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CEDC > SEC Filings for CEDC > Form 10-K/A on 5-Oct-2012All Recent SEC Filings

Show all filings for CENTRAL EUROPEAN DISTRIBUTION CORP | Request a Trial to NEW EDGAR Online Pro

Form 10-K/A for CENTRAL EUROPEAN DISTRIBUTION CORP


5-Oct-2012

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation

The following analysis should be read in conjunction with the Consolidated Financial Statements and the notes thereto appearing elsewhere in this report.

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995 Regarding Forward-Looking Information.

This report (and other oral and written statements we have made or make, including press releases containing information about our business, results of operations, financial condition, guidance and other business developments), contains forward-looking statements, which provide our current expectations or forecasts of future events. These forward-looking statements may be identified by the use of forward-looking terminology, including the terms "believes," "estimates," "anticipates," "expects," "intends," "may," "will" or "should" or, in each case, their negative, or other variations or comparable terminology, but the absence of these words does not necessarily mean that a statement is not forward-looking. These forward-looking statements include all matters that are not historical facts. They appear in a number of places throughout this report and include, without limitation:

• information concerning possible or assumed future results of operations, trends in financial results and business plans, including those relating to earnings growth and revenue growth, liquidity, prospects, strategies and the industry in which the Company and its affiliates operate, as well as the integration of recent acquisitions and other investments and the effect of such acquisitions and other investments on the Company;

• statements about the expected level of our costs and operating expenses, and about the expected composition of the Company's revenues;

• information about the impact of governmental regulations on the Company's businesses;

• statements about local and global credit markets, currency exchange rates and economic conditions;

• other statements about the Company's plans, objectives, expectations and intentions including with respect to its credit facility and other outstanding indebtedness; and

• other statements that are not historical facts.

By their nature, forward-looking statements involve known and unknown risks and uncertainties because they relate to events and depend on circumstances that may or may not occur in the future. We caution you that forward-looking statements are not guarantees of future performance and that our actual results of operations, financial condition and liquidity, the development of the industries in which we operate, and the effects of acquisitions and other investments on us may differ materially from those anticipated in or suggested by the forward-looking statements contained in this report. In addition, even if our results of operations, financial condition and liquidity, and the development of the industry in which we operate, are consistent with the forward-looking statements contained in this report, those results or developments may not be indicative of results or developments in subsequent periods.

We urge you to read and carefully consider the items of this and other reports and documents that we have filed with or furnished to the SEC for a more complete discussion of the factors and risks that could affect our future performance and the industry in which we operate, including the risk factors described in this Annual Report on Form 10-K/A. In light of these risks, uncertainties and assumptions, the forward-looking events described in this report may not occur as described, or at all.

You should not unduly rely on these forward-looking statements, because they reflect our views only as of the date of this report. The Company undertakes no obligation to publicly update or revise any forward-looking statement to reflect circumstances or events after the date of this report, or to reflect on the occurrence of unanticipated events. All subsequent written and oral forward-looking statements attributable to us or to persons acting on our behalf are expressly qualified in their entirety by the cautionary statements referred to above and contained elsewhere in this report.

The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and the notes thereto found elsewhere in this report.

Overview

The Company is one of the world's largest vodka producers and Central and Eastern Europe's largest integrated spirit beverages business with its primary operations in Poland, Russia and Hungary. During 2011, the Company continued its strategy of integrating the business in Russia following the buyout of the remaining stake in Whitehall in the first quarter of 2011 where the Company took full economic and controlling ownership of the business. In addition, the Company continued to focus on developing sales volumes in its key markets of Poland and Russia. Overall, both the Polish and Russian vodka markets continued to see an overall market decline, however in Poland the Company was able to see year on year domestic volume growth for year ending December 31, 2011 of 33% primarily due to the continued success of its recently launched ?ubrówka Bia?a brand. Additionally the Company also began to show progress in the higher margin flavored segment with a successful launch of Je?ówka and the re-launch of Soplica which grew by 27%


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during the fourth quarter of 2011. Total Russian volumes were down which was driven by lower domestic volumes partially offset by higher export volumes. On the domestic front, sales volumes for the year 2011 in Russia were down by 18% as compared to 2010. This was due to factors including an overall weak spirit market and the continued impact of the wholesaler relicensing process during the first three quarters. Finally spirit, which is the main ingredient in vodka production, continued to see higher price levels as compared to 2010, which together with higher levels of market investment resulted in a contraction of gross margins as compared to the prior year and impacted total gross margins by $36.7 million in 2011 as compared to the prior year.

