Central European Distribution Corporation Q4 2008 Earnings Call Transcript

Mar. 2.09 | About: Central European (CEDC)

Central European Distribution Corporation (NASDAQ:CEDC)

Q4 2008 Earnings Call Transcript

March 2, 2009 8:30 am ET

Executives

James Archbold – Director, IR

William Carey – President, CEO & Chairman

Chris Biedermann – VP and CFO

Analysts

Doug Lane – Jefferies

Walter Ramsley – Walrus Partners

James Schainuck – Jewel Investments

Olivier Momender [ph] – Fortis Investments

Bastian Gries [ph] – WestLB Mellon

Gulsen Ayaz – JPMorgan

Operator

Good day, everyone, and welcome to the CEDC fourth quarter and full year 2008 earnings conference call. Today's call is being recorded. At this time for opening remarks and introductions, I would like to turn the conference over to the Director of Investor Relations, Mr. James Archbold. Please go ahead, sir.

James Archbold

Thank you. I'd like to welcome everyone to today's CEDC's fourth quarter and full year 2008 earnings conference call. Joining me this morning are William Carey, our President, CEO and Chairman, and Chris Biedermann, our Chief Financial Officer.

Please note that the content of this call contains time sensitive information that is accurate only as of the date of the live broadcast March 2nd, 2009. The online replay will be available shortly after the conclusion of the call. You may also view a copy of today's press release on our Web site.

Please also note that statements made during this conference call other than those related to historical information constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Without limiting the foregoing discussion the forecasts, estimates, targets, schedules, plans, beliefs, expectations and the like are intended to identify forward-looking statements.

These forward-looking statements which are based on management's current beliefs and assumptions and current information known to management involve known and unknown risks and uncertainties. And other factors that may cause actual results, performance or achievements to differ materially from any future results, performance or achievements, expressed or implied by forward-looking statements.

Additional information concerning factors that could cause actual results to differ materially from those forward-looking statements are contained in the press release issued today and the 2008 Form 10-K to be filed with the Securities and Exchange Commission. CEDC is under no duty and undertakes no obligation to update any forward-looking statements made in this call.

With that I'll turn the call over to William Carey, our President and Chief Executive Officer. Bill?

William Carey

Thank you, Jim. I would like to welcome everyone to our 2008 full year earnings call. Just take you through kind of what we'll be discussing today. First off is over sort of a regional outlook what we're seeing for the region, also what's happening with the currencies, then we'll go over the trading environment what we're seeing in the trading environment in terms of competition, the consumer, receivables and what's happening to the import and our key markets with the moving currencies.

We'll also discuss, of course, the '08 numbers, all that take you down to operating profit. Chris will take you down to the rest of the P&L and balance sheet and then I'll discuss the Russian Alcohol Group, the announcement that we put in the press release today, also the Whitehall Company, that we file I think an 8-K later today, some new information on Whitehall and then also discuss '09 on the outlook that we see for 2009 trading in our key markets.

First off, again, welcome to the call. Get into the regional outlook, certainly that we've seen not only with the global slowdown, certainly the regions that we operate in Russia, Poland, Hungary has really not seen any different in terms of crisis than the global crisis. We've seen the Poland and Russia GDP come down over the last four months to five months from mid single digits.

You can find different estimates today from GDP range, slightly negative to slightly positive for both markets. So it's really difficult to get a true picture on the underlying movement of GDP for the remainder of this year but as estimates are like I said from slightly negative to slightly positive.

What we've seen from – also from inflation, we've seen inflation start to come down quite rapidly in Poland. Unemployment as you know in almost every country is moving up. Certainly on the currency side has been a bit too far – has fallen too much based on fundamentals in Poland.

I think when we look at the Polish currency that is probably a clear case of undershooting, probably times in our view indiscriminate regional panic there is really no fundamental reason for the Zloty to lose certainly more value. Of course, we can't predict that for sure, but certainly, we don't see anything fundamental of why the Zloty is not 10% to 15% under value today is where most people are putting it. Of course, there has been also numerous press releases out about Eastern Europe in the last two weeks, three weeks.

And again, I think that people need to strip out of what countries are good in those Eastern European countries, certainly Poland, Russia are certainly in the stronger group of Eastern Europe and certainly does not have the same fundamental problems as many of the Baltic and other smaller countries. I think it will start to come out more and more that there is a differentiation between Eastern European countries in terms of their market development and where they are in their country risk and country development.

I think the Ruble, we've seen the Ruble stabilize in the last three weeks or so in the 34 to 37 range. As you know, the Russian government did the slow devaluation, that's 34, 37 to the USD and that's within their budget. That's also based on a round of $40 oil price. Pretty much Ruble has traded in that range for the last three weeks. I think it's around 36 today. So it is pretty much in line with the government range that they've put out with the $40 oil price.

If we move on to the trading environment, first take a look at competition. What we've seen in the competition, we'll move back and forth between Poland and Russia. What we've seen generally is you've probably listened to some of the beer companies as well. What we've seen from the beer companies that are really struggling in Poland and Russia, both have negative growth. For 2008, it’s very interesting to note that the alcohol basket for Poland, beer lost 3% to the spirits in terms of total value market share.

