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Central European Distribution Corp. (NASDAQ:CEDC)

Q2 2009 Earnings Call

August 05, 2009 08.00 AM ET

Executives

Jim Archbold - Vice President, Secretary and Director of Investor Relations

William Carey - Chairman, President and Chief Executive Officer

Christopher F. Biedermann - Vice President and Chief Financial Officer

James Archbold - Vice President, Secretary and Director of Investor Relations

Analysts

Douglas Lane - Jefferies and Company

Daniel Wakerly - Morgan Stanley

Natasha Zagvozdina - Renaissance Capital

Operator

Good day and welcome to the CEDC Second Quarter Earnings Conference Call. Today's call is being recorded. At this time for opening remarks and instructions, I would like to turn the call over to the Director of Investor Relations, Mr. James Archbold. Please go ahead sir.

Jim Archbold

Thank you. I'd like to welcome everyone today to CEDC second quarter 2009 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 today with the live broadcast. Excuse me, -- August 5, 2009. The online replay will be available shortly after the conclusion of the call. You may also view a copy of yesterday's press release on our website. 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 and Reform Act of 1995. Without limiting the foregoing discussions of the forecast estimate targets scheduled plan believes, expectations and the like 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, 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 for those forward-looking statements are contained in the press release issued August 4th, in the Form 10-Q 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 want to welcome everyone to our second quarter earnings call. As we typically do in these calls, get to a brief summary of what we're going to be discussing. First half, I'd like to discuss about the economy and our markets we work in, little about the market overview kind of what we're seeing in Poland and Russia today, are given to the P&L down to operating profit. I'll turn it over to Chris Biedermann, our CFO who'll take you through the changes in our balance sheet that took place with the consolidation of RAG this quarter and then I'll take you through a bit the outlook and then open up the call to questions.

But generally on the economy what we're seeing is certainly in terms of sentiments, certainly sentiment is improving for emerging markets. It's vastly improved over last four to five months. GDP is coming off to lows, as you know most markets hit their lows in the first quarter through April and Russia and Poland is coming off these lows and both markets are expecting around a 2 to 3% GDP growth going into 2010.

Interest rates have been coming down in both markets, 2-300 basis points over the last six months. Inflation has been somewhat slowing, we're seeing cost pressure certainly reduced in both of our markets and obviously with these more positive dynamics you've seen of the currencies, with the sentiment also have been quite strong over the last 60 to 90 days and also I think oil had to play in the ruble. Also that the oil price moving from around 50 to $70.

If you look at the market overview, generally what we're out of Poland, we're seeing the vodka market slightly improving. As said before the vodka market was generally down about 9 to 10%. What we're seeing now is projected probably about a 5 to 6% decline versus the 10% decline before, slight improvement in July, spirit pricing remaining low still down 30-40% from year ago periods, that's the raw spirit pricing. The other cost pressures and the raw material goods we don't really see any. Import still doing quite well, still holding out, we have 12% in the quarter, our margins are trying to improve. Also the imports now with the strengthening of the currency over the last 90 days. Our exports are doing extremely well, we're up 40% in the quarter even when we look at July, we're up over 100% on exports in July, obviously coming off a little bit but still it's encouraging to see the exports picking up quite dramatically.

Inventories which you know, we had a problem in the first quarter; inventories have walked its way through, inventories are more at the market norms today and if you look at the excise situation, the government is pretty much flat this year on six to seven months of excise collections and from meetings we've had with the administrative finance, we're not really seeing probably any bigger interest to increase excise to any same degree as you saw this year, starting in 2010 and what even talking 2009 but that win squashed on because they're barely breakeven now with the excise reduction...with the excise increase from beginning of this year.

And we're still taking costs out of our business in Poland as well. We saw a 10% head count reduction through April out of Poland, we're still during a lot of our basic work in terms of reducing the key SG&A items, new tenders in the marketplace, its the right time to make new tenders for some biggest SG&A items like Telecom, transport, et cetera. So we're still seeing cost pressures come out of our Polish operations. Liquidity is still improving; we had a solid cash flow in the second quarter, receivables are coming in and pretty much in line with what expected bad debts are remaining quite low, still operating about 0.01% of sales out of bad debts out of Poland.

