly, it is possible that we may be a PFIC in the current or any future taxable year due to changes in our asset or income composition or if our projections are not accurate. The volatility and instability of Argentina’s economic and financial system may substantially affect the composition of our income and assets and the accuracy of our projections. If we become a PFIC, United States Holders of our shares or ADSs will be subject to certain United States federal income tax rules that have negative consequences for United States Holders such as additional tax and an interest charge upon certain distributions by us or upon a sale or other disposition of our shares or ADSs at a gain, as well as reporting requirements. Please see “Taxation-United States Taxation” for a more detailed discussion of the consequences if we are deemed a PFIC. You should consult your own tax advisors regarding the application of the PFIC rules to your particular circumstances. Risks Related to IRSA’s Business IRSA’s performance is subject to risks associated with its properties and with the real estate industry. IRSA’s economic performance and the value of its real estate assets, and consequently the value of its securities, are subject to the risk that if IRSA properties do not generate revenues sufficient to meet IRSA’s operating expenses, including debt service and capital expenditures, IRSA’s cash flow and ability to pay distributions to its shareholders will be adversely affected. Events or conditions beyond IRSA’s control that may adversely affect IRSA’s operations or the value of its properties include:
23
Table of Contents
IRSA’s investment in property development or redevelopment may be less profitable than IRSA anticipates. IRSA is engaged in the development and construction of office space, retail and residential properties, frequently through third-party contractors. Risks associated with IRSA’s development, re-development and construction activities include the following, among others:
IRSA faces risks associated with property acquisitions. IRSA has in the past acquired, and intend to acquire in the future, properties, including large properties (such as the acquisition of Abasto de Buenos Aires or Alto Palermo Shopping) that would increase IRSA’s size and potentially alter IRSA’s capital structure. Although we believe that the acquisitions that IRSA has completed in the past and that IRSA expects to undertake in the future have, and will, enhance IRSA’s future financial performance, the success of such transactions is subject to a number of uncertainties, including the risk that:
24
Table of Contents
Acquired properties may subject IRSA to unknown liabilities. Properties that IRSA acquire may be subject to unknown liabilities for which IRSA would have no recourse, or only limited recourse, to the former owners of such properties. As a result, if a liability were asserted against IRSA based upon ownership of an acquired property, IRSA might be required to pay significant sums to settle it, which could adversely affect IRSA’s financial results and cash flow. Unknown liabilities relating to acquired properties could include:
Demand for IRSA’s premium properties which target the high-income demographic, might be insufficient. IRSA has focused on development projects intended to cater to upper-middle income individuals and have entered into property swap agreements pursuant to which IRSA contributes its undeveloped properties to ventures with developers who will deliver to IRSA units in full-service apartments in premium locations of downtown Buenos Aires, such as the Renoir towers. These developments are currently estimated to be completed in 2008 and will bring to the market over 11,500 square meters of high quality residential apartments. At the time the developers return these properties to IRSA, demand for premium apartments could be significantly lower than IRSA currently project. In such case, IRSA would be unable to sell these apartments at the prices or in the time frame IRSA estimated, which could have a material adverse effect on IRSA’s financial condition and results of operations. Some of the land IRSA purchases is not zoned for development purposes, and IRSA may be unable to obtain, or may face delays in obtaining the necessary zoning and other permits. IRSA owns several plots of land which are not currently zoned for development purposes or for the type of developments IRSA propose, including Santa María del Plata, Puerto Retiro and Terrenos de Caballito. In addition, IRSA does not yet have the required land-use, building, occupancy and other required governmental permits and authorizations. IRSA cannot assure you that IRSA will continue to be successful in its attempts to rezone land and to obtain all necessary permits and authorization, or that rezoning efforts and permit requests will not be unreasonably delayed. Moreover, IRSA may be affected by building moratoria and anti-growth legislation. If IRSA is unable to obtain all of the governmental permits and authorizations IRSA needs to develop its present and future projects as planned, IRSA may be forced to make unwanted modifications to such projects or abandon them altogether.
25
Table of ContentsSome potential losses are not covered by insurance, and certain kinds of insurance coverage may become prohibitively expensive. IRSA currently carries liability, fire, extended coverage and rental loss insurance on all its properties. Although IRSA believes the policy specifications and insured limits of these policies are generally customary, there are certain types of losses, such as lease and other contract claims and terrorism and acts of war that generally are not insured. Should an uninsured loss or a loss in excess of insured limits occur, IRSA could lose all or a portion of the capital IRSA has invested in a property, as well as the anticipated future revenue from the property. In such an event, IRSA might nevertheless remain obligated for any mortgage debt or other financial obligations related to the property. We cannot assure you that material losses in excess of insurance proceeds will not occur in the future. If any of IRSA’s properties were to experience a catastrophic loss, it could seriously disrupt IRSA’s operations, delay revenue and result in large expenses to repair or rebuild the property. In addition, we cannot assure you that IRSA will be able to renew insurance coverage in an adequate amount or at reasonable prices. Insurance companies may no longer offer coverage against certain types of losses, such as losses due to terrorist acts and mold, or, if offered, these types of insurance may be prohibitively expensive. Moreover, IRSA does not purchase life or disability insurance for any of its key employees. If any of IRSA’s key employees were to die or become incapacitated, IRSA could experience losses caused by a disruption in its operations which will not be covered by insurance, and this could have a material adverse effect on its financial condition and results of operations. It may be difficult to buy and sell real estate quickly, and transfer restrictions apply to some of IRSA’s properties. Real estate investments are relatively illiquid, and this tends to limit IRSA’s ability to vary its portfolio promptly in response to changes in economic or other conditions. In addition, significant expenditures associated with each equity investment, such as mortgage payments, real estate taxes and maintenance costs, are generally not reduced when circumstances cause a reduction in income from the investment. If income from a property declines while the related expenses do not decline, IRSA’s business would be adversely affected. A significant portion of IRSA’s properties are mortgaged to secure payment of indebtedness, and if IRSA is unable to meet its mortgage payments, IRSA could lose money as a result of foreclosure on the properties by the various mortgagees. In addition, if it becomes necessary or desirable for IRSA to dispose of one or more of the mortgaged properties, it might not be able to obtain a release of the lien on the mortgaged property without payment of the associated debt. The foreclosure of a mortgage on a property or inability to sell a property could adversely affect IRSA’s business. In transactions of this kind, IRSA may also agree, subject to certain exceptions, not to sell the acquired properties for significant periods of time. The loss of significant tenants could adversely affect both the operating revenues and value of IRSA’s shopping center and other rental properties. If certain of IRSA’s most important tenants were to experience financial difficulties, including bankruptcy, insolvency or a general downturn of business, or if IRSA simply failed to retain their patronage, its business could be materially affected. IRSA’s shopping centers and, to a lesser extent, IRSA’s office buildings are typically anchored by well-known department stores and other significant tenants who generate shopping traffic at the mall. A decision by anchor tenants to cease operations at IRSA’s shopping centers or office buildings could have a material adverse effect on the revenues and profitability of the affected segment and, by extension, on IRSA’s financial condition and results of operations. The closing of anchor tenants may induce other anchors and/or tenants at an affected property to terminate their leases, to seek rent relief and/or cease operating their stores or otherwise adversely affect occupancy at the property. The bankruptcy and/or closure of significant tenants, if IRSA
26
Table of Contentsis not able to successfully re-tenant the affected space, could have a material adverse effect on both the operating revenues and underlying value of the properties involved. The real estate industry in Argentina is increasingly competitive IRSA’s real estate and construction activities is highly concentrated in the Buenos Aires metropolitan area, an area where the real estate market is highly competitive due to a scarcity of properties in sought-after locations and the increasing number of local and international competitors. Furthermore, the Argentine real estate industry generally is highly competitive and fragmented, and does not have high-entry barriers restricting new competitors from entering the market. The main competitive factors in the real estate development business include availability and location of land, price, funding, design, quality, reputation and partnerships with developers. A number of residential and commercial developers and real estate services companies compete with IRSA in seeking land for acquisition, financial resources for development and prospective purchasers and tenants. Other companies, including foreign companies working in partnerships with local companies, have become increasingly active in the real estate business in Argentina, further increasing this competition. To the extent that one or more of IRSA’s competitors are able to acquire and develop desirable properties, as a result of greater financial resources or otherwise, IRSA’s business could be materially and adversely affected. If IRSA is not able to respond to such pressures as promptly as its competitors, or the level of competition increases, IRSA’s financial condition and results of its operations could be adversely affected. IRSA’s shopping center business is subject to competition. Many of IRSA’s properties are located close to other shopping centers, numerous retail stores and residential properties. The number of comparable properties located in the vicinity of IRSA’s properties could have a material adverse effect on its ability to lease retail space in IRSA’s shopping centers or sell units in its residential complexes and on the rent price or the sale price that IRSA is able to charge. Although to date there have been few companies competing with IRSA for shopping center properties, we cannot assure you that other shopping center operators, including international shopping center operators, will not invest in Argentina in the near future. As additional companies become active in the Argentine shopping center market, such increased competition could have a material adverse effect on IRSA’s results of operations. IRSA is subject to risks inherent to the operation of shopping centers that may affect its profitability. Shopping centers are subject to various factors that affect their development, administration and profitability. These factors include:
An increase in operating costs, caused by inflation or other factors, could have a material adverse effect on IRSA if its tenants are unable to pay higher rent due to the increase in expenses. Moreover, the
27
Table of Contentsshopping center business is closely related to consumer spending and to the economy in which customers are located. All of IRSA’s shopping centers are in Argentina, and, as a consequence, their business could be seriously affected by potential recession in Argentina. For example, during the economic crisis in Argentina, spending decreased significantly, unemployment, political instability and inflation would reduce consumer spending in Argentina, lowering tenants’ sales and forcing some of them to leave IRSA’s shopping centers. This could affect the revenues from the shopping center activity. IRSA is subject to payment default risks due to its investments in credit card businesses through its subsidiary Alto Palermo. IRSA’s subsidiary Alto Palermo owns an 80% interest in Tarshop S.A., a credit card company which originates credit card accounts to promote sales from Alto Palermo’s tenants and other selected retailers. During the fiscal year ended June 30, 2006, Tarshop had net revenues of Ps.122.9 million, representing 34% of Alto Palermo’s revenues and 21.3% of IRSA’s consolidated revenues for such fiscal year. Credit card businesses such as Tarshop are adversely affected by defaults or late payments by card holders on credit card accounts, by difficulties enforcing collection of payments, by fraudulent accounts and by the writing off of past due receivables. The present rates of delinquency, collection proceedings and loss of receivables may vary and be affected by numerous factors beyond IRSA’s control which among others, include:
These and other factors may have an adverse effect on rates of delinquency, collections and receivables, any one or more of which could have a material adverse effect on the results of operations of Tarshop’s credit card business. In addition, if IRSA’s credit card business is adversely affected by one or more of the above factors, the quality of IRSA’s securitized receivables is also likely to be adversely affected. Therefore, IRSA would be adversely affected to the extent that IRSA holds an interest in any such securitized receivables. IRSA’s level of debt may adversely affect its operations and its ability to pay its debt as it becomes due. IRSA has had, and expects to continue to have, substantial liquidity and capital resource requirements to finance its business. As of June 30, 2006, IRSA’s consolidated financial debt amounted to Ps.391.4 million (including accrued and unpaid interest and deferred financing costs). The fact that IRSA is leveraged may affect its ability to refinance existing debt or borrow additional funds to finance working capital, acquisitions and capital expenditures. This would require IRSA to allocate a substantial portion of cash flow to repay principal and interest, thereby reducing the amount of money available to invest in operations, including acquisitions and capital expenditures. IRSA’s leverage could place IRSA at a disadvantage compared to its competitors who are less leveraged and limit its ability to react to changes in market conditions, changes in the real estate industry and economic downturns. Although IRSA has successfully restructured its debt, we cannot assure you that IRSA will not relapse and become unable to pay its obligations.
28
Table of ContentsIRSA may not be able to generate sufficient cash flows from operations to satisfy its debt service requirements or to obtain future financing. If IRSA cannot satisfy its debt service requirements or if IRSA defaults on any financial or other covenants in its debt arrangements, the holders of IRSA’s debt will be able to accelerate the maturity of such debt or cause defaults under the other debt arrangements. IRSA’s ability to service debt obligations or to refinance them will depend upon its future financial and operating performance, which will, in part, be subject to factors beyond IRSA’s control such as macroeconomic conditions and regulatory changes in Argentina. If IRSA cannot obtain future financing, it may have to delay or abandon some or all of its planned capital expenditures, which could adversely affect IRSA’s ability to generate cash flows and repay its obligations. IRSA is subject to risks affecting the hotel industry. The full-service segment of the lodging industry in which IRSA’s hotels operate is highly competitive. The operational success of IRSA’s hotels is highly dependant on IRSA’s ability to compete in areas such as access, location, quality of accommodations, rates, quality food and beverage facilities and other services and amenities. IRSA’s hotels may face additional competition if other companies decide to build new hotels or improve their existing hotels to increase their attractiveness. In addition, the profitability of IRSA’s hotels depends on:
IRSA’s business is subject to extensive regulation and additional regulations may be imposed in the future. IRSA’s activities are subject to federal, state and municipal laws, and to regulations, authorizations and licenses required with respect to construction, zoning, use of the soil, environmental protection and historical patrimony, consumer protection and other requirements, all of which affect IRSA’s ability to acquire land, develop and build projects and negotiate with customers. In addition, the companies in this industry are subject to increasing tax rates, the creation of new taxes and changes in the taxation regime. IRSA is required to obtain licenses and authorizations with different governmental authorities in order to carry out its projects. Maintain IRSA’s licenses and authorizations can be a costly provision. In the case of non-compliance with such laws, regulations, licenses and authorizations, IRSA may face fines, project shutdowns, cancellation of licenses and revocation of authorizations. In addition, public authorities may issue new and stricter standards, or enforce or interpret existing laws and regulations in a more restrictive manner, which may force IRSA to spend funds to comply with such new rules. Development activities are also subject to risks relating to the inability to obtain or delays in obtaining all necessary zoning, environmental, land-use, development, building, occupancy and other required governmental permits and authorizations. Any such actions from the public authorities may have an adverse effect on IRSA`s business. In the past, in response to housing shortages, high rates of inflation and difficulties in accessing to credit, the Argentine government imposed strict and burdensome regulations regarding leases. Such regulations limited or prohibited increases on rental prices and prohibited eviction of tenants, even for failure to pay rent. Most of IRSA’s leases provide that the tenants pay all costs and taxes related to their respective leasable areas. In the event of a significant increase in the amount of such costs and taxes, the
29
Table of ContentsArgentine government may respond to political pressure to intervene by regulating this practice, thereby negatively affecting IRSA’s rental income. We cannot assure you that the Argentine government will not impose similar or other regulations in the future. Changes in existing laws or the enactment of new laws governing the ownership, operation or leasing of properties in Argentina could negatively affect the Argentine real estate market and the rental market and materially and adversely affect IRSA’s operations and profitability. IRSA’s development activities depend on its ability to obtain and maintain zoning, environmental, land-use and other governmental approvals IRSA owns several substantial plots of land which are not zoned for the type of development its propose, including Santa María del Plata, Puerto Retiro and Terrenos de Caballito. In addition, IRSA does not yet have the required building, occupancy and other governmental permits and authorizations that IRSA will need to be able to develop these properties as IRSA currently propose. As a result, we cannot assure you that IRSA will be successful in its attempts to rezone such land and to obtain all necessary permits and authorizations, or that rezoning efforts and permit requests will not be unreasonably delayed. Moreover, IRSA may be affected by building moratoria and anti-growth legislation, particularly in the City of Buenos Aires. If IRSA is unable to obtain all of the governmental permits and authorizations IRSA needs to develop its present and future projects, IRSA may be forced to make unwanted modifications to such projects or abandon them altogether which could have a material adverse effect on its financial condition and results of operations. Argentine Leasing Law No. 23,091 imposes restrictions that limit IRSA’s flexibility. Argentine laws governing leases impose certain restrictions, including the following:
As a result of the foregoing, IRSA is exposed to the risk of increases of inflation under its leases and the exercise of rescission rights by its tenants could materially and adversely affect IRSA’s business and we cannot assure you that IRSA’s tenants will not exercise such right, especially if rent values stabilize or decline in the future. Eviction proceedings in Argentina are difficult and time consuming. Although Argentine law permits a summary proceeding to collect unpaid rent and a special proceeding to evict tenants, eviction proceedings in Argentina are difficult and time-consuming. Historically, the heavy workload of courts and the numerous procedural steps required have generally delayed landlords’ efforts to evict tenants. Eviction proceedings generally take between six months and two years from the date of filing of the suit to the time of actual eviction. Historically, delinquency
30
Table of Contentsregarding IRSA’s office rental space has been very low, approximately 2%, and IRSA has usually attempted to negotiate the termination of lease agreements with defaulting tenants after the first few months of non-payment in order to avoid legal proceedings. Delinquency may increase significantly in the future, and such negotiations with tenants may not be as successful as they have been in the past. Moreover, new Argentine laws and regulations may forbid or restrict eviction proceedings, and in such case, they would likely have a material and adverse effect on IRSA’s financial condition and results of operation. IRSA’s assets are concentrated in the Buenos Aires area. IRSA’s principal properties are located in the City of Buenos Aires and the Province of Buenos Aires, and a substantial portion of its revenues are derived from such properties. For the fiscal year ended June 30, 2006, more than 85% of IRSA’s consolidated revenues was derived from properties in the Buenos Aires metropolitan area including the City of Buenos Aires. Although IRSA owns properties and may acquire or develop additional properties outside Buenos Aires, IRSA expects to continue to depend to a large extent on economic conditions affecting those areas, and therefore, an economic downturn in those areas could have a material adverse effect on its financial condition and results of operations. IRSA face risks associated with potential expansion to other Latin American Markets. From 1994 to 2002 IRSA had substantial investments outside of Argentina, including Brazil Realty, which was sold in 2002 and Fondo de Valores Inmobiliario in Venezuela, which was sold in 2001. IRSA continues to believe that Brazil and other Latin American countries offer attractive opportunities for growth in the real estate sector. IRSA will continue to consider investment opportunities outside of Argentina as they arise. Investments in Brazil and other Latin American countries are subject to significant risks including sovereign risks and risks affecting these countries’ real estate sector. These risks include competition by well-established as well as new developers, unavailability of financing or financing on terms that are not acceptable to IRSA, exchange rate fluctuations, lack of liquidity in the market, rising construction costs and inflation, extensive and potentially increasing regulation and bureaucratic procedures for obtaining permits and authorizations, political and economic instability that may result in sharp shifts in demand for properties, risks of default in payment and difficulty of evictions for defaulting tenants. If the court extends Inversora Dársena Norte S.A.’s bankruptcy to Puerto Retiro, IRSA will likely lose a significant investment in a unique waterfront land reserve in the City of Buenos Aires. On November 18, 1997, in connection with IRSA’s acquisition of its subsidiary Inversora Bolívar S.A. (“Inversora Bolívar”), IRSA indirectly acquired 35.2% of the capital stock of Puerto Retiro. Inversora Bolívar had purchased such shares of Puerto Retiro from Redona Investments Ltd. N.V. in 1996. In 1999, IRSA, through Inversora Bolívar, increased its interest in Puerto Retiro to 50.0% of its capital stock. On April 18, 2000, Puerto Retiro received notice of a complaint filed by the Argentine Federal Government seeking to extend the bankruptcy of Inversora Dársena Norte S.A. (“Indarsa”). Upon filing of the complaint, the bankruptcy court issued an order restraining the ability of Puerto Retiro to dispose of, in any manner, the real property it had purchased in 1993 from Tandanor S.A. (“Tandanor”). In 1991, Indarsa had purchased 90% of Tandanor, a formerly government owned company, which owned a large piece of land near Puerto Madero of approximately 8 hectares, divided into two spaces: Planta 1 and 2. After the purchase of Tandanor by Indarsa, in June 1993 Tandanor sold “Planta 1” to Puerto Retiro, for a sum of US$18 million pursuant to a valuation performed by J.L. Ramos, a well-
31
Table of Contentsknown real estate brokerage firm in Argentina. The Argentine Government sustains the Indarsa did not cancel the outstanding balance of the purchase price of Tandanor, and as a result of this,, through its Ministry of Defense, petitioned the bankruptcy of Indarsa. Since the sole asset of Indarsa was its ownership interest in Tandanor, the Argentine Government is seeking to extend the bankruptcy procedures to any company or individual, which, according to its view, acted as a group, and therefore, in this process requested the bankruptcy of Puerto Retiro and other companies and persons. In particular, the Argentine Government has requested the extension of Indarsa’s bankruptcy to Puerto Retiro which acquired Planta 1 from Tandanor. On April 18, 2001, the trial began, and a measure prohibiting IRSA`s disposition of this plot of land is still in effect. We cannot give you any assurance that IRSA will prevail in this proceeding, and if the plaintiff’s claim is upheld by the courts, all of the assets of Puerto Retiro would likely be used to pay Indarsa’s debts and IRSA´s investment in Puerto Retiro, valued at Ps.46.5 million as of June 30, 2006, would be lost. As of June 30, 2006, IRSA had not established any reserve in respect of this contingency. The management and legal advisors of Puerto Retiro S.A. estimates that there are legal and technical issues sufficient to consider that the request for postponement of bankruptcy will be denied by the court. However, taking the circumstances into account and the progress of the legal action, this position cannot be considered final. If Alto Palermo cannot reach an agreement with sellers regarding IRSA’s acquisition of a significant interest in the Neuquén Project, the sale may be voided, and Alto Palermo may not recover its original investment On July 6, 1999, Alto Palermo acquired 94.6% ownership of Shopping Neuquén S.A. (“Shopping Neuquén”) for Ps.4.2 million. Shopping Neuquén’s sole asset is a plot of land of approximately 50,000 square meters on which IRSA seeks to build a shopping center. The proposed project contemplates the building of a shopping center, a hypermarket, a hotel and a housing complex, none of which have begun. Alto Palermo paid Ps.0.9 million on September 1, 1999, and the remaining Ps.3.3 million were originally scheduled to be paid on the earlier to occur of July 5, 2001, and the completion of the construction of the shopping center. Alto Palermo did not pay the balance of the purchase price. On August 15, 2003, the former holders of 85.8% of Shopping Neuquén filed a complaint against Alto Palermo seeking recovery of the unpaid balance of the purchase price, plus interest and legal costs. In September 2003, Alto Palermo answered the complaint and raised several defenses including, plaintiffs’ non-compliance with their duties under the contract and the pesification of the purchase price balance pursuant to emergency legislation adopted in 2002. Alto Palermo also filed a counterclaim alleging there should be a readjustment of the terms of the contract which became excessively burdensome given the 2001 economic, social and political crisis. In November 2003, the plaintiffs replied to Alto Palermo’s counterclaim alleging that the payment under the purchase agreement was overdue before the economic and social crisis emerged and thus Alto Palermo’s contract readjustment claim was inadmissible. The matter is currently subject to appeal, as the ruling of the trial court was appealed by both former shareholders of Shopping Neuquén and Alto Palermo. If Alto Palermo cannot reach agreement with the former owners of Shopping Neuquén, Alto Palermo would be compelled to pay the sum the court determines. As of June 30, 2006, the Ps.3.3 million deferred balance of the purchase price remains unpaid. Alto Palermo is engaged in litigation with the Municipality of Neuquén In June 2001, Shopping Neuquén filed a request with the Municipality of Neuquén to extend the construction deadlines that had been originally scheduled. In addition, it requested authorization to convey certain plots of land to third parties so that each participant to the Neuquén project would be able to build on his own land. On December 20, 2002, the Municipality of Neuquén issued Decree 1437/02 denying both requests. In addition, it declared that the rights under Ordinance 5178 had lapsed and that
32
Table of Contentsthe land purchase agreements would be terminated. As a result, the improvements already made by Shopping Neuquén would be lost and passed on to the Municipality of Neuquén, leaving Shopping Neuquén with no right to compensation. On January 21, 2003, Shopping Neuquén submitted its response to the Decree 1437/02 requesting its revocation and requesting permission to submit a new construction timetable, which would be prepared in accordance with the current situation of the project, including reasonable short and medium term projections. The Municipal Executive issued Decree 585/2003 rejecting these requests. On June 25, 2003, Shopping Neuquén filed an administrative action with the Supreme Court of Neuquén requesting the annulment of Decrees 1437/2002 and 585/2003. On December 21, 2004, the Supreme Court of Neuquén ruled in favor of the Municipality of Neuquén, declaring that the administrative action filed by Shopping Neuquén had expired. The decision, however, is not final. Alto Palermo filed an appeal, but the Supreme Court of Neuquén has not yet issued a decision with regards to its admissibility. If the appeal is declared admissible the Federal Supreme Court will give a final decision, but if it is declared inadmissible Alto Palermo will file an appeal directly with the Federal Supreme Court. On December 13, 2006, Shopping Neuquén subscribed an agreement with the Municipality of Neuquén and the Province of Neuquén in which Shopping Neuquén was given a new timetable to implement the commercial and housing project. In addition, Shopping Neuquén will be empowered to transfer to third parties further subdivisions of the plot of land owned by Shopping Neuquén, provided that the plot to be transferred is not the one in which the shopping center is going to be built. The agreement is subject to the City of Neuquén Council’s approval and the promulgation of the new Ordinance by the Mayor of the City of Neuquén. Should the agreement be disapproved by the City Council, such agreement will be void. Property ownership through joint ventures may limit IRSA’s ability to act exclusively in its interest. IRSA develops and acquires properties in joint ventures with other persons or entities when IRSA believes circumstances warrant the use of such structures. For example, in the shopping center segment, IRSA owns 61.5 % of Alto Palermo Shopping, while Parque Arauco S.A. owns another 29.6 %. In the development and sale segment, IRSA has a majority ownership interests in various properties, including 61.5% ownership of Predio Phillips, 83% ownership of Pereiraola, 83% of Abril/Baldovinos. IRSA also holds a minority interest of 50% in Puerto Retiro. In the hotels segment, IRSA owns 50% of the Llao Llao Hotel, while another 50% is owned by the Sutton Group. IRSA owns 80% of the Hotel Libertador, while 20% is owned by Hoteles Sheraton de Argentina S.A. On the financial services sector, IRSA owns 11.8% of Banco Hipotecario, while the Argentine government has a controlling interest in it. IRSA could become engaged in a dispute with one or more of its joint venture partners that might affect IRSA’s ability to operate a jointly-owned property. Moreover, IRSA’s joint venture partners may, at any time, have business, economic or other objectives that are inconsistent with IRSA’s objectives, including objectives that relate to the timing and terms of any sale or refinancing of a property. For example, the approval of certain of the other investors is required with respect to operating budgets and refinancing, encumbering, expanding or selling any of these properties. In some instances, IRSA’s joint venture partners may have competing interests in IRSA’s markets that could create conflicts of interest. If the objectives of IRSA’s joint venture partners are inconsistent with IRSA’s own objections, IRSA will not be able to act exclusively in its interests. If one or more of the investors in any of IRSA’s jointly owned properties were to experience financial difficulties, including bankruptcy, insolvency or a general downturn of business, there could be an adverse effect on the relevant property or properties and in turn, on IRSA’s financial performance.