And to be clear, this is the first time that I can remember probably in 12 years to 13 years that the beer companies have lost to the spirit in terms of value gains. So it's quite interesting to see the consumer move now as beer has sort of tapped out at its consumption per capita levels and the same thing is happening in Russia and even more so sometimes in crisis in countries like Poland and Russia where spirit is sort of historical let's say drink of choice that we believe spirit could gain also additional two beer in the current trading environment. But I think it was very interesting to note that it is the first time in 12 years, 13 years beer has lost to spirits in Poland.

If you look at also what our competitors are doing, look first at the Belvedere Group in Poland, again that the company is not emerging out of their bankruptcy protection. They got another six month stay from the French courts. And my guess is could they get another six months, I guess the limit is January '010 is the last time they could stay under the bankruptcy protection. What we're seeing is they're losing considerable market share. And the company month by month, we certainly believe is having more and more difficulty of their liquidity.

In terms of state companies, also that they continue to struggle. As I mentioned on previous calls, we see continued loss of market share from most state companies. If we look at Russia, what we're seeing in Russia is that we mentioned on the last call that there was some bankruptcies of some key competitors, Gross [ph] and Veda [ph]. This is certainly helping the rest of us in the marketplace gain market share. Also, you have a number of Ukranian companies. Certainly, Ukraine is going through its own problems.

I think some of the Ukranian companies, that’s a very large in Ukraine but also very large in Russia, especially companies like Salusvictan [ph] and Hortiza, some of the leading companies in Ukraine with big operations in Russia. They're also struggling to stay afloat, not only because of the Russian operations, but also because of their local problems in Ukraine that they're having with the local economic environment there.

Generally, we don't have any major exposure to the region, in terms of Baltics or Ukraine in terms of any really risk of bad debt or other companies basically other regions are having more difficulty, these smaller countries. So generally, we are quite well protected in terms of exposure to the region.

If we turn to the consumer, what we're seeing with the consumer is that through 2008 the economy sector had a continual slide, quite rapid slide downwards in terms of market share. What we're seeing now is that's more stabilizing with maybe a small slide or stabilizing and then the move towards more and more mainstream and that's really happening in Poland, Russia and Hungary.

And what does that mean for us? Well, our biggest market share in all three of these markets is in the mainstream category. So generally, this trade, say trade down or from premium to mainstream is not so bad for us as this is our largest market share areas.

And even further to that, even we look at 2009 what's happening, our best performing products in Poland and Russia in terms of market share growth has been bold which is not even in premium, it’s in the subpremium category and Juravli which is in the subpremium category in Russia. I think this only brand specific but generally, the consumer is trading down into generally mainstream and which is a not again, not a bad thing for our Company's position today.

If you look at the receivables, what's happening in our receivables in each market, we do not see any deterioration in our receivables in Poland or Hungary and in Russia our receivable collection is pretty much in line with our projections. We see about, five days longer receivable days in Russia than we saw say, six months to nine months ago but there's really nothing material.

We've also taken a conservative approach for 2009 which is budgeted in our numbers. It's about $11 million including the RAG business, Russian Alcohol business for defaults which is about 1% of our growth sales including excise in Russia. I think what's helping on our receivables is that because we have a market leading positions in each of our markets that it gives us quite a bit of leverage with the retailers, with the wholesalers to get payments quicker. So I think that certainly is helping us collect money.

But some of the press that's been put out over last four months to five months of lack of payments in Russia and so forth and so on that we just don't see it in our business and that's been for the last two months to four months and we're now pretty much at the end of our receivable cycle from our busiest time in the spirit sector which is the fourth quarter, so, I think that we're in pretty good shape in terms of our cash flow and receivables coming in from the fourth quarter in Russia.

If you look at the imports, what we're seeing on the import is business in all three of our markets, certainly impact the currency, certainly it had an impact on the sales volume growth. Certainly, the Zloty has been hit the hardest of the Forint or the Ruble.

What we have been able to do in Poland and Hungary is that we've taken two price increases in December and one in February and what this has done, we've also gone to our key suppliers within each of our markets of Poland and Hungary and have asked them to give us a 5% to 10% extra price reduction not to increase the shelf price too much too fast.

And generally, we've had most of our key suppliers agree with this so we're pleased with our price increase and the price discount we got from our foreign suppliers, we have been able to not lose too much certainly in the margin and keep shelf prices pretty good on the shelf.

In terms of Russia, the Ruble has only moved about 10% since January 1 to the Euro and most of our imports are in Euro. So it's really not that bad of a situation for our import business in Russia and most of our competitors Diageo, Pernod, Bacardi, Remy and others in Russia have increased prices in Russia, 15% to 30%.

So we certainly do anticipate a slower growth of our Whitehall business in Russia which we had 23% growth last year in volume and around 32% in value that we do predict certainly much smaller growth than those numbers but really we don't believe it will be any catastrophic or material issue from single digit volume growth and probably another 10% price increase on top of that.