If we look at the Russian market, the Russian market's been down more than the Poland's market, the vodka market in the first overall six months. The vodka market was down roughly around 10 to 50% depending which sector you're operating in. We don't really see any trade down in really Poland or Russia, it was little bit of trade down when the crisis first hit in the first few months of this year, but what we're seeing lately is that generally the consumption is slower but we don't really see the trade down that we experience in the first couple of months of the year; so that's our pretty major shift.

What we're seeing is that there is a, certainly that this market has stabilized over the last three months or so and generally we're anticipating is probably moving out on the fourth quarter 2009 into 2010 probably a bit of consumer pick up and those numbers to come down probably quite dramatically in terms of the overall vodka consumption.

I think some of that's moved into the black market, it's hard to say as there is no reliable data for that but spirit prices remain low as we've mentioned last quarter, it's still low, it's about 20% lower than a year ago. The imported wine market is still doing extremely well still up double-digits, high in Cognac markets has come off this year down about 20-25% but that has stabilized here in the last 60 days and we're anticipating some pickup here in the next four to five months.

Exports are still going strong with over 30% growth, inventories which was a major concern, again for liquidity and for other factors in the first four to five months of this year, has really gone down too lows that we've been, that we've seen in the last 15 months, a lowest level that we've seen, which is certainly helping the improved liquidity which is on our cash flow. We're still seeing a lot of cost reduction coming out of the business, not only on the mass of head count reduction that took place over the last four to five months but also just general, all the cost reductions coming from transport tenders, banking tenders. The next wave of head count reductions and just overall streamlining the businesses that we invested in last year.

There's been a lot of discussion on the excise in Russia over the last say 90 days. What we've seen is that the government has come out publicly a week or two ago, and that they're now anticipating; they were thinking of a much larger excise increase or ports out of the 30% or so. What they're saying is they don't really see any increase more than they already planned increase in the budget which they do a yearly increase of 9% every year, for the last six years. I think they're sticking to that for the '010 budgets, I think another 9%. So which is quite good news.

Also prudent I think they have taken a very active role in terms of trying to work down the black market in Russia. They've come out and stated they want to take a more control over the ROSS spirit manufacturing as a lot of the black market spirit is coming out of the ROSS spirit manufacturing, they want to put more bank guarantees in place, more guarantees in terms of transporting the liquid across the country. So I think these are all good things for us, they want some more penalties on operating -- criminal penalties on operating in this black market, which I think is all good news for the industry.

Also what is good news is that they're coming out at least, publicly what we've seen is that, they're much, much higher increased on beer side, which potentially could be quite favorable for the overall spirit market as well.

If we look at liquidity certainly that with the inventory reduction, a certain liquidity is improving of also with the sales slowdown and the top-line slowdown in Russia. We're seeing, business really starting to generate good cash flow, bad debts, there was a lot of bad debts written off in 2008 that we made the acquisition of Russian Alcohol Group which we think they're pretty well reserved for and I think we're in pretty good shape on our bad debt situation in Russia today.

If you look at our business in particular, obviously we're performing better than the markets, Poland and Russia in those numbers I gave you. If you look at the sales first in Poland, there's various factors that are looking at our sales revenue. We were down about 4 to 5% in volume where the market was down as I said about 9 to 10%. We're relatively flat in value, maybe 1% up in value, we're gaining some market share, which are very nice imported growth of 12%. Exports were up 30% to 40% as I said.

The distribution business have had a pretty good quarter, as the inventory worked its way out from the first quarter, we still had roughly about a $15 million drop in sales revenue, distribution but that again is coming from the lower import portfolio that we took out in the fourth quarter of 2008 which we saw in the first quarter and you'll see that in the second, third and fourth quarter as well. Lower import portfolio, its not really affecting the EBIT but more of the top-line, these are low value products that we weren't really making any money with and that's why we also saw the margins improve in Poland and at distribution where the less percentage overall sales revenue and we saw roughly about 100 basis points improvement in the underlying margin which is double of what you were expecting.