33
Table of ContentsShould a joint venture partner become bankrupt, IRSA could become liable for its partner’s share of joint venture liabilities. IRSA may not be able to recover the mortgage loans IRSA has provided to purchasers of units in its residential development properties. In recent years, IRSA has provided mortgage financing to purchasers of units in IRSA’s residential development properties. Before January 2002, IRSA’s mortgage loans were U.S. Dollar-denominated and accrued interest at a fixed interest rate generally ranging from 10% to 15% per year and for terms generally ranging from one to fifteen years. However, on March 13, 2002, the Central Bank converted all U.S. Dollar denominated debts into Peso denominated debts at the exchange rate of Ps.1.00 to U.S. Dollars 1.00. In addition, the Central Bank imposed maximum interest rates of 3% for residential mortgage loans to individuals and 6% for mortgage loans to businesses. These regulations adversely affected the U.S. Dollar value of IRSA’s outstanding mortgages, which on June 30, 2006, approximately Ps.33.1 million. Beside risks normally associated with providing mortgage financing, including the risk of default on principal and interest, other regulatory risks such as suspension of foreclosure enforcement proceedings could adversely affect IRSA’s cash flow. Argentine law imposes significant restrictions on IRSA’s ability to foreclose and auction properties. Thus, when there is a default under a mortgage, IRSA does not have the right to foreclose on the unit. Instead, in accordance with Law No. 24,441, in order to reacquire a property IRSA is required to purchase it at a court ordered public auction, or at an out-of-court auction. However, the Public Emergency Law temporarily suspended all judicial and non-judicial mortgage and pledge enforcement actions. Several laws and decrees extended this mortgage foreclosure suspension period, most recently on June 14, 2006 which established a 180-day suspension period for mortgage foreclosure proceedings affecting debtors’ only dwellings and where the original loan was no higher than Ps.100,000. Law No. 25,798 enacted November 5, 2003, and implemented by Decrees No. 1284/2003 and No. 352/2004, among others, sets forth a system to restructure delinquent mortgage payments to prevent foreclosures on debtor’s only dwelling (the “Mortgage Refinancing System”). The Mortgage Refinancing System establishes a trust over assets contributed by the Argentine government and income from restructured mortgage loans. Banco de la Nación Argentina, in its capacity as trustee of said trust, enters into debt restructuring agreements with delinquent mortgage debtors establishing the following terms: (i) a grace period on the mortgage loan of one year and (ii) monthly installment payments on the mortgage loan not to exceed 30% of the aggregate income of the family living in the mortgaged property. Banco de la Nación Argentina then subrogates the mortgagee’s rights against the debtor, by issuing notes delivered to the mortgagee to settle the amounts outstanding on the mortgage loan. The sum restructured under the Mortgage Refinancing System may not exceed the appraisal value of the property securing the mortgage after deducting any debts for taxes and maintenance. The Mortgage Refinancing System was established for a limited period of time, during which parties to a mortgage loan agreements could opt to participate in it. However, it was extended by a number of decrees and laws. Recently enacted Law No. 26.167 established a special proceeding to replace ordinary trials regarding the enforcement of mortgage loans, by virtue of which creditors have 10 days to inform the amounts owed to them and later agree with the debtor on the amount and terms of payment. In case of failure by the parties to reach an agreement, payment conditions are to be determined by the judge.
34
Table of ContentsWe cannot assure you that laws and regulations relating to foreclosure on real estate will not continue to change in the future or that any changes will not adversely affect IRSA’s business, financial condition or result of operations. IRSA is dependent on its chairman Eduardo Elsztain and certain other senior managers. IRSA’s success depends on the continued employment of Eduardo S. Elsztain, IRSA’s chief executive officer, president and chairman of the board of directors, who possess significant expertise and knowledge of IRSA’s business and industry. The loss of or interruption in his services for any reason could have a material adverse effect on its business. We cannot assure you that IRSA would be able to find an appropriate replacement should the need arise. IRSA’s future success also depends in part upon IRSA’s ability to attract and retain other highly qualified personnel. We cannot assure you that IRSA will be successful in hiring or retaining qualified personnel and, if IRSA is not, it would likely have a material adverse effect on IRSA’s financial condition and results of operations. IRSA may face potential conflicts of interest relating to its principal shareholders. IRSA`s largest beneficial owner is Mr. Eduardo S. Elsztain. As of November 30, 2006, such beneficial ownership consisted of:
Conflicts of interest between IRSA`s management, IRSA`s Company and IRSA`s affiliates may arise in the performance of IRSA`s respective business activities. Mr. Elsztain also beneficially owns (i) approximately 21.13% of our common shares, and (ii) approximately 61.54% of the common shares of our subsidiary Alto Palermo. We cannot assure you that IRSA`s principal shareholders and their affiliates will not limit or cause IRSA to forego business opportunities that their affiliates may pursue or that the pursuit of other opportunities will be in IRSA`s interest. Due to the currency mismatches between its assets and liabilities, IRSA has significant currency exposure. As of September 30, 2006, the majority of IRSA’s liabilities, such as its unsecured loan agreement, IRSA’s Series 3 secured floating rate notes due 2009, the mortgage loan to Hoteles Argentinos, its convertible notes and Alto Palermo’s convertible notes are denominated in U.S. Dollars while IRSA’s revenues and most of its assets as of September 30, 2006 are denominated in Pesos. This currency gap exposes IRSA to risk of exchange rate volatility, which would negatively affect its financial results if the dollar were to appreciate against the Peso. Any further depreciation of the Peso against the U.S. Dollar will correspondingly increase the amount of IRSA’s debt in Pesos, with further adverse effects on its results of operation and financial condition, and may increase the collection risk of IRSA’s leases and other receivables from its tenants and mortgage debtors, most of whom have Peso-denominated revenues. IRSA’s subordinated interest in Tarshop’s securitized assets may have no value. Tarshop S.A., an Alto Palermo subsidiary, is a credit card company that originates credit card accounts to promote sales from Alto Palermo’s tenants and other selected retailers. Tarshop’s accounts receivables, which consist of cash flows from sales on credit, are placed into a number of trust accounts that securitize those receivables. Tarshop sells beneficial interests in these trust accounts through the sale
35
Table of Contentsof debt certificates, but it also remains a beneficiary of these trust accounts by holding, as of September 30, 2006, Ps.49.7 million worth of these participation certificates. We cannot assure you that collection of payments from credit card accounts will be sufficient to distribute earnings to holders of participation certificates, which would reduce Tarshop’s earnings. In addition, local authorities might increase credit card or trust account regulations, negatively affecting Tarshop’s revenues and results of operation. Risks Related to IRSA’s Investment in Banco Hipotecario IRSA’s investment in Banco Hipotecario subjects us to risks affecting Argentina’s highly regulated banking sector. As of June 30, 2006, IRSA owned 11.8% of Banco Hipotecario which represented 9.5% of IRSA’s consolidated assets at such date. Substantially all of Banco Hipotecario’s operations, properties and customers are located in Argentina. Accordingly, the quality of its loan portfolio, its financial condition and results of operations depend to a significant extent on macroeconomic and political conditions prevailing in Argentina. The political and economic crisis in Argentina during 2002 and 2003, and the Argentine government’s actions to address it have had and may continue to have a material adverse effect on Banco Hipotecario’s business, financial condition and results of operations. Financial institutions in Argentina are subject to significant regulation by the Central Bank and certain other regulatory authorities. Measures adopted by the Central Bank have had and may continue to have a material adverse effect on Banco Hipotecario’s financial condition and results of operations. On July 25, 2003, the Central Bank announced its intention to adopt new capital adequacy requirements that it will implement gradually through 2009. In addition, the IMF and other multilateral agencies encouraged the Argentine Government to impose minimum capital adequacy, solvency and liquidity requirements consistent with international standards, which could impose material operating restrictions on Banco Hipotecario. Laws and decrees implemented during the economic crisis in 2001 and 2002 have substantially altered contractual obligations affecting Argentina’s financial sector. Recently, various initiatives have been presented to the Argentine Congress intended to reduce or eliminate a portion of the mortgage loan portfolio on the debt owed to Banco Hipotecario. Also, there have been certain initiatives intended to review the terms pursuant to which Banco Hipotecario was privatized. As a result, we cannot assure you that the Argentine legislature will not enact new laws that will have a significant adverse effect on Banco Hipotecario’s shareholders’ equity or that, if this were to occur, the Argentine Government would compensate Banco Hipotecario for the resulting loss. The future outcome of the uncertainties described above could have an adverse effect on the value of IRSA’s investment in Banco Hipotecario. Government intervention on mortgage loans may have an adverse effect on Banco Hipotecario’s mortgage loans performance. On November 29, 2006, Law No. 26,177 created the “Unidad de Reestructuración” which will consider the possibility of restructuring the whole mortgage loans, between the debtors and the old Banco Hipotecario (state-owned corporation). These and other measures may have a future impact in Banco Hipotecario’s mortgage loans performance. Banco Hipotecario relies on mortgage lending and may not be able to implement successfully its new diversification strategy. Historically, Banco Hipotecario has been engaged exclusively in mortgage lending and related activities. As a result, factors having an adverse effect on the mortgage market have a greater adverse
36
Table of Contentsimpact on Banco Hipotecario than on its more diversified competitors. Due to its historical concentration in this recession-sensitive sector, Banco Hipotecario is particularly vulnerable to adverse changes in economic and market conditions in Argentina due to their adverse effect on the demand for new mortgage loans and the asset quality of outstanding mortgage loans. In light of the economic conditions in Argentina, Banco Hipotecario cannot rely exclusively on mortgage lending and related services. Although Banco Hipotecario has adopted a new business strategy to diversify its banking business, it must overcome significant challenges to implement this strategy including, among others, its lack of experience and client relationships outside the mortgage sector, the existence of large, well-positioned competitors and significant political, regulatory and economic uncertainties in Argentina. As a result, we cannot give any assurance that Banco Hipotecario will be successful in developing significant retail banking activities in the future. If Banco Hipotecario is unable to effectively transition to a new and viable operating model, the value of IRSA’s substantial investment in Banco Hipotecario would likely be materially and adversely affected. Banco Hipotecario may not be successful in its diversification strategy given recent disagreements with the Argentine government. Banco Hipotecario faces significant challenges in seeking to develop its business plan through internal growth and therefore continuously explores acquisition opportunities. The pace of change in the Argentine financial system may require Banco Hipotecario to take advantage of opportunities and make decisions on an expedited basis, which may prove difficult to accomplish given applicable regulatory requirements and the requirement that the Argentine government, as one of its shareholders, approve certain transactions. These acquisition opportunities may require Banco Hipotecario to incur additional debt or other direct or contingent liabilities, and its ability to incur such liabilities is limited. In addition, any such acquisitions would likely divert a significant amount of its management’s attention to the integration of these businesses into Banco Hipotecario’s current operations. The Argentine government, one of Banco Hipotecario’s major shareholders, has a “golden share”, meaning that it has an effective veto in respect of transactions involving any merger Banco Hipotecario may contemplate. In 2005, Banco Hipotecario entered into an agreement to acquire an important bank in Argentina, but the Argentine Government did not approve the proposed acquisition and as a result it was not consummated. If IRSA, as shareholders, is not able to receive government support to successfully implement new business strategies, Banco Hipotecario’s ability to implement such strategies may be materially and adversely affected. The Argentine government may prevail in all matters to be decided at a Banco Hipotecario’s general shareholders meeting. According to the Privatization Law and Banco Hipotecario’s by-laws, holders of Class A and Class D Shares have special voting rights relating to certain corporate decisions. Whenever such special rights do not apply (with respect to the Class A Shares and the Class D Shares) and in all cases (with respect to the Class B Shares and the Class C Shares), each share of common stock entitles the holder to one vote. Pursuant to Argentine regulations, Banco Hipotecario may not issue new shares with multiple votes. The holders of Class D Shares have the right to elect nine of Banco Hipotecario’s board members and their respective alternates. In addition, for so long as Class A Shares represent more than 42.0% of Banco Hipotecario’s capital, the Class D Shares shall be entitled to three votes per share, provided that holders of Class D Shares will be entitled to only one vote per share in the case of a vote on:
37
Table of Contents
In addition, irrespective of what percentage of Banco Hipotecario’s outstanding capital stock is represented by Class A Shares, the affirmative vote of the holders of Class A Shares is required to adopt certain decisions. Class D Shares will not be converted into Class A Shares, Class B Shares or Class C Shares by virtue of their reacquisition by the Argentine government, PPP (Programa de Propiedad Participada) participants or companies engaged in housing development or real estate activities. According to the Privatization Law, there are no restrictions on the ability of the Argentine government to dispose of its Class A shares, and all but one of such shares could be sold to third parties in a public offering. If the Class A shares represent less than 42% of Banco Hipotecario’s total voting stock as a result of the issuance of new shares other than Class A shares, or otherwise the Class D shares IRSA holds will automatically lose their triple voting rights. If this were to occur, IRSA would likely lose its current ability, together with IRSA`s affiliates that also hold Class D shares of Banco Hipotecario, to exercise substantial influence over decisions submitted to the vote of Banco Hipotecario’s shareholders. Banco Hipotecario’s mortgage loan portfolio is not adequately indexed for inflation and any significant increase in inflation could have a material adverse effect on its financial condition. In accordance with Emergency Decree 214/02 and its implementing regulations, pesified assets and liabilities were adjusted for inflation as of February 3, 2002, by application of the Coeficiente de Estabilización de Referencia, or CER, a consumer price inflation coefficient. On May 6, 2002, the executive branch issued a decree providing that mortgages originally denominated in U.S. Dollars and converted into Pesos pursuant to Decree No. 214/2002 on property constituting a borrower’s dwelling may be adjusted for inflation only pursuant to CVS index, which during 2002 was significantly less than inflation as measured by the wholesale price index. Law No. 25,796 Section 1, effective April 1, 2004, eliminated the use of the CVS as an indexation mechanism, as applied to the relevant portion of Banco Hipotecario’s mortgages. During 2005, the CER was 11.75% and the wholesale price index 10.7%, while for the six months of 2006 the CER and wholesale price index increased by 5.77% and 5.0%, respectively. Argentina’s history prior to the adoption of the Convertibility Law raises serious doubts as to the ability of the Argentine government to maintain a strict monetary policy and control inflation. As a result of the high inflation in Argentina in 2002 and 2003, Banco Hipotecario’s mortgage portfolio experienced significant erosion in value. If inflation were to increase significantly once again, it may continue to materially erode value. Accordingly, an increase in Banco Hipotecario’s funding and other costs due to inflation may not be offset by indexation, which could adversely affect its liquidity and results of operations.
38
Table of ContentsBanco Hipotecario’s mortgage loan portfolio was materially and adversely affected by the devaluation of the Peso and may be further impacted by future fluctuations in exchange rates. While the one-to-one Peso-U.S. Dollar parity was in effect, Banco Hipotecario had no exchange rate risk with respect to its Peso-denominated revenues. However, its repeal on January 7, 2002, and the subsequent devaluation of the Peso have had the effect of significantly reducing its shareholders’ equity and Banco Hipotecario’s net income. This is also a consequence of the mismatch between Banco Hipotecario’s Peso-denominated revenues and its significant U.S. Dollar obligations, particularly in light of the pesification of its U.S. Dollar-denominated mortgage loans described below. On January 11, 2002, the Peso began to float freely for the first time in eleven years trading at Ps.1.40 = US$1.00; however, the Peso has devalued significantly, trading as low as Ps.3.90 = US$1.00 in June 2002, as reported by Banco de la Nación Argentina. Since then, the value of the Peso has begun to recover and on October 31, 2006, the exchange rate as reported by Banco de la Nación Argentina was approximately Ps.3.089 = US$1.00. Beginning on February 3, 2002, the Argentine government converted (i) certain foreign currency-denominated debts into Peso-denominated debts at a one-to-one exchange rate, (ii) certain foreign currency-denominated public sector debts into Peso-denominated debts at an exchange rate of Ps.1.40 per US$1.00 and (iii) foreign currency-denominated bank deposits into Peso-denominated bank deposits at an exchange rate of Ps.1.40 per US$1.00. As a result, 100% of Banco Hipotecario’s mortgage loans denominated in foreign currency were converted to Pesos at a one-to-one exchange rate and 100% of the Argentine government securities Banco Hipotecario held, including federal, provincial and municipal bonds, were converted to Pesos at an exchange rate of Ps.1.40 per US$1.00. On the other hand, less than 8% of its liabilities denominated in foreign currency were converted to Pesos at an exchange rate of Ps.1.40 per US$1.00, and the remainder of its liabilities remained denominated in foreign currency. Due to the fact that Banco Hipotecario’s loan portfolio now generates interest income only in Pesos, any further devaluation of the Peso against the U.S. Dollar will further impair its ability to make payments on its liabilities denominated in such currencies. Moreover, although the Argentine government has issued National Government Compensating Bonds (“BODEN”), notes that are intended to compensate Banco Hipotecario in part for its losses resulting from pesification, Banco Hipotecario cannot assure us that the Argentine government will honor its obligations to deliver the additional BODEN to which Banco Hipotecario is entitled, or that any BODEN it may receive will be sufficient to compensate adequately for the harm caused by the asymmetric pesification of its assets and liabilities. Additionally, Banco Hipotecario cannot assure you that future exchange rate policies to be implemented by the Argentine government will not further affect its financial condition and the results of its operations; and if such were the case, Banco Hipotecario cannot ensure you that the Argentine government will compensate such differences nor up to which amount. Due to interest rate and currency mismatches of Banco Hipotecario’s assets and liabilities, Banco Hipotecario has significant currency exposure. As of June 30, 2006, Banco Hipotecario’s foreign currency-denominated liabilities exceeded its foreign currency denominated assets by approximately US$101 million. Substantially all of Banco Hipotecario’s foreign currency assets consist of dollar-denominated BODEN, but Banco Hipotecario’s liabilities in foreign currencies are denominated in both U.S. Dollars and Euros. This currency gap exposes Banco Hipotecario to risk of exchange rate volatility which would negatively affect Banco Hipotecario’s financial results if the U.S. Dollar were to depreciate against the Peso and/or the Euro. We cannot assure you that the U.S. Dollar will not depreciate against the Peso, or that we will not be adversely affected by Banco Hipotecario’s exposure to risks of exchange rate fluctuations.
39
Table of ContentsBecause of Banco Hipotecario’s large holdings of BODEN and guaranteed government loans, Banco Hipotecario has significant exposure to the Argentine public sector. On December 23, 2001, the Argentine government declared the suspension of payments on most of its sovereign debt, which as of December 31, 2001, totaled approximately US$144.5 billion, a substantial portion of which was restructured by the issuance of new bonds in the middle of 2005. Additionally, the Argentine government has incurred, and is expected to continue to incur, significant new debt obligations, including the issuance of compensatory bonds to financial institutions. As of September 30, 2006 Banco Hipotecario had a total of US$ 888.9 million of BODEN issued by the Argentine Government. At that same date, Banco Hipotecario also had a total of approximately US$50.2 million of guaranteed government loans. Given Banco Hipotecario’s BODEN holdings, Banco Hipotecario has a significant exposure to the Argentine government’s solvency. Further, defaults by the Argentine government on its debt obligations, including the BODEN and other government securities (such as the guaranteed government loans) held by Banco Hipotecario, would materially and adversely affect its financial condition which would in turn affect IRSA’s investment. Banco Hipotecario faces potential material litigation which could adversely affect its financial condition and results of operations. As of August 31, 2006, approximately 3,895 borrowers of pre-1991 loans had initiated legal proceedings against Banco Hipotecario, alleging that the write-downs performed on the balance of such loans have been insufficient and did not comply with the Privatization Law. As of that date those loans had an aggregate outstanding balance of approximately Ps.88.5 million. If Banco Hipotecario does not prevail in these proceedings or settle the claims, or if more borrowers bring similar claims against them, Banco Hipotecario may need to effect substantial write-downs on the affected loans. The majority of the borrowers involved in this litigation have obtained a preliminary injunction ordering Banco Hipotecario to charge a lower service of capital and interest with respect to the amount previously determined. Banco Hipotecario can not assure you that additional borrowers will not bring similar lawsuits against them, objecting to the adequacy of the write-down on balances under the Privatization Law, nor that the courts will not issue other decisions against Banco Hipotecario’s lawsuits. In the event that Banco Hipotecario loses this litigation, is unable to settle claims or more borrowers bring similar claims against it, they may be required to write-down significant amounts that they had previously capitalized. Any one or more of these events may materially and adversely affect Banco Hipotecario’s business, financial condition or results of operations. In addition, in May 2003, an Argentine court entered a judgment directing Banco Hipotecario to pay an amount that, at the date of the judgment, was approximately Ps.40 million in connection with a proceeding initiated by a private developer who received financing for the construction of certain projects. The developer alleged that Banco Hipotecario breached certain of the original conditions of the loan agreement, including failure to make funds available. Banco Hipotecario currently faces other similar claims by other private developers or construction companies that involve approximately Ps.269 million in the aggregate. Although Banco Hipotecario has appealed the judgment to the National Supreme Court and believes that its appeal may be successful, the possible confirmation of the judgment and/or eventual extension of the ruling to other proceedings could materially adversely impact Banco Hipotecario’s financial condition and results of operations. An Argentine social security agency has also filed suit seeking summary judgment against Banco Hipotecario alleging that it owes Ps.335 million in employer contributions to the pension plan that were not made by Banco Hipotecario prior to its privatization by the Argentine government. This claim has been dismissed in a judgment entered by the lower court. Although the plaintiff has filed an appeal, Banco Hipotecario considers that the Privatization Law under which it was privatized clearly precludes them from being liable for these payments and establishes that this is an exclusive obligation of the
40
Table of ContentsArgentine government. Nonetheless, a court may rule against Banco Hipotecario and this may have a material adverse effect on its financial condition and results of operations. A number of lawsuits filed against Banco Hipotecario by certain holders of their bonds could adversely affect Banco Hipotecario’s liquidity. In the course of the last two years Banco Hipotecario has been sued in Argentine courts by individual bondholders seeking summary judgments (juicios ejecutivos) based on Banco Hipotecario’s defaulted payment of amounts due on its notes issued prior to its debt restructuring. In each of these lawsuits, the lower courts had rendered a decision favorable to holders of Banco Hipotecario’s existing notes. At the closing of Banco Hipotecario’s exchange offer, existing bondholders, representing 5% of the principal amount subject to restructuring did not participate in the offering. Currently, approximately 2.5% of this debt remains outstanding. To the extent such bondholders initiate other lawsuits against Banco Hipotecario, Banco Hipotecario may be required to make additional payments to settle or satisfy possible adverse judgments which may adversely affect its liquidity. Risks Related to IRSA’s Global Depositary Shares and the Shares Shares eligible for sale could adversely affect the price of IRSA’s shares and Global Depositary Shares The market prices of IRSA’s common shares and Global Depositary Shares could decline as a result of sales by IRSA’s existing shareholders of common shares or Global Depositary Shares in the market, or the perception that these sales could occur. These sales also might make it difficult for us or IRSA to sell equity securities in the future at a time and at a price that we or IRSA deem appropriate. The Global Depositary Shares are freely transferable under U.S. securities laws, including shares sold to IRSA’s affiliates. We, which as of June 30, 2006 owned approximately 26.7% of IRSA’s common shares (or approximately 116,305,767 common shares which may be exchanged for an aggregate of 11,630,576 Global Depositary Shares), are free to dispose of any or all of its common shares or Global Depositary Shares at any time in our discretion. Sales of a large number of IRSA’s common shares and/or Global Depositary Shares would likely have an adverse effect on the market price of IRSA’s common shares and the Global Depositary Shares. Different Corporate Disclosure and Accounting Standards. IRSA is subject to certain different corporate disclosure requirements and accounting standards than domestic issuers of listed securities in the United States. There is less publicly available information about the issuers of securities listed on the Bolsa de Comercio de Buenos Aires than information publicly available about domestic issuers of listed securities in the United States and certain other countries. In addition, all listed Argentine companies must prepare their financial statements in accordance with Argentine GAAP which differs in certain significant respects from U.S. GAAP. For this and other reasons, the presentation of Argentine financial statements and reported earnings may differ from that of companies in other countries in this and other respects. IRSA is exempted from the rules under the Exchange Act prescribing the furnishing and content of proxy statements, and its officers, directors and principal shareholders are exempted from the reporting and short-swing profit recovery provisions contained in Section 16 of the Exchange Act. Investors may not be able to effect service of process within the U.S., limiting their recovery of any foreign judgment. IRSA is a publicly held corporation (sociedad anónima) organized under the laws of Argentina.