Remember that our brands in Russia are very dominant. They have dominant share in terms of cognac, champagne, leading wines from Concha y Toro and Constellation. So again, typically strong brands, dominant brands in the marketplace in these type of times and typically do much better than weaker brands. So I think we are in pretty good shape in both markets in terms of imports, but obviously there will be slower growth than 2008.

If we turn to the 2008 numbers, it was definitely – looking at 2008 it was definitely two half of the year and then we break out sort of an overview of what we saw in the two half of the year. The first half of the year, we made quite significant Russian investments in Parliament, Whitehall, the Russian Alcohol Group. We saw local GDPs increasing quite rapidly. We saw currencies quite strong in all markets and cost pressures starting to come off mid-year in terms of cost pressures on our SG&A.

Obviously, a lot of those factors reversed in the second half of the year 2008, more in the last four months, not only with the global financial crisis, the regional currencies were under heavy pressure. You had slower GDP growth moving through each market that we operate. But on the positive side, we also saw continued cost pressures coming off in terms of spirit pricing, in terms of some raw material inputs, in terms of wage increases and other energy and other cost components that were coming down in the last few months of the year as well for 2008.

But what we were able to achieve quite considerable strong results in 2008. First starting on the sales side, we had continued strong growth of our owned and imported brands. Just to give you a quick run down of some of our percentage of growth of our key brands.

In Poland we had 12% growth in some of our key premium brands like Bols and Soplica. We had 12% growth in Royal vodka, the number one vodka in Hungary in 2008. Our import business in Poland, we had 26% growth in Gallo, which is the number one wine brand in Poland. 43% growth in Grant, 8% growth in Jagermeister in Hungary. These are all volume numbers, not value, value would be on top of that.

In Russia, we had quite good growth of Whitehall, a 23% in terms of volume, around 31% value. Green Mark 40%, Juravli, 50% both of these in the Russian Alcohol Group of 50% and you can add another 8% to 10% on top of that in terms of value and Parliament was around 15% volume and around 23%, 24% in value. So again, you can see very solid growth, growth rates did come down a bit in the fourth quarter but they were still quite buoyant.

Also, in the distribution business we took a decision in the fourth quarter also to reduce some of our beer business, some of our lower end beer business which we really don't make a lot of money in, in terms of local beer and we've been taking that out of the distribution business, which will continue in the first half, the first three quarters of '09 and accordingly, we'll take out the overhead associated with that business as well.

In terms of an organic number, we had a 4% organic number and that includes the whole business, plus the Russian acquisitions, plus acquisitions in Poland and currency movements and that's 4% is already after stripping out the beer decline that we took out in the fourth quarter.

We move to the margins. The margin you saw had a large acceleration and that growth again was coming from the growth of our own brands which I mentioned which is our priority. Our imported brands that we import as well. The consolidation of the Russian business, and, of course, the spirit price moving down that we saw throughout 2008.

If you look at the SG&A side, the overall decrease in inflation over the second half of the year certainly led to energy prices coming down, wages starting to stabilize in the first half of the year was quite different. We had inflation going up, wages going up, but again, that is really two half of the year for the SG&A and we had – we started with a headcount reduction throughout our business also in the fourth quarter coming one from the distribution and second in the overall streamlining of our business which I will talk a little bit in 2009.

If you look at the operating margin of the business, what we saw was that the operating margin improved almost 500 basis points – I'm sorry, the gross margin improved almost 500 basis points for the year from 20.9 to 25.6 on the gross margin. On the operating margin, we're able to improve from 9.9% to 12.1% and for the fourth quarter, we're able to increase the operating margin almost 550 basis points over the third quarter, which is quite significant and again, coming from all these positive factors that I mentioned.

I'll now turn over to Chris Biedermann who will take you through the rest of the P&L and the balance sheet.

Chris Biedermann

Thanks, Bill. Looking at our P&L below operating profit probably two items that stand out when FX and taxes and I'll discuss those in a minute. First, briefly in terms of net interest expense, the interest expense is $60.6 million for '08 compared to $44 million in '07 and really main driver here as we talked in the past is the increased borrowings we have for our investments we made in Russia in the first half of the year, namely the Parliament, Whitehall Group and Russian Alcohol.

Going into 2009 and 2010 we have been benefiting from the reductions in the underlying interest rates LIBOR and VIBOR having coming down. Our interest rate for the quarter is about $16.5 million which is roughly in line with what it was in the prior quarter.

Moving down to our other financial expenses, we had a cost there of $132 million. That’s in prior quarters this relates to the translation of our USD and Euro liabilities in our Polish subsidiaries, primarily merchant subsidiaries with functional currencies of the zloty and ruble. Now the vast majority of this represents the revaluation from our senior secured notes and the convertible secured notes.

Taking $310 million of convertible notes which were lent to our Polish sub to complete the Whitehall Group and Parliament acquisitions during the fourth quarter we saw the USD TL balance sheet exchange rate move from a 237, 296 and that drove revaluation liability. However, these notes are only due in 2013. This represents a non-cash charge for the period.