If you look at the Russian business, the Russian Alcohol Group continues to grab a lot of market share. We're up over our double-digit in value and our four key vodka brands in Russian Alcohol Group for the quarter which is quite a big change to it. As I said the market was down 10 to 15% in volume. We were at mid single-digit in volume in Russian Alcohol Group and up double-digit in value, and we think the market share that we grew was probably around 18% to 19, 19.5%

As the part of the business operating more in the sub-premium sector, this suffered a little bit more than certainly the RAG business, this was down roughly around 10 to 12% in volume and mid single-digits in value. Overall though as I said the market share of our vodka portfolio in Russia, we think we grew about 1, 1.5 points for the quarter. The import business is doing quite well especially the wine business, the Cognac business have suffered a bit on the high end Cognacs, but it has stabilized the Cognacs side, that once continued to do well, and we're quite encouraged moving on the second half of the year, on the import business especially with the better FX rates, certainly the margins are improving there as well.

If we look at the overall margins in the business, there was big jump in the gross margins you saw on the financials for 25% or 33% in gross margins. Main factors affecting this like I said was a lower percentage of the business of distribution in the overall sales pipe. The lowest spirit pricing we're seeing throughout Poland and Russia, the consolidation of the Russian Alcohol Group in the second quarter, also the double-digit growth of our good growth of the export and also the import business on key brand in the overall import business.

Also interesting note, on the gross margins which we highlighted in the press release, our business is highly seasonal on the fourth quarter, even more so now that Russia's a little bit more than half of our operating profit and as that plays out here, you're going to see the gross margins jump even further up to 36-38% moving to the fourth quarter, which is our highest seasonality period, and certainly a highest profitable quarter of the year.

On the expense side, on the SG&A side, the company is doing a lot of work to take cost out of the business, as you mentioned before there was a 10% head count reduction across all businesses, RAG business excluded, the Russian Alcohol Group went further, went down 20% over the last five months you start to see that coming through in the Russian Alcohol Group more than apples-to-apples base in the third and fourth quarter.

Also we're doing a lot of work on logistics in Russia, in terms of getting tenders in place, banking tenders and just doing overall much more work on leveraging the size of our group in Russia, in terms of Russian Alcohol Group in getting better cost or rather key cost points.

Salary inflation remains close to zero; our last increase that we took in salaries was in the third quarter of 2008. So I think once you move into the third quarter and fourth quarter particular, you're going to see the overall like-for-like comparison even better. We're also seeing the overall cost pressures, as I've mentioned we have negotiated a quite good terms in this environment as well.

The market expense is in line with percent of sales, so if it goes up or down it's in line with sales and we're still investing at the same level behind our brands which also is helping our improve our market shares.

So really for all these factors we saw a very, very strong quarter. We felt significant improvement in really a tough environment and we're seeing improving operating margins from 10.2% a year ago to a 11.6% this year and again remember on the seasonality effect, where you really jump up in operating profit in the fourth quarter, where you're going to see that moving up to 17 and 18% in the fourth quarter and traveling to around a 14 to 15% a yearly operating profit up at least to 2-300 basis points over last year.

Chris, I'll turn it over to you know to discuss the key changes in the balance sheet.

Christopher F. Biedermann

Okay. Thanks Will.

Before we get into some of the general items, I want to highlight some of the changes that the consolidation of RAG has reduced this quarter, we saw a number of changes in our balance sheet and P&L driven by this first time consolidation in Russian Alcohol Group.

Some key highlights resulting from the consolidation group, obviously you have sales and cost now improved a full impact to drive through quarter (ph). Also as part of accounting this transaction we require to revalue our initial equity investments up to market value and which resulted in the gains of approximately of 430 million which is offset to goodwill, at the same time we took a write-off goodwill resulting in a non-cash gain of 206 million. It was backed out of our comparable EPS number.

Although as of today we only purchased a 52% economic stake line and now in Q3 additional 6% from the Russian minority investors. The accounting treatment is fresh that I view a firm commitment at fixed price at purchase ready stake line. We regard to treated -- with line as if we completed today. Therefore we have booked a liability for these deferred payments on our balance sheet.

These liabilities are core as long and short-term deferred consideration at a discount to reflects its inner value. Each period will accrue a non-cash charge reflect the amortization discount to the P&L. The new effects in our non-operating costs is a charge of 11.2 million this quarter. Also related to this, we've recorded minority interest on our transactions, and we have 91%. Our comparable EPS we've adjusted to this non-cash interest and the money interest reflect our true equity stake point of 52%.

All lines low P&L, EPS operating profit (ph) is primarily affect the quarter made positive impact from the translation of dollar and new liabilities which resulted in the 63 million FX gains due to the loss of the period. This impact is also adjusted for a comparable EPS.