41
Table of ContentsMost of its directors and IRSA’s senior managers, and most of its assets are located in Argentina. As a result, it may not be possible for investors to effect service of process within the United States upon IRSA or such persons or to enforce against them in United States courts judgments obtained in such courts predicated upon the civil liability provisions of the United States federal securities laws. IRSA has been advised by its Argentine counsel, Zang, Bergel & Viñes, that there is doubt as to whether the Argentine courts will enforce to the same extent and in as timely a manner as a U.S. or foreign court, an action predicated solely upon the civil liability provisions of the United States federal securities laws or other foreign regulations brought against such persons or against IRSA. If IRSA is considered to be a passive foreign investment company for United States federal income tax purposes, United States holders of its equity securities would suffer negative consequences. Based on the current and projected composition of our income and valuation of our assets IRSA does not believe IRSA was a Passive Foreign Investment Company (“PFIC”), for United States federal income tax purposes for the tax year ending June 30, 2006, and IRSA does not currently expect to become a PFIC, although there can be no assurance in this regard. The determination of whether IRSA is a PFIC is made annually. Accordingly, it is possible that IRSA may be a PFIC in the current or any future taxable year due to changes in IRSA`s asset or income composition or if IRSA`s projections are not accurate. The volatility and instability of Argentina’s economic and financial system may substantially affect the composition of IRSA`s income and assets and the accuracy of our projections. If IRSA become a PFIC, United States Holders of IRSA`s shares or ADSs will be subject to certain United States federal income tax rules that have negative consequences for United States Holders such as additional tax and an interest charge upon certain distributions by IRSA or upon a sale or other disposition of IRSA`s shares or ADSs at a gain, as well as reporting requirements. Please see “Taxation-United States Taxation” of IRSA’s 20-F for a more detailed discussion of the consequences if IRSA is deemed a PFIC. Investors are urged to consult their tax advisors regarding the application of the PFIC rules to them. Item 4. Information on the Company A. HISTORY AND DEVELOPMENT OF CRESUD General Information Our legal name is Cresud Sociedad Anónima Comercial, Inmobiliaria, Financiera y Agropecuaria. We were incorporated and organized on December 31, 1936 under Argentine law as a stock corporation (sociedad anónima) and were registered with the Public Registry of Commerce of the City of Buenos Aires (Inspección General de Justicia, or “IGJ”) on February 19, 1937 under number 26, on page 2, book 45 of National By-laws Volume. Pursuant to our bylaws, our term of duration expires on July 6, 2082. Our headquarters are located at Moreno 877, (C1091AAQ), Buenos Aires, Argentina. Our telephone is +54 (11) 4814-7800, and our website is www.cresud.com.ar. Information contained in or accessible through our website is not a part of this annual report on form 20-F. All references in this annual report on Form 20-F to this or other internet sites are inactive textual references to these URLs, or “uniform resource locators” and are for your information reference only. We assume no responsibility for the information contained on these sites. History We were incorporated and organized on December 31, 1936 under Argentine law as a stock corporation (sociedad anónima), and were registered with the Public Registry of Commerce of the City of Buenos Aires (Inspección General de Justicia) on February 19, 1937. We were incorporated in 1936
42
Table of Contentsas a subsidiary of Credit Foncier, a Belgian company engaged in, among other things, the business of providing rural and urban loans in Argentina. We were incorporated to, among other things; administer real estate holdings foreclosed by Credit Foncier. Credit Foncier was liquidated in 1959, and as a part of such liquidation, our shares were distributed to Credit Foncier’s shareholders and, on December 12, 1960, were listed on the Buenos Aires Stock Exchange. From the 1960s to 1970s, our business shifted to exclusively agricultural activities. During a period of approximately two years and ending in September 1994, Dolphin Fund Management S.A. acquired on behalf of certain investors an aggregate of 22% of our outstanding shares on the Buenos Aires Stock Exchange. In September 1994, an investor group led by Dolphin Fund Management S.A. and including Dolphin Fund plc. (formerly Quantum Dolphin plc.) acquired the control by purchasing an additional 51.4% of our outstanding shares. In November 1994, the investor group acquired an additional 13.6% of our outstanding shares. On May 29, 1995, we completed a rights offering in Argentina which was fully subscribed and added paid-in capital of Ps. 144.9 million (including prior capital contributions of the investor group of Ps. 61.8 million). On December 31, 1996, Dolphin Fund plc, owned 39.0% of our shares. From June 30, 1994 (approximately two months prior to the change of control) to June 30, 1996, our net worth increased from approximately Ps. 37.6 million to Ps. 196.3 million, our total assets have increased from Ps. 40.5 million to Ps. 210.8 million, the number of our farms increased from seven to sixteen, the number of our hectares from approximately 20,263 to 345,410, the number of our leased hectares from 5,350 to 16,381, the number of our hectares sown from 4,719 to 15,839, the number of our leased hectares sown from 736 to 6,227 hectares, the number of beef-cattle heads from 20,177 to 58,346 and the number of our cattle head involved in milk production from approximately 1,669 to approximately 4,262. From December 2000 to June 2006, we invested approximately Ps. 263.7 million to acquire approximately 26.71% of the outstanding shares of IRSA. In addition, we owned IRSA’s Convertible Notes for a total amount of US$ 12 million. Consequently, as of June 30, 2006, our investment in IRSA amounted to Ps. 357.4 million representing 41.05% of our consolidated assets. IRSA is one of Argentina’s largest real estate companies. As of June 30, 2006, IRSA had total assets of Ps. 2,740.1 million, and its net income for the fiscal year ended June 30, 2006, was Ps. 96.6 million. As of June 30, 2006, our net worth was Ps. 632.5 million and total assets were Ps. 870.7 million. As of June 30, 2006, we owned 17 farms together with our subsidiaries and 395,459 hectares, including 35.723% of the 8,299 hectares owned by Agro-Uranga S.A. and 50% of the 170 hectares owned by Cactus Argentina S.A. As of June 30, 2006, 41,283 hectares were sown (including 35.723% of the 11.928 hectares sown by Agro-Uranga S.A.), 17,004 leased hectares were sown, we had 82,840 beef-cattle heads (including 35.723% of the 738 owned by Agro-Uranga S.A. and 50% of the 3.814 owned by Cactus Argentina S.A.) and 2,675 cows were involved in milk production (including 35.723% of the 743 cows owned by Agro-Uranga S.A.). For fiscal year ended June 30, 2006, our total sales totalled Ps. 112.3 million. Capital expenditures totaled Ps. 55.8 million, Ps. 25.9 million and Ps. 15.2 million for the fiscal years ended June 2006, 2005, and 2004, respectively, including property and equipment acquired in business combinations. Our capital expenditures consisted of the acquisition and improvement of productive agricultural assets, as well as purchases of farms. For the fiscal year ended June 30, 2006, our main investments consisted of Ps. 25.7 million in the acquisition of real estate, Ps. 0.6 million in improvements, Ps. 0.1 million in furniture and equipment, Ps. 1.2 million in facilities, Ps. 1.3 million in new pastures, Ps. 0.9 million in vehicles, Ps 23.7 million in construction, Ps. 1.13 million in machinery, Ps. 0.3 million in computer and communication accessories, Ps. 0.9 million in construction in progress, Ps. 0.1 million in feed lot and Ps. 0.7 million in advances. For the fiscal year ended June 30, 2005, our main investments consisted of Ps. 12.5 million in the acquisition of real estate, Ps. 0.2 million in improvements, Ps. 0.1 million in furniture and equipment, Ps.
43
Table of Contents4.2 million in facilities, Ps. 1.1 million in new pastures, Ps. 0.3 million in vehicles, Ps 0.6 million in construction, Ps. 1.8 million in machinery, Ps. 0.3 million in computer and communication accessories, Ps. 4.6 million in construction in progress (including Ps. 3.7 million from the development of our farm Los Pozos adding more space for agricultural and cattle production), Ps. 0.1 million in feed lot and Ps. 0.1 million in advances. For the fiscal year ended June 30, 2004, our main investments consisted of Ps. 2.7 million in the acquisition of real estate, Ps. 0.1 million in improvements, Ps.0.1 million in furniture and equipment, Ps. 1.6 million in facilities, Ps. 0.4 million in new pastures, Ps. 0.5 million in vehicles, Ps 0.1 million in construction, Ps. 0.1 million in machinery, Ps. 0.1 million in computer and communication accessories, Ps. 8.8 million in construction in progress (including Ps. 4.2 million from the development of our Los Pozos farm adding more space for agricultural and cattle production and Ps. 3.8 million from the development of hectares to be used in agriculture under irrigation in our La Gramilla and Santa Bárbara farm), Ps. 0.6 million in feed lot and Ps. 0.1 million in advances. Business acquisitions Year Ended June 30, 2006 In December 2005, the Company acquired the outstanding common stock of Agropecuaria Cervera (ACER) to exploit 160,000 hectares of undeveloped land and natural forests. ACER was granted a 35-year concession right (with option to extend it for an additional 29-year period) by the provincial government of Salta, Argentina. The concession entitles ACER to conduct agricultural, cattle breeding and/or forestry activities during the concession period. As of the date of the acquisition, the Company has not had any developed plans of the type of activities to be performed in the land. The aggregate purchase price for the acquisition was US$ 9.6 million paid in cash (US$ 1.1 million) and US$ 3.6 million by surrendering IRSA´s Convertible Notes held by the Company. The acquisition was accounted for as a purchase. The excess of the purchase price over the fair value of the net identifiable assets acquired, (mainly forestry products and certain other fixed assets) amounting to Ps. 23.6 million, was allocated to concession rights. Concession rights are amortized on a straight line basis over its useful life of 35 years. Amortization will begin upon commencement of operations. In September 2005, the Company acquired a farm (San Pedro) covering 6,022 hectares in Uruguay, Province of Entre Rios, for US$ 16 million. The Company paid US$ 13.5 million in cash, and the remaining amount of US$ 2.5 million will be paid within the next 15 months. The Company mortgaged the property in an amount of US$ 2.5 million as collateral for the remaining balance. Formation of Companies In March 2006, we and other parties founded BrasilAgro for the purpose of expanding our business to Brazil. The Company contributed cash in the amount of Ps. 63.1 million in exchange for shares and 104,902 warrants to purchase additional shares. The Company’s equity interest in BrasilAgro is 7.3%. BrasilAgro’s shares went public in the Brazilian Stock Exchange (Bovespa) in May 2006. Warrants vest in one-thirds starting May 2, 2007 and are exercisable for a period of up to 15 years at an exercise price equivalent to the initial public offering price adjusted by the Brazilian IPCA inflation index. Should the Company exercise the warrants, the equity interest would be increased to 14.1%. Moreover, an additional 104,902 warrants were issued which can only be exercised, at the Company’s option, in the event of a tender offer. These warrants are exercisable through the year 2021 at an exercise price equivalent to the purchase price of the tender offer by the acquirer of BrasilAgro. Year Ended June 30, 2005 On March 9, 2005 the Company signed a preliminary purchase agreement to acquire 72 hectares
44
Table of Contentslocated in the Province of Buenos Aires, for a total consideration of Ps. 0.8 million. The transaction is subject to certain closing conditions. On June 24, 2005 the Company acquired El Invierno farm covering 1,946 hectares located in the Province of La Pampa, for a total purchase price of US$ 3.0 million. Year Ended June 30, 2004 On November 11, 2003, Feria Jovita S.R.L. repaid the commercial loan due to Cresud by executing a deed to formalize the delivery in lieu of payment of a 9-hectare farm located at Lavalle, Province of Mendoza. The value of the property is Ps. 25,600. Farm Sales Year Ended June 30, 2006 On July 25, 2005 the Company sold El Gualicho farm, covering 5,727 hectares, located in the Province of Córdoba, for a total sales price of US$ 5.7 million, resulting in a gain of US$ 3.4 million. The company collected US$ 2.9 million and will collect the balance in five equal annual installments through July 2010. Year Ended June 30, 2005 On February 1, 2005, the Company sold Ñacurutú farm, covering 30,350 hectares, located in the Province of Santa Fe, for a total sales price of US$ 5.6 million, resulting in a gain of Ps. 7.7 million. On June 8, 2005 the Company sold San Enrique farm, covering 977 hectares, located in the Province of Santa Fe, for a total sales price of US$ 5.0 million, resulting in a gain of Ps. 12.3 million. Year Ended June 30, 2004 On July 29, 2003, the Company sold three properties located in the Province of Catamarca, covering 5,997 hectares, for a total sales price of US$ 0.4 million, resulting in an aggregate gain of Ps. 0.6 million. On November 26, 2003 the Company sold El 41 y El 42 farms covering 6,478 hectares, located in the Province of Chaco, for a total sales price of US$ 1.0 million, resulting in a gain of Ps. 1.1 million. General We are a leading Argentine producer of basic agricultural products and the only such company with shares listed on the Buenos Aires Stock Exchange and on the Nasdaq. We are currently involved in various operations and activities including crop production, cattle raising and fattening, milk production and certain forestry activities. We are not directly engaged in the real estate development business but from time to time sell properties to profit from real estate appreciation opportunities which supplement our primary operations. Most of our farms are located in Argentina’s pampas, one of the largest temperate prairie zones in the world and one of the richest areas of the world for agricultural production, covering portions of the provinces of Buenos Aires, Santa Fe, Córdoba, Chaco, San Luis, Catamarca, Salta, Entre Ríos and La
45
Table of ContentsPampa. At June 30, 2006, we, together with our subsidiaries, owned 17 farms. Approximately 19,507 hectares of the land we own are productive and suitable for crop production, approximately 97,299 hectares are best suitable for beef-cattle production, and 1,698 hectares are used for milk production. The remaining 418,477 hectares are primarily natural woodlands. In addition, during fiscal year 2005, we leased farms for crop production on an aggregate total area of 16,299 hectares on 22 farms and during fiscal year 2006 we leased farms for crop production on an aggregate total area of 17,004 hectares on 25 farms for crop production. The following table sets forth, for the periods indicated below, the amount of land used for each production activity (including total owned and leased land):
Operations and Principal Activities In fiscal year 2005, our operations were conducted on 17 owned farms and 22 leased farms. In fiscal year 2006, our operations were conducted on 17 owned farms and 25 leased farms. Some of the farms we own are engaged in more than one productive activity at a time. The following table sets forth, for the periods indicated below, the volumes of our production by principal product line:
46
Table of ContentsLand Land Acquisition. In our view, the sector’s potential lies in developing marginal areas and/or underutilized areas, as it has been the case in many countries in the world. Thanks to current technology, we may achieve similar yields with higher profitability than core areas; this may result in the appreciation of land values. At present, prices of farmlands used in agricultural production have increased in the southern hemisphere (mainly South America) but continue to be relatively low compared to the northern hemisphere (US and Europe). Our financial capacity relative to other Argentine producers enables us to increase our land holdings at attractive prices, increase our production scale and create potential for capital appreciation. Several important intermediaries, with whom we habitually work, bring farmlands available for sale to our attention. The decision to acquire farmlands is based on the assessment of a number of factors. In addition to the land’s location, we normally carry out an analysis of soil and water, including the quality of the soil and its suitability for our intended use (crops, beef-cattle, or milk production), classify the various sectors of the lot and the prior use of the farmland; analyze the improvements in the property, any easements, rights of way or other variables in relation to the property title; examine satellite photographs of the property (useful in the survey of soil drainage characteristics during the different rain cycles) and detailed comparative data regarding to neighboring farms (generally covering a 50-km area). Based on the foregoing factors, we assess the farmland in terms of the sales price compared against the production potential of the land and the appreciation potential of the capital. We consider that competition for the acquisition of farmlands is, in general, limited to small farmers for the acquisition of smaller lots, and that there is scarce competition for the acquisition of bigger lots. In addition, we may consider the acquisition of farmlands in marginal zones and their improvement by irrigation in non-productive areas as well as the installation of irrigation devices in order to obtain attractive production yields and to create potential for capital appreciation. In September 2005, the Company acquired a farm (San Pedro) covering 6,022 hectares in Uruguay, Province of Entre Rios, for US$ 16 million. The Company paid US$ 13.5 million in cash, and the remaining amount of US$ 2.5 million will be paid within the next 15 months. The Company mortgaged the property in an amount of US$ 2.5 million as collateral for the remaining balance. On June 24, 2005, El Invierno, a farm located in Rancul, Province of La Pampa, was purchased for a total US$ 3.0 million. The farm’s surface amounts to 1,946 hectares and was destined to agricultural production. Also during March 2005, we purchased 72 neighboring hectares of the farm La Adela, located in Lujan, Province of Buenos Aires, increasing the total surface to 1,054 hectares. The purchase amounted to Ps. 0.79 million. Land Sales. We periodically sell properties to take advantage of the appreciation in the value of the property. We analyze the possibility of selling based on a number of factors, including the expected future yield of the farmland for continued agricultural and livestock exploitation, the availability of other investment opportunities and cyclical factors that have a bearing on the global values of farmlands. The following chart shows, for the periods indicated below, certain information concerning to the farm’s sales during each of the past three fiscal years ended on June 30:
47
Table of Contents
On July 25, 2005 the Company sold El Gualicho farm, covering 5,727 hectares, located in the Province of Córdoba, for a total sales price of US$ 5.7 million, resulting in a gain of US$ 3.4 million. The company collected US$ 2.9 million and will collect the balance in five equal annual installments through July 2010. On February 1, 2005, the Company sold Ñacurutú farm, covering 30,350 hectares, located in the Province of Santa Fe, for a total sales price of US$ 5.6 million, resulting in a gain of Ps. 7.7 million. On June 8, 2005 the Company sold San Enrique farm, covering 977 hectares, located in the Province of Santa Fe, for a total sales price of US$ 5.0 million, resulting in a gain of Ps. 12.3 million. Land Leasing. The decision to enter into lease agreements involves similar criteria in relation to the quality and projected profitability. However, our analysis of such criteria also takes into account our production and yield objectives in the short or medium term. Generally, we are advised of the existence of farms available for lease directly through the owners. The initial duration of lease agreements is habitually one season or less. Leases of farms for production of grains consist in lease agreements with payments based on a fixed amount of Pesos per hectare or crop sharing agreements (“aparcería”) with payments in kind based on a percentage of the crops obtained or a fixed amount of tons of grains obtained or their equivalent value in Pesos. Leases of farmlands for cattle raising consist in lease agreements with fixed payments based on a fixed amount of Pesos per hectare or number of cattle head or capitalization agreements with payments in kind or in cash based on the weight gain in kilograms. Land Management. In contrast to traditional Argentine farms, run by a family, we centralize policy making in an executive committee that meets on a weekly basis in Buenos Aires. Individual farm management is delegated to farm managers, who are responsible for farm operations. The executive committee lays down commercial and production rules based on sales, market expectations and risk allocation. We rotate the use of our pasture lands between agricultural production and cattle feeding and the frequency depends on the location and characteristics of the farmland. The use of land habitually rotates in four-year periods of cattle feeding and four to twelve years of agricultural production, according to the region. The use of preservation techniques (including exploitation by direct sowing) frequently allows us to extend agricultural exploitation periods. Subsequent to the acquisition of the properties, we make investments in technology in order to improve productivity and to increase the value of the property. It may be the case that upon acquisition, a given extension of the property is sub-utilized or the infrastructure may be in need of improvement. We have invested in traditional fencing and in electrical fencing, watering troughs for cattle herds, irrigation equipment and machinery, among other things.
48
Table of ContentsCrop Production Our agriculture production is mainly based on crops and oilseeds. Main crops include wheat, corn, soybean and sunflower. Other crops, as sorghum, are sown occasionally and only represent a small percentage of total sown land. The following chart shows, for the periods indicated below, the production of the main crops:
The following table sets forth, for the periods indicated below, our owned and leased sown land for crop production:
As of June 30, 2006, the surface of leased land amounted to 41% of the total sown land. Wheat seeding takes place from June to September, and harvesting takes place in December and January. Corn, soybean and sunflower are sown from September to December and are harvested from February to June. Grains are available to be sold as commodities after the harvest from December to June and we usually store part of our production until prices recover after the drop that normally takes place during the harvesting campaign. A major part of production, specially wheat and sunflower seeds, corn and sorghum is sold and delivered to buyers pursuant to agreements in which price conditions are fixed by reference to the market price at a specific time in the future that we determine. The rest of the production is either sold at current market prices or delivered to cover any futures contract that we may have entered into. Our crop stocks at any given time vary according to market conditions. As of June 30, 2006, our crop stocks amounted to 11,426 tons of wheat, 4,538 tons of corn, 11,662 tons of soybean, 193 tons of
49
Table of Contentssorghum and 479 tons of sunflower, whereas as of June 30, 2005 such stocks consisted in 6,978 tons of wheat, 52,179 tons of corn, 28,555 tons of soybean, 532 tons of sorghum and 1,810 tons of sunflower. During fiscal year 2006, we have invested approximately Ps 6.8 million in irrigation equipment, machinery and technology application through no tillage sowing. Beef-Cattle Production Our cattle beef production involves the breeding and fattening of our own stock. In some cases, if market conditions are favorable, we purchase and fatten cattle which we sell to slaughterhouses and supermarkets. In addition, as part of our strategy to move along the production chain, during 2003 we started to slaughter our own cattle, after obtaining the appropriate licenses. As of June 2006, the company’s cattle stock amounted 80,669 heads, with a total surface, destined to the activity, of 129,946 hectares. Beef-cattle production was 9,803 tons, an 8% decrease compared to the previous year. This drop was mainly caused by the effect of droughts on grass availability. Breeding farms were forced to send a part of their stocks to the feedlot to finish it on grains and be able to sell such stocks. Despite this, in the course of fiscal year 2006, fewer cattle stocks were finished in feed-lots than in the previous year. Pregnancy levels, which have been improving over the years, showed satisfactory levels of efficiency in light of the adverse weather conditions. Genetics and herd management is expected to further improve pregnancy levels in the coming years. Currently, the cattle raising farms are officially registered as export farmlands pursuant to the identification and traceability rules in force in Argentina. Animals are individually identified, thus allowing for the development of special businesses in this area. Management by lot in our pastures is aided by electrical fencing, which may be easily relocated to supplement our land-rotation cycles. Our cattle herd is subject to a 160-kg to 300-kg fattening cycle by grazing in pastures located in our north farmlands where conditions are adequate for initial fattening. Cattle are subsequently fattened until they reach 430 kg in the south farmlands and in our San Luis feedlot. The feedlot fattening system leads to homogeneity in production and beef of higher quality and tenderness because of the younger age at which animals are slaughtered. Demand and prices for this beef in international markets are higher. The Company’s cattle breeding activities are carried out with breeding cows and bulls and its fattening activities apply to steer, heifers and calves. Breeding cows calve approximately once a year and their productive lifespan is from six to seven years. Six months after birth, calves are weaned and transferred to fattening pastures. Acquired cattle are directly submitted to the fattening process. Upon starting this process, cattle have been grazing for approximately one year to one and a half year in order to be fattened for sale. Steer and heifers are sold when they have achieved a weight of 380–430 kilograms and 280–295 kilograms, respectively, depending on the breed. The breeding herd reproduction rate, which has improved year after year, recorded satisfactory efficiency levels despite the adverse weather conditions. The work on genetics and handling of herds is expected to result in further improvements in the coming years. Within the process of de-commoditization and technological innovation, we implemented a self-developed identification and tracing system in compliance with European and the National Service of the Sanitation and Quality for Agricultural Food Products (Servicio Nacional de Sanidad y Calidad Agroalimentaria, or “SENASA”) standards.
50
Table of ContentsWith the purpose of distinguishing our production and obtaining higher prices in production sales, we plan to extend the use of the tracing system to our whole herd. Our beef-cattle stock is organized into breeding and fattening activities. The following table indicates, for the periods set forth below, the number of head of beef-cattle for each activity:
We seek to improve beef-cattle production and quality in order to obtain a higher price through advanced breeding techniques. We cross breed our stock of Indicus, British (Angus and Hereford) and Continental breeds to obtain herds with characteristics better suited to the pastures in which they graze. To enhance the quality of our herds even further, we plan to continue improvement of our pastures through permanent investment in seeds and fertilizers, an increase in the watering troughs available in pastures, and the acquisition of round bailers to cut and roll grass for storage purposes. Our emphasis on improving the quality of our herd also includes the use of animal health-related technologies. We comply with national animal health standards that include laboratory analyses and vaccination aimed at controlling and preventing disease in our herd, particularly FMD (Foot – and –mouth disease). Direct costs of beef production are relatively low because the main inputs are seeds for pasture (for instance, alfalfa, oats and barley) and purchases of cattle for fattening purposes. During the fiscal 2006 year we have invested approximately Ps. 14.6 million in equipment, machinery, pastures and genetic improvement in relation to cattle production. Milk Production During fiscal year 2006, milk production was 99.5% higher than in the prior fiscal year because of the twelve-month production at the dairy farm recently built at the El Tigre farm. The farm can milk 2,000 cows per day. With a merry-go-round structure, which required a significant investment of Ps 3.9 million, it is one of the largest dairy farms in Argentina. During fiscal year 2005, milk production was 9% higher than the prior fiscal year since the new dairy farm started operating during the last four months of the fiscal year. The following table sets forth, for the periods indicated below, the total number of our milking cows, average daily production per cow and our total milk production:
51
Table of Contents
During fiscal year 2004, we devoted 820 hectares and 3,472 heads of cattle to the production of milk. During fiscal year 2005, we had 4,203 heads of cattle on 1,583 hectares involved in the production of milk. As of June 30, 2006, we applied 6,214 heads of cattle on 1,505 hectares to milk production. Our milk production is based on a herd of top-quality Holando Argentina dairy cows, genetically selected through the use of imported frozen semen of North American Holando bulls. Male calves are sold, at calving, for a given amount per head, whereas female calves are weaned after 24 hours, spend approximately 60 days in raising and approximately 100 being days fed on the basis of grass, grains and supplements. Young heifers then graze for an additional 12 to 15 month period, prior to artificial insemination at the age of 18 to 20 months and they calve nine months later. Heifers are subsequently milked for an average of 300 days. Milking dairy cows are once again inseminated during the 60 to 90 day period following. This process is repeated once a year during six or seven years. The pregnancy rate for our dairy cows is 85-90%. We milk our dairy herd mechanically twice a day. The milk obtained is cooled to less than five degrees centigrade in order to preserve it quality and is then stored in a tank for delivery once a day to trucks sent by buyers. Dairy cows are fed mainly with grass, supplemented as needed with grains, hay and silage. For winter grazing, corn stubbles are also used. We have invested in certain technologies that focus on genetic improvement, animal health and feeding in order to improve our milk production. These investments include imports of top quality frozen semen from genetically improved North American Holstein bulls, agricultural machinery and devices such as two feed-mixer trucks, use of dietary supplements and the installation of modern equipment to control milk heating and cooling. We are currently acquiring dietary supplements for our dairy cows and have invested to increase the quantity and quality of forage (pasture, alfalfa and corn silage) in order to reduce feeding costs. Ever since the change of control, we have invested approximately Ps.13.3 million (excluding the amount invested in rebuilding the milk parlor) in equipment, machinery and research, pasture and development with respect to our dairy herd. Cattle feeding operation During past years, due to high margins in the agricultural sector, crop production displaced livestock production to marginal areas. Consequently beef production based on traditional pasture has decreased and feed lot production has increased. As an alternative to traditional means of production Argentine producers have started using hostelry services to finish the fattening stage of their cattle. Cactus Argentina S.A., has been a pioneer in this service with a 25,000 head capacity, which depends on the size of the cattle. During fiscal year 2006 the average occupation level reached 61.77%. Such level showed signs of recovery towards the end of the period reaching 79.11%. The uniformity obtained in the feed lot’s final product has provided buyers a high quality product, enabling an easier commercialization and achieving the higher final sale price. Yearling cattle arrived
52
Table of Contentswith an average weight between 250 and 300 kg. and are fattened to reach 430/470 kg. This production is mainly destined to foreign markets, particularly the European Union. For the coming fiscal year, Cactus Argentina S.A. is prepared to receive an important amount of cattle for export markets. Cresud’s cattle production meets all standards required by these. Other Production Charcoal production was affected by the recessive market conditions that pushed down sales prices, diminishing our profits. This situation forced us to look for new commercial agreements. During fiscal year 2002 and fiscal year 2003, we managed to commercialize our production in the external market, mainly in Chile. However, during fiscal year 2003, we had to abandon this agreement due to its small production scale and its high administrative expenses, resulting in the interruption of the activity. Principal Markets Crops Our grains production is entirely sold in the local market. The prices of our grains are based on the market prices quoted in Argentine grains exchanges, such as the Bolsa de Cereales de Buenos Aires and the Bolsa de Cereales de Rosario, that take as a reference the prices in international grains exchanges. The largest part of this production is sold to exporters who offer and ship this production to the international market. Prices are quoted in relation to the month of delivery and the port in which the product is to be delivered. Different conditions in price, such as terms of storage and shipment, are negotiated between the end buyer and ourselves. Beef-Cattle Our cattle production is sold in the local market. The main buyers are slaughterhouses and supermarkets. Prices in the cattle market in Argentina are fixed in the Liniers Market (located on the outskirts of the province of Buenos Aires) where live animals are sold by auction on a daily basis. At Liniers Market, prices are negotiated by kilogram of live weight and are mainly determined by local supply and demand. Prices tend to be lower than in industrialized countries. Some supermarkets and slaughterhouses establish their prices by kilogram of processed meat; in these cases, the final price is influenced by processing yields. Milk During the fiscal years 2005 and 2006, we sold our entire milk production to the largest Argentine dairy company, Mastellone S.A., which manufactures a range of mass consumption dairy products sold in Argentina and abroad. We negotiated with this company the prices of raw milk on a monthly basis in accordance with domestic supply and demand. We understand that other major dairy companies in Argentina would be willing and in a position to buy our milk production, in whole or in part, if we decided to diversify our sales of milk. The price of the milk we sell is mainly based on the percentage of fat and protein that it contains and the temperature at which it is cooled. The price we obtain from our milk also rises or drops based on the content of bacteria and somatic cells. Customers In 2006, our sales amounted to Ps.112.3 million and were made to approximately 200 customers. Sales to our ten largest customers represented approximately 61% of our net sales in 2005 and approximately 69% for the fiscal year ended June 30, 2006. Of these customers, our biggest three customers, Cargill S.A., Mastellone Hnos. S.A. and Quickfood S.A represented, in the aggregate,
53
Table of Contentsapproximately 48% of our sales for 2006, and the remaining seven customers, in the aggregate, represented approximately 21% of our net sales in the course of that fiscal year. We have signed non-binding letters of intent with some of our largest customers, which allow us to estimate the demand for certain products and to plan production accordingly. We generally enter into short-term agreements with a term of less than a year. Marketing Channels and Sales Methods Crops We normally work with grains brokers and other intermediaries to trade in the exchanges. Usually, we sell part of our production in advance, through futures contracts, and we buy and sell options to protect against a drop in prices. Approximately 30% of the futures and options contracts are closed through the Bolsa de Granos de Buenos Aires (Buenos Aires Grains Exchange) and 70% in the Chicago Board of Trade. Our storage capabilities allow us to condition and storage grains with no third-party involvement and thus to capitalize on the fluctuations in the price of commodities. Our largest storage facility, with a 10,000 tons capacity is located in Las Vertientes, close to Río Cuarto, Province of Córdoba. Beef-Cattle We primarily sell directly to local meat processors and supermarkets, such as Quick Food S.A., Frigorífico La Pellegrinense S.A., Friar S.A., Swift Armour S.A., Frigorífico Amancay, Supermercados Norte S.A., Ziar S.A. and Arrebeef S.A., at prices based on the price determined at Liniers Market. We are usually responsible for the costs of the freight to the market and, in general, we do not pay commissions on our transactions. Raw Materials The current direct cost of our production of grains varies with respect to each crop and normally includes the following costs: tillage, seeds, agrochemicals and fertilizers. We buy in bulk and store seeds, agrochemicals and fertilizers to benefit from discounts offered during off-season sales. Competition The agricultural and livestock sector is highly competitive with many of producers. Cresud is one of Argentina’s leading producers, but its overall market share in the country is extremely low. Our leading position improves our bargaining power with suppliers and customers. In general, we obtain discounts in the region for the acquisition of supplies and an excess price for our seeds and cattle. Historically, there have been few companies competing for the acquisition and leases of farmlands for the purpose of benefiting from land appreciation and optimization of yields in the different commercial activities. However, we anticipate the possibility that new companies, some of them international, becoming active players in the acquisition of farmlands and the leases of sown land, which would add competitors to the market in coming years. Seasonality As is the case with any company in the agro-industrial sector, our business activities are inherently seasonal. Harvest and sales of grains (corn, soybean and sunflower) generally take place from February to June. Wheat is harvested from December to January. Other segments of our activities, such as our sales of cattle and milk and our forestry activities, tend to be more successive than seasonal in nature.