Similarly, the other non-cash charge relates to our senior secured notes where we have 245 million of outstanding which also went down and during the fourth quarter we saw the Euro move from 340 to 410. Again these notes are only due in 2012 so for the period it's purely a non-cash charge for the period.

On an after-tax basis the revaluation of our Euro, USD debt resulted in a non-cash charge of about 134 million which is partially offset by a non-cash gain we have on notes receivable in dollars from the Russian Alcohol Group of $27 million on an after-tax basis.

In addition to the FX recorded on the face of our P&L we also incurred FX on our USD debt and Russian Alcohol Group investment. The group has committed five year USD financing in place from a consortium of western banks. As with our debt above this needs to be revalued in local currency terms. However, as we account for RAG on an equity method and the full results is one line, this line then includes the FX as well. So for the period ending December 31st 2008 the after-tax FX loss which we recognized there in a proportional share of RAG earnings was $22 million.

Next moving down to tax, our tax rate for the period was 81% which is clearly well above our normal effective tax rate and this was driven by a certain true-ups of our deferred tax assets in Q4. Majority of this true-ups related to the additional provision for tax loss carry forwards for one of our Polish subsidiaries.

And due to these FX losses incurred which will also get recognized for tax purposes, management has taken a conservative view that portion of these NOLs will not get utilized in the future. Therefore we've taken a provision for them. As of December 31st, the total provision for these tax loss carry forwards approximately $7 million and covered by 50% of these tax loss carry forward balance we have.

Additionally, the tax rate in Russia is going down from 24% to 20% which will provide a benefit in the future. However, at the end of '08 we needed to write down the deferred tax asset in Russia to reflect that change. Both of these changes are clearly the non-cash and nonrecurring nature.

Also below our profit before tax is the $9 million losses from equity earnings related to our proportional share of the Moet Hennessey and our share earnings in Russian Alcohol Group. As it was talked about above, the Russian Alcohol profit was impacted by the 22 million FX non-cash translation loss. But without this FX impact our equity earnings would have been $13 million for the period.

The minority interest again represents our net income attributable to the 25% and 15% minority positions that are held in Whitehall Group and Parliament respectively. Therefore, on a comparable basis, net income was $131.2 million for the year or 293 per fully diluted share as compared to 699.9 million in 2007 or 173 per fully diluted share. This reflects a 69% increase in the comparable fully diluted EPS. This represents a strong growth in underlying business performance plus the accretive impact of our recent investments in Russia.

Again, the main difference in our comparable income and our GAAP income is the FX and tax adjustments that I just described. However, full reconciliation is available in our press release.

Now some highlights of our balance sheet. First, in terms of liquidity, as December 31st 2008 we had $107 million of cash on our balance sheet which is roughly equal to the total of our short-term bank facilities drawn of $109 million. In addition we had head room of about 13 million on top of the left to borrow. This combined with our $72 million of cash flow from operations for the period we believe puts us in a strong position from a cash flow perspective.

As mentioned in 2008 we purchased Parliament Group in March and structure of this transaction was such that we purchased newly created companies with no material working capital. Thus we had to fund $27 million into this business during the course of the year to build up this normalized working capital plans. Additionally, we purchased the Whitehall Group in May 2008 and traditionally the first quarter is the strongest period of cash in flows following the peak holiday season at year-end. In 2008 we consolidated the peak period of outflows at year end but not the inflows. We believe that normalizing our cash flow from operations fully items we would have had over 100 million of cash flow from operating activity in 2008.

Generally, in terms of working capital, Bill mentioned, we've seen improvement in receivables and overall we've seen our working capital days decline by about five days. Of the remaining short-term bank facilities coming due in 2009 we feel we are well positioned to ensure a smooth roll over of these amounts. Our long-term debt is primarily the senior notes due 2012, our convertible notes due 2013 and our recently renewed long-term facility of approximately $90 million which is due in two years.

Therefore, net debt to EBITDA at year end is $822 million on a pro forma basis that puts the ratio about 3.5 times. This does not include any EBITDA from the Russian Alcohol Group, which we currently account for under the equity method. However, the Russian Alcohol Group is operating due to their bank covenants at 2.5 times net debt to EBITDA. Our EBITDA interest coverage was at 3.5 times. Both our ratios are well within the range of our bank covenants.

I'll now turn it back over to Bill who will provide further overview of some of our current activities.

William Carey

Thank you, Chris. I think what's interesting to note also on our balance sheet is that we were able to reduce our receivables from 64 days to 60 days over the full year. So this certainly an improvement in an environment that is difficult at the moment.

Moving on, we talked about the Russian Alcohol Group. I think it's – we put a note out on our recent discussions with Lion Capital to restructure the current agreement regarding the buyout of the 58% stake of the Russian Alcohol Group that we don't own. We've been in discussions for a little over two months so we are quite advanced in discussions. We've pretty much agreed the main commercial terms, which we're highlighting here which I'll get into. Obviously there is still some further legal and accounting and tax analysis and board approval but the main general commercial terms have been agreed with Lion Capital.