Based on the comparable basis, net income was 18.6 million from quarter or $0.38 for fully diluted share and 22.7 million in '08 or $0.52 for fully diluted share. We'll see the main difference between the comparable income and our GAAP income as I've mentioned any FX impact, elimination of the non-cash gain and revaluation of that equity interest. The adjust accounts for actual equity ownership RAG which included the elimination non-cash amortization charge and adjusting the minority interest which reflected a 62% stake as compared to a GAAP 91% interest.

As these adjustments will change to derive the consolidation of our big numbers needed to complete, I'll be happy at some point you'll have to call, I am going to take some of the questions and follow-ups if you need further clarification.

Looking at the balance sheet, some part of the balance, business liquidity as Jim mentioned we had a 226 million cash from our balance sheet which is greater than the pull of our short-term bank facility at 76 million and since year end we've been negotiated with almost all of our short-term working capital facilities and always converted them to almost an entirely P&L or Zloty facilities as well as extending maturity to 2010 and beyond.

Our working capital as in balance sheet was stabled in the quarter and our cash flow from operations in second quarter is 66.7 compared to 7 million, estimate 700,000 last year. On a six month basis in our cash of operations, we have 67.9 million ahead of prior year which now includes a cash flow from the second quarter. During the first quarter which we didn't consolidate the cash flow from operations arrived as approximately 40 million again which is non-accretive number therefore on a pro forma basis, the operating cash flow would have been about 96.7 million for the six months of this year.

Our net debt at quarter is 905 million and our pro forma basis including the EBITDA from non-consolidated period for RAG and Möet Henessy joint venture, we would have approximately 3.4 times net debt to EBITDA. Our target is continued to drive this number down to a sub-three times net debt to EBITDA next year.

And let's turn it back over to Bill who will talk further overview of our planned activities.

William Carey

Thanks, Chris. Yes, as we look out in kind of what we're doing right now in the business and the recent equity offering both...but you know obviously we did equity offering recently two to three weeks ago that was very well subscribed to, I think its being quite successful. The main rates behind as was to buy all certain minorities, one which we announced on the press release, that we were completed earlier this week.

The buy of the 6% of the Russian Alcohol Group, I think there are quite attractive terms for the company. Also for the proceeds, a large, we used to buy to potent minorities is well you can get the liabilities hanging from the SPA equipment we find a year ago. And I think that as we remove the closure of this in the next few months, we will be able to really start to really plan and execute synergies certainly much faster by having better control of the overall business that really take advantage of the synergies which I'll talk about in the minute that can afford itself between the market producing companies of part of Parliament of Russian Alcohol Group.

On the brand side, we've been working very hard on re-launching as you know, our key number one brand in Poland Absolwent, our number five brand Polmos (ph), which we relaunch Polmos in May and Absolwent in June. Polmos what we are seeing in July is up over 200% in sales in July which we're very encouraged to see the really strong consumer interest in the new packaging of the Polmos product and Absolwent which we put on the market in June, and we're also seeing quite good results, its too early to say the exact numbers yet, we can probably come back in a month and see what the results are showing as you move it into the promotional period now with the little product but so far its been very well received in a market place, we're quite encouraged by the probably 1, 1.5% share pick up we think we can have from these re-launches.

Also in Russia, one of the key price points that we don't really operate in today, even though we're the largest market producer in Russia probably double anyone else, still the price points are missing in our portfolio, we only work with really four key vodka brands, Parliament in Jersey in the sub-premium sector Green Mark being a number one vodka brand in Russia, number two worldwide and then one economy brand. We're kind of we're missing is between economic and Green Mark which is middle mainstream. We're looking in lower mainstream as a certain big market share there, that we don't really operate is today and we're launching two new brands this fall, one by Parliament and one by Russian Alcohol Group that will be coming out this fall which we think will continue to add to overall our penetration in the Russian vodka space and certainly drive increased market share.

I think the overall vodka market also just started to coming off its lows, certainly in Poland we've already seen signs of it coming off its lows, as I was saying in the last few months, and I think Russia as we've been encouraged in the last few weeks, listening to retailers in the last couple of weeks, seeing our sales result; I think that we look at the fourth quarter, I think that you're going to see vodka markets start to pick up again in terms of coming off its lows and I think if we reposition our company suddenly with a greater market share, much lower cost base moving into 2010, I think we're very well situated for any consumer rebound in both of our key markets.

