Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Central European Distribution (NASDAQ:CEDC)

Q1 2010 Earnings Call

May 07, 2010 8:30 am ET

Executives

Christopher Biedermann - Chief Financial Officer, Principal Accounting Officer and Vice President

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

William Carey - Chairman, Chief Executive Officer and President

Analysts

Lukasz Wachelko - Deutsche Bank AG

Julien Martin - BofA Merrill Lynch

Vadim Kovshov

Victor Dima - OTKRITIE Financial Corporation

Douglas Lane - Jefferies & Company, Inc.

Daniel Wakerly - Morgan Stanley

Margaret Kalvar - Harding Loevner Management

Andrzej Knigawka - ING Groep N.V.

Operator

Good day and welcome to the CEDC First Quarter 2010 Earnings Conference Call. At this time, for opening remarks and introductions, I would like to turn the call over to the Director of Investor Relations, Mr. James Archbold. Please go ahead, sir.

James Archbold

Thank you. I'd like to welcome everyone today to CEDC's First Quarter 2010 earnings conference call. Joining me this morning are William Carey, President, CEO and Chairman of CEDC; and Chris Biedermann, 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, May 7, 2010. 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 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 Reform Act of 1995. Without limiting the foregoing discussions, 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 earlier today and 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 2010 first quarter conference call. There's a lot of information to go through today, so we'll jump right into it. I'll give you a brief overview on the economic data, and because there's quite a bit of accounting change for Whitehall, as well as the consolidation or the de-consolidation of the distribution entity, I'll take you through that. And then because of the guidance changes, I will take you through the top line and bottom line guidance changes, I'll sort of breaking you out to a better understanding of the break out of the top line and bottom line guidance changes, and then I'll give you to the business and the market and give you some outlook for '10 and also what's happening on some other things we're working on.

So I'll start off on the economic data. What we're seeing out of Poland is pretty stable on GDP, around 3% projected for 2010. Inflation, also, is fairly stable, looking about 2%, 2.5%. Unemployment is fairly steady at around 12.5%. Interest rates, we're not anticipating really any movement of interest rates, again pretty steady for a while, now around 4.25%. Obviously, with the sovereign debt situation, a bit of the equity sell off. Over last few weeks, obviously, the currency has moved quite aggressively, which has been unfortunate, but it has. The currency has lost around 12% to the dollar, about 8% to the euro over the last, say, three weeks. The government elections, because of the catastrophic event which happened with the President, the new government elections are scheduled for June. Again, the expectations is rather stable outcome of either winner.

If you look at Russia, GDP growth, again, is expected roughly in the range of 3% to 3.5% this year. Obviously, as we know, it was minus 8% last year. Inflation is looking a much lower number around 6% to 7% this year. Again, in the years passed, it was around 12% to 13% for the last few years. The unemployment is holding fairly steady. It's come down the last few months, but generally holding pretty steady in the 8.5% to 9% range. Base interest rates have continued to come down. It's been down about 300 basis points over the last seven months, and most projections are anticipating a further roughly 50 to 75 even up to another 100 basis point move before the end of the year.

The currency, which was rather stable and certainly even over the last three weeks has remained more stable than certainly the zloty. It's down about 4% over last, say, three weeks on the dollar and down about 1% on the euro. So nothing really significant on the euro and zloty, which is important for us, certainly for our Import business because we import a lot in euros.

Now getting into the significant changes in our reporting, I'll let Chris give you a little more color later on that as well, but overall, if we first look at the Distribution business, I think most of you knew, with the selling of this business, this would be put in a discontinued operation line, which it now is and will be until the sale, potentially sale process to be completed in July or even -- probably July is the best date.

The second major change that we have was the new accounting rule that came into effect, the ASC 810. That's a new adoption, a new accounting change from January 2010, and that change is effectively saying that on a minority investment or equity investment, you need to show that you have effective management control and that you have significant influence on all key management decisions. We do not have that in line. We do not effectively have significant influence on all key management decisions, so discussing with price, we're not able to consolidate until we buy out the remainder of that stake. This is currently accounted for in the equity line. Obviously, there's no impact on our net income or EPS, but there is certainly line item changes above net income because it's not there, it's sitting in the equity line. It's the full number.