Restatement

The Company is restating its consolidated financial statements for the years ended December 31, 2011 and 2010. The Restatement corrects certain accounting errors primarily related to the accounting for retroactive rebates provided to customers during those periods, accounting for revenue transactions, assets write offs, cut off errors and income taxes. The Restatement also includes reclassifications of accounts payable for periods prior to 2011 to conform to the current presentation. All amounts in Management's Discussion and Analysis of Financial Conditions and Results of Operations (Restated) have been adjusted, as appropriate, for the effects of the Restatement. For a more detailed description of the Restatement, see Note 2, "Restatement of consolidated financial statements", to the accompanying consolidated financial statements.

Recent Developments

Evaluation of Strategic Alternatives; Current Financial Condition

Over the past several months, the management of the Company, in consultation with the Board and with assistance of financial and legal advisors, has been reviewing the Company's strategic alternatives in light of its existing financial obligations. This review has taken on added importance given challenging economic and market conditions and a difficult operating environment.

The Board and the management of the Company believe that all strategic alternatives should be evaluated, and is not ruling out any transaction that is in the best interests of stockholders. In the context of its evaluation of strategic alternatives, the Board continues to consider the letter from Mr. Tariko of Russian Standard Corporation (Russian Standard), dated February 1, 2012 proposing a "strategic alliance" whereby, among other things, Russian Standard would seek to convert a portion of its 3.00% Convertible Senior Notes due 2013 in exchange for common stock of the Company, obtain certain minority rights and board seats, possibly extend a backstop credit facility to the Company and possibly sell certain distribution and other rights to the Company. Although discussions are ongoing, no agreement has been reached. Moreover, there can be no assurance that any transaction or series of transactions will be completed with Russian Standard or any other third party.

The Company also is considering the feasibility of restructuring its outstanding debt. The management of the Company has concluded that cash generated from operations, cash on hand and amounts expected to be available under existing credit facilities will not be sufficient to pay principal on the Company's 3.00% Convertible Senior Notes due 2013 (2013 Notes), which is due and payable on March 15, 2013. The Company's cash flow forecasts include the assumption that certain credit and factoring facilities that are coming due in 2012 will be renewed to manage the working capital needs. Moreover, the Company had a net loss and significant impairment charges in 2011. As a result of these conditions, the Company's auditors' report for the year ended December 31, 2011, included herein, expresses substantial doubt about the Company's ability to continue as a going concern.

Further, the Company may not be able to raise finance in the capital markets to repay principal on its 2013 Notes. A failure to pay amounts owed under these convertible notes would constitute a default under those notes and the Company's 9.125% Senior Secured Notes and 8.875% Senior Secured Notes, each due 2016, and other indebtedness.

See also "Management's Discussion and Analysis of Financial Condition and Results of Operations - The Company's Future Liquidity and Capital Resources."

Significant factors affecting our consolidated results of operations

Effect of Acquisitions of Whitehall

As disclosed in prior filings, on May 23, 2008, the Company and certain of its affiliates entered into, and closed upon, a Share Sale and Purchase Agreement and certain other agreements whereby the Company acquired shares representing 50% minus one vote of the voting power, and 80% of the economic interests in Whitehall.

On February 7, 2011, the Company entered into a definitive Share Sale and Purchase Agreement and registration rights agreement, in accordance with the terms that were agreed by the parties on November 29, 2010, and disclosed in the Company's Current Report on Form 8-K, filed with the Securities and Exchange Commission on December 3, 2010. Pursuant to these agreements, among other things and upon the terms and subject to the conditions contained therein, we received the remaining 20% of the economic interest and 50% plus one vote of the voting interest in the Whitehall Group ("Whitehall") previously not owned by us, as well as the global intellectual property rights for the Kauffman Vodka brand. In exchange we paid total consideration of $93.2 million including $17.5 million for the intellectual property rights for the Kauffman Vodka brand. For further details on the whole structure of this acquisition please refer to Note 3 of the accompanying Consolidated Condensed Financial Statements attached herein.