The agreement, the discussion agreement we have with Lion Capital is that we – that the price would be fixed for the remaining 58% stake that we don't own and that would include the conversion of our notes plus interest, which would give us about a 7% to 8% stake, additional to our 42% stake today – or I'm sorry, 8% or 9% additional to our 42% stake today that we would buy in tranches over five years, starting 2009, with a smaller tranche and '013 with a smaller tranche and '010 through '012 with more medium sized payments and these payments would be reflected also of ownership increases but we would not take voting control until 2011 and the main reason for that is why wait until 2011 for voting control.

The main reason is that even though we have a much higher economic stake at 50%, that the main reason is that we would still owe Lion a quite substantial amount of money and for Lion security, it gives them some security to keep control for a few more years until we pay them a good part of our money that we would owe them.

Also, we've been quite pleased with the way Lion's been running the business. They've been doing pretty much the same type of things that we would do in the business in terms of streamlining the portfolio, reducing headcount, getting better administrative procedures in the Company, financial procedures, so they are doing a lot of things that we would already be doing in the Company so we're quite pleased with working them on an ongoing basis for the next couple years until we would take control.

As I said, the payments will be spread out over five years which will give us certainly financial flexibility. Also, that there would be certain security arrangements agreed with Lion as well in terms of securing the money that would owe to them. We would also have significantly enhanced minority rights from budget approval, strategic decisions, approval of key management changes, investment decisions and so forth and so on, but certainly be much more enhanced than today's minority rights.

And also, in terms of valuation, also the valuation is more reflective of today's market conditions, also considering the business is growing quite well, which certainly would bring down the multiple quite quickly as the business performance is growing, which certainly be beneficial for the shareholders in CEDC.

We believe this new proposed structure is really a win-win, not only for Lion but also for CEDC as Lion would get to solidify its return in difficult market conditions, and CEDC would receive financial flexibility to buy out the remaining shares of Russian Alcohol Group, which we believe as I said before is probably arguably the best performing spirit, consumer Company in Russia today.

And not to mention with the cash flow of the business, it also gives us the opportunity to use dividends over future periods to help pay for the payments that would be due to Lion as well. I'm sure we'll get some more questions on this after the call. I'd be happy to answer the questions as we can on the current discussion that we have ongoing with Lion on this investment.

I think also it's interesting to note by agreeing this position today, it alliance us and Lion really on one page in terms of, yes, Lion does take over the operating performance of the business for another year and a half, two years, but also they share some of the Ruble and operating performance risk with some performance payments that we've agreed as well. And also, while we're both on the same page, it gives us the opportunity to develop synergies faster as really we're both on the same page in terms of driving the business forward.

Moving on to the Whitehall Company, we signed an amendment to the SPA agreement last week. I think that will be filed today. Both parties agreed on settlement conditions for remaining liabilities that were agreed a year ago, that will be settled over the course of the next 12 months. As well as CEDC has bought an additional 5% stake in the Whitehall Group which increases our stake from 75% economic stake to 80% stake effective now.

The settlements and purchase were down with a combination of equity and existing cash and we're very exciting to have continued involvement with the Whitehall Group, it's a great Company in Russia and they just signed some new agreements as well Jose Cuervo and De Kuyper in the last month so we're pleased they're able to get new products, coming into the portfolio as well and we look forward to working also closer with the Whitehall Group.

Moving on to 2009, for the outlook for 2009, if we look at the guidance that we put out in terms of our top line and bottom line guidance, the guidance has taken into account the obviously consumer softness in the market compared to last year as well as recent currency moves as we outlined in the last press release and even if we take the recent weakness that we're still in line with our guidance that we put out in top line and bottom line guidance, so we're quite comfortable with what we put out for '09.

We're still anticipating a single digit to double digit growth for most of our key vodka brands in Poland and Russia and Hungary, and again this is also driven from the fact that we will be anticipating market share gains in both markets of Poland, Hungary and Russia.

We're relaunching our biggest brand Absolwent and Palace in Poland this year. We’re also relaunching Royal with a new package in the next few months in Hungary and we also have a number of new brands in Russia that will be coming into the Parliament business, not only the ones I mentioned for Whitehall, but also for Gallo is – we had to wait because of the movement of the Ruble but now that is stabilized we will be starting to move ahead with Gallo and Borco and others we are negotiating with to move in with us into Russia. In Hungary, where we signed with Campari and Cinzano to represent them last month so that's already getting started which is very nice portfolio for us in Hungary as well.

Overall, if we look at Russia, the overall vodka market, again, the consumer, the biggest benefit that we see is going to be mainstream and certainly by Green Mark, the biggest vodka brand in Russia and the biggest vodka brand in the mainstream. We're going to have the biggest opportunity to develop market share gains and we believe that in the next 12 months to 15 months we can increase our Russian market share to roughly around 25% from 20% today and 12% just a little over one year ago.

Gross margins will continue to improve. Not only do we have the consolidation of Russian business helping that, we have spirit pricing down still compared to 2008 and we're also reducing unprofitable distribution business which I mentioned before.

We're also streamlining our current business, not only in Poland and Hungary, but also in Russia, including Reliance doing in the rank business as well. In all of our businesses, we're looking about 8% to 10% headcount reduction, that's already started throughout our three businesses in each country which is about 700 people to 750 people in total.