Now, on the Whitehall business, they're currently putting Poland in place for 2013 to buy the remainder of the stake. We have been looking over the last four to five months to speed up this, we would like to take control of this earlier. We have been in discussion with Mr. Kauffman over this period of time, which we are currently discussing about moving this up. We're hopeful that something can be done. Approximate value, for your information, would be a range of around $60 million to $70 million to buy out the remainder of the stake to effectively take control of this earlier, which obviously then we would also consolidate. But that's not the main issue. Consolidation for us is we believe that with what we have in Russia today and having management control now with our full business [indiscernible] having that integrated now from the second quarter, we're ready really to take control over the rest of our business in Russia as well.

Now, because of significant changes on the guidance on top line and that had been on the bottom line, I'm going to walk you through. I'll sort of walk on that so you'll have better understanding of what we're looking at. If you look at the top line, we had a midpoint range before, $1.85 billion. The Distribution business is reducing that by about $675 million, but then we have a pickup of intercompany sale, that are not anymore intercompany, it would be third-party sales from our production company, but I think it's about $100 million. So the net effect of that is about $575 million reduction from the $185 million. Also, within the Whitehall company, that's roughly around a $200 million business, so between those two numbers, that's $775 million, which gets you down to $1.75 billion net revenue number.

Now because the FX moved and we believe it's prudent in today's environment to use more of today's FX in terms of forecasting, the FX move on top of this is going to lose another $55 million and around $45 million more coming from softness that we're seeing in our overall vodka market that I'll get into a little bit later. So the 10 75 minus $55 million FX minus $45 million, a bit softness in our top line, you're getting down to a 9 75 midpoint, and that's the number you see in our guidance, that's around 9 75 midpoint in our top line guidance.

Now, just to add some comments this morning that we've been a bit aggressive on the currency in terms of taking too higher currency, but again, I think that what we see in the marketplace on these sovereign issues, I think it's better from our side to be updated on the conservative side, and as the currency comes back to a stronger level, the ruble and the zloty over the next period of time, that's great. And we'll be more than happy over time to look at increasing. But I think right now we'll view more of it -- err more on the conservative side.

On the EPS, we have $2.56 midpoint in our previous guidance. Because the distribution asset is going out, which we are generating, as you recall around $21 million of EBITDA, that's before about $19 million EBIT or operating profit. And then if you lose some currency on top that, then you're getting down to about a $0.15 dilution. But again, this is coming from the fact that we are just using the cash coming from the distribution assets currently in our business model just on a normal cash return sitting on the bank deposit. Obviously, we'd be looking more aggressively with this money. We used this money for a better return of capital, and certainly some of that money to be used potentially if we're successful with the number of acquisitions. But currently, that $0.15 dilution is just assuming a normal bank interest.

Also on the currency, if you take the total currency impact, you're looking at around a $0.16 dilution from the numbers that you saw that we've changed our currency guidance, which was a bit over 10% on the zloty and around 3% on the ruble. And then the overall business, as I've said before, the $45 million top line equates around a $0.10 EPS hit in the overall EPS. So $2.56 minus $0.15, $0.16 and $0.10, beginning to the midpoint of our guidance of $2.15. Now again, back on this distribution assets, you also must remember that this is giving us a much stronger balance sheet, which you don't see today in our numbers, but that's moving down our net debt ratio down from 4.7, down to around 4.1 total fee selling of this business in July. That's down from, as you recall, 5.7 million back last fall. That's moving all the way down now to 4.1 and again, we are very committed to reduce overall leverage ratios in the short to medium term.

So I hope I gave some clarity, and I'd certainly open up to any call afterwards and if you have any questions about that. But I believe that I gave you a fair walk of what we're expecting on the top line and bottom line.

Now getting into the first quarter, overall in Russia and Poland vodka markets, we saw roughly a 7% to 9% drop in both markets. They're both very similar. Also we saw the consumer is still have not recovered fully, and we saw a continued trend of their participation in the value sector, which we are not that strong with overall bucket portfolio. We have very limited portfolio in Poland of the value sector, and in Russia, we do have the number one value brand, which is doing quite nicely, but certainly that's the best mix for our most favorable mix. We do anticipate recovery in the second half of the year, a slight recovery and probably a better consumer recovery coming in the first half of '11. I think some people expected there will be faster consumer recovery in second first half '10. To be honest, I think what we're looking at is more first half of '11 for a faster consumer recovery.