54
Table of ContentsHowever, the production of beef and milk is generally higher during the second quarter, when pasture conditions are more favorable. As a result, there may be significant variations in results between quarter. IRSA From December 2000 to June 2005 and pursuant to our strategy of diversifying our business activities, we made a significant investment in IRSA’s shares. In addition, during November and December 2002, we purchased a total amount of US$ 49.7 million IRSA’s Convertible Notes. Moreover, during July and November 2003, we purchased additional 0.25 million Convertible Notes (for a total amount of US$ 0.4 million) issued by IRSA. As of June 30, 2006, our total investment in IRSA amounted to Ps. 357.4 million. IRSA is one of Argentina’s largest real estate companies in terms of total assets, and is engaged in a range of real estate activities in Argentina. Its principal activities consist of:
Additionally, IRSA holds property for residential purposes for sale and land reserves for current and future developments in the amount of Ps. 499.5 million. The total consolidated assets of IRSA as of June 30, 2006 amounted to Ps. 2,740.1 million and the shareholders’ equity amounted to Ps. 1,485.8 million. IRSA has an 11.8% equity interest in Banco Hipotecario, the largest Argentine bank granting mortgages with an equity amounting to Ps. 2,247.6 million. During fiscal year 2006, all of IRSA’s business units improved their performance considerably, mainly due to strategic decisions in the favorable context of the Argentine economy, which witnessed a recovery of consumption credit, salaries, and investment. The considerable growth of IRSA is reflected in all its business activities, which boosted the increase in the operating result by 43.5%, from Ps. 141.1 million to Ps. 202.4 million in the fiscal year ended June 30, 2006. In addition, during this fiscal year, the company’s net income amounted to Ps. 96.6 million. Based on this improvement, and as part of its investment strategy, the company carried out acquisitions and developments of several projects for all its activities. The growth resulted from an increase in the results of operations registered during fiscal year 2006 of Shopping Centers, Hotels, Sales and Developments amounting to 37.0%, 31.5% and 112.7% respectively compared to the results corresponding to the previous fiscal year. Regarding the office rental business, despite a decrease of 9.6% in results of operations, this drop is mainly a consequence of a lower result in operations in real estate holdings and an increase in administrative expenses. However, it is worth mentioning that gross profit for this business unit grew 84.7% due to an increase in revenues, which have proportionately grown more than costs. As of June 30, 2006, the company owned 116,305,767 IRSA shares, which equals 26.71% of the equity. In addition, the company owned 12,000,000 convertible bonds and 32,958,011 warrants issued by IRSA.
55
Table of ContentsOur investment in IRSA during fiscal year 2006 resulted in a Ps. 23.4 million profit for the company. During fiscal years 2004, 2005 and 2006, we invested in shares of IRSA a total amount of Ps. 29.3 million, Ps. 34.4 million (including Ps. 14.8 resulting from the conversion of US$ 5.0 million of IRSA’s Convertible Notes) and Ps. 66.3 million (including Ps. 66.3 resulting from the conversion of US$ 20.9 million of IRSA’s Convertible Notes) respectively. As of June 30, 2004 our investment in IRSA had increased to 25.4% of its outstanding shares. As of June 30, 2005 our investment in IRSA had decreased to 21.8% of its outstanding shares. As of June 30, 2006 our investment in IRSA had increased to 26.7% of its outstanding shares. Our total investment in IRSA, considering our interest in its common shares and Convertible Notes, amounted to 41.05% of our consolidated assets. A majority of our directors are also directors of IRSA, and we are under common control by the same group of controlling shareholders. REGULATION AND GOVERNMENT SUPERVISION Farming and Animal Husbandry Agreements Agreements relating to farming and animal husbandry activities are regulated by Argentine law, the Argentine Civil Code and local customs. According to the Law No. 13,246, all lease agreements related to rural properties and land are required to have a minimum duration of 3 years. Upon death of the tenant farmer, the agreement may continue with his successors. Upon misuse of the land by the tenant farmer or default on payment of the rent, the land owner may initiate an eviction proceeding. Law No. 13,246 also regulates agreements for crop sharing pursuant to which one of the parties furnishes the other with farm animals or land with the purpose to share benefits between tenant farmer and land owner. These agreements are required to have a minimum term of duration of 3 years. The tenant farmer must perform himself the obligations under the agreement and may not, assign it under any circumstances. Upon the death, incapacity or impossibility of the tenant farmer, the agreement will be terminated. Quality control of Grains and Cattle The quality of the grains and the health measures of the cattle are regulated and controlled by the Servicio Nacional de Sanidad y Calidad Agroalimentaria, which is an entity within the Ministry of Economy and Production that oversees the farming and animal sanitary activities. Argentine law establishes that the brands should be registered with each provincial registry and that there cannot be brands alike within the same province. Sale and Transportation of Cattle Even though the sale of cattle is not specifically regulated, general contract provisions are applicable. Further, every province has its own rural code regulating the sale of cattle. Argentine law establishes that the transportation of cattle is lawful only when it is done with the respective certificate that specifies the relevant information about the cattle. The required information for the certificate is established by the different provincial regulations, the inter-provinces treaties and the regulations issued by the Servicio Nacional de Sanidad y Calidad Agroalimentaria. Sales and Ownership of Real Estate The acquisition and transfer of real estate is governed by provisions of the Argentine Civil Code, as well as municipal zoning ordinances.
56
Table of ContentsAntitrust Law Argentine law provides for antitrust measures and requires administrative authorization for transactions that qualify as economic concentrations in accordance with the Antitrust Law No. 25,156. According to such law, mergers, transfers of goodwill, acquisitions of property or rights over shares, capital or other convertible securities, or similar operations by which the acquirer controls a company, are considered economic concentrations. Whenever an economic concentration involves a company or companies, (i) which hold 25% or more of the relevant market or (ii) whose accumulated sales volume exceeds approximately Ps. 200 million in Argentina or Ps. 2,500 million worldwide; the respective concentration must be submitted for approval to the National Antitrust Commission. The request for approval may be filed, either prior to the transaction or within a week after its completion. Currently, we are not involved in any transaction that requires notification to the National Antitrust Commission. Property and Transfer Taxes Value Added Tax. Under Argentine law, the sale of cattle and grains are taxable at a rate equal to 10.5% of the sale price. The sale of milk is taxable at a rate equal to 21%. The sale of land is not taxable. Gross Sales Tax. A local transfer tax is imposed on the sale price of cattle, grains and milk at a general rate of 1%. In some provinces the sale of primary goods is not taxable. Stamp Tax. This is a local tax that 23 provinces and the City of Buenos Aires collect based on similar rules regarding subject matter, tax base and rates. In general, this tax is levied on acts validated by documents, (e.g. acts related to the constitution, transmission, or expiration of rights, contracts, contracts for sales of stock and company shares, public deeds relating to real property, etc.). In the City of Buenos Aires (federal district) the stamp tax only applies to public deeds for the transfer of real estate, or for any other contract whereby the ownership of real property is transferred. The purchase and sale of real estate through public deed is not taxable if the real estate will be used for housing. In the City of Buenos Aires the tax rate is 2.5%. In the Province of Buenos Aires, the tax rate is 4% for public deeds of transfer of real property. Subsidiaries and Affiliated Companies The following table includes a description of our subsidiaries and affiliated companies, all of which are organized under the laws of Argentina, as of June 30, 2006:
57
Table of Contents
IRSA. During the fiscal year ended June 30, 2004, we acquired 6,050,983 additional shares, for a total consideration of Ps. 14.6 million. In addition, in May 2004, we have decided to convert 5.0 million aggregate principal amount of IRSA’s Convertible Notes in exchange for 9,174,311 shares. During the fiscal year ended June 30, 2005, we acquired 5,426,229 additional shares, for a total consideration of Ps. 16.5 million. On September 30, 2004, Cresud exercised 5.0 million of its IRSA warrants for 9,174,311 ordinary shares of IRSA’s stock at a total cost of US$ 6.0 million. During the fiscal year ended June 30, 2006, we acquired 2,561 additional shares, for a total consideration of Ps. 0.01 million. On February 28, 2006 and June 30, 2006, Cresud exercised 5.0 and 16.0 million respectively of its IRSA’s Convertible Notes in exchange for 9,174,311 and 29,280,754 ordinary shares respectively. As of June 30, 2006, the Company owned 116,305,767 IRSA shares, equivalent to 26.71% of the equity. Our investment in IRSA during fiscal year 2006 resulted in a Ps. 21.4 million profit for the Company. Futuros y Opciones.Com S.A. In May 2000, we acquired 70% of the shares and an irrevocable purchase option for the remainder of the shares of Futuros y Opciones.Com S.A. for Ps. 3.5 million. We made additional capital contributions for Ps. 3.0 million for prospective developments. As of June 30, 2001 we had provided capital contributions amounting to Ps. 2.1 million. On April 16, 2002 an agreement was signed whereby Cresud completed the abovementioned contribution. The site was launched in November 1999 and is aimed at becoming the most important agriculture business community in Latin America. Futuros y Opciones.Com S.A. has launched its e-commerce strategy in
58
Table of ContentsMarch 2001, in order to sell products, buy inputs, ask for loans, and obtain insurance, among other things. The results of Futuros y Opciones.Com S.A. have been included in our consolidated statement of income from the date of acquisition through June 30, 2006. The areas with the greatest potential for growth are: input commercialization, grain businesses and beef-cattle operations. These areas were organized during fiscal year 2002. In terms of inputs the business volume was concentrated in a smaller number of suppliers, the agreements with the suppliers were improved in order to increase the margin of the business, and contracts of direct distribution were achieved. In terms of grains, the brokerage department was created, with the purpose of participating directly in the business by trading and offering services. In beef-cattle, Futuros y Opciones.Com S.A had created an alliance with a leading broker in the sector, which will allow them to obtain better uses of their clients’ database and technological knowledge. On May 31, 2005, the Ordinary Shareholders’ Meeting of Futuros y Opciones.Com S.A. decided that the company’s capital stock should be increased by Ps. 206,080 with no additional paid-in capital and Ps. 42,857 with an additional paid-in premium of Ps.857,143, thus raising the company’s capital stock from Ps. 12,000 to Ps. 260,937. The capital stock was further increased by Ps.100,000 through the issuance of 100,000 preferred shares. This capitalization was conducted after absorbing unappropiated losses of Ps. 4,257,262 against the Irrevocable Contributions account for a total amount of Ps.2,060,321 and the Adjustment to Irrevocable Contributions account for an amount of Ps.2,196,941. The corporate bylaws have thus been amended to incorporate the resolution adopted by the Shareholders’ Meeting, which delegated its implementation on the Board of Directors. As a result of such capital increase, Cresud’s investment has increased by Ps.0.6 million. This effect has been recognized in the additional paid-in capital account, pursuant to section 33 of the Argentine Corporation Law No. 19,550 under the Shareholders’ Equity section. As of June 30, 2006, the company showed an increase of over 97% in its revenues as compared to the previous fiscal year and a 202% growth in the crop brokerage invoicing segment. In addition, the Company posted growth by 100% in the volume of deals closed as compared to the previous fiscal year, though 35% of these were pending settlement at the close of this fiscal year. Despite the dramatic drop in the country’s crop production, the increase in our customers’ ton volume was 50% higher than forecasted in the business plan prepared at the beginning of the fiscal year. This growth resulted from the addition of approximately 150 new customer accounts and the development of new business modalities. The portal keeps consolidating as the leading site for the agricultural and cattle-beef sector. Various private polls have agreed that it is the most visited site by farmers engaged in both agricultural and cattle-beef activities. Currently, the site has an average of 13,000 visitors per day and it is strengthening its position as a leading supplier of market information for the sector. For the coming year, the Company expects to maintain its high growth rate. The objective of fyo.com is to become one of the five largest brokers in Argentina in a period of three years. With regard to new businesses, we expect to offer our customers the possibility of trading futures and options in the Chicago and Rosario Futures Market in the current fiscal year. We also plan to improve financial services to customers through partnerships with banks, purchaser credits and our own funds. Cactus Argentina S.A. is a joint venture operation between the Company and Cactus Feeders Inc., one of the largest feed lot companies in the United States. The site is located in Villa Mercedes, in the Province of San Luis and covers 170 hectares. The feed lot began to operate in September 1999.
59
Table of ContentsThe Company has a 50% interest in the joint venture and exercises joint control. Effective July 1, 2004, the Company adopted Technical Resolution No. 21, “Equity Method of Accounting, Consolidation of Financial Statements and Related Party Transactions” (“RT No. 21”), which among other things, requires for proportionate consolidation where effective joint control is exercised. Accordingly, these financial statements reflect the Company’s pro-rata equity interest in the joint venture on a line-by-line basis. During past years, due to high margins in the agricultural sector, crop production displaced livestock production to marginal areas. Consequently beef production based on traditional pasture has decreased and feed lot production has increased. As an alternative to traditional means of production Argentine producers have started using hostelry services to finish the fattening stage of their cattle. Cactus Argentina S.A., has been a pioneer in this service with a 25,000 head capacity, which depends on the size of the cattle. During fiscal year 2006 the average occupation level reached 61.77%. Such level showed signs of recovery towards the end of the period reaching 79.11%. The obtained in the feed lot’s final product has provided buyers a high quality product, enabling easier commercialization and achieving higher final sale price. Yearling cattle arrived with an average weight between 250 and 300 kg. and are fattened to reach 430/470 kg. This production is mainly destined to foreign markets, particularly the European Union. During fiscal year 2006, Cactus Argentina recorded income as a result of the services supplied to farmers and investors and the profits generated by its own fattened cattle. Given that the conditions prevailing were favorable, Cactus held approximately 3,000 head of its own stock. While external markets were open, huge quantities of beef were exported. Starting in March, the only alternative channel for sales was the domestic market, which was stable for a time but then dropped as a result of the large supply of beef. In spite of the scarce harvest of corn at the national level, there was not a major increase in the price of inputs related to animal foodstuff. The demand for corn was lower than expected in the cattle-beef sector basically because agricultural and livestock policies did not show a favorable outlook for investments. With regards to customers, Cactus continues to receive cattle from farmers that repeat their productive process whereby they breed and re-breed their animals in their own farms and finish them at Cactus. Cactus has acquired a reputation in the market as a producer of high-quality and consistent beef. Several slaughterhouses and some supermarket chains are starting to analyze the possibility of having their own stock of cattle finished through feed-lot fattening. In spite of posting an average occupancy of 15,500 head on a constant basis, which represents a drop compared to the stocks for the prior year because the weight of the fattened animals was higher and the consumption of foodstuff is higher, the profitability of the business was very good. Cactus obtained major benefits during this exercise, net income for the year was Ps. 0.19. Cactus liquidity is high and it has no indebtedness to banks. As a consequence, it may obtain top quality supplies at highly competitive prices. Cactus Argentina’s financial position is very robust. Therefore, the stock of cattle expected to be held during 2006/2007 is higher and more consistent. Expectations for next year are positive as the purchase values are attractive and cattle policies are expected to be more favorable to the sector.
60
Table of ContentsAgropecuaria Cervera S.A. On December 27, 2005, Cresud and its controlled company IGSA acquired 100% of the shares in Agropecuaria Cervera S.A. (ACER) pursuant to a barter agreement. Agropecuaria Cervera S.A. has, among other assets and rights, the concession for the start-up of production pertaining to a comprehensive biological, economic and social development project over various properties located in the Department of Anta, in the Province of Salta, and it is duly authorized to implement a large-scale project covering agricultural, cattle breeding and forestry activities. The concession agreement covers 160,000 hectares for 64 years (initially 35 years with an option to 29 additional years). Under the concession there is a new project to assign 35,000 hectares to agriculture and it has progressed about 10% at the end of the year. In consideration for this barter, Cresud transferred 3.6 million of Corporate Bonds convertible into common shares issued by IRSA Inversiones y Representaciones S.A. and paid Ps 0.96 million, while IGSA paid Ps 0.1 million and U$S 0.7 million. BrasilAgro Companhia Brasileira de Propiedades Agrícolas was created in September 2005 in order to expand Cresud`s business to Brazil. BrasilAgro will be engaged mainly in four business segments: (i) sugar cane, (ii) grains and cotton, (iii) forestry activities (iv) livestock. BrasilAgro’s founding shareholders include Cresud, Cape Town, Tarpon Investimentos, Tarpon Agro, Agro Managers and Agro Investment. Cape Town is a company incorporated under the laws of the State of Delaware, U.S., wholly owned by Mr. Elie Horn, who is the controlling shareholder and chief executive officer of Cyrela Brazil Realty, S.A. Tarpon is an independent Brazilian asset manager engaged in management of mutual funds focusing primarily on Brazilian equities. Tarpon Agro is a company incorporated in the United States of America under the laws of the State of Delaware, and is owned by Tarpon’s shareholders and certain of its affiliates. Agro Investment and Agro Managers are companies incorporated under the laws of Argentina, owned directly or indirectly by certain officers, directors, employees and shareholders of Cresud and its affiliates. Part of the knowledge and experience required to implement BrasilAgro`s proposed business plan will be initially provided pursuant to a consulting agreement with Paraná Consultora do Investimentos S.A., a special purpose advisory company. BrasilAgro`s advisory company is 50% owned by Tarpon BR, 37.5% owned by Consultores Asset Management, a company controlled by Mr. Eduardo Elsztain and 12.5% owned by Mr. Alejandro Elsztain. Tarpon BR is a joint venture between Tarpon and Mr. Elie Horn. Cresud entered into a shareholder agreement with Mr. Elie Horn and Tarpon stipulating, among other things, that both parties should have a joint vote at shareholders’ meetings and that both parties have a preemptive right to acquire shares of the other party. BrasilAgro’s board of directors is composed of nine members. Cresud, as founder of BrasilAgro, appointed three members. Tarpon and Cape Town appointed three more members and, in addition, BrasilAgro has three independent directors. On May 2, 2006, BrasilAgro’s shares started being listed in the Novo Mercado of the Brazilian Stock Exchange (BOVESPA) with the symbol AGRO3, meeting Brazil’s highest Corporate Governance standards. The shares were placed jointly with Banco de Investimentos Credit Suisse (Brazil) S.A. in the Brazilian market through investment mechanisms regulated by controlling authorities and with sales efforts abroad in full conformity with the U.S. Securities Act of 1933 and other applicable regulations set forth by the Securities and Exchange Commission.
61
Table of ContentsThe amount originally offered amounted to Reais 432 million, equivalent to 432,000 book-entries, common shares at a price of Reais 1,000 per share of BrasilAgro. In addition, as is customary in the Brazilian market, BrasilAgro had an option to increase the size of the issuance by 20% and the investment bank Credit Suisse had another option to increase it by 15% (Green shoe). Given the high demand shown by the placement, both BrasilAgro and Credit Suisse exercised such options increasing the placement up to 583,200 shares equivalent to Reais 583.2 million, which were fully placed and paid in. In addition to the funds originally contributed, Cresud contributed Reais 42.4 million (approximately US$ 20.6 million) during the offer. Following such contribution, Cresud now holds a total amount of 42,705 shares, equivalent to 7.3% of BrasilAgro’s capital. As compensation for having founded BrasilAgro, Cresud received, at no cost, 104,902 warrants to subscribe additional BrasilAgro shares for 15 years and at the same price as was established in the initial public offering, Reais 1,000, adjusted by the IPCA inflation index. Should it decide to exercise such warrants, Cresud might acquire 59,850 additional shares, thereby holding 14.1% of BrasilAgro’s diluted capital stock. One third of these warrants may be exercised starting the first anniversary of the placement; another third may be exercised starting the second anniversary and the balance starting the third anniversary. In addition, Cresud received, at no cost, a second series of warrants for a total of 104,902, which may only be exercised at Cresud’s discretion in the event of a tender offer. The exercise price of these warrants shall be the same price as the purchase price of the tender offer by the acquirer of BrasilAgro. The second series of warrants matures in the year 2021. In order to finance the investment in Brazil, on May 2, 2006, Cresud obtained a US$ 8 million loan from Credit Suisse, for a term of 30 months, accruing interest at the 3-month LIBOR rate plus 375 basis points. The loan mentioned has been initially secured through a repo transaction with IRSA’s Convertible Notes for a total of US$ 10 million, which were subsequently replaced by 1,834,860 IRSA’s ADRs, plus a US$-denominated amount that fluctuates in accordance with the price of IRSA’s share. Accordingly, as of June 30, 2006, we had deposited US$ 1.4 million. Additionally, to complete its investment, Cresud used short-term loans and its own funds. As of June 30, 2006, BrasilAgro had not booked any amount whatsoever to reflect the holdings of such warrants. D. PROPERTY, PLANT AND EQUIPMENT Overview of Properties In December 2003, we started to sublease our headquarters from Inversora Bolívar S.A., a subsidiary of IRSA. The following table sets forth our properties’ size (in hectares), primary current use and book value. The market value of farmland is generally higher the closer a farm is located to Buenos Aires:
62
Table of Contents
Farms As of June 30, 2006, we owned, together with our subsidiaries, 17 farms, with a total surface area of 395,429 hectares. Two of them are located in Buenos Aires, two in the Province of Santa Fe, two in the Province of Córdoba, two in the Province of Chaco, three in the Province of San Luis, two in the Province of Catamarca, two in the Province of La Pampa, one in the Province of Salta and one in the province of Entre Ríos. La Adela. Located 60 kilometers Northwest of Buenos Aires, La Aldea is one of our original farms. In December 2001, La Adela’s dairy parlor was closed down. Its total surface area is used for agricultural purposes. During this fiscal year ended June 30, 2006, 819 hectares were used for wheat, corn and soybean crops for high-yielding grain production. In March, 2005, 72 hectares were bought and added to the existing 982 hectares. La Juanita. La Juanita, located 440 kilometers Southwest of Buenos Aires, was acquired in January 1996. As of June 30, 2006, 2,943 head of cattle were grazing in 716 hectares of sown and natural pastures, and 1,714 hectares were used in the production of grains. This farm produced 6.8 million liters of milk during the fiscal year ended June 30, 2006, with an average of 1,050 dairy cows being milked and 17.76 liters per cow per day.