We're going to continue to focus on receivables, which I said in the press release as well as cash generation. We've been very active in trying to complete the RAG deal which we hope will complete soon and from completion we will be able to consolidate that business soon after into our numbers.

And to summarize, we believe the Company is very well positioned to not only benefit from the market share gains in this current crisis, but profitable market share gains. Sometime it's very easy to look at just market share gains and maybe not collect money but we've been very steadfast in terms of not only market share gains, but profitable and certainly good cash flow generation behind it.

We certainly believe we have a proven management team that's been working here very long in this region that knows how to drive bottom line performance and certainly knows how to control receivables in difficult times. Now that the RAG business is getting more clarity, certainly that gives us the financial flexibility to increase our stake in probably the – and certainly the fastest growing Russian spirit business, and certainly add improved valuations. So we're very excited about the future, obviously, we're still going to move through difficult times but the future we believe is we're going to come out of the future a much stronger Company and certainly I open up the floor to questions. Thank you.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions). We'll go ahead to our first question which will come from Doug Lane with Jefferies.

Doug Lane – Jefferies

Yes, hi, Bill, hi, Chris.

Chris Biedermann

Hi, Doug.

Doug Lane – Jefferies

On the new deal with Lion Capital, even though it's spread out over five years, it's still a pretty big transaction and it sounds like there is some sort of payment due in 2009 and it doesn't appear that the credit crunch is getting any better. Can you give us some order of magnitude and how you anticipate financing that, maybe in conjunction with that, Chris, you can give us what your estimate for free cash flow this year?

Chris Biedermann

Yes, I think, Doug, that we are probably looking at around probably around $80 million for 2009, with the bulk of it to be paid in the last half of 2009, which would certainly leave our options open to certainly on how we finance it from cash, debt, or equity, but certainly the bulk of it to be paid in the last half of '09, is the current arrangement with Lion.

Doug Lane – Jefferies

Okay.

William Carey

There are some options by structuring it that way.

Doug Lane – Jefferies

Okay. And Chris, you talked about –

Chris Biedermann

In terms of free cash flow, we said that, we usually target about 50% of our EBITDA to come out of cash flow from operations. We are probably looking at about the $100 million range, and on top of that CapEx, operating CapEx will be around $15 million to $17 million range as we finalize the facilities in Russia.

Doug Lane – Jefferies

Okay. That's helpful. And do you think working capital will be a source of cash or a use of cash this year?

Chris Biedermann

I believe it should be a source of cash for the year, some of the items mentioned before in terms of Russia cycle.

Doug Lane – Jefferies

Okay. Can you talk a little bit, in Russia, Bill, on the LVMH portfolio, obviously it's a (inaudible) portfolio and I imagine that is a little (inaudible).

William Carey

I am sorry, Doug?

Doug Lane – Jefferies

I am sorry, I was asking about the LVMH portfolio, how that's holding up, given its very, very premium price?

William Carey

Yes, I mean, we certainly anticipate, like I said, a slowdown from the 23% of volume gains we had last year. When we look at the first couple months, we just closed February. To be honest, it was pretty decent. It was up I think a couple percent, up over last year. And this is pretty much what we're anticipating is single-digit growth for volume, and probably another 10% on value on top of that for the Whitehall business, and then maybe some of these new products coming in, as I mentioned, maybe to enhance that a little bit, but this is that market leading positions, and then the bulk of the Hennessey, for example, is in your VS and VSOP, is not coming from your XO and Hennessey parodies, and very, very high end stuff, so your basic cognac and champagnes still will be bought, Doug.

Doug Lane – Jefferies

That sounds pretty good. That's reasonable. That's pretty encouraging, given all that we are hearing over here about how Russia is being impacted by the economic turn down. Can you give us or did you give us and maybe I missed it, an updated production market share in Poland?

William Carey

We've around 28% volume, around 30% value. And you got to remember, we stripped out over the last couple of years lot of low end stuff out of our production facilities over than when we acquired it three and a half years ago.

Operator

We will move to our next question which will come from Walter Ramsley with Walrus Partners.

Walter Ramsley – Walrus Partners

Good morning, Chris and Bill. Congratulations. Just wondering if you could ,Chris, anyway, go through all the debt that the Company has to pay off, and go year by year how much is owed and what currency has to be paid in?

Chris Biedermann

Yes, sure. Okay. Generally speaking as I mentioned, our short-term debt which is the $109 million, that's a few local working capital facilities, those are all pretty much Zloty [ph] facilities and they – I think will be due, we've got piece coming due in May, piece coming due in August, piece coming due in December. I think we feel pretty comfortable these are main relationship banks here, we work with them on a daily basis, these things are all forward. In addition to that, we've got two amortizing facilities, one is for $40 million, one is for $30 million, and these are due in 2011 and 2013. This year we got about $9 million combined payments due under those facilities in terms of the amortizing portion. And then in Russia we got another combined about $20 million as well working capital financing. Then on top of that is our long-term debt which is the $310 million of convertible notes, which is due in 2013, and the senior secured notes, the Euro notes of 205 million which are due in 2012.