Where, as Chris mentioned, we're also very...we've been working very hard to improve the leverage ratio in the company. Certainly working in different times today in terms of leverage ratios, the 3.3, 3.4 number we achieved in the second quarter, we're looking to move that down in mid 2010 to below three and we think eventually giving down to 2.5 net debt position is certainly is where our goal is and we're certainly looking hard to reach that goal.

In terms of the synergies that we talked about, by taking out the minorities taking Parliament, it gives much a free hand, I think much like Carlsberg (ph), we're discussing already today as well as they were able to buy out their minority stake, they were getting much faster synergies through their business in terms of buying out some of the minority stakes. I think the same thing that we're anticipating as well as we move into the sales opportunities a problem we can have within the Russian Alcohol Group. They operate a much deeper level of penetration, the logistics the savings on certain head count reductions, their logistics opportunity in terms of combining product in terms of a bigger logistic infrastructure in terms of negotiating better logistic companies, warehousing, marketing opportunities, the whole back office head count as well. As you see there is a lot of opportunities here pretty easy opportunities much like we did in 2005 in Poland with two leading producers that we did a lot of early positive work on synergies in 2006, from those two acquisitions we made in 2005 and I think we're looking at least half of these synergies to come in 2010. I think over two to three years certainly feasible to achieve the full synergies out of these two vodka businesses.

What this means is that in terms of guidance, that we confirm guidance in our press release. 1.55 to $1.68 billion with 240 to 265 EPS and that's using shares, diluted share count of 52.5 to 53 million diluted share count for the year. Also because obviously currency is certainly a bit stronger than our internal forecast on currency today, but remember there are forecast for currencies on the full year and obviously the first quarter and second quarter the currency is not near the same level, as we have today, obviously there are some tailwinds here but I think rather than chasing currency, we've made it clear I think last quarter. We will come out into late 2009 or say in the fall 2009 with '10 guidance and also update 2009 guidance and see more currencies trading as you know quite volatile in the last six months. So we'd like to be more in the conservative side and just take a look and see where currency is and update guidance this fall as well as put out 2010 guidance.

I think overall, the company is very well positioned to enjoy any further consumer pick up I think as these markets started moving to positive GDP territory as well, I think we're in a very good position to move further in our business strategy of being a leader in fear factor and sort of certainly in Central Europe and further our position as a global producer number and number vodka producer. I will now open the call to questions, thank you.

Question-and-Answer Session

Operator

Thank you. The question and answer session will be conducted electronically. (Operator Instructions). And we'll take our first question from Doug Lane of Jefferies.

Douglas Lane - Jefferies and Company

Yes hi good afternoon everybody. Chris, do you have an updated leverage number for post transaction? I think you said coming out of the quarter at 33 or 34 times net debt to EBITDA. Is there any change now with transaction to that number?

Christopher Biedermann

We'll see it forward basically including the full period of Russian Alcohols on a trailing 12 months pro forma basis in 34 including all that to Russian Alcohol.

Douglas Lane - Jefferies and Company

And why don't you adjust -- okay, okay that's right.

Christopher Biedermann

Obviously factoring the equity proceeds it would come down.

Douglas Lane - Jefferies and Company

Okay, lets move on to the business Bill. You mentioned improving trends, we're almost halfway through the quarter here. What's your take, you think that we could see positive volumes as soon as the third quarter or is this really more of a fourth quarter kind of call?

William Carey

As we're saying, that we're seeing an improved trend in Poland. I think we're saying that we think that the polish market will come down in half in terms of 9 to 10% decline to 5 to 6. Obviously our aim is to certainly do better in the market place which we were able to do in the first half of the year.

The Russian market, we haven't see any pickup in the last say three or four months; its been pretty much at 10 to 15 % decline but I think as we move in to the fourth quarter, that we are anticipating some pick up, we haven't really focused our numbers but I think that talking to other companies in Russia and retailers, most of us are expecting some pick up in the fourth quarter moving in to 2010. But right now I think John the consumer is relatively soft in Russia and I don't see any new change right now, that's best not giving any worse either (ph).