As a result of this transaction, the Company acquired 100% of the voting and economic interest in the Whitehall Group and changed the accounting treatment for interest in Whitehall from the equity method of accounting to consolidation starting from February 7, 2011.


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Effect of Exchange Rate and Interest Rate Fluctuations

Substantially all of Company's operating cash flows and assets are denominated in Polish zloty, Russian ruble and Hungarian forint. This means that the Company is exposed to translation movements both on its balance sheet and statement of operations. The impact on working capital items is demonstrated on the cash flow statement as the movement in exchange on cash and cash equivalents. The impact on the statement of operations is due to the movement of the average exchange rate used to restate the statements of operations from Polish zloty, Russian ruble and Hungarian forint to U.S. dollars. The amounts shown as exchange rate gains or losses on the face of the statements of operations relate only to realized gains or losses on transactions that are not denominated in Polish zloty, Russian ruble or Hungarian forint.

Because the Company's reporting currency is the U.S. dollar, the translation effects of fluctuations in the exchange rate of our functional currencies have impacted the Company's financial condition and results of operations and have affected the comparability of our results between financial periods.

The Company also has borrowings including its Convertible Notes due 2013 and Senior Secured Notes 2016 that are denominated in U.S. dollars and euros, which have been lent to its operations where the functional currency is the Polish zloty and Russian ruble. The effect of having debt denominated in currencies other than the Company's functional currencies is to increase or decrease the value of the Company's liabilities on that debt in terms of the Company's functional currencies when those functional currencies depreciate or appreciate in value, respectively. As a result of this, the Company is exposed to gains and losses on the re-measurement of these liabilities. The table below summarizes the pre-tax impact of a one percent movement in each of the exchange rate which could result in a significant impact in the results of the Company's operations.

                                                                             Pre-tax impact of a 1%
Exchange Rate                           Value of notional amount            movement in exchange rate
USD-Polish zloty               $426 million                                 $4.3 million gain/loss
USD-Russian ruble              $264 million                                 $2.6 million gain/loss
EUR-Polish zloty               €430 million or approximately $556 million   $5.6 million gain/loss

Effect of Impairment Testing

The Company continued to observe an overall market environment of declining vodka consumption and significant price sensitivities in its core markets of Poland and Russia. Additionally the Company experienced other key changes in market conditions, including changing of sales channel and product mix and market disruptions from relicensing in Russia. As such the Company determined that an impairment indicator exists, performed a goodwill impairment test during the third quarter of 2011 and fourth quarter of 2011, and took an impairment charge of $930.1 million related to its core businesses in Poland and Russia during 2011. We also experienced related underperformance of certain brands in Poland, primarily Bols Vodka, due to among other factors the movement of consumer purchasing from the sub-premium sector, where Bols Vodka is the leading brand, to the mainstream sector. Therefore, the Company also took an impairment charge for trademarks during the third quarter of 2011 of $127.7 million.

We also have experienced impairment charges in prior periods, which affect our period to period comparability. Due to the continued lower performance of certain brands as compared to our expectations in 2010, primarily Absolwent and Bols, we determined that the fair value of the trademarks related to these brands had deteriorated and recorded an impairment charge of $131.8 million during the fourth quarter of 2010 that included an impairment to the carrying values of our trademarks related predominantly to the Absolwent and Bols brands in Poland and an impairment charge of $20.3 million for the twelve months ended December 31, 2009 related to the Bols brand in Poland. See Notes "11. Goodwill" and "12. Intangible Assets other than Goodwill" to our consolidated financial statements contained elsewhere herein for further details of these impairment charges.

We cannot assure you that we will not recognize further asset impairments or experience declines in our financial performance in connection with the ongoing challenges that we are facing in our core markets.


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Year ended December 31, 2011 compared to year ended December 31, 2010

A summary of the Company's operating performance (expressed in thousands except per share amounts) is presented below.