Walter Ramsley – Walrus Partners

The convertible are in dollars?

Chris Biedermann

These convertibles are dollars, and the other ones are in Euros. So all of our short-term is at a Zloty base. The intermediary amortizing facilities that are due in '11 and '13, which are combined about $70 million are in dollars and then our long-term debt is dollar and Euro as I mentioned.

Walter Ramsley – Walrus Partners

Okay. Thank you.

Operator

Okay. We will move to our next question which comes from James Schainuck with Jewel Investments.

James Schainuck – Jewel Investments

I wonder if you could talk about capital controls and how you can move capital or restricted in terms of the three countries you operate in and how you expect that to go forward?

Chris Biedermann

Yes, I will take that. Generally speaking, within Poland and Hungary, they are both within the EU. We have dividends and there is no issues, no withholding tax. When you are dealing with Russia, if you structure it properly through Cyprus, you have a majority of your directors actually Cyprian-based, which we have, you do have a small withholding tax about 5%, coming out of Russia and Cyprus. And then once money is in Cyprus in terms of dividend, you can dividend it anywhere in Europe without any withholding tax. So it's really not an issue, same with intercompany loans, generally within the European countries, Poland, Hungary, no issues, through Russia we generally go through a Cyprus intermediary and no withholding tax in that.

James Schainuck – Jewel Investments

And do you expect to hear anything changing in regards to what's happening in Russia?

Chris Biedermann

I don't expect anything. It's hard for me to predict what the Russian government is going to do. Up to now I haven't heard anything that would lead me to believe there would be any sort of additional restrictions.

James Schainuck – Jewel Investments

Let me ask you a general, almost philosophical question about the level of demand for your products over the recent periods and comparing it to now and going forward over the next year or two. Do you have a sense for how much of the demand for the products, a sort of boom demand, sort of a one-time demand that's going to go away, and that will have to be rebuilt over a very long period? Could it be 10%, 20%? Or has it really not except for maybe the very high end brands in Russia been affected on the upside so much by what we might call boom demand or false demand that's now going away?

William Carey

Well, I think interesting to note, looking at the Polish and Russian markets separate. If you look at the Polish market, certainly the market is more mature, here in the vodka sector, us being a clear market leader. Certainly, it's more difficult to attain very profitable market share gains. But certainly that the market has been growing here for the last three years to four years quite robustly in terms of the spirit market, so I am certain that will come down this year, but still we anticipate when you do have situations of more, let's say, crisis mode, typically your stronger companies will move faster in market share, which we are anticipating here within Poland.

Look at the Russian market, you still have a very unconsolidated market. We don't have any multinationals to compete with today in the vodka sector in Russia. Smirnov doesn't really sell much in Russia, you really competing against Russian entrepreneurs. And I think without having a quite strong balance sheet within Russia and not having any Russian local debt, we are in quite strong position to develop market share as we have gone from 12% to 20% share, the market has grown in value. It has declined in value over the last few years, and really where people were trading into beer. But as I mentioned earlier the beer sector is now in decline in Russia and where people anticipate, some of the analysts have put out from (inaudible) and others that they anticipate the consumer will trade back into some spirits and we think not only do you have the ability of a continued value appreciation of the vodka market, you still have a lot of market share gains as the market is really unconsolidated, we think there are some easy 10%, 15% market share gains to take over the next couple years.

James Schainuck – Jewel Investments

Thank you. One final question. Pro forma for Russian Alcohol Group, roughly speaking, sort of back of the envelope, what portion of your EBITDA would come from the three different countries and then how would it be broken down between manufacturing and distribution?

William Carey

Yes, we don't break out distribution, as you know, we will be filing 10-K, if it is not filed already, the 10-K, quite soon today, where we do give segment reporting on Russia and Poland, in terms of the two groups, and on RAG, I am sure once we give – once we sign the final agreement with Lion in the near future, we will give obviously when we consolidate we will give out more clear guidance on the EBITDA of the business. But certainly is trending upwards with the sales volume, so, I think it will be a pleasant surprise.

Operator

Our next question comes from Olivier Momender [ph] with Fortis Investments.

Olivier Momender – Fortis Investments

Yes, I got a couple of questions. First question, can you break down for the fourth quarter of the year what was the level of the organic sales growth, please?

William Carey

We have around a 4% for the year and because of the distribution, we took some beer out of the distribution company. It might have been a little bit lower than that in the fourth quarter. I don't have it in front of me. I just have the year number. It might have been a little bit lower than that, but not much lower.

Olivier Momender – Fortis Investments

For the full year, it was 4%?

William Carey

Yes.

Olivier Momender – Fortis Investments

Okay.

William Carey

That stripping out currency and acquisitions.

Olivier Momender – Fortis Investments

Yes. Regarding your debt in dollar and Euro, have you considered taking any hedges for your debt exporter?