Douglas Lane - Jefferies and Company

Okay that's good to know. And if I remember right in both Poland and Russia you were talking about value numbers that were better than volume numbers, is this price increases or is it favorable mixed shift?

William Carey

It's a little of both that your seeing, as you know we increase prices every year in both markets and as you remember that we price on top of sites (ph) re-price in the market place and we report financials we eliminate at sites, so for example as you know that 1 % increase in Poland, equate totally a 3% jump in the margin and 1 % in Russia is increase is roughly a 2 % increase in margins.

Douglas Lane - Jefferies and Company

Got it.

William Carey

And I think that there was a couple increases in 2009 or 2008. So you're looking at this year on a like-for-like comparison, you're seeing quite a big jump from volume to value because of the increases taken over the last 12 months.

Douglas Lane - Jefferies and Company

Okay, I got it. And then finally, you mentioned strong export numbers, is this mostly the Żubrówka or is there something else going on?

Christopher Biedermann

Yeah, there is a lot of things in export. We're quite encouraged that there has been a lot of new agreements signed in the last nine months for the U.S. market as we mentioned last quarter as well that for example the Petrone (ph), they bought this ultimate vodka here in the U.S. and we're producing that for them. There's been a lot of importers in U.S. that are using us as sort of -- pretty much what we're seeing is that people want to produce Polish vodka, where we saw the first one to come and see and we're still able to achieve very healthy 40-50% margins on this business. So we're seeing a lot of pickup also in Europe in the same fashion. So I think we're and Żubrówka also doing very well in France in a tough market environment still growing in France. We did a new bottle launch that we did in February, U.K is still growing. We have some good news out of U.S, which I can't really comment right now on, which should cannot soon on Żubrówka as we settle the trademark issue we had on the grass and the bottle issue, we settled that few months ago. So I think we are looking at the new development there.

And I think overall I think we're going to see the export market, even Parliament in Germany is doing extremely well, again in a tough environment growing quite nicely. Which ones is s bigger brand in Germany and I think Green Mark offers also a great opportunity as we move forward as well. So, we're quite encouraged by the overall export, even though it is a smaller base of our business but it is something that is certainly encouraging.

Douglas Lane - Jefferies and Company

Okay. Thank you.

Operator

And our next question comes form David Kraken of Downtown (ph). It looks as though David Kraken has no longer has a question. Our next question will come from Dan Wakerly of Morgan Stanley.

Daniel Wakerly - Morgan Stanley

Hi there, I have two questions please. The first one is I know we weren't got the 10-Q for a few days but can you give us a heads up on how 2Q sales and EBIT was split by country possible and my second question is if we had to saw that one of the reasons you continue to gain share in Russian vodka is that some of the competition is lets say in somewhat financially distressed. Has there elements of the competition? They are now experiencing more stable condition and therefore, other factors which are more important for you in terms of gaining share now? Thank you.

William Carey

On the first one Daniel, I don't have all those numbers in my head, I don't have it in front of me but I think certainly there were no surprises out of to say like that but certainly as a move forward, obviously Russia is going to take a greater weight and certainly the margin improvement in Poland as I mentioned, almost the 4 percentage point also but as I said, that very on the distribution piece being a lesser weight of the Polish business

Daniel Wakerly - Morgan Stanley

Okay

William Carey

If you look at the competition landscape in Russia, certainly the Ukrainian producers are still under heavy pressure in terms of financial pressure. I'm not really sure in terms of how their banks are working with them in terms of their issues. We're not seeing the same bankruptcies as we saw last fall with the initial crisis took place. I think companies are still under extreme working capital pressure. I think most people have sort of survived, lets say, the initial wave of problems in the last fall beginning of this year and I think people are surviving and operating. So we haven't seen a new wave of bankruptcies, but still there is still increase in pressure on while our competitors to really under working capital.

Daniel Wakerly - Morgan Stanley

Do you see the main drive of your Russian market share growth being sort of natural because of your positioning, so consumers just migrate into your brand for maybe pricing reasons or is it that your finance sale teams are doing a better job working the three factors of the company (ph).