63
Table of ContentsEl Recreo. Weather conditions in the El Recreo farm, located 970 kilometers Northwest of Buenos Aires and acquired in May 1995, are similar to the Tali Sumaj farm, with semi-arid climate and annual rainfall not in excess of 400 mm. This farm is maintained as productive reserves. On July 29, 2003, Inversiones Ganaderas S.A. sold, three properties located in the Santo Domingo district, department of La Paz, Province of Catamarca with a total surface area of 5,997 hectares to Las Rejas S.A. for US$ 0.43 million, which was completely paid off by the time the deed was executed. This sale yielded a profit of Ps. 0.58 million. Tali Sumaj. The Tali Sumaj farm, located 1,000 kilometers Northwest of Buenos Aires, was acquired in May 1995 and it is located in a semi-arid area. As of June 30, 2006, Tali Sumaj had 3,316 cattle head in approximately 12,700 hectares of pasture. The farm is divided into 16 lots with peripheral fencing and watering troughs with a reserve of 1,000,000 liters of water. Los Pozos. The Los Pozos farm, located 1,600 kilometers Northwest of Buenos Aires and acquired in May 1995, is located in a semi-arid area with average rainfall of 500 mm, predominantly summer rainfall. The area is naturally suited to cattle raising and forestry activities (poles and wood coal), and it has agricultural potential for summer crops such as sorghum and corn, among others. For this fiscal year ended June 30, 2006, we used 1,300 hectares in agricultural production. We completed the development of tropical pastures in approximately 20,500 hectares. As of June 30, 2006, there were 23,108 head of cattle in this farm. This farm has shown major growth through a complete cycle in the production of beef by succeeding in raising, re-raising and fattening steer to be sold at an average weight of 392 kg. San Nicolás. The San Nicolás farm is a 4,005-hectare farm owned by Agro-Uranga S.A., and is located in the Province of Santa Fe, approximately 45 kilometers away from the Port of Rosario. As of June 30, 2006, approximately 5,736 hectares were in use, including double crops, for agricultural production. The farm has two plants of silos with storage capacity of 14,950 tons. Las Playas. The Las Playas farm has a surface area of 4,294 hectares and is owned by Agro-Uranga S.A. Located in the Province of Córdoba, it is used for agricultural and milk purposes. As of June 30, 2006, the farm had 540 hectares of pasture used for milk production, and a sown surface area of 6,192 hectares including double crops, for grain production. Tapenagá. This farm, with a surface area of 20,833 hectares is located in Cote Lai, in the Southern part of the Province of Chaco. The farm is located along provincial route No. 89, 75 km West of Resistencia. This farm is mainly devoted to cattle raising with low production costs. As of June 30, 2006, the farm had 8,464 head of cattle. La Gramilla and Santa Bárbara. These farms have a surface area of 7,052 hectares in Valle del Conlara, Province of San Luis. In contrast to other areas in the province, this valley has a high quality underground aquifer, which makes these farms well suited for agricultural production after investments were made in the development of lands, pits and irrigation equipment. In the course of 2005/2006, a total of 475 hectares was sown under contractual arrangement with seed producers and leases to third parties of 1,373 hectares. Commodities were also sown. La Suiza. La Suiza has a surface area of 41,993 hectares and it is located in Villa Ángela, Province of Chaco. It has outstanding cattle raising potential and it is used in cattle raising. La Suiza may host over 30,000 cattle head. As of June 30, 2006, La Suiza had a stock of approximately 23,011 head. La Esmeralda. La Esmeralda has a surface area of 11,841 hectares, and it is located in Ceres, Province of Santa Fe. This farm, acquired in June 1998 has potential for both agricultural production and cattle raising. During the 2005/2006 farm season, a total area of 1,710 hectares was used for production of corn, sunflower and sorghum. We also leased 3,103 hectares to third parties leased for grain production. As of June 30, 2005, La Esmeralda had 9,211 head in 6,577 hectares and as of June 30,
64
Table of Contents2006, has 10,101 head in 6,754 hectares. The objective to enhance cattle raising efficiency and increase the surface area devoted to agriculture. El Tigre El Tigre was acquired on April 30, 2003, with a surface area of 8,360 hectares and is located in Trenel, Province of La Pampa. As of June 2006, 6,335 hectares were devoted to agriculture production. This farm produced 7.8 million liters of milk in the twelve-month period ended June 30, 2006, with 1,360 cows being milked and 15.6 liters a day per cow. El Invierno. The El Invierno farm was acquired on June 24, 2005 with a surface area of 1,946 hectares and is located in Rancul, Province of La Pampa, 621 kilometers to the west of Buenos Aires. During the fiscal year ended June 30, 2006, the land used was entirely for agricultural production. San Pedro. The farm in San Pedro was purchased on September 1, 2005. It has a surface area of 6,022 hectares and is located in Concepción del Uruguay, Province of Entre Ríos, 305 kilometers north of the province of Buenos Aires. During the fiscal year ended June 30, 2006, 1,100 hectares were destined to the livestock activity and 335 hectares to agricultural production. Silos As of June 30, 2006, we had an approximate storage capacity of 15,341 tons (including 35.723% of the 14,950 tons available at Agro-Uranga S.A.). The following table sets forth, for the periods indicated, our storage facilities:
Item 4A. Unresolved Staff Comments. This section is not applicable. Item 5. Operating financial review and prospects A. CONSOLIDATED OPERATING RESULTS The following management’s discussion and analysis of our financial condition and results of operations should be read together with “Selected Consolidated Financial Data” and our consolidated financial statements and related notes appearing elsewhere in this Form 20-F. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. These forward-looking statements include such words as, “expects,” “anticipates,” “intends,” “believes” and similar language. Our actual results may differ materially and adversely from those anticipated in these forward-looking statements as a result of many factors, including those set forth elsewhere in this Form 20-F.
65
Table of ContentsFor purposes of the following discussion, unless otherwise specified, references to fiscal years .2006, 2005 and 2004 relate to the fiscal years ended June 30, 2006, 2005 and 2004, respectively. We maintain our financial books and records in Pesos. Except as discussed in the following paragraph, we prepare our financial statements in conformity with Argentine GAAP and the regulations of the Comisión Nacional de Valores. See Note 17 to our financial statements for a description of the principal differences between Argentine GAAP and U.S. GAAP, as they relate to us, and a reconciliation to U.S. GAAP of net income (loss) and total shareholders’ equity. The differences involve methods of measuring the amounts shown in the financial statements as well as additional disclosures required by U.S. GAAP and Regulation S-X of the SEC. As discussed in Notes 2.c) and 3.k) to our Consolidated Financial Statements, contained elsewhere in this annual report, in order to comply with Comisión Nacional de Valores regulations, we discontinued inflation accounting as of March 1, 2003 and we recognized deferred income tax assets and liabilities on a non-discounted basis. These accounting practices represent departures from generally accepted accounting principles in Argentina. However, we believe that such departures have not had a material effect on our financial statements. Discussion of Critical Accounting Policies In connection with the preparation of the financial statements included in this annual report, we have relied on variables and assumptions derived from historical experience and various other factors that we deemed reasonable and relevant. Although we review these estimates and assumptions in the ordinary course of business, the portrayal of our financial condition and results of operations often requires our management to make judgments regarding the effects of matters that are inherently uncertain on the carrying value of our assets and liabilities. Actual results may differ from those estimated under different variables, assumptions or conditions. In order to provide an understanding about how management forms its judgments about future events, including the variables and assumptions underlying the estimates, and the sensitivity of those judgments to different variables and conditions, we have included comments related to each critical accounting policy described as follows:
Investments in affiliates We use the equity method of accounting for investments in affiliates in which we have significant influence. Critical accounting policies of these affiliates include provision for allowances and contingencies, impairment of long-lived assets, accounting for debt restructuring and accounting for deferred income tax and asset tax credits. As of June 30, 2006, investments in affiliates were Ps. 357.5 million representing 41.0% of our total assets. Impairment of Long-Lived Assets We periodically evaluate the carrying value of our long-lived assets for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We consider the carrying value of a long-lived asset to be impaired when the expected cash flows, from such asset are separately identifiable and less than its carrying value. In that event, a loss would be
66
Table of Contentsrecognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset. We determine the fair market value primarily using independent appraisal valuations and utilizing anticipated cash flows discounted at a rate commensurate to the risk involved. Under Argentine GAAP a previously recognized impairment loss is reversed when there is a subsequent change in estimates used to compute the fair market value of the asset. In that event, the new carrying value of the asset is the lower of its fair market value or the net carrying value the asset could have had if not impairment would have been recognized. Both the impairment charge and the impairment reversal are recognized in earnings. U.S. GAAP prohibits the reversal of a previously recognized impairment charge. We believe that the accounting estimate concerning the impairment of long-lived assets is a critical accounting policy because, when one takes into account that farms are non-depreciable assets of unlimited useful life, their value could be calculated as a perpetuity (i.e., dividing the expected return of each farm by a discount rate representative in the market). As farming is a low-risk business and has betas near to zero or even negative, a 6% discount rate was taken for purposes of the calculation. Even if there is a reduction of 20% in the expected return, it would not have been necessary to recognize any loss for depreciation of the referred assets. Intangible assets – concession rights The concession received (a higher value paid) for the acquisition of the subsidiary Agropecuaria Cervera S.A. (ACER) has been valued at cost, which was calculated as the difference between the prices paid for that investment and the estimated current value of the assets added. Amortization of the ACER concession fee will be calculated over the life of the project, which was set at 35 years, with an option to extend it for an additional 29-year period. The concession fee of the project will be amortized as from its start-up. The allocation of the purchase price to the fair value of concession rights acquired was completed in this fiscal year and resulted in recognition of intangible assets of approximately Ps. 23.6 million. These intangibles will be amortized as from its start-up, estimated in 35 years, with an option to extend it for an additional 29-year period, over their estimated useful lives and are tested for impairment whenever events or circumstances indicate that impairment may have occurred. If the carrying amount of an intangible asset exceeds its fair value based on estimated future undiscounted cash flows, an impairment loss would be indicated. The amount of the impairment loss to be recorded would be based on the excess of the carrying amount of the intangible asset over its discounted future cash flows. Judgment is used in assessing whether the carrying amount of intangible assets is not expected to be recoverable over their estimated remaining useful lives. Impairment testing is performed in accordance with SFAS No. 142, Goodwill and Other Intangible Assets. Impairment testing is conducted at the operating segment level of the Corporation’s businesses and is based on a discounted cash flow approach to determine the fair value of each operating segment. The determination of fair value requires significant management judgment including estimating future sales volumes, selling prices and costs, changes in working capital, investments in property and equipment and the selection of an appropriate discount rate. Sensitivities of these fair value estimates to changes in assumptions for sales volumes, selling prices and costs are also tested. If the carrying amount of an operating segment that contains goodwill exceeds fair value, a possible impairment would be indicated. If a possible impairment is indicated, the implied fair value of goodwill would be estimated by comparing the carrying amount of the net assets of the unit excluding goodwill to the total fair value of the unit. If the carrying amount of goodwill exceeds its implied fair value, an impairment charge would be recorded. Judgment is used in assessing whether goodwill should be tested more frequently for impairment than annually. Factors such as unexpected adverse economic conditions and other external events may require more frequent assessments. The Corporation’s annual goodwill impairment testing has been completed and it has been determined that none is impaired.
67
Table of ContentsDerivative Instruments All derivative instruments are recorded as assets or liabilities on the balance sheet at fair value. Changes in the fair value of derivatives are either recorded in income or other comprehensive income, as appropriate. The gain or loss on derivatives designated as fair value hedges and the offsetting loss or gain on the hedged item attributable to the hedged risk are included in current income in the period that changes in fair value occur. The gain or loss on derivatives designated as cash flow hedges is included in other comprehensive income in the period that changes in fair value occur and is reclassified to income in the same period that the hedged item affects income. Additionally in accordance with the definition described in paragraph 9(a) of the FASB 115, the Company determined that Brasilagro Warrants were not derivative instruments based on the definition of “Delivery of assets that are readily convertible to cash” because the security would not be readily convertible if the number of shares to be exchanged is large relative to the daily transaction volume. Deferred income tax The Company records income taxes using the deferred tax liability method. Accordingly, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recorded or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company has treated the differences between the price-level restated amounts of assets and liabilities and their historical basis as permanent differences for deferred income tax calculation purposes. At the end of the fiscal year there are temporary net liabilities (tax liabilities) mainly originated in the beef cattle valuation and the roll-over. The management has made estimations that allow it to recognize this deferred tax. We believe that the accounting estimate related to deferred income tax is a “critical accounting estimate” because:
On December 29, 2005, through Resolutions 485 and 487, the National Securities Commission (CNV) adopted with certain changes the standards of the Consejo Profesional de Ciencias Económicas de la Ciudad Autónoma de Buenos Aires, or “CPCECABA”. The standards adopted will become effective for the Company on July 1, 2006 (date of beginning of the next fiscal period). The principal change arising from the consolidation of the accounting standards is related to the treatment given to the adjustment for inflation in the calculation of the deferred tax, which can be taken as a temporary difference, according to the Company´s criteria. The adjustment for inflation is currently considered as a permanent difference in the calculation of the deferred tax. The Company has decided to maintain this accounting criteria. Principal differences between Argentine GAAP and U.S. GAAP The principal differences, other than inflation accounting, between Argentine GAAP and U.S. GAAP are related to the following:
68
Table of Contentsa) Retrospective application of accounting standards; b) Accounting for IRSA investment; c) Valuation of inventories; d) Deferred income tax; e) Accounting for futures and options contracts; f) Web site development costs; g) Differences in basis relating to purchase accounting; h) Amortization expense; i) Elimination of gain on acquisition of minority interest; j) Available-for sale securities; k) Investments in Agro-Uranga S.A.; l) Accounting for stock options; m) Accounting for Convertible Notes; n) Effect of US GAAP adjustments on management fee; o) Minority interest; p) Investments in Cactus. In addition, certain other disclosures required under U.S. GAAP have been included in the U.S. GAAP reconciliation. See Note 17 to our consolidated financial statements. Net income under Argentine GAAP for the years ended June 30, 2006, 2005 and 2004 was approximately Ps. 32.9 million, Ps. 76.8 million and Ps.32.1 million, respectively, as compared to approximately Ps. 27.5 million, Ps. 86.7 million and Ps. 3.3 million, respectively, under U.S. GAAP. Shareholders’ equity under Argentine GAAP as of June 30, 2006 and 2005, was Ps. 632.5 million and Ps. 523.0 million, respectively, as compared to Ps. 614 million and Ps. 425.9 million, respectively, under U.S. GAAP. Effects of Devaluation and Economic Crisis All of our assets are located and our operations are performed in Argentina. Accordingly, our financial condition and results of operations depend substantially upon economic conditions prevailing in Argentina. Due to the four-year-old recession ended on the second quarter of 2002, the Argentine economy has deteriorated sharply. However, during 2003, certain signs of economic recovery appeared and have continued during 2004, 2005 and 2006. In the fourth quarter of 1998, the Argentine economy entered into a recession that caused the gross domestic product to decrease in real terms by 3.4% in 1999, 0.8% in 2000 and 4.4% in 2001. During the second half of 2001, Argentina’s recession worsened significantly, precipitating a serious political and economic crisis. During 2002, the gross domestic product decreased 10.9% as compared to
69
Table of Contents2001, and during the first three quarters of 2003, the gross domestic product increased 7.3%. In 2003, the economy began to recover, closing the year with year-onyear growth of 11.7%. Exceeding growth expectations, in 2004 the GDP increased 9.0% in comparison with 2003 and during 2005 the economy also expanded strongly at a rate of 9.2%. On December 23, 2001, President Adolfo Rodriguez Saá declared the suspension of the payment of foreign debt and later President Eduardo Duhalde ratified his decision. On January 6, 2002, the Congress enacted the Public Emergency Law which repeals several provisions of the Convertibility Law which prevailed in Argentina for 10 years, and the executive branch announced the devaluation of the Peso the establishment of a dual exchange rate system in which certain limited transactions will occur at a fixed rate of Ps. 1.4 to US$ 1.0 and all other transactions will be settled at a floating market rate depending on supply and demand. This new legislation had a material adverse effect on our financial position and the results of our operations in fiscal year 2002 mainly through its effects in IRSA, which was partially offset during fiscal year 2004, 2005 and 2006. During fiscal year 2005, the Government of President Néstor Kirchner submitted a proposal to creditors to continue the payments of external debt. The official offer for the sovereign debt exchange obtained very good results and was supported by 76.07% of its creditors. The Government was able to record a partial remission of the debt in terms of current value of 65.2%, which exceeds any remission recorded in any other debt restructuring process in other countries. This significant achievement represented an opportunity for the country to recover reliability internationally and gave way to an economic context of higher feasibility. On the other hand, in February 2006, the government paid the total debt to the International Monetary Fund (“IMF”) through the payment of US$ 9.530 million, reducing significantly the sovereing debt of the country. This significant advancement represented an opportunity for the country to recover the international market reliability and allowed generating an economic context of higher feasibility, which in turn will encourage the concretion of future investments. Effects of inflation The Argentine Peso devaluation by the Executive Power carries the risk of a significant inflation increase. The following are annual inflation rates that reflect the variation with respect to the same month of the previous year published by the Argentine Ministry of Economy:
The inflationary risk increase may erode macroeconomic stability currently attained, which would negatively affect the development of our operations. Retail prices accumulated a significant increase during 2005, which turned inflation into one of the main issues. In order to limit inflation, the government intervened through trade agreements, with
70
Table of Contentsnegotiations in the foods and textiles sector stand out. In this way, the CPI accumulated increase for the first semester of 2006 accounted for 4.9% and 5.1% for the Wholesale Price Index (“IPIM”), thus showing signs of desacceleration in the price increase for the rest of calendar year 2006. Operating Results Fiscal year ended June 30, 2006 compared to the fiscal year ended June 30, 2005 Sales Sales reached Ps. 112.3 million, 43.7% higher than those recorded in the previous year. Higher sales in the rest of the segments partially offset smaller livestock sales. Crops. Sales of grains increased by 99.6%, from Ps. 30.9 million in fiscal year 2005 to Ps. 61.7 million in fiscal year 2006. The 86.2% increase in the volume of sales, from 88,123 tons to 164,104 tons, was accompanied by a 7.2% increase in unit price in fiscal year 2006 compared to the price for fiscal year 2005. Average price per ton sold was Ps. 376 compared to Ps. 351 in the prior fiscal year. The production of grains decreased by 28.7%, from 149,785 tons in fiscal year 2005 to 106,867 tons in fiscal year 2006 (the production of sunflower increased by 45.3% and wheat, corn and soybean increased by 8.1%, 52% and 12.2%, respectively). The total sown surface area increased from 36,293 hectares in fiscal year 2005 to 37,022 in fiscal year 2006. The leased sown surface area increased from 16,299 hectares in fiscal year 2005 to 17,004 hectares in fiscal year 2006 and the Company’s own sown surface area increased 19,994 hectares in fiscal year 2005 to 20,018 hectares in fiscal year 2006. Beef Cattle. Sales of beef cattle decreased by 8.5%, from Ps. 36.8 million in fiscal year 2005 to Ps 33.7 million in fiscal year 2006. The 17.0% decrease in the volume of sales was offset by a 10.3% increase in the price per ton sold. The volume of sales decreased from 17,783 tons to 14,762 tons, whilst the sales price increased from Ps. 2.07 per kilogram in fiscal year 2005 to Ps. 2.28 per kilogram in fiscal year 2006. Average cattle stock decreased from 96,231 in fiscal year 2005 to 91,500 in fiscal year 2006 and the total production of beef cattle decreased by 8.0%, from 10,657 tons in fiscal year 2005 to 9,803 tons in fiscal year 2006. This decline was caused by the drought that affected the supply of grazing land where we produce meat at a lower price, as well as a smaller number of cattle head finished in feedlots. The number of our own hectares used in the production of beef cattle decreased from 126,879 hectares in fiscal year 2005 to 97,299 hectares in fiscal year 2006. This decrease was caused by the sale of the Ñacurutú and El Gualicho farmlands, partially offset by acquisition of San Pedro farmlands and the shift of hectares from land reserve to cattle raising in the Los Pozos farmlands. Milk. Sales of milk increased by 127.9%, from Ps. 3.5 million in fiscal year 2005 to Ps. 7.9 million in fiscal year 2006 mainly due to a 99.5% rise in production volume, 7.3 million liters in fiscal year 2005 to 14.6 million liters in fiscal year 2006, mainly from the incorporation of our milk parlor in El Tigre farm and to a lesser extent, by a change in the feed system as a result of the drought. Price levels increased by 14.2% from Ps. 474 per thousand liters of milk in the past fiscal year to Ps 541 per thousand liters of milk in fiscal year 2006. On March 1, 2005 we opened a large-scale milk parlor in El Tigre farm equipped with cutting edge technology. We increased production capacity to 36,000 liters a day. We project this business to post higher yields than the agricultural business. On March 1, 2005, the investment made in this milk parlor amounted to approximately U$S 1.0 million. Feed lot. Revenues from this segment increased 27.8%, from Ps. 2.1 million in 2005 to Ps. 2.7 million in fiscal year 2006. This resulted mainly from producer’s use of heavier livestock during 2006, which required greater volumes of feed rations, taking into account that the levels of feed lot occupation were slightly lower with respect to the past fiscal year. As a result of the above, there was a lower utilization rate, from an average of 16,300 heads during 2005 to 15,400 heads during 2006. Others. Sales increased by 30.7% from Ps. 4.9 million in fiscal year 2005 to Ps. 6.4 million in fiscal year 2006 mainly due to an increase in from Futuros y Opciones.com and form third party
71
Table of Contentsrevenues and leases of farms. Revenues from leases to third parties are connected to irrigation services to third parties. The leases increased due to a greater surface area used in this activity. Leasing prices continue to be attractive. Cost of sales Cost of sales increased by 54.7% from Ps. 59.7 million in fiscal year 2005 to Ps. 92.3 million in fiscal year 2006. Cost of sales as a percentage of net sales increased from 76.3% in fiscal year 2005 to 82.2% in fiscal year 2006. Crops. The cost of sales of grains increased from Ps. 21.3 million in fiscal year 2005 to Ps. 50.6 million in fiscal year 2006. This rise is attributable mainly to a larger sales volume coupled with an increase in the level of average commodities prices during this fiscal year, and a larger opening stock which affected, to a smaller extent, the cost of sales in fiscal year 2006. The cost of grain sales as a percentage of overall sales increased by 69.0% to 82.1% in fiscal year 2006. Direct costs per produced ton were greater in fiscal year 2006 due to the level of crops production, which as a result of the drought, was lower with respect to the past fiscal year. The production costs per produced ton increased to Ps. 345 in fiscal year 2006 from Ps. 225 in fiscal year 2005. Beef cattle. Cost of sales for beef cattle decreased by 4.2% from Ps. 32.8 million in fiscal year 2005 to Ps. 31.4 million in fiscal year 2006. This decrease mainly corresponds to a lower volume of meat sales, an 8% decrease in beef cattle production with respect to the past fiscal year as a consequence of the drought that affected cattle raising areas in the country, and to the effect of a lower quantity of beef cattle finished in the feedlot, offset to a smaller extent by higher average cattle prices over a lower position of stock at the end of this fiscal year. The cost of sales for beef cattle as a percentage of sales of cattle increased from 89.1% in fiscal year 2005 to 93.3% in fiscal year 2006. The cost for each ton sold also increased from Ps. 1,846 in fiscal year 2005 to Ps. 2,130 in fiscal year 2006. Milk. The cost of sales of milk increased by 179.0% from Ps. 2.1 million in fiscal year 2005 to Ps. 5.8 million in fiscal year 2006. This increase is attributable to increased milk production and sales in this fiscal year, the positive effect resulting from the reclassification of dairy cattle in the previous fiscal year, and with the negative impact of larger supplementary feeding costs due to the drought that took place during this fiscal year. Another factor that led to the rise in costs this year was the increase in costs for the incorporation of the milk parlor of El Tigre farm, which generated revenue only in the last four months of fiscal year 2005. The cost of milk sales per thousand liters has gone up from Ps. 286 in fiscal year 2005 to Ps. 401 in fiscal year 2006. Feed lot. The cost of feed lot sales increased by 24.9%, from Ps. 1.9 million in 2005 to Ps. 2.3 million in fiscal year 2006. The increase corresponds to greater volumes of feeding rations resulting from the acquisition of stock of greater weight, which required an increase in feeding costs. The feed ration price per ton increased approximately 8.5%, from Ps. 191 in fiscal year 2005 to Ps. 207 in fiscal year 2006, because of a corn price increase during this year. The cost of feed lot services as a percentage of total sales decreased from 87.1% in fiscal year 2005 to 85.2% in fiscal year 2006. Others. Costs increased by 35.4% from Ps. 1.6 million in fiscal year 2005 to Ps. 2.1 million in fiscal year 2006 mainly due to higher costs related to Futuros y Opciones.com. Gross Profit As a result of the factors mentioned, gross profit amounted to Ps. 20.0 million in fiscal year 2006 compared to a Ps. 18.5 million profit recorded in fiscal year 2005.
72
Table of ContentsSelling Expenses Selling expenses increased from Ps 6.6 million in fiscal year 2005 to Ps. 10.1 million in fiscal year 2006. Selling expenses in agricultural activities represented 85.8% of total selling expenses, selling expenses in cattle raising activities represented 10.2% and the remaining 3.9% corresponds to the other activities. Selling expenses in grains as a percentage of sales decreased to 14.1% in fiscal year 2006 with respect to 15.3% in fiscal year 2005. Selling expenses by ton of grains sold slightly decreased compared to those of the prior fiscal year amounting to Ps. 53 per ton in the current fiscal year. Selling expenses as a percentage of the sales of beef cattle decreased from 4.0% in fiscal year 2005 to 3.1% in fiscal year 2006 due to an improvement in our business deals with customers. Sales of milk do not generate selling expenses as the production of milk is sold on a direct basis. Administrative Expenses Administrative expenses increased by 59.0% from Ps. 7.3 million in fiscal year 2005 to Ps. 11.6 million in fiscal year 2006, mainly due to the increase in salaries, social contributions, fees for services, taxes, rates and contributions, and office expenses. Administrative expenses include the Company’s general expenses but they exclude expenses related to farmland management. Net gain on sale of farms The sale of fixed assets amounted to Ps. 9.9 million in fiscal year 2006 and Ps. 20.0 million in fiscal year 2005, due to the sale of the following: - During fiscal year 2006 On February 24, 2005, the bill of sale for the farm El Gualicho of 5,727 hectares, located in General Roca and Presidente Roque Sáenz Peña, province of Córdoba was signed. The agreed price was US$ 5.7 million. The title deed was executed on July 25, 2005 and the sale generated income in the amount of Ps. 9.9 million. - During fiscal year 2005 On February 1, 2005 deeds were executed for the sale of Ñacurutú, with a surface area of 30,350 hectares, located in the departments of General Obligado and Vera, Province of Santa Fé. The agreed price was US$ 5.6 million. The gain on this sale amounted to Ps. 7.6 million. On June 8, 2005 a deed was executed for the sale of San Enrique, with a surface area of 977 hectares, located in the department of General López, Province of Santa Fé. The agreed price was US$5.0 million and the gain made on the sale amounted to Ps. 12.3 million. On June 29, 2005 a bill of sale was signed with respect to a share of the farm located in El Recreo, Province of Catamarca, where two hectares were sold for US$ 20,000. The gain on the sale amounted to Ps. 0.1 million. Gain from inventory holding The gain from holdings amounted to Ps. 2.8 million in fiscal year 2006, compared to Ps. 11.6 million in fiscal year 2005. This decrease reflects the profit from cattle holdings based on the increase in real prices during fiscal year 2006.