Chris Biedermann

Yes, we have looked into hedges but generally it doesn't make a lot of economic sense. I think if you look at some indicative market quotes to hedges, for example, $100 million of an exchange rate with zeramandi [ph] or Ruble, you are looking at, for example, 50 million to 75 million Zloties for each $100 million tranche. In this environment, with volatility as high at, derivatives are quite expensive and we just think that given that it is long term debt, it doesn't make sense to put a lot of short-term cash out there to hedge these long-term debts.

Operator

We will move to a question from Bastian Gries [ph] with WestLB Mellon.

Bastian Gries – WestLB Mellon

Hi, good afternoon, gentlemen. Couple of questions if I may. Just to double check, did you say the potential rach payment for H2'09 will be 80 million?

William Carey

No. I said the payment '09 would be 80 million, with the bulk of that coming in the second half of the year.

Bastian Gries – WestLB Mellon

Yes. But 80, I understood correctly.

William Carey

80, yes.

Bastian Gries – WestLB Mellon

Okay. And so if I understand correctly, you haven't seen any meaningful changes in your bad debt levels yet, but you have made a provision for '09 for Russia, is that correct?

William Carey

Yes, I mean, we had write-offs in '08 as well, but our provisions for '09 is around $11 million, and putting in context of the gross sales, which is about 1% of sales. So we think that's pretty respectable in today's market, and we think what we're seeing in the market for the first couple of months, we think that should be enough.

Bastian Gries – WestLB Mellon

Okay. And in terms of your margin development, you are guiding for improvement in gross margins. So overall, we should be expecting further margin enhancement –?

William Carey

Yes.

Bastian Gries – WestLB Mellon

–in '09?

William Carey

Yes, there will be further margin enhancement in '09, because again you are a consolidating business, that in our Russian business you didn't have a full year in 2008, also with spirit pricing being lower, plus the growth of the business is mainly going to be driving from our owned brands, and not really driving from the distribution business, and the owned brands you are working on a much, much higher growth and operating margin, so the overall mix will be significantly moved upwards.

Bastian Gries – WestLB Mellon

Okay. So even if I take Q4 as a reference, we should see improvements compared to the Q4 run rate?

William Carey

Yes, I mean, the business is quite seasonal with the Q4 being our highest margin quarter, but yes, you will see comparison on quarter by quarter '08 to '09 improvements in gross margin.

Bastian Gries – WestLB Mellon

Okay. And finally, Chris, with most of refinancing announced for –

Chris Biedermann

Hello?

Operator

I apologize, he dropped from the queue. We are going to go ahead and move to our next question which comes from Gulsen Ayaz with JPMorgan.

Gulsen Ayaz – JPMorgan

Hi, there. Thank you for taking the question. Chris, if you can give us an idea of how much of the debt is in RAG? And in your segment reporting, do you think you are going to publish RAG balance sheet uphold?

Chris Biedermann

Segment, no, as we don't consolidate RAG, it is not in our balance sheet, it's only the one line. In the future if we were to consolidate, obviously it would go into the Russian segment. They have net debt at around 180 million to 200 million level.

Gulsen Ayaz – JPMorgan

And considering that you are going to be paying roughly around $80 million towards the end of 2009, when should we expect RAG to be consolidated into your numbers?

Chris Biedermann

We are still finalizing the exact details with our account advisors, but most likely, it's finalizing an agreement with them, it would trigger consolidation, so Q2/Q3, probably, Q2.

Gulsen Ayaz – JPMorgan

And by then, you will have exercised the convertibles as well?

Chris Biedermann

Yes, that would be the first step of the process.

Gulsen Ayaz – JPMorgan

And this 180 to 200 net debt does not include the convertibles?

Chris Biedermann

That's effectively outside debt, yes.

Operator

We will go ahead and move to our next question which comes from Doug Lane with Jefferies.

Doug Lane – Jefferies

Yes, Chris, I bumped off a little bit during your comments. Did you talk about where you are with your debt covenants and where you plan to be vis-à-vis the end of the year?

Chris Biedermann

Yes, we still believe that we got pretty good head room on our covenants, if you look at our main ones, which our EBITDA interest coverage, which is in our bank agreements as well as the senior notes as an current test. We're about 3.5 times and our covenants 2.25. In the past, most of our bank agreements turn net debt to EBITDA on a pro forma basis are in the 5 to 5.5 range, 5 being the lowest we have in any agreements. So we feel pretty comfortable that we have quite a bit of head room in all of our main quantitative covenants.

William Carey

We are around 3.5 on current business, Doug, and then RAG is operating less than 2.5 on their covenants, so even when you consolidate RAG, it would lower our number on a consolidated base, just from inclusion of RAG as well.

Doug Lane – Jefferies

Got it. Okay. Thank you.

William Carey

And with the cash flow generation, we should be bringing that number down over the next few years.

Operator

Okay. Thank you, sir. And it appears that we are out of time for questions. So at this time, I will turn the call back over to Mr. Archbold for any additional or closing remarks.

James Archbold

Thank you. We would like to thank everyone for joining us today and we look forward to speaking with you again next quarter. Thank you.

William Carey

Thank you.

Operator

Thank you, sir. That does conclude today's teleconference. We thank you all for your participation. You may now disconnect.

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