                                                             Year ended December 31,
                                                             2011                2010
                                                          (Restated)          (Restated)
Sales                                                    $  1,737,996         $ 1,563,100
Excise taxes                                                 (908,430 )          (860,969 )
Net sales                                                     829,566             702,131
Cost of goods sold                                            530,495             392,461

Gross profit                                                  299,071             309,670

Selling, general and administrative expenses                  262,175             235,412
Gain on remeasurement of previously held equity
interests                                                      (7,898 )                 0
Impairment charges                                          1,057,819             131,849

Operating Loss                                             (1,013,025 )           (57,591 )

Non operating income / (expense), net
Interest expense, net                                        (110,158 )          (101,325 )
Other financial income / (expense), net                      (139,069 )             3,024
Other non operating expenses, net                             (17,910 )           (13,879 )

Loss before taxes, equity in net income from
unconsolidated investments                                 (1,280,162 )          (169,771 )

Income tax benefit/(expense)                                  (35,276 )            26,717
Equity in net earnings/(losses) of affiliates                  (7,946 )            13,386

Loss from continuing operations                            (1,323,384 )          (129,668 )

Discontinued operations
Loss from operations of distribution business                       0              (8,442 )
Income tax benefit                                                  0                  37

Loss on discontinued operations                                     0              (8,405 )

Net Loss                                                 $ (1,323,384 )       $  (138,073 )

Loss from continuing operations per share of common
stock, basic                                             $     (18.34 )       $     (1.85 )
Income / (loss) from discontinued operations per
share of common stock, basic                             $       0.00         $     (0.12 )

Loss from operations per share of common stock,
basic                                                    $     (18.34 )       $     (1.97 )

Loss from continuing operations per share of common
stock, diluted                                           $     (18.34 )       $     (1.85 )
Income / (loss) from discontinued operations per
share of common stock, diluted                           $       0.00         $     (0.12 )

Loss from operations per share of common stock,
diluted                                                  $     (18.34 )       $     (1.97 )

Other comprehensive income / (loss), net of tax:
Foreign currency translation adjustments                      (28,337 )           (61,155 )

Comprehensive income / (loss) attributable to the
Company                                                  $ (1,351,721 )       $  (199,228 )


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Net Sales

Net sales represent total sales net of all customer rebates, excise tax on production and imports and value added tax. Total net sales increased by approximately 18.2%, or $127.5 million, from $702.1 million for the year ended December 31, 2010 to $829.6 million for the year ended December 31, 2011. The overall increase was driven primarily by the consolidation of Whitehall starting from February of 2011, as it was not consolidated in 2010, giving additional $154.6 million. Excluding the impact of sales increase from the consolidation of Whitehall our sales value decreased by $27.1 million which was primarily a function of lower domestic sales of $79.5 million in Russia due to lower domestic sales volume, higher trade marketing spend, decrease in sales due to higher market investments and product sales mix in total of $31.4 million as well as lower local currency sales in Hungary of $1.5 million. This was offset by higher local currency sales in Poland of $21.1 million and by higher sales from foreign exchange translation of $24.8 million and higher export sales in Russia of $39.4 million. Our business split by segment, which represents our primary geographic locations of operations, Poland, Russia and Hungary, is shown below:

                                       Segment Net Sales Twelve
                                       months ended December 31,
                                        2011               2010
                                     (Restated)         (Restated)
                  Segment
                  Poland            $     226,411       $   225,281
                  Russia                  572,148           446,329
                  Hungary                  31,007            30,521

                  Total Net Sales   $     829,566       $   702,131

Sales for Poland increased by $1.1 million from $225.3 million for the year ended December 31, 2010 to $226.4 million for the year ended December 31, 2011. This increase was driven mainly by a strengthening of the Polish zloty against the U.S. dollar which accounted for approximately $11.4 million of sales in U.S. dollar terms and higher volume sales of $21.1 million offset by a decrease in sales due to higher market investments and product sales mix in total of $31.4 million. The main drivers of our sales volume growth was the continued success of the ?ubrówka Bia?a brand which grew by 473% from 2010 to reach 22 million liters. Offsetting some of this growth were declines in Bols and Absolwent which were down 27% and 30% respectively. Although overall net volumes were up, the mix impact of Bols decline had negative impact on overall gross margins in Poland when comparing to the prior year.