73
Table of ContentsOperating Income Given the factors described above, the operating income amounted to Ps. 11.1 million in fiscal year 2006 compared to Ps. 36.3 million recorded in fiscal year 2005. The operating margin was 9.9% in fiscal year 2006 and 46.4% in fiscal year 2005. Net Financial results Net financial results amounted to a gain of Ps. 12.4 million in fiscal year 2006 and a gain of Ps. 63.8 million for fiscal year 2005. The difference between both years is mainly attributable to an increase in the sale of corporate notes bought from IRSA during fiscal year 2005 compared to fiscal year 2006 and, to a lesser extent to the net effect of exchange losses and interests. Financial results are broken down as follows: (i) a gain of Ps. 14.9 million on the sale of corporate bonds acquired from IRSA; (ii) a gain of Ps. 2.2 million resulting from net exchange rate differences; (iii) a loss of Ps. 2.2 million attributable to the financial transactions tax; (iv) a loss of Ps. 2.5 million resulting from interest and others. Income from related companies The income on equity investments decreased by 21.2% from a gain of Ps. 28.1 million in fiscal year 2005 to a gain of Ps. 22.1 million in fiscal year 2006. The 2006 gain resulted mainly from the net income of IRSA which amounted to Ps. 23.4 million, the gain from our interest in Agro Uranga S.A. of Ps. 1.2 million, and a loss of Ps. 2.5 million from our interest in BrasilAgro. Other income and expenses, net In 2006, the item Other income and expenses, net amounted to a loss of Ps. 3.4 million compared to a loss of Ps. 5.1 million in fiscal 2005, mainly due to a minor negative effect of the Ps. 1.4 million shareholders personal assets tax that was incurred by the Company this fiscal year. Management Fee Under the agreement entered into with Dolphin Fund Management S.A., we pay a fee equal to 10% of our net income for agricultural advisory services and other management services. The fees amounted to Ps. 3.8 million and Ps. 8.5 million in the fiscal years 2006 and 2005, respectively. Income tax expense Income tax expenses decreased from Ps. 37.8 million in fiscal year 2005 to Ps. 5.4 million in fiscal year 2006. The Company recognized its income tax charge on the basis of the deferred tax liability method, thus recognizing temporary differences between accounting and tax assets and liabilities measurements. The main temporary differences derive from cattle stock and fixed assets valuation. For purposes of determining the deferred assets and liabilities, the tax rate expected to be in force at the time of their reversion or use, according to the legal provisions enacted as of the date of issuance of these financial statements (35%) has been applied to the identified temporary differences and tax losses. Minority interest A third party negative interest amounting to Ps. 0.1 million was recorded during fiscal year 2006 to show the minority interest in Futuros y Opciones.com S.A. results. Net Income
74
Table of ContentsGiven the factors described above, the net income decreased from a Ps. 76.8 million for fiscal year 2005 to Ps. 32.9 million for fiscal year 2006. The net margin, computed as net income over total sales amounted to 29.3% for fiscal year 2006 and 98.2% for fiscal year 2005. B. LIQUIDITY AND CAPITAL RESOURCES Our liquidity and capital resources include our cash and cash equivalent, proceeds from operating activities, sales of real estate investments, bank borrowing, long-term debt and capital financing. The table below shows, for the periods indicated, our cash flows:
As of June, 2006, we had cash and cash equivalents totaling Ps. 27.4 million, a decrease from the Ps.67.5 million balance held as of June 30, 2005. This decrease was primarily due to the acquisition and improvement of fixed assets for Ps. 55.8 million, an increase in investments in related companies for Ps. 64.6 million, cash outflows used in operating activities for Ps. 21.5 million and dividend payments of Ps. 10 million partially, offset by the proceeds from the exercise of warrants for Ps. 53.6 million and the net proceeds from short-term and long-term debt for Ps. 65 million. As of June, 2005, we had cash and cash equivalents totaling Ps. 67.5 million, an increase from the Ps. 13.1 million balance held as of June 30, 2004. This increase resulted primarily from the proceeds from sale of convertible notes for Ps. 93.5 million, from the sale of farms for Ps. 28.5 million and proceeds from the exercise of warrants for Ps. 10.9, which were partially offset by cash outflows used in operating activities for Ps. 10.1 million, an increase in interest in a related company for Ps. 34.4 million, and acquisition and upgrading of fixed assets for Ps. 26.0 million and payments of short-term debt. Net Cash (Used in) Provided by Operating Activities Net cash used in operations increased from Ps. 10.1 million in fiscal year 2005 to Ps. 21.4 million in fiscal year 2006. The increase in net cash used in operations activities was primarily due to the increase in other receivables, in trade accounts payable and in social security payable, charges, taxes payable and advances to customers for Ps. 40.3 million, which were partially offset by a decrease in current investments of Ps. 3.2 million in fiscal year 2005 as compared to fiscal year 2006. Our operating activities resulted in net cash outflows of Ps. 21.5 million for fiscal year 2006, essentially due to a decrease in current investments, inventories other debts and dividends collect of Ps. 21.8 million that was offset by an increase in trade accounts receivable, other receivables, taxes payable, and advances to customers amounting to Ps. 51.5 million. Net cash used in operations increased from Ps. 0.3 million in fiscal year 2004 to Ps. 10.1 million in fiscal year 2005. Our operating activities resulted in net cash inflows of Ps. 10.1 million for fiscal year 2005 essentially due to a decrease in current investments through the collection of interest of Convertible Notes, an increase in trade accounts payable and in dividends collected an operating gain of Ps. 6.3 million totaling Ps. 14.6 million which were offset by an increase in trade accounts receivable, other receivables, inventories, in social securities, charges, taxes payable and an increase in other liabilities payable for Ps. 24.7 million.
75
Table of ContentsNet Cash Provided by (Used in) Investing Activities Net cash used in investing activities decreased from Ps. 62.7 million in fiscal year 2005 to a net cash out-flows of Ps. 111.0 million in fiscal year 2006. Our investing activities resulted in net cash outflow of Ps. 111.0 million in fiscal year 2006 mainly due to investments in related companies of Ps. 64.6 million and the acquisition and upgrading of fixed assets for Ps. 55.8 million partially offset by the sale of fixed assets for Ps. 5.6 million and collection of secured receivables from sale of farms for Ps. 5.7 million. Net cash used in investing activities increased from a net use of Ps. 25.1 million in fiscal year 2004 to a net cash inflows of Ps. 62.7 million in fiscal year 2005. Our investing activities resulted in net cash inflows for Ps. 62.7 million in fiscal year 2005 mainly due to our sale of IRSA´s convertible notes for Ps. 93.5 million, the collection of receivables related to the sale of fixed assets for Ps. 1.1 million and from the sale of fixed assets for Ps. 28.5 million partially offset by the acquisition and upgrading of fixed assets for Ps. 26.0 million and the increase of our investment in IRSA for Ps. 34.4 million. Net Cash Provided by (Used in) Financing Activities Net cash provided from financing activities increased from Ps. 1.7 million in fiscal year 2005 to Ps. 92.3 million in fiscal year 2006 primarily due to a increase in proceeds of financial loans for Ps. 72.4 million and by the exercise of warrants for Ps. 42.7 million partially offset by the payment of secured payable from the purchase of farms for Ps.16.5. Our financing activities resulted in net cash inflows of Ps. 92.3 million primarily due to the exercise of warrants and proceeds from financial loans for Ps. 137.8 million partially offset by dividend payments, payments of financial loans and payment of secured payable from purchase of farms for Ps. 29.0 million. Net cash inflow from financing activities decreased from a net cash outflow of Ps. 16.7 million in fiscal year 2004 to Ps. 1.7 million in fiscal year 2005. Our financing activities resulted in net cash inflows of Ps. 1.7 million primarily due to the exercise of warrants, stock option and contributions of minority shareholders of Ps. 12.0 million which were partially offset by payments of financial loans and dividends paid for Ps. 10.3 million. In our opinion, our working capital is sufficient for our present requirements. In the event that cash generated from our operations is at any time insufficient to finance our working capital, we would seek to finance such working capital needs through new debt, equity financing or selective asset sales. Our Indebtedness On October 15, 2002, we initiated a preemptive rights offering to subscribe for 50.0 million units consisting of US$ 50.0 million of 8% Convertible Notes due 2007 and non-detachable warrants to purchase additional shares of our common stock. The Convertible Notes may be converted at the holder’s option into shares of our common stock until maturity on November 14, 2007, at the initial conversion price of US$ 0.5078 per common share. Each warrant will be exercisable on or after conversion of the Convertible Note to which it is attached at the same conversion price plus a 20% premium (US$ 0.6093). The rights offering to holders of our common shares and ADSs expired on November 13, 2002, and was fully subscribed. As of November 30, 2006, certain of our Convertible Notes holders exercised their conversion rights for a total of 25,182,860 units with a face value of US$ 1 each, whereas the ordinary stock delivered in exchange amounted to 49,592,029 with a face value of Ps.1 each. During the same period, 24,286,226 warrants were exercised, resulting in a cash inflow of US$ 29.1 million and the issuance of 47,826,324 shares with a face value of Ps. 1 each.
76
Table of ContentsAs of November 30, 2006, we had US$ 24,817,140 aggregate principal amount of Convertible Notes outstanding and 221,702,745 common shares outstanding. On May 2, 2006, we entered into a loan agreement with Credit Suisse for a total consideration of US$ 8 million (the “Loan Agreement”). The term of the Loan Agreement is 30 months, and the interest rate is 3-month LIBOR plus 375 basis points. The Loan Agreement has a collateral of US$ 10 million IRSA`s Convertible Bonds that were replaced for 1.834.860 of IRSA’s ADRs. The proceeds have been fully applied to the subscription of BrasilAgro’s shares. Under this Loan Agreement there are some restrictions on the payment of dividends. We can pay or distribute, directly or indirectly, whether in cash or other property or in obligations to any other person up to USD 5,000,000 for any calendar year:
Our total outstanding debt as of June 30, 2006 was Ps. 164.1 million, consisting of the Convertible Notes which mature on November 14, 2007 for Ps. 78.1, million and other loans in the amount of Ps. 85.9 million. Capital Expenditures Capital expenditures totaled Ps. 55.8 million, Ps. 25.9 million and Ps. 15.2 million for the fiscal years ended June 2006, 2005 and 2004, respectively, including property and equipment acquired in business combinations. Our capital expenditures consisted of the acquisition and improvement of productive agricultural assets, as well as purchases of farms. Our future capital expenditures for fiscal year 2007 will depend on the prevailing prices of land for agriculture and cattle as well as the evolution of commodity prices. For the fiscal year ended June 30, 2006, our main investments consisted of Ps. 25.7 million in the acquisition of real estate, Ps. 0.6 million in improvements, Ps. 0.1 million in furniture and equipment, Ps. 1.2 million in facilities, Ps. 1.3 million in new pastures, Ps. 0.9 million in vehicles, Ps 23.7 million in construction, Ps. 1.13 million in machinery, Ps. 0.3 million in computer and communication accessories, Ps. 0.9 million in construction in progress, , Ps. 0.1 million in feed lot and Ps. 0.7 million in advances. For the fiscal year ended June 30, 2005, our main investments consisted of Ps. 12.5 million in the acquisition of real estate, Ps. 0.2 million in improvements, Ps. 0.1 million in furniture and equipment, Ps. 4.2 million in facilities, Ps. 1.1 million in new pastures, Ps. 0.3 million in vehicles, Ps 0.6 million in construction, Ps. 1.8 million in machinery, Ps. 0.3 million in computer and communication accessories, Ps. 4.6 million in construction in progress (including Ps. 3.7 million from the development of our farm
77
Table of ContentsLos Pozos adding more space for agricultural and cattle production), Ps. 0.1 million in feed lot and Ps. 0.1 million in advances. For the fiscal year ended June 30, 2004, our main investments consisted of Ps. 2.7 million in the acquisition of real estate, Ps. 0.1 million in improvements, Ps. 0.1 million in furniture and equipment, Ps. 1.6 million in facilities, Ps. 0.4 million in new pastures, Ps. 0.5 million in vehicles, Ps 0.1 million in construction, Ps. 0.1 million in machinery, Ps. 0.1 million in computer and communication accessories, Ps. 8.8 million in construction in progress (including Ps. 4.2 million from the development of our Los Pozos farm adding more space for agricultural and cattle production and Ps. 3.8 million from the development of hectares to be used in agriculture under irrigation in our La Gramilla and Santa Bárbara farm), Ps. 0.6 million in feed lot and Ps. 0.1 million in advances. IRSA’s Results of Operations Overview We do not consolidate the consolidated financial statements of our subsidiary IRSA. However, according to Rule 3-09 of Regulation S-X we are required to include the separate financial statements of significant subsidiaries. This Operating and Financial Review and prospectus should be read together with IRSA’s consolidated financial statements appearing elsewhere in this annual report. This discussion contains forward-looking statements that involve risks, uncertainties and assumptions. These forward-looking statements include, among others, those statements including the words “expects”, “anticipates”, “intends”, “believes” and similar language. The actual results may differ materially and adversely from those anticipated in these forward-looking statements as a result of many factors, including those set forth elsewhere in this prospectus. IRSA maintains its financial books and records in Pesos and prepares its financial statements in conformity with Argentine GAAP and the regulations of the Comisión Nacional de Valores. See note 27 to the consolidated financial statements of IRSA for a description of the principal differences between Argentine GAAP and U.S. GAAP as they relate to IRSA, and a reconciliation to U.S. GAAP of net (loss) income and total shareholders’ equity. The differences involve methods of measuring the amounts shown in the financial statements as well as additional disclosures required by U.S. GAAP and Regulation S-X of the SEC. As discussed in Notes 2.c. and 3.m. to IRSA’s consolidated financial statements, contained elsewhere in this annual report, in order to comply with Comisión Nacional de Valores regulations, IRSA discontinued inflation accounting as of March 1, 2003 as well as recognized deferred income tax assets and liabilities on a non-discounted basis. These accounting practices represent departures from generally accepted accounting principles in Argentina. However, IRSA believes such departures have not had a material effect on the Consolidated Financial Statements. Critical Accounting Policies and Estimates In connection with the preparation of the financial statements included in this annual report, IRSA has relied on variables and assumptions derived from historical experience and various other factors that IRSA deemed reasonable and relevant. Although IRSA review these estimates and assumptions in the ordinary course of business, the portrayal of IRSA’s financial condition and results of operation often requires its management to make judgments regarding the effects of matters that are inherently uncertain on the carrying value of IRSA’s assets and liabilities. Actual results may differ from those estimated under different variables, assumptions or conditions. In order to provide an understanding about how management forms its judgments about future events, including the variables and assumptions underlying the estimates, and the sensitivity of those judgments to different variables and conditions, IRSA has included comments related to each critical accounting policy described as follows:
78
Table of Contents
Revenue recognition Accounting for real estate barter transactions During the years ended June 30, 2006, 2005 and 2004 the IRSA entered into certain non-monetary transactions with third parties pursuant to which IRSA sold parcels of land held for sale in the ordinary course of business in exchange for cash and/or other real estate properties. Under Argentine GAAP, these transactions were recorded based on the fair value of the assets involved and, as a result, a gain or loss were recognized at the time of the exchange. IRSA believes that this accounting policy is a “critical accounting policy” because the impact of accounting for real estate barter transactions under this method could have a material effect on IRSA`s consolidated balance sheet as well as on the results of our operations. The performance of a sensitivity analysis, which reduced the fair market value of the assets by 5%, would have resulted in a smaller revenue of Ps. 3.2 million. Recognition of inventories at net realizable value Inventories, on which IRSA received down payments that fix the sales price and the terms and conditions of the contract assure reasonably the closing of the transaction and the realization of the gain, are valued at net realizable value. Ps.9.1 million were valued according to this criteria, which was principally applied to the following developments: “Cruceros” for Ps.4.6 million, “Torres Rosario”, for Ps.3.5 million, and “Dock III – Plot Z”, for Ps.1.6 million and “San Martín de Tours” for Ps.0.6 million in losses. IRSA believes that the accounting policy related to recognition of inventories at net realizable value is a “critical accounting policy” because the impact of accounting under this method could have a material effect on its consolidated balance sheet as well as on the results of its operations. The performance of a sensitivity analysis, which reduced the market value of the properties by 5%, would have resulted in a smaller “Gain from recognition of inventories at net realizable value” of Ps. 0.8 million. Provisions for allowances and contingencies IRSA provides for losses relating to mortgage, lease and other accounts receivable. The allowance for losses is recognized when, based on current information and events, it is probable that IRSA will be unable to collect all amounts due according to the terms of the agreements. The allowance is determined on a one-by-one basis considering the present value of expected future cash flow or the fair value of collateral if the loan is collateral dependent, when applicable. While IRSA uses the information available to make evaluations, future adjustments to the allowance may be necessary if future economic conditions differ substantially from the assumptions used in making these evaluations. IRSA has considered all events and/or transactions that are subject to reasonable and normal methods of estimations, and IRSA’s Consolidated Financial Statements reflect that consideration.
79
Table of ContentsIRSA has certain contingent liabilities with respect to existing or potential claims, lawsuits and other proceedings, including those involving labor and other matters. IRSA accrues liabilities when it is probable that future costs will be incurred and such costs can be reasonably estimated. Such accruals are based on developments to date, IRSA’s estimate of the outcomes of these matters and its lawyers’ experience in contesting, litigating and settling other matters. As the scope of the liabilities becomes better defined, there may be changes in the estimates of future costs, which could have a material effect on IRSA’s future results of operations and financial condition or liquidity. Impairment of long-lived assets IRSA periodically evaluate the carrying value of its long-lived assets for impairment. IRSA consider the carrying value of a long-lived asset to be impaired when the expected cash flows, from such asset is separately identifiable and less than its carrying value. IRSA determine the fair market value primarily using independent appraisals and utilizing anticipated cash flows discounted at a rate commensurate with the risk involved. The reposition value is mainly determined using independent appraisals or projections of future cash flows. In that event, a loss would be recognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset. Impairments are allocated to the results of the year. Under Argentine GAAP a previously recognized impairment loss is reversed when there is a subsequent change in estimates used to compute the fair market value of the asset. In that event, the new carrying value of the asset is the lower of its fair market value or the net carrying value the asset would have had if no impairment would have been recognized. Both the impairment charge and the impairment reversal are recognized in earnings. US GAAP prohibits the reversal of a previously recognized impairment charge. IRSA believes that the accounting policy related to the impairment of long-lived assets is a “critical accounting policy” because:
As of June 30, 2002 IRSA had reviewed its assets related to Development and sale of properties, Office and others, Hotels and Shopping Centers segments for impairments due to the continued deterioration of the Argentine economy. As a result, as of June 30, 2002 IRSA had recognized an impairment of Ps.140.6 million. During the years ended June 30, 2003 and 2005 IRSA had recognized impairment losses totaling Ps.14.0 million and Ps.0.2 million, respectively. As a result of increases in their fair market values, during the years ended June 30, 2003, 2004, 2005 and 2006, IRSA partially reversed the impairment losses, recognizing gains of Ps.25.4 million, Ps.63.1 million, Ps.28.2 million and Ps.12.6 million, respectively. Assets related to those four segments represent approximately 92% of IRSA’s total long-lived assets as of June 30, 2006. The fair market value of IRSA’s office and retail buildings was determined following the rent value method, considering each property’s future cash flow, competition and historical vacancy rates. The price per square meter of IRSA’s properties varies based on the category and the type of building as
80
Table of Contentswell as each projected variation. Vacancy rates are today the lowest in the past 15 years and no new stock will be incorporated in the next 36 months in Buenos Aires class A/B office market. For the analysis a 5% flat vacancy was considered in all cash flows. For Class A buildings the average price per square meter used was Ps.55.53 while for Class A/B buildings the average price per square meter was Ps.42.5 and for Class B/C buildings it was Ps.20.0 per square meter. The performance of a sensitivity analysis, which would have reduced the fair market value of these properties by 5%, would have resulted in a smaller reversal of impairment losses as of June 30, 2006 of Ps.2.2 million. As regards hotels, the discounted cash flows methodology was applied by taking the forecasts of each hotel in a 10-year flow and discounting such estimated amounts at rates according to risk, location, etc. The cash flows to be discounted considered revenues per room, per guest, per additional charge as well as the fixed and variable expenditures related to the transaction. Rate increases and occupancy variations were estimated based on the information supplied by each hotel’s management and comparing them to industry-specific data in the local market. Tourism activities and related industries grew by 19% over the last 12 months at the national level, even though at a worldwide level these industries only grew by 3%. Argentina has then become a major attraction for tourists. As regards IRSA’s hotel portfolio, it goes hand in hand with the growth shown by tourism and occupancy rates in the City of Buenos Aires and on top of that it offers an additional advantage: because of its location and its history, Llao Llao is a unique hotel in its niche. The Sheraton Libertador hotel has regained after the crisis a healthy position and hosts major volumes of regional guests, as these are the visitors that have increased the most and IRSA forecast sustained occupancy levels with a stepwise increase in rates. Mirroring the opening of high-end 5-star hotels in Recoleta and Puerto Madero, the Intercontinental Hotel has posted increases in occupancy rates resulting from a larger number of tourists and business guests that cannot be accommodated by the city’s most expensive hotels and is starting to rank as the best 5-star alternative in the city given its infrastructure, amenities and prices. Thanks to this outlook, the level of revenues from IRSA’s hotel portfolio is estimated to improve over the coming 24 months. The performance of a sensitivity analysis, which reduced the fair market value of these properties by 5%, would have resulted in a smaller reversal of impairment losses as of June 30, 2006 of Ps. 0.3 million. Valuation of shopping centers was performed according to the rent value method. IRSA calculated discount rates considering each property’s location, competition in its market, its historical rents income, vacancy rates and cash flow. The average discount rates IRSA used ranged between 8.0% and 12.0%, and the average vacancy rate was projected at 5% flat, taking into consideration the actual vacancy is less than 2%. The performance of a sensitivity analysis, which reduced prices per square meter by 5%, would have resulted in a smaller reversal of impairment losses as of June 30, 2006 of Ps.3.3 million. IRSA used the open market method for determining the fair market value of its parcels of undeveloped land (taking into consideration the cost participation of the land per saleable surface in each site) and inventories. The performance of a sensitivity analysis, which would have reduced the fair market value of these properties by 5%, would have resulted in a smaller reversal of impairment losses as of June 30, 2006 of Ps.1.4 million. Debt restructuring Extension of Alto Palermo`s Convertible Notes’ maturity date On August 20, 2002, APSA issued an aggregate amount of US$ 50 million of uncollateralized convertible notes (the “Convertible Notes”) in exchange for cash and the settlement of certain liabilities.
81
Table of ContentsThe Convertible Notes accrue interest at a fixed annual interest rate of 10% (payable semiannually), are convertible at any time at the option of the holder into common shares of Ps. 0.10 par value per share and originally matured on July 19, 2006. On May 2, 2006 a meeting of noteholders resolved to extend the maturity date of the Convertible Notes through July 19, 2014 although the remaining terms and conditions were left unchanged. Under Argentine GAAP, from a debtor’s perspective, an exchange of debt instruments between, or a modification of a debt instrument by, a debtor and a creditor shall be deemed to have been accomplished with debt instruments that are substantially different if the present value of the cash flows under the terms of the new debt instrument is at least 10 percent different from the present value of the remaining cash flows under the terms of the original instrument The new debt instrument should be initially recorded at fair value and that amount should be used to determine the extinguishment gain or loss to be recognized. Fair value should be determined by the present value of the future cash flows to be paid under the terms of the new debt instrument discounted at a rate commensurate with the risks of the debt instrument and time value of money. If it is determined that the original and new debt instrument are not substantially different, then a new effective interest rate is to be determined based on the carrying amount of the original debt instrument and the revised cash flows. IRSA believes that the accounting policy related to the extension of our Convertible Notes’ maturity date is a “critical accounting policy” because it required management to make an estimate of the present value of the future cash flows, using an estimated discount rate which is highly susceptible to changes from period to period, and as such the impact on the fair market value of its debt instruments could be material. Based on the analysis performed, IRSA concluded that the instruments were not substantially different and accordingly the old instrument was not derecognized. Deferred income tax IRSA recognizes income tax using the liability method. Accordingly, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recorded or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Technical Resolution No. 17 requires companies to record a valuation allowance for that component of net deferred tax assets which is not recoverable. IRSA provided a valuation allowance for a portion of its net deferred tax assets, as IRSA does not consider the realization of the full tax benefit to be more likely than not. IRSA considered all evidence, both positive and negative, in determining if a valuation allowance is needed for some portion or all its deferred tax assets. This evidence consists primarily of:
82
Table of ContentsAs a result of the evaluation of this evidence, IRSA accounted for a valuation allowance of approximately 42% of its deferred tax assets, amounting to Ps.27 million. Net deferred tax assets as of June 30, 2006 were Ps.65 million. A decrease and an increase of 10%, 20% and 30% in the net result of IRSA’s projections utilized in determining the valuation allowance of its deferred tax assets would have had the following impact:
IRSA believes that the accounting estimate related to deferred income tax is a “critical accounting estimate” because:
Asset tax credits IRSA calculates the asset tax provision by applying the current 1% rate on computable assets at the end of the year. This tax complements income tax. IRSA’s tax obligation in each year will coincide with the higher of the two taxes. However, if asset tax provision exceeds income tax in a given year, that amount in excess can be offset against income tax arising in any of the following ten years. IRSA has recognized the asset tax provision paid in previous years as a credit as IRSA estimates that it will offset future years’ income tax. IRSA believes that the accounting policy related to asset tax provision is a “critical accounting policy” because it requires management to make estimates and assumptions with respect to IRSA’s future results that are highly susceptible to change from period to period, and as such the impact on IRSA’s financial position and results of operations could be material. IRSA’s economic limitations related to the distribution of dividends. In accordance with certain obligations assumed by IRSA, there are limitations on the dividends that IRSA can distribute. Under the Unsecured Loan Agreement for US$ 51 million, IRSA: (i) shall not be able to pay dividends or make any distribution or repurchase of debt or shares except for restricted payments from IRSA’s subsidiaries, (ii) restricted payments can be made as long as no event of default shall have occurred and be continuing or would occur as a consequence thereof, and no breach of the financial covenants shall have occurred in the calculation period immediately preceding the proposed date of such restricted payment.