William Carey

I think there's three factors, one is that certain factor that the competitive landscape is certainly under some financial pressure working capital, I think first and the second is on the brand equity that we have within Russia, they're still coming out on top of brand equity surveys in terms of the distribution coverage we have with the Russian Alcohol Group sales force being probably double anyone else or triple anyone else sales force in Russia in the spirit sector. It totally gives us an added reach in terms of we're making sure shop positioning, pricing et cetera is number one in the market place throughout Russia, not just in a few cities.

And I think the trademark in budget was pending roughly around 90 to $100 million of trade marketing span which is far, far more than the competitor spending not that we're over spending. Just that we're spending pretty much in line with what we're doing in Poland and what other companies do around the world. And I think this is adding in, that your people want to work with you because you are giving them opportunity to make more money with the trade marketing budget that we support in terms of sales percentage, discounts, power displays, merchandising displays et cetera.

So I think all those factors are certainly driving increased market share.

Daniel Wakerly - Morgan Stanley

Okay great. Thanks very much.

William Carey

Thank you.

Operator

And our next question will come from David Kraken of Downtown (ph).

Unidentified Analyst

Hi. Good morning, Bill. Just two questions. You made the comparison with Carlsberg in terms of the ability to drive margin having full control of the business. And I was just thinking about your numbers that we've spoken about. If you look at what based on disinvest versus loss with full control and despite volumes being down five. Their operating margin there are about 850 basis points? So using that as a comparison, do you think you're being quite conservative on the margin guidance that you are talking about, given what we've seen they can deliver and also a bit more that you want to have track ability for trade marketing with investment for launching new brands again so a greater market share. And the second question is just on the excise duty, just to re-clarify why there would be a such difference between the magnitude of the duty on increased on beer versus vodka

William Carey

Okay, yeah I think to the first question. Certainly the beer companies David are more advanced in Russia. Carlsberg having a 40% market share some thing like this in Russia versus our 19%, there's pretty big difference their operating leverage as well. But obviously as we've discussed in the past certainly as we move forward our business model. We certainly think there is a tremendous opportunity moving in the next two to three years are really moving up quite dramatically, the gross and operating margins of our business. The margins I talked about really were in the next really five months to the end of this year. So and as we move into the synergies, we really cant -- that doesn't really start in 2010, so its but as we move out to two to three years certainly out of our margin, at least its going to be quite dramatic in terms of growth and operating margin certainly in Russia.

Comparing its call, what I can't really say on percentages but certainly that there will be upside even more upside as potentially that we gain more market share is certainly is our aim. If we get up to a 30-35% market share here in the next three to four years.

In terms of your second question, if you can remind me?

Unidentified Analyst

Just to clarify the first. I can see, the other point I was making is obviously, there is price out in your Russia and -- lower cost and all the cost cutting that big companies are doing. But these margin numbers that being recorded at the annual report in your -- of very negative volume growth. Buying historical standards. The other point is, as in when volumes recovers sort of first stabilize when you actually get sort of volume growth. This should fairly be considerable operational leverage from that.

William Carey

No I don't think. There is no doubt. That's what I was saying I mean, maybe I was a bit conservative in my statement but I think that I said that the companies can be very well positioned. When the consumer does pick up in the markets to grow and your sectors that we operate in mainstream and sub-premium, we'll continue to take market share. Economy will continue to lose and mainstream will be a winner and as we continue to grow with our product portfolio as well as the new products this fall, that yeah, we're very well positioned to with a lower cost base, to where we start to leverage up the operating profit.

Unidentified Analyst

And the second question was just in terms of the events that you have a high degree of confidence of that the visibility of the excise duties for vodka and obviously the situation in beer with the level of increase that we're taking about are considerably higher and that's just more a catch up process, given the different alcohol content in the products. So is that the way you're sort of and vodka obviously has the size of the illegal market...it's sort of driven...

William Carey

Yeah. I have all the time analyzing the Russian behind the beer excise increase or lets say proposed excise increase, I'm not sure its confirmed yet on the beer increase but this is what we've been, what we heard from the government. But I'm not sure its head is down (ph) but I cant really answer on why the beer would be so much more than the spirit moving in 2010 other than that the beer market has grown faster over time than the percentage in the vodka market and maybe they want to tax the industry which is fresh from considerable growth overtime versus the spirits market that has relatively has not grown in volume, maybe in value but not in volume -- market also David in beer (ph).

Unidentified Analyst

Do you have any idea how much?