Sales for Russia increased by $125.8 million from $446.3 million for the year ended December 31, 2010 to $572.1 million for the year ended December 31, 2011. Included in the sales growth was a sales increase of $154.6 million from the consolidation of Whitehall into sales starting from February 2011. Additionally, sales increased by $11.3 million in U.S. dollar terms due to strengthening of the Russian ruble against the U.S. dollar. Export sales grew by $39.4 million; however export sales primarily to Ukraine, which represented 68% of these exports, contribute a lower gross margin percentage than domestic sales. Offsetting this was mainly lower local currency sales of $79.5 million including a $3.4 million decrease in sales for Bravo in the first quarter due to suspended production caused by its production license not being timely renewed. In early April, Bravo received its production license and normal sales continued again from this point with higher sales of its ready to drink products of $2.4 million in comparison to second quarter 2010. Although overall vodka brands were down in 2011 as compared to 2010, the Company successfully launched the Talka brand during the year which reached over 5.2 million liters of volume sales during the year and is expected to be a key driver in 2012.

Sales for Hungary increased by $0.5 million from $30.5 million for the year ended December 31, 2010 to $31.0 million for the year ended December 31, 2011 which results in a $1.5 million decrease in volumes in local currency terms as well as a increase resulting from strengthening of the Hungarian forint against the U.S. dollar which accounted for approximately $2.0 million of sales in U.S. dollar terms.

Gross Profit

Total gross profit decreased by approximately 3.4%, or $10.6 million, to $299.1 million for the year ended December 31, 2011, from $309.7 million for the year ended December 31, 2010. Gross profit margins as a percentage of net sales declined by 8.0 percentage points from 44.1% to 36.1% for the year ended December 31, 2011 as compared to the year ended December 31, 2010. The overall impact of higher cost of goods which includes the higher spirit pricing resulted in a $26.0 million impact on gross margins for the year ended December 31, 2011 compared to the same period in 2010. In addition to higher spirit prices, higher trade marketing spend and lower sales volumes reduced the overall gross margin in Russia. Within the Polish market the main factor driving the lower gross profit margins is that the Polish market continues to experience a strong competitive environment from other producers and retailers, especially discounters, making it difficult to increase prices in line with the spirit cost increases.


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Operating Expenses

Operating expenses consist of selling, general and administrative, or "S,G&A" expenses, advertising expenses, non-production depreciation and amortization, provision for bad debts and impairment charges. Total operating expenses increased by $944.8 million, from $367.3 million for the year ended December 31, 2010 to $1,312.1 million for the year ended December 31, 2011. This change is primarily driven by a non-cash impairment charge for Poland and Russia recorded as of December 31, 2011 of $1,057.8 million, and one-time gain recognized in the year ended December 31, 2011, amounting to $7.9 million based on the re-measurement of previously held equity interests in Whitehall to fair value. For comparability of costs between periods, items of operating expenses after excluding these fair value adjustments are shown separately in the table below. Operating expenses, excluding fair value adjustments as a percent of net sales decreased from 33.5% for the year ended December 31, 2010 to 31.6% for the year ended December 31, 2011. Operating expenses, net of fair value adjustments increased by $26.8 million, from $235.4 million for the year ended December 31, 2010 to $262.2 million for the year ended December 31, 2011. The increase resulted primarily from the consolidation of the results of Whitehall giving additional $37.2 million of costs, relicensing and restructuring costs in Russia of $21.2 million, as well as strengthening of the Russian ruble and Polish zloty against the U.S. dollar which accounted for approximately $5.2 million of sales in U.S. dollar terms offset by cost savings achieved in Poland and Russia.

The table below sets forth the items of operating expenses.

                                               Year Ended December 31,
                                               2011               2010
                                            (Restated)         (Restated)
           S,G&A                           $     220,510      $    192,261
           Marketing                              30,828            35,149
           Depreciation and amortization          10,837             8,002

. . .
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