83
Table of ContentsThe Fourth Supplemental Indenture that governs the terms of the Series 03 Secured Notes due 2009 for US$ 37.4 million contains the same restrictions on the payment of dividends, although limited to the existence of outstanding Series 03 Secured Notes due 2009. As from fiscal year 2003 IRSA reported profits each year, although owing to the restrictions arising from its debt instruments, IRSA was prevented from distributing dividends. IRSA is temporarily restricted in the distribution of dividends until November 2009 due to the financial commitments assumed in its debt restructuring. Although IRSA expects to distribute cash dividends in the future, IRSA cannot assure that it will be able to do so. The table that follows presents the dividend payment ratio and the total amount of dividends paid for, each paid entirely in common shares, for the mentioned years. Figures in Pesos are stated in historical Pesos at their respective payment date. See “Exchange Rates.”
IRSA’s U.S. GAAP Reconciliation The accounting principles applied in Argentina vary in certain significant respects from accounting principles applied in the United States. U.S. GAAP application would have affected the determination of amounts shown as net income for each of the three years in the period ended June 30, 2006, and the amounts of total shareholders’ equity as of June 30, 2006 and 2005, to the extent summarized in Note 27 to IRSA’s consolidated financial statements. The principal differences, other than inflation accounting, between Argentine GAAP and U.S. GAAP are related to the following:
84
Table of Contents
In addition, certain other disclosures required under U.S. GAAP have been included in the U.S. GAAP reconciliation. See Note 27 to IRSA’s consolidated financial statements, included elsewhere in this annual report for details. Net income under Argentine GAAP for the years ended June 30, 2006, 2005 and 2004 was Ps. 96.6 million, Ps. 103.2 million, and Ps. 87.9 million, respectively, as compared to Ps. 90.0 million, Ps. 129.4 million and Ps. 2.8 million, respectively, under U.S. GAAP. Shareholders’ equity under Argentine GAAP as of June 30, 2006 and 2005, was Ps. 1,485.8 million and Ps. 1,252.2 million, respectively, as compared to Ps. 1,158.4 million and Ps. 921.7 million, respectively, under U.S. GAAP.
85
Table of ContentsIRSA’s Results of Operations for the fiscal years ended June 30, 2006 and 2005. Revenues IRSA´s revenues increased 56.2% from Ps.369.9 million for IRSA`s 2005 fiscal year to Ps.577.7 million for Its 2006 fiscal year, primarily as a result of increases in revenues in IRSA´s Shopping Center and Development and Sale of Properties segments. Shopping Centers Revenues from IRSA’s Shopping Center segment increased 46.9% from Ps.230.1 million for IRSA’s 2005 fiscal year to Ps.338.0 million for IRSA’s 2006 fiscal year. The increase is attributed principally to a 30.2% increase in revenues from leases and services (from Ps.165.8 million to Ps.215.9 million) mainly due to (i) increased revenues of Ps.48.1 million from leases and admission rights of IRSA’s Shopping Centers, as a consequence of the 33.9% increase in sales by IRSA’s tenants from Ps.1,698.1 million for Its 2005 fiscal year to Ps.2,273.3 million for Its 2006 fiscal year and (ii) a 90.5% increase (from Ps.64.6 million to Ps.123.0 million) in revenues from credit cards reflecting improved macroeconomic conditions and a related increase in the level of private consumption which enabled IRSA to open new branches, increase the number of credit cards issued and expand the number of shops that accept IRSA’s credit cards. The average occupancy rate in IRSA’s shopping centers was 99.1% for IRSA`s 2006 fiscal year similar to 99% in IRSA`s 2005 fiscal year. Development and Sale of Properties. Revenues from IRSA’s Development and Sale of Properties segment increased 221.8% from Ps.32.3 million for IRSA’s 2005 fiscal year to Ps.104.0 million for its 2006 fiscal year. The increase in revenues from this segment was attributable principally to: (i) Ps.23.0 million of revenues from Alto Palermo’s sale of Alcorta Plaza, a plot of land by Paseo Alcorta shopping center; (ii) Ps.22.8 million of revenues from the sale of block 36 of plot named “Terrenos de Caballito” in IRSA`s 2006 fiscal year; (iii) Ps.41.8 million of revenues from the sale of plot Y of Dock III during IRSA’s 2006 fiscal year; and (iv) Ps.10.0 million of revenues from its sale of units of Edificios Cruceros in IRSA’s 2006 fiscal year, partially offset by the absence in Its 2006 fiscal year of Ps.23.6 million of revenues from the sale of plot X of Dock III and Ps.3.5 million of revenues from the sale of Madero 1020, both of which IRSA sold during it’s 2005 fiscal year. Offices and Other Non-Shopping Center Rental Properties. Revenues from IRSA’s Offices and Other Non-Shopping Center Rental Properties segment increased 57.3%, from Ps.19.4 million for IRSA’s 2005 fiscal year to Ps.30.6 million for its fiscal year. This increase was mainly due to: (i) a 52.0% increase in revenues from office rents, from Ps.27.4 million in its 2005 fiscal year, to Ps.18.0 million for Its 2006 fiscal year. This increase in revenues is attributed to a 3 % increase in average occupancy rates in Its 2006 fiscal year and a 41.5 % increase in average monthly rates of the majority of the buildings, principally due to the increase in accumulated annual rents in Bouchard 710 for Ps.5.4 million, Libertador 498 for 0.8 million, Maipú 1300 for Ps.0.7 million, Laminar Plaza for 0.7 million, Suipacha 652 for Ps.0.4 million and Edificios Costeros Dock IV for Ps.0.5 million; and (ii) a 135.9% increase in revenues of other properties from Ps.0.9 million in IRSA´s 2005 fiscal year to Ps 2.1 million for Its 2006 fiscal year, mainly due to Santa María del Plata for an amount of Ps.1.2 million. The rate of occupancy in this segment increased from 94.0% on June 2005 to 97.0% on June 2006. Hotel Operations
86
Table of ContentsRevenues from IRSA´s hotel operations increased 19.1% from Ps.87.1 million for IRSA’s 2005 fiscal year to Ps.103.8 million for its 2006 fiscal year, mainly due to a 18.4% increase in average price per room of its hotels from Ps.320 in 2005 to Ps.379 in 2006. On the other hand, IRSA´s average occupancy rates remained stable at 78.7% during Its 2006 fiscal year compared to 75.4% in Its 2005 fiscal year. Revenues from Hotel Intercontinental increased by Ps.6.1 million, revenues from the Hotel Llao Llao increased by Ps.5.8 million from Ps.33,336 to 39,156 and revenues from Hotel Sheraton Libertador increased by Ps.4.7 million. Financial Operations and Others Revenues from IRSA´s Financial Operations and Other segment increased 55.5% from Ps.0.9 million for its 2005 fiscal year, to Ps.1.4 million for Its 2006 fiscal year. Revenues included in this segment represent fees for services with no specific allocation to any of the previous segments. Costs IRSA’s costs increased 45.1% from Ps.168.1 million for IRSA’s 2005 fiscal year to Ps.243.8 million for its 2006 fiscal year, reflecting an increase in costs in each of IRSA´s business segments during its 2006 fiscal year. Total costs as a percentage of revenues decreased from 45.4% for its 2005 fiscal year to 42.2% for its 2006 fiscal year. Shopping Centers. Costs related to Shopping Centers increased 30.6% from Ps.92.9 million for IRSA´s 2005 fiscal year to Ps.121.3 million for IRSA’s 2006 fiscal year. This increase was primarily due to: (i) an increase in depreciation an amortization expense of Ps.4.5 million and an increase in the charges of unrecoverable expenses of Ps.2.6 million and (ii) an 86.0% increase in the cost of sales relating to credit cards operations from Ps.24.5 million for Its 2005 fiscal year to Ps.45.5 million for Its 2006 fiscal year, mainly due to a cost increase of Ps.6.2 million in salaries and social security charges, of Ps.3.0 million in taxes, dues and contributions, of Ps.1.3 million of electricity and telephone expenses as a result of the expansion of IRSA´s operations; a higher charge in commissions and interest by a margin of Ps.5.6 million and an increase in fees and services of Ps.2.3 million mainly due to the new issues under the securitization program. Development and Sale of Properties. Costs related to Development and Sale of Properties increased 209.0%, from Ps.17.5 million for IRSA’s 2005 fiscal year to Ps.54.2 million for IRSA´s 2006 fiscal year. The increase in costs from this segment is mainly due to the following occurring: (i) Ps.18.4 million in costs related to the sale of Alcorta Plaza (through Alto Palermo); (ii) Ps.11.3 million in costs related to the sale of block 36 of the plot named “Terrenos de Caballito”; (iii) Ps.7.9 million in costs related to the sale of plot Y of Dock III; (iv) of Ps.8.8 million in costs related to the sale of units of Edificios Cruceros, (v) a decrease due to the sale of plot X of Dock III during IRSA’s 2005 fiscal year for Ps.23.6 million and (vi) a decrease of Ps.3.5 million in connection with the sale of Madero 1020 during the previous fiscal year. Costs relating to Development and Sale of Properties as a percentage of revenues from this segment decreased from 54.3% for IRSA´s 2005 fiscal year to 52.1% for its 2006 fiscal year. Offices and Other Non-Shopping Center Rental Properties. Costs of Offices and Other Non-Shopping Center Rental Properties increased by 16.0% from Ps.7.7 million for IRSA’s 2005 fiscal year to Ps.9.0 million for IRSA´s 2006 fiscal year, mainly due to
87
Table of Contentsthe amortization in its 2006 fiscal year of Bouchard 710 which IRSA acquired in June 2005. The main component of cost for offices is the depreciation of leased properties. Hotels Operations. Costs from hotel operations increased 18.5% from Ps.48.9 million for IRSA´s 2005 fiscal year to Ps.58.0 million for its 2006 fiscal year, primarily due to revenue increases. Higher costs for Hotels are primarily due to an increase in the depreciation of the assets, food and beverages, salaries and social security contributions. Costs from Llao Llao Hotel increased Ps.5.3 million, costs from Hotel Intercontinental increased Ps.2.0 million and costs from Hotel Sheraton Libertador increased Ps.1.8 million. Costs from hotel operations as a percentage of revenues from this segment decreased from 56.2% in IRSA’s 2005 fiscal year to 55.9% in its 2006 fiscal year. Financial Operations and Other. Costs from the Financial Operations and Other segment increased by Ps.0.4 million from Ps.1.0 million for IRSA´s 2005 fiscal year to Ps.1.4 million for Its 2006 fiscal year. Costs included in this line represent expenses incurred for the rendering of services that generate revenues. Gross Profit As a result of the foregoing, the gross profit increased by 65.4%, from Ps. 201.8 million during the fiscal year ended June 30, 2005 to Ps 333.8 million during the fiscal year ended June 30, 2006. Gain from recognition of inventories at net realizable value This line is generated as a result of valuing at the net realizable value those inventories for which IRSA has received purchase price or advances that fix prices, and the contract terms and conditions of the transactions that IRSA signed states the consummation of the sale and the gain. Ps.9.1 million were valued according to this criteria, which was principally applied to the following developments: “Cruceros” for Ps.4.6 million, “Torres Rosario”, for Ps.3.5 million, and “Dock III – Plot Z”, for Ps.1.6 million and “San Martín de Tours” for Ps.0.6 million in losses. Selling Expenses Selling expenses increased 63.2% from Ps.36.8 million for IRSA´s 2005 fiscal year to Ps.60.1 million for IRSA’s 2006 fiscal year primarily due to an increase in selling expenses in its Shopping Center and Hotel segments. Selling expenses as a percentage of revenues increased from 10.0% for IRSA’s 2005 fiscal year to 10.4% for its 2006 fiscal year. Shopping Centers. Selling expenses relating to Shopping Centers increased 93.0% from Ps.24.2 million for IRSA´s 2005 fiscal year to Ps.46.6 million for its 2006 fiscal year. The increase was mainly due to the following: (i) a 34.1% increase in selling expenses from leases and services (from Ps.11.0 million for its 2005 fiscal year to Ps.14.8 for Its 2006 fiscal year), principally due to an increase of Ps.2.0 million in the charge for gross sales taxes in line with IRSA’s higher revenues, an increase of Ps.1.1 million in the charge for provision of bad debts and an increase of Ps.0.5 million in the charge of advertising and (ii) charges from credit cards increased from Ps.13.5 million for its 2005 fiscal year to Ps.30.9 million for its 2006 fiscal year, mainly due to an increase of Ps.6.7 million in advertising expenses, a higher charge of Ps.3.8
88
Table of Contentsmillion in gross sales taxes as a result of IRSA’s higher revenues, and an increase in the charge for bad debts of Ps.6.2 million in line with the growth of IRSA´s credit portfolio. Development and Sale of Properties Selling expenses from Development and Sale of Properties decreased 8.4% from Ps.2.0 million for IRSA´s 2005 fiscal year to Ps.1.8 million for its 2006 fiscal year. Selling expenses for Development and Sale of Properties are mainly commissions and expenses from sales, sealing and gross sales tax. Offices and Other Non-Shopping Center Rental Properties Selling expenses relating to Offices and Other Non-Shopping Center Rental Properties increased 10.6% from Ps.0.9 million for IRSA´s 2005 fiscal year 2005 to Ps.1.0 million for its 2006 fiscal year. Hotels Operations Selling expenses relating to IRSA´s Hotel operations increased 9.2% from Ps.9.8 million for Its 2005 fiscal year to Ps.10.7 million for Its 2006 fiscal year, mainly due to an increase in the gross sales tax, salary and social security and the tourism agencies commissions due to an increase in revenues in the segment in line with higher levels of activity. Administrative Expenses Administrative expenses increased 37.5%, from Ps.69.6 million for IRSA´s 2005 fiscal year to Ps.95.6 million for its 2006 fiscal year, due to an increase in administrative expenses for IRSA’s Shopping Center segment and, to a lesser extent, each of its other business segments. The main components of administrative expenses are salaries and social security, Directors’ fees, fees and compensation for services, and depreciation and amortization. Shopping Centers Administrative expenses of IRSA´s Shopping Centers increased 64.9%, from Ps.31.4 million for IRSA´s 2005 fiscal year to Ps.51.8 million for its 2006 fiscal year primarily as a result of (i) an increase in expenses from leases and services reflecting an increase in directors’ fees of Ps.3.4 million, an increase in the fees and services of third parties of Ps.3.2 million, an increase in salaries, bonuses and social security charges of Ps.1.9 million, and an increase in taxes, rates and assessments of Ps.0.6 million, mainly due to the financial transactions tax; and (ii) a Ps.11.4 million increase in credit card administrative expenses, from Ps.14.9 million in IRSA´s 2005 fiscal year to Ps.26.3 million in Its 2006 fiscal year, basically due to a Ps.5.9 million increase in salaries, bonuses and social security charges, Ps.2.4 million increase in fees and compensations for services, Ps.1.3 million increase in taxes and rent, and of Ps.1.6 million in insurance, amortization and others due to an expansion and increase of IRSA´s operations. Development and Sale of Properties Administrative expenses of Development and Sale of Properties increased 27.6%, from Ps.9.5 million for IRSA´s 2005 fiscal year to Ps.12.1 million for IRSA´s 2006 fiscal year, primarily due to (i) increases in expenses related to the design and implementation of IRSA´s new system; (ii) an increase of Ps.0.8 million in salary and social security charges, and (iii) an increase in directors’ fees of Ps.0.3
89
Table of Contentsmillion. Administrative expenses for Development and Sale of Properties as a percentage of revenues from this segment decreased from 29.5% for IRSA’s 2005 fiscal year to 11.7% for its 2006 fiscal year. Offices and Other Non-Shopping Center Rental Properties Administrative expenses of Offices and Other increased 16.3%, from Ps.9.2 million for IRSA´s 2005 fiscal year to Ps.10.7 million for its 2006 fiscal year. The increase is mainly due to an increase of Ps.0.7 million in salaries and social security charges and a Ps.0.3 million increase in Directors’ fees. Hotels Operations Administrative expenses of IRSA´s Hotels increased 8.0%, from Ps.19.4 million for IRSA´s 2005 fiscal year to Ps.21.0 million for Its 2006 fiscal year, primarily due to (i) a Ps.1.0 million increase from Hotel Intercontinental mainly due to an increase of 0.7 million of fees and services to third parties, of Ps.0.1 million of salaries and social security charges and Ps.0.1 million of depreciations; (ii) an increase of Ps.1.0 million in Hotel Sheraton Libertador mainly due to an increase of Ps.0.5 million in fees and compensation for services and of Ps.0.4 million in salaries and social security charges; partially offset by a decrease of Ps.0.4 million in Hotel Llao Llao mainly due to a decrease of Ps.1.5 million related to lawsuits and to an increase of Ps.0.4 million in salaries and social security charges, an increase of Ps.0.3 million in taxes, duties and contributions, an increase of Ps.0.2 million in fees and compensation for services and to an increase of Ps.0.1 million in depreciation and amortization. Administrative expenses of Hotels as a percentage of revenues from hotel operations decreased from 22.3% for IRSA´s 2005 fiscal year to 20.2% for its 2006 fiscal year. Net income in from retained interest in securitized receivables This gain results from the interest held by Alto Palermo in the Tarjeta Shopping Credit Card Trusts. The results of these credit card trusts increased 520.6% from Ps.0.4 million for IRSA’s 2005 fiscal year to Ps.2.6 million for IRSA’s 2006 fiscal year as a result of the expansion of its credit card business segment through Tarshop, Alto Palermo’s subsidiary. Gain from Operations and Holdings of Real Estate Assets, net The results from operations and holdings of real estate assets, net, decreased 54.8%, from a gain of Ps.27.9 million for IRSA´s 2005 fiscal year to a gain of Ps.12.6 million for IRSA´s 2006 fiscal year. The decrease in income from the previous year is due to a lower amount of recovery on the allowance for impairment of long lived assets. Operating Income IRSA´s operating income increased 43.5% from Ps.141.1 million for its 2005 fiscal year to Ps.202.4 million for its 2006 fiscal year primarily as a result of increases in IRSA´s Shopping Center and Development and Sale of Properties segments, partially offset by a small decrease in its Offices and Other Non-Shopping Center Rental Properties segment. Operating income as a percentage of revenues increased from 36.7% from its 2005 fiscal year to 109.61% for its 2006 fiscal year primarily as a result of a greater increase in the revenues of 56.2% compared to a 45.1% increase in costs. Shopping Centers Operating income from Shopping Centers increased 37.0% from Ps.95.2 million for IRSA´s 2005 fiscal year to Ps.130.4 million for its 2006 fiscal year primarily due to a 46.9% increase in revenues
90
Table of Contentsmainly due to increases in sales and the expansion of IRSA´s credit card business. Operating income from Shopping Centers as a percentage of revenues from this segment decreased from 41.4% for fiscal year 2005 to 38.6% for IRSA’s 2006 fiscal year. This is mainly attributable to an increase of 46.9% in revenues accompanied by an increase of 30.6% in costs and an increase of 93.0% in selling expenses for this segment. Development and Sale of Properties Operating income from Development and Sales of properties increased 112.7%, from Ps.21.1 million for IRSA´s 2005 fiscal year to Ps.44.9 million for IRSA´s 2006 fiscal year. Operating income from the Development and Sale of Properties segment as a percentage of revenues from this segment decreased from 65.4% for its 2005 fiscal year to 43.2% for its 2006 fiscal year primarily as a result of an increase of 209.0% in costs which was accompanied by an increase of 221.8% in revenues for this segment. Offices and Other Non-Shopping Center Rental Properties Operating income from Offices and Other Non-Shopping Center Rental Properties decreased 9.6% from Ps.13.8 million for its 2005 fiscal year to Ps.12.5 million for its 2006 fiscal year. Operating income from Offices and Other Non-Shopping Center Rental Properties as a percentage of revenues from this segment decreased from 70.9% for its 2005 fiscal year to 40.7% in its 2006 fiscal year primarily as a result of an increase of 57.3% in revenues accompanied with an increase of 16.0% in costs from this segment. Hotels Operations Operating income from Hotels increased 31.5% from Ps.11.1 million for its 2005 fiscal year to Ps.14.6 for IRSA’s 2006 fiscal year. Operating income from Hotels as a percentage of revenues from this segment increased from 12.7% for fiscal year 2005 to 14.0% in fiscal year 2006 primarily as a result of a 18.5% increase in costs compared to a 19.1% increase in revenues. Financial Operations and Other Operating income from Financial Operations and Other segment increased 150% from a loss of Ps.0.04 million for its 2005 fiscal year to a gain of Ps.0.1 million for IRSA’s 2006 fiscal year. Operating income from Financial Operations and other as a percentage of revenues from this segment increased from -4.1% for IRSA´s 2005 fiscal year to 4.0% for IRSA`s 2006 fiscal year. This is mainly attributable to an increase of 50.4% in revenues accompanied with an increase of 38.7% in costs from this segment. Amortization of goodwill Amortization of goodwill mainly includes: (i) the amortization of goodwill, during this fiscal year, for the goodwill from the following subsidiaries of Alto Palermo: Shopping Alto Palermo S.A., Fibesa S.A., Tarshop S.A. and Emprendimiento Recoleta S.A., with no significant variation and (ii) the depreciation, during this year, of its own negative goodwill due to the purchase of Alto Palermo stock. Amortization of goodwill decreased 35.1% from a loss of Ps.1.7 million for fiscal year 2005 to a loss of Ps.1.1 million for fiscal year 2006, as a result the incorporation of new negative goodwill as described in point (ii) above. Financial results, net Financial results, net showed a variation of 238.7%, from a loss of Ps.12.2 million for IRSA´s 2005 fiscal year to a loss of Ps.41.4 million for its 2006 fiscal year. The main reasons for this variation
91
Table of Contentswere: (i) a Ps.21.7 million increase in its loss attributable to variation in exchange rates, owing to the depreciation of the Peso to the U.S. dollar from Ps.2.887 in IRSA’s 2005 fiscal year to 3.086 in its 2006 fiscal year; (ii) the non-recurrency of Ps.2.2 million of discounts obtained in 2005 due to the cancellation with discount of financial loans owed by Mendoza Plaza Shopping S.A.; (iii) a loss with respect to the previous fiscal year of Ps.2.6 million of financial results mainly due to interest and other expenses in connection with the loan of Hoteles Argentinos Sociedad Anónima (“Hoteles Argentinos”) and financial expenses from Alto Palermo, and (iv) the decrease of Ps.10.6 million in financial operations, due to Dolphin Fund PLC decrease in profits by Ps.16.3 million and NCH Development Partner Fund increase in profits by Ps.4.6 million and the gains from the interest rate swap agreement entered into with Deustche Banc AG for Ps.1.2 million, and (v) the increase of Ps.7.4 million on interest gain as a result of the refinancing of the Hoteles Argentinos loan Equity gain (loss) from related companies IRSA´s gain on equity investments decreased 38.0% from a gain of Ps.67.2 million for IRSA´s 2005 fiscal year to a gain of Ps.41.7 million for its 2006 fiscal year. This lower gain is mainly due to: (i) a lower gain by Banco Hipotecario of Ps.8.2 million from Ps. 57.0 million to Ps. 43.1 million as a result of a lower gain from Banco Hipotecario`s investment in Sovereign Bonds (BODEN), (ii) a gain of Ps.12.2 million corresponding to the hotels segment, and (iii) the negative impact of the dilution of IRSA´s interest in Alto Palermo amounting to Ps.0.9 million. Other expenses, net Other expenses, net increased 28.5% from net expenses of Ps.14.8 million for IRSA´s 2005 fiscal year to net expenses of Ps.19.1 million for Its 2006 fiscal year, primarily due to the effect of (i) an increase of Ps.7.5 million in the allowance for doubtful accounts; (ii) an increase of Ps.1.9 million from non recoverable value added tax, (iii) a gain of Ps.2.4 million due to the accelerated accrual of unrealized revenues, (iv) a decrease of Ps.1.3 million in donation charges and (v) a lower charge of Ps.1.2 million for personal assets tax. Income before Taxes and Minority Interest As a result of the foregoing, income before taxes and minority interest increased 1.6%, from a gain of Ps.179.6 million for IRSA’s 2005 fiscal year, to a gain of Ps.182.6 million for Its 2006 fiscal year. Minority Interest Minority interest increased 17.4% from a loss of Ps.23.2 million for IRSA´s 2005 fiscal year to a loss of Ps.27.2 million for its 2006 fiscal year, mainly as a result of an increase in net income from the Shopping Centers segment that generated an increase in the results of minority interest. Income and Asset tax expense Income and asset tax expense increased 10.5%, from Ps.53.2 million for its 2005 fiscal year, to Ps.58.8 million for its 2006 fiscal year. The deferred tax allocation method was used to calculate the income tax corresponding to the two fiscal years, thus recognizing the temporary differences in the accounting and tax assets and liabilities. The variation of Ps.5.6 million was mainly due to the net impact of (i) a Ps.14.9 million increase in Alto Palermo’s income tax expense, from Ps.33.6 million for its 2005 fiscal year to Ps.48.5 million for its 2006 fiscal year; (ii) increased income tax expense of Nuevas Fronteras., Baldovinos, Inversora Bolívar and Llao Llao Resort which during its 2006 fiscal year were
92
Table of ContentsPs.1.9 million, Ps.1.0 million, Ps.0.8 million and Ps.0.5 million higher, respectively, than during its 2005 fiscal year; (iii) a Ps.1.1 million increase in IRSA’s income tax expense, and (iv) the variation in income tax expense for Buenos Aires Trade & Finance Center S.A. which changed from a Ps.12.6 million expense for its 2005 fiscal year to a Ps.0.2 million gain for its 2006 fiscal year. Net income As a result of the foregoing, net income decreased 6.5% from a gain of Ps.103.2 million for IRSA´s 2005 fiscal year to a gain of Ps.96.6 million for its 2006 fiscal year. Results of Operations for the fiscal years ended June 30, 2005 and 2004. Revenues Revenues increased 41.8% from Ps.260.8 million for IRSA´s 2004 fiscal year to Ps.369.9 million for its 2005 fiscal year. This increase is due to an increase in revenues from all IRSA’s business units. Shopping Centers Revenues from Shopping Centers increased 60.6 % from Ps.143.2 million for its 2004 fiscal year, to Ps.230.1 million for its 2005 fiscal year. The increase primarily attributable to an increase of 46.2% in revenues from leases and services from Ps.113.2 million to 165.5 million as a result of increases in its tenants’ sales, and an increase of 114.9% in revenues from credit card operations from Ps.30.0 million to Ps.64.6 million as a result of greater sales from all its tenants. The occupancy rates of its shopping centers stayed constant at 99% during both fiscal years. Development and Sale of Properties Revenues from Development and Sale of Properties increased 6.8%, from Ps.30.3 million for its 2004 fiscal year, to Ps.32.3 million for its 2005 fiscal year. The increase in revenues in the Development and Sale of Properties segment was attributable principally to the net effect of (i) Ps.23.6 million of revenues from its sale of units of Dock III during its 2005 fiscal year; (ii) a Ps.3.5 million decrease in sales from the residential communities of Abril, which decreased 48%; (iii) a Ps.11.8 million decrease in sales of land reserves due to the non-recurring sale of Benavides in its 2004 fiscal year; and (iv) a Ps.5.9 million decrease in the sale of other real estate, principally due to the non-recurring sale of Dock II for Ps.5.2 million in its 2004 fiscal year. Offices and Other Non-Shopping Center Rental Properties Revenues from Offices and Other Non-Shopping Center Rental Properties increased 28.3%, from Ps.15.1 million for IRSA´s 2004 fiscal year, to Ps.19.4 million for its 2005 fiscal year. This increase is mainly due to a 29.7% increase in revenues from office rents, from Ps.13.8 million in IRSA´s 2004 fiscal year, to Ps.17.9 million for its 2005 fiscal year. This increase in revenues is attributed to (i) the increase of the occupancy rate and of monthly average rates of the majority of the buildings, principally in Intercontinental Plaza Tower for Ps.1.2 million, Maipú 1300 for Ps.0.8 million, Costeros Dock IV for Ps.0.6 million and Libertador 498 for Ps.0.5 million, and (ii) the purchase of Bouchard 710, a new building for rent which provided revenues of Ps.0.4 million during June 2005. The room occupancy rate in this segment increased by 13% from 76% as of June 2004 to 89% as of June 2005. Hotels Operations