William Carey

And I think that's a big factor why the government is more concerned on spirit excise that we are saying before really any big excise increase on vodka just going to drive more people to the black market and that some thing that they really don't want where beer is not do any black market. So may be that's also.

Unidentified Analyst

All right. Thanks very much

William Carey

Thank you

Operator

And our next question comes from Natasha Zagvozdina of Renaissance Capital.

Natasha Zagvozdina - Renaissance Capital

Good morning and good afternoon gentlemen. I have a question although you have touched on this subject already about the Russian Alcohol Group environment, ferment in the second quarter in Russia, in Dutch and maybe some insights of what's happening in the third quarter. Bill you earlier said when you were covering first quarter numbers that, Russian Alcohol Group was showing quite strong double-digit below 20%.

William Carey

Yes.

Natasha Zagvozdina - Renaissance Capital

Yes volume growth and then it slowed down to 6 and 5 and 7% and volume in the second quarter. What I need to see in this third quarter of the year, we assume that the market shows a decline of more than 10% in volume still?

William Carey

Also, far we're seeing similar trends right now, so

Natasha Zagvozdina - Renaissance Capital

Similar in a way that if market is down 10%

Christopher Biedermann

... in the Russian Alcohol we really haven't seen change either, and Parliament the same.

Natasha Zagvozdina - Renaissance Capital

You mean no change in the interest in volume or no change has been slightly up in volume for Russian Alcohol Group, both?

William Carey

The reason I think for the decline in Russian Alcohol because the first quarter was a pretty easy comp, if you compare to the first quarter of 2008. Do you remember that we launched the Zlota (ph) brand, Zlota was launched back in 2007 and the brand really started to take off in the first quarter was a easier comp for the company to achieve and the second quarter was more difficult comp But certainly the market did slow down from the retail sales you saw in Russia the second quarter certainly slowed down from the first quarter. I think there was no difference in that in the vodka business. We didn't see a big change from first and second quarter in terms of overall market. That's only the Russian Alcohol Group with a reduction around 16 to 7% but again on 16 was on easier comp comparing a quarter-on-quarter this year before. So we are quite encouraged that from our data we're not seeing really I don't think any company really growing in volume in Russia.

So we're still encouraged by grabbing market share and also generating quite good cash flow from the lower revenue number we're starting as you saw that the $40 million in the first quarter of Russian Alcohol Group and good cash from the second quarter certainly, with a slowdown they're seeing very good liquidity.

Natasha Zagvozdina - Renaissance Capital

That part of my other question. You said that $40 million for our Europe, kind of estimate of the operating cash flow of Russian Alcohol and first quarter of this year, could we take the first half kind of pro forma operating cash flow of Russian Alcohol Group, it would give us $96 million. Is that what's...?

William Carey

No.

Christopher Biedermann

That was a pro forma number if you took you our reported cash after six months and added back in the first quarter cash flow number that that was not consolidated.

Natasha Zagvozdina - Renaissance Capital

96 would pro forma 40 this year or...?

Christopher Biedermann

Almost to CEDC for six months.

[Multiple Speakers]

William Carey

It also remember that we lost 30% of currency as well on the Zloty and Ruble in the first half of the year. So that 96 would have been much higher if you had stable currency.

Natasha Zagvozdina - Renaissance Capital

Right. And my clarification question was that we have in the second quarter, you have minorities assuming 91% stake in Russian Alcohol and now you're down to plus 6% prior to just 3% in minorities.

Christopher Biedermann

Well, 3% of minority after this recent buyout.

Natasha Zagvozdina - Renaissance Capital

But in Parliament you early said that...Pardon?

Christopher Biedermann

I'm sorry, go ahead.

Natasha Zagvozdina - Renaissance Capital

I'm saying that you haven't yet completed two buyout of Parliament minorities and that would be completed you said in the next several months. So we're assuming that you still have 15% minorities in Parliament in the third quarter. Correct?

Christopher Biedermann

Yeah, until any of the acquisition yes.

Natasha Zagvozdina - Renaissance Capital

Until the announcement comes, okay. Thank you very much.

Operator

And Mr. Archbold, it does appear to be at the time we have no questions. I'd like to turn the conference back over to you for any additional or closing comments.

James Archbold

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

William Carey

Thank you.

Operator

This does conclude today's conference. We thank you for your participation. You may now disconnect and have a great day.

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