93
Table of ContentsRevenues from hotel operations increased 22.2%, from Ps.71.3 million for IRSA’s 2004 fiscal year to Ps.87.1 million for Its 2005 fiscal year, due to an increase in average price per room at the Llao Llao Hotel, and an increase in average occupancy in all IRSA´s hotels, from 68% for Its 2004 fiscal year to 75% for Its 2005 fiscal year. Revenues from Hotel Sheraton Libertador increased by Ps.4.9 million, revenues from the Hotel Intercontinental increased by Ps.7.1 million and revenues from Hotel Llao Llao increased by Ps.3.8 million. Financial Operations and Other Revenues from Financial Operations and Other remained constant at Ps.0.9 million for both fiscal years. Revenues included in this line represent fees for services that cannot be specifically allocated to any of the previous segments. Costs Costs increased 14%, from Ps.147.4 million for IRSA´s 2004 fiscal year to Ps.168.1 million for its 2005 fiscal year. This variation is mainly due to the net effect of an increase in costs in IRSA´s Shopping Centers and Hotel segments, partially offset by a decrease in costs in Its Development and Sale of Properties and Its Offices and Other Non-Shopping Center Rental Properties segments. Costs as a percentage of revenues decreased from 56.5% for its 2004 fiscal year to 45.4% for IRSA´s 2005 fiscal year. Shopping Centers Costs related to Shopping centers increased by 28.2% from Ps.72.4 million in IRSA´s 2004 fiscal year to Ps.92.9 million in IRSA´s 2005 fiscal year. This increase is due to: (i) an increase of 15.3% in leases and services costs mainly due to a Ps.4.9 million cost resulting from the opening of Alto Rosario Shopping and a Ps.3.2 million cost relating to Its consolidation of Mendoza Plaza Shopping S.A. as of October 2004; and (ii) a 77.1% increase of credit card operations cost due to an increase of Ps.3.6 million in expenses arising from salaries and social security charges and of Ps.1.5 million in taxes, duties and contributions as a result of the expansion and opening of new branches, a higher charge in commissions and interest of Ps.2.3 million and an increase in fee and services expenses of Ps.1.6 million, due to the new offerings of the securitization program. Development and Sale of Properties Costs related to Development and Sale of Properties decreased 32.1%, from Ps.25.8 million for IRSA´s 2004 fiscal year to Ps.17.5 million for IRSA´s 2005 fiscal year as a result of a decrease in the operation volume of sales as well as to a low cost of sales in the case of Dock III in comparison with costs of sales recorded in the cases of Benavidez and Dock II. Costs relating to Development and Sale of Properties as a percentage of revenues from the segment decreased from 85.4% for IRSA´s 2004 fiscal year to 54.3% for its 2005 fiscal year. Offices and Other Non-Shopping Center Rental Properties Costs of Offices and Other decreased 6.4%, from Ps 8.3 million for IRSA´s 2004 fiscal year to Ps.7.7 million for its 2005 fiscal year. This decrease in cost of Offices and Other segment did not follow the increase in revenues from this segment mainly due to a reduction in maintenance expenses relating to vacant space in IRSA´s buildings during this year, as a result of higher occupancy rates in IRSA’s buildings. The main component of cost for Offices is represented by the depreciation of leased properties. Hotels Operations
94
Table of ContentsCosts from Hotel operations increased 22.2%, from Ps.40.0 million for IRSA´s 2004 fiscal year to Ps.48.9 million for its 2005 fiscal year, primarily due to the increase in revenues. Higher costs of Hotels are also due to an increase in depreciation, salaries and social security contributions. Costs relating to hotel operations as a percentage of segment revenues remained constant at 56.2% for both fiscal years. Financial Operations and Other Costs from the Financial Operations and Other segment increased 22.7% from Ps.0.8 million for IRSA´s 2004 fiscal year to Ps.1.0 million for its 2005 fiscal year. Costs included in this line represent expenses incurred for the rendering of services that generate revenues. Gross Profit As a result of the foregoing, the gross profit increased 78% from Ps.113.4 million for IRSA´s 2004 fiscal year to Ps 201.8 million for Its2005 fiscal year. Gain from recognition of inventories at net realizable value This line was generated for the current year and arose as a result of valuing at fair market value those inventories for which IRSA has received purchase price or lease advances that fix prices, and the contract terms and conditions IRSA signed assure the effective conclusion of the sale and the gain. Such a valuation criteria was principally applied to the “Cruceros” and “Dock III” undertakings in a total amount of Ps.17.3 million. Selling Expenses Selling expenses increased 67.5%, from Ps.22.0 million for IRSA´s 2004 fiscal year to Ps.36.8 million for Its 2005 fiscal year, primarily due to the net effect of an increase in selling expenses of IRSA´s Shopping Centers, Offices and Other Non-Shopping Center Rental Properties and Hotel segments, partially offset by a decrease in selling expenses of its Development and Sale of Properties segment. Selling expenses as a percentage of revenues increased from 8.4% for IRSA´s 2004 fiscal year, to 10% for its 2005 fiscal year. Shopping Centers Selling expenses relating to Shopping centers increased 145.8% from Ps.9.8 million for IRSA´s 2004 fiscal year to Ps.24.2 million for IRSA’s 2005 fiscal year. The increase was mainly due to the following: (i) a 112.7% increase in selling expenses from leases and services from Ps.5.2 million for The IRSA´s 2004 fiscal year to Ps.11 for Its 2005 fiscal year, principally due to an increase of Ps.2.7 million in the charge for provision of bad debts, an increase of Ps.1.4 million in the charge for turnover taxes in line with its higher revenues, the inclusion of the expenses of Mendoza Plaza Shopping amounting to 1.3 million due to its consolidation, and Ps.0.4 million in stamp taxes resulting from the opening of Alto Rosario; and (ii) an increase in marketing expenses of IRSA´s credit cards segment from Ps.4.5 million for Its 2004 fiscal year to Ps.13.5 million for Its 2005 fiscal year due to an increase of Ps.6.3 million in advertising expenses, a higher charge of Ps.2.1 million in gross sales taxes as a result of IRSA’s higher revenues, and an increase in the charge for bad debts of Ps.0.5 million in line with the growth of IRSA’s credit portfolio. Development and Sale of Properties Selling expenses from Development and Sale of Properties decreased 50.4%, from Ps.4.0 million for IRSA´s 2004 fiscal year to Ps.2 million for IRSA´s 2005 fiscal year, as a consequence of the
95
Table of Contentsdecrease in sales operations during this fiscal year and due to the fact that the principal sale transaction of the current period, Dock III, had no direct commercial expenses or significant commissions. Main components of selling expenses of Development and Sale of Properties are commissions and expenses from sales, sealing and gross sales tax. Offices and Other Non-Shopping Center Rental Properties Selling expenses relating to Offices and Other Non-Shopping Center Rental Properties increased 1,607.4%, from Ps.0.1 million for its 2004 fiscal year to Ps.0.9 million for its 2005 fiscal year. The increase of marketing expenses is directly related to the increase in revenues in such segment. Hotels Operations Selling expenses relating to Hotels operations increased 20.1% from Ps.8.2 million for IRSA’s 2004 fiscal year to Ps.9.8 for Its 2005 fiscal year, mainly due to an increase in the gross sales tax, salaries and social security charges and the tourism agencies commissions due to an increase in revenues in the segment in line with higher activities. Administrative Expenses Administrative expenses increased 38.4%, from Ps.50.2 million for IRSA’s 2004 fiscal year to Ps.69.6 million for its 2005 fiscal year, due to an increase in administrative expenses relating to all business units. The main components of administrative expenses are salaries and social security, fees and compensation for services, and depreciation and amortization. Shopping Centers Administrative expenses of Shopping centers increased 32.9%, from Ps.23.6 million for IRSA’s 2004 fiscal year to Ps.31.4 million for IRSA’s 2005 fiscal year, primarily as a result of an increase in administrative expenses from leases and services, due to the consolidation of Mendoza Plaza Shopping’s administrative expenses amounting to Ps.1.3 million, and as a result of increases in salaries, bonuses, and social security contributions, directors’ fees, and taxes. Development and Sale of Properties Administrative expenses for Development and Sale of Properties increased 42.2%, from Ps.6.7 million for IRSA’s 2004 fiscal year to Ps.9.5 million for its 2005 fiscal year, primarily due to (i) a Ps.1.1 million increase in salary and social security; (ii) a Ps.0.6 million increase in directors’ fees; and (iii) the change between fiscal years in percentages of pro-rata allocation of administration expenses among this segment, and Offices and other non-shopping center leased properties segment. Administrative expenses of Development and Sale of Properties as a percentage of revenues from this segment increased from 22.1% for IRSA’s 2004 fiscal year to 29.4% for its 2005 fiscal year. Offices and Other Non-Shopping Center Rental Properties Administrative expenses of Offices and other non-shopping center rental properties increased by 113.0%, from Ps.4.3 million for IRSA’s 2004 fiscal year to Ps.9.2 million for its 2005 fiscal year. The increase is mainly due to the change between fiscal years in percentages of pro-rata allocation of administrative expenses among this segment and the Development and Sale of Properties segment, and to a lesser extent to, a Ps.0.8 million increase in salaries and social security charges and a Ps.0.4 million increase in Directors fees. Hotels Operations
96
Table of ContentsAdministrative expenses of Hotels increased 24.5%, from Ps.15.6 million for IRSA’s 2004 fiscal year to Ps.19.4 million for its 2005 fiscal year, primarily due to (i) a Ps.2.6 million increase from Hotel Llao Llao as a consequence of the increase in taxes, duties, services and salaries attributable to the hotel’s higher level of activity; (ii) a Ps.0.9 million increase from Sheraton Libertador hotels, as a consequence of the increase in fees and compensations for services; and (iii) a Ps.1.0 million increase from Hotel Intercontinental. Administrative expenses of Hotels as a percentage of revenues from hotel operations increased from 21.9% for IRSA´s 2004 fiscal year to 22.3% for its 2005 fiscal year. Net income from retained interest in securitized receivables This result stems from an interest held by Alto Palermo in the Tarjeta Shopping Credit Card Trusts. Credit card trusts increased from Ps.0.3 million for IRSA’s 2004 fiscal year to Ps.0.4 million for its 2005 fiscal year. Gain from Operations and Holdings of Real Estate Assets, net The results from operations and holdings of real estate assets, net, decreased from one year to another by Ps.35.1 million, from a gain of Ps.63.1 million for IRSA’s 2004 fiscal year to a gain of Ps.27.9 million for Its 2005 fiscal year. The lower income generated during the present year in comparison with the previous year is due to a lower amount of recovery of the allowance for the impairment of real estate assets. Operating Income As a result of the foregoing, its operating income increased 35% from Ps.104.5 million for its 2004 fiscal year to Ps.141.1 million for its 2005 fiscal year primarily as a result of increases in its Shopping Center, Development and Sale of Properties and Hotels segments, partially offset by a decrease in its Offices and Other Non-Shopping Center Rental Properties segment. Operating income as a percentage of revenues decreased from 40.1% for its 2004 fiscal year to 38.2 % for its 2005 fiscal year. Shopping Centers Operating income from Shopping Centers increased from Ps.63.3 million for its 2004 fiscal year to Ps.95.2 million for its 2005 fiscal year. Operating income from Shopping Centers as a percentage of revenues for this segment decreased from 45.0% for its 2004 fiscal year to 41.4% for its 2005 fiscal year. This is mainly attributable to an increase of 60.6% in revenues accompanied with an increase of 28.2% in costs. Development and Sale of Properties Operating income from Development and Sales of properties increased from Ps.0.8 million for its 2004 fiscal year to Ps.21.1 million for its 2005 fiscal year. Operating income from Development and Sales of Properties as a percentage of revenues for this segment increased from 2.6% to 65.4% primarily as a result of an increase of 32.1% in costs, accompanied by an increase of 6.8% in revenues for this segment and an increase of Ps. 17.3 million from gain from valuation at fair market value. Offices and Other Non-Shopping Center Rental Properties Operating income from Offices and Other decreased from Ps.30.2 million for its 2004 fiscal year to Ps.13.8 million for its 2005 fiscal year. Operating income from Offices and Other Non-Shopping Center Rental Properties as a percentage of revenues for this segment decreased from 199.6% for its 2004 fiscal year to 70.9% in its 2005 fiscal year primarily as a result of an increase of 28.3% in revenues
97
Table of Contentsaccompanied by a decrease of 7.2% in costs and a decrease of Ps. 15.5 million as a result of a lower gain from operations and holdings of real estate assets. Hotels Operations Operating income from Hotels increased 9.2% from Ps.10.1 million for its 2004 fiscal year to Ps.11.1 for its 2005 fiscal year. Operating income from Hotels as a percentage of revenues for this segment decreased from 14.2% for fiscal year 2004 to 12.7% in its 2005 fiscal year primarily as a result of a 22.2% increase in costs accompanied with an increase of 22.2% in revenues for this segment and an increase of 24.5% in administrative expenses. Financial Operations and Other Operating income from Financial Operations and Other decreased by Ps.0.1 million from operating income of Ps.0.06 million for its 2004 fiscal year to an operating loss of Ps.0.04 million for its 2005 fiscal year. Operating income from Financial Operations and other as a percentage of revenues for this segment decreased from 7.1% for its 2004 fiscal year to -4.1% for its 2005 fiscal year. This is mainly attributable to an increase of 0.0 % in revenues for this segment accompanied with an increase of 22.7% in costs from this segment. Amortization of goodwill This heading mainly includes (i) the amortization of goodwill stemming from the acquisition of Alto Palermo subsidiaries: Shopping Alto Palermo S.A. (SAPSA), Fibesa S.A. and Tarshop S.A.; and (ii) the amortization of the negative goodwill from the purchase of Alto Palermo stock. Amortization of goodwill decreased 42.7% from a loss of Ps.2.9 million for IRSA’s 2004 fiscal year to a loss of Ps.1.7 million for IRSA´s 2005 fiscal year, largely due to positive amortization related to an increase in negative goodwill during the fiscal year. Financial results, net Financial results, net showed a variation of Ps.24.0 million, from a gain of Ps.11.6 million for IRSA’s 2004 fiscal year to a loss of Ps.12.2 million for its 2005 fiscal year. The main reasons for this variation were: (i) the exchange difference gain with regard to the previous year amounting to Ps.17.0 million, owing to the appreciation of the Peso to the U.S. dollar from 2.958 in 2004 to 2.887 in 2005; (ii) a gain of Ps.48.7 million generated in the previous year from Banco Hipotecario shares, that, as a result of a change in valuation criteria, during this year were valued by using the equity method of accounting, disclosed under “Equity gain (loss) from related companies” in the Income Statement, whereas in the preceding fiscal year they were valued at quotation as to May 2004; (iii) the lower discounts obtained this year amounting to Ps.5.0 million; and (iv) the Ps.13.2 million decrease of financial costs due mainly to the decrease in financial debt as a consequence of conversions of IRSA´s negotiable obligations made by holders and the settlement of Alto Palermo negotiable obligations. Equity gain (loss) from related companies Gain from related companies increased by Ps.40.6 million from a gain of Ps.26.7 million for its 2004 fiscal year to a gain of Ps.67.2 million for its 2005 fiscal year. This increase is mainly due to: (i) a higher gain of Ps.29.0 million recorded in current year compared to previous year because of the change of criterion of valuation in Banco Hipotecario from market value to the equity method, and (ii) a gain of Ps.12.2 million for its 2005 fiscal year corresponding to the Hotels segment.
98
Table of ContentsOther expenses, net Other expenses, net increased by Ps.1.2 million, from a loss of Ps.13.6 million for IRSA’s 2004 fiscal year to a loss of Ps.14.8 million for IRSA’s 2005 fiscal year, primarily due to the net effect of (i) an increase of Ps.2.9 million in the personal assets tax having an incidence on shareholders; (ii) an increase in donations for Ps.1.5 million; and (iii) a decrease of Ps.3.3 million in the charge for contingencies due to lower exposures from lawsuits. Income before Taxes and Minority Interest As a result of the foregoing, income before taxes and minority interest increased 42.1%, from Ps.126.4 million for IRSA’s 2004 fiscal year, to Ps.179.6 million for IRSA’s 2005 fiscal year. Minority Interest Minority interest increased 80.3% from a loss of Ps.12.8 million for IRSA’s 2004 fiscal year to a loss of Ps.23.2 million for IRSA’s 2005 fiscal year, mainly due: (i) the decrease in IRSA’s minority interest in Alto Palermo and of Alto Palermo in its subsidiaries, which increased from a Ps.9.3 million loss for Its 2004 fiscal year to a Ps.17.2 million loss for the year 2005 and (ii) the increase of Its minority interest results in Palermo Invest, which increased from a Ps.0.8 million loss during the previous year to a Ps.2.1 million loss during the current year. Income and Asset tax expense Income tax and asset tax increased by Ps.27.5 million, from Ps.25.7 million for IRSA’s 2004 fiscal year, to Ps.53.2 million for IRSA’s 2005 fiscal year. The effective tax rates for fiscal years 2005 and 2004 were 30% and 20%, respectively. These effective rates differ from the statutory tax rate mainly due to non-deductible amortization and depreciation charges originated by inflation accounting and the inventories’ costs considering that it have been adjusted by inflation in accordance with accounting principles. IRSA records income taxes using the deferred tax method. Accordingly, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. IRSA have treated the differences between the price-level restated amounts of assets and liabilities and their historical basis as permanent differences for deferred income tax calculation purposes as prescribed by Argentine GAAP. The Ps.27.5 million increase is mainly due to the net impact of (i) a Ps.17.3 million increase in Alto Palermo’s income tax expense, from Ps.16.3 million for IRSA´s 2004 fiscal year to Ps.33.6 million for Its 2005 fiscal year; and (ii) a Ps.12.5 million increase in the income tax expense of Buenos Aires Trade & Finance Center S.A. during IRSA’s 2005 fiscal year, partially offset by a Ps.2.3 million reduction in the income tax expense of the Llao Llao Hotel during Its 2005 fiscal year. Net income As a result of the foregoing, net income increased 17.5% from Ps.87.9 million for IRSA´s 2004 fiscal year to Ps.103.2 million for its 2005 fiscal year. Liquidity and Capital Resources IRSA’s liquidity and capital resources include its cash and cash equivalents, proceeds from bank borrowings and long-term debt, capital financing and sales of real estate investments. As of June 30, 2006, IRSA had a working capital of Ps.62.6 million. At the same date, IRSA had cash and cash equivalents totaling Ps.163.9 million, an increase of 15.0 % over the Ps.142.6 million of cash and cash equivalents held as of June 30, 2005.
99
Table of ContentsAs of June 30 2005, IRSA had a working capital of Ps. 78.8 million. At the same date, IRSA had cash and cash equivalents totaling Ps. 142.6 million, an increase of 16.0 % from Ps. 122.9 million of cash and cash equivalents held as of June 30, 2004. Operating Activities IRSA’s operating activities resulted in net cash inflows of Ps.194.7 million, for fiscal year 2006 primarily as a result of operating gains of Ps.218.5 million, an increase in trade accounts payable of Ps.56.0 million, a decrease in inventories of Ps.25.1 million, an increase in accrued interest of Ps.14.0 million, a decrease in current investments of Ps.10.3 million partially offset by an increase in mortgages and leases receivables of Ps.80.3 million, a decrease in customer advances, salaries and social security payable and taxes payable of Ps.28.4 million and an increase in non-current investments of Ps.26.4. IRSA’s operating activities resulted in net cash inflows of Ps. 93.5 million for fiscal years 2005.The operating cash inflows for fiscal year 2005 primarily resulted from operating gains of Ps.127.2 million, an increase in customer advances, salaries and social security payable and taxes payable of Ps.12.0 million and an increase in trade accounts payable of Ps.21.0 million partially offset by an increase in mortgages and leases receivables for Ps.49.2 million and a decrease in other liabilities of Ps.17.7 million. IRSA’s activities resulted in net cash inflows of Ps. 74.7 million for fiscal years 2004.The operating cash inflows for fiscal year 2004 primarily resulted from operating gains of Ps.90.6 million and an increase in trade accounts payable of Ps.14.4 million, partially offset by a decrease in other liabilities of Ps.24.6 million. Investment Activities IRSA’s investing activities resulted in net cash outflows of Ps.136.6 million for fiscal year 2006, primarily as a result of investments in fixed assets of Ps.54.1 million due to (i) improvements made in shopping centers amounting to Ps.33.6 million and (ii) improvements in the Hotel operations segment for Ps.20.1 million. IRSA also invested Ps.62.1 million in undeveloped parcels of land primarily through its subsidiary Alto Palermo. IRSA also made investments of Ps.4.3 million to increase IRSA`s ownership interest in Alto Palermo, and Ps.4.2 million in the acquisition of 43.18% of Canteras Natal Crespo S.A. Additionally, IRSA posted a guaranty deposit for Ps.8.6 million at Deustche Bank guaranteeing their obligations to Argentimo S.A. relating to an agreement entered into between Alto Palermo, Argentimo S.A. and Constructora San José Argentina S.A. for the acquisition of land for the development of a shopping center and a dwelling and/or office building. On December 12, 2006 IRSA purchased from different holders 34,710 shares of Canteras Natal Crespo for a total amount of US$ 597,968.75. After this transaction, IRSA´s interest on Canteras (jointly with our partner ECIPSA) increased up to 98.45%. IRSA’s investing activities resulted in net cash outflows of Ps.126,7 million for fiscal year 2005, primarily as a result of investments in fixed assets of Ps.79.3 million, due to (i) the development of Alto Rosario Shopping and improvements made in other shopping centers totaling Ps.50.9 million, and (ii) partial payment for the acquisition of Bouchard 710 for Ps.20.4 million. IRSA also invested Ps.35.0 million in the acquisition of an additional ownership interest of 49.9% in Mendoza Plaza Shopping and IRSA also made a payment of US$4 million (Ps.11.7 million) in connection with a contract entered into with Credit Suisse in June 2005, pursuant to which, subject to the satisfaction of certain conditions, IRSA expect to take out a loan for US$10.0 million, establishing a mortgage on an office building in the City of Buenos Aires. IRSA’s investing activities resulted in net cash outflows of Ps.97.2 million for fiscal year 2004,
100
Table of Contentsprimarily as a result of a net investment of Ps.70.3 million in shares of Banco Hipotecario. IRSA also invested in fixed assets for Ps.26.4 million primarily in connection with the development of Alto Rosario Shopping. Financing Activities IRSA’s financing activities resulted in net cash outflows of Ps.36.8 million. IRSA’s net cash spent on financing activities for fiscal year 2006 was primarily related to the payment of short-term and long-term debt for Ps.82.5 million, the payment of dividends by its subsidiaries to minority shareholders totaling Ps.12.7 million, the repayment of debt owed to minority shareholders for Ps.5.2 million and a partial repayment of Ps.25.6 million of a mortgage payable, partially offset by its issuance of common stock as a result of the exercise of warrants for Ps.43.6 million, and proceeds from issuance of short-term and long-term debt totaling Ps.45.1 million . IRSA’s financing activities resulted in net cash inflows of Ps.52.9 million. IRSA’s net cash provided by financing activities for fiscal year 2005 relates to its issuance of common stock as a result of the exercise of warrants for Ps.105.7 million, proceeds from issuance of short-term and long-term debt totaling Ps.117.2 million and proceeds from the settlement of a swap agreement for Ps.15.8 million, partially offset by the payment of short-term and long-term debt for Ps.167.3 million, the payment of dividends by IRSA’s subsidiaries to minority shareholders totaling Ps.10.3 million and the payment of Ps.5.8 million to Credit Suisse, establishing a guarantee for the debt of IRSA’s subsidiary Hoteles Argentinos. IRSA’s financing activities resulted in net cash outflows of Ps.47.6 million. IRSA’s net cash spent on financing activities for fiscal year 2004 was primarily related to the repayment of short-term and long-term debt, and to seller financing amounting to Ps.67.8 million, and the payment of dividends by IRSA’s subsidiaries to minority shareholders for Ps.4.9 million, partially offset by the proceeds from the issuance of common stock as a result of the exercise of warrants for Ps.24.8 million. IRSA’s Indebtedness IRSA’s total outstanding debt as of June 30, 2006 was Ps.391.4 million, of which 83% was dollar-denominated and 28% was short-term.
| |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||