If you look at the Russian market, overall, our share has slightly improved in the first quarter, but again, that we didn't have the most favorable mix, and at the same time, pricing that we are taking in our business model of Poland and Russia, were not taking pricing increases until the end of the first quarter. So we didn't really see any pricing uplift, but we will see that coming in the second quarter as we took price increases as part of our business plan in the back end of the first quarter.

If you look at the overall Polish market, it's in a very similar situation to Russia. The consumer trend in Poland continued down the value sector. Again, we have a limited portfolio there, and we did lose a little bit of share because we don't participate there very much. And again, pricing, we didn't see a lot of pricing opportunities as we didn't put pricing in until the end of the first quarter. The imports remained relatively flat in value, which also reflected volume because there were not any price increases on the imports. The exports were up 35%, over 35%, but again, coming from a small base, but we're very encouraged by the continued opportunity with the overall export market especially with the new Remy contract coming up in July.

Our aim in Poland is to get back the market share or enter Poland with a new product launch and we want to put much more effort in Poland in terms of increasing our market share, which was down to about 26%. We want to move that up to 28%, 30% share in the next two years. So we're very committed to get back market share in Poland over the next 24 months. We've seen cost of goods in our core markets fairly stable. We don't see any inflationary pressures at all. We actually see some extra benefits coming from better purchasing opportunities in Russia from our core raw materials.

Our SG&A, we've done a great job on our SG&A. Certainly, that were offsetting some of the weaker top line, but we improved SG&A in both of our markets, Poland and Russia by over 15% versus the prior year in local currency. So a very, very strong dynamic in terms of our streamlining of the business that we've been putting forth. At the same time, it doesn't take into account the synergies that are yet to come that really got started in April coming from the Parliament and Russian Alcohol Group integration.

Translating all that down to operating profit, we saw a $26.6 million of operating profit. Again, that's versus the $12.3 million last year. That $12.3 million do not include Russian Alcohol Group which had $9.7 million. If we include Russian Alcohol Group, it's really $22 million to compare apples to apples, $22 million versus $26.6 million, a like-for-like base, which is about a 27% increase. Of course, there were some currency gains on that, they're really on a like-for-like base, it was a 4% to 5% increase in stripping out currency gain on operating profit. So all in all, it wasn't so bad considering overall, it was a pretty tough operating environment. I'll now turn it to Chris, who'll take you through a bit on the operating income as well as the balance sheet.

Christopher Biedermann

Thank you, Jim. Looking down further to our P&L. In the quarter, we had interest expense in the quarter of about $25.7 million compared to $9.9 million last year. This increase reflects the impact of a financing we did last year, where we issued new bonds to purchase that remaining stake of Russian Alcohol Group. Also included in non-operating income and expense is the foreign exchange rate gain of $34.9 million and this is primarily applicable to our USD and euro long-term financing as the currency expected on the quarter. Additionally, we recognize a $70.9 million charge, which is related to our earlier payment of our euro note of EUR 245 million that were due 2012, this includes the 4% call premium as well as the non-cash write-off of all the prepaid financing costs.

The equity earnings line [indiscernible] 1.8 million represents our proportional earnings of the Whitehall Group, which is still a little early as to change from a consolidated entity to an equity accounting. [indiscernible] on a GAAP basis was $11.5 million. That excludes the impact of our discontinued operations of the Polish Distribution business which translates about $0.17 full diluted earnings per share, and if you eliminate some of the one-off itemsincluding FX gains, the loss of earlier payment of our bonds and from the restructuring cost in Russia related to our integration of Parliament and RAG, our comparable net income is about $454,00.01 per fully diluted share. We reported separately the results of our Distribution business, which tend [ph] to be fully diluted here the discounts and therefore is recorded in discontinued operations, which has a of $34.9 million. The summary includes the goodwill impairment charge of $28 million. The remaining losses and net unit were driven by restructuring clean-up effort as compared to business for sale.

Now looking at the balance sheet. Again, a lot of changes in the P&L as we noted. Some highlights of the balance sheet and as still noted earlier, post December and March numbers have been adjusted to reflect both the deconsolidation of Whitehall and the treatment of the Distribution business as a discontinued operation. This reflects in the balance sheet the form of the full value of the Whitehall investment recorded in long-term assets, in equity investment line, and for Distribution, this condensed line in each category of the balance sheet, which means in current assets, non-current assets, current liabilities, non-current liabilities, is a one-line summary that reflects the respective positions of the balance sheet from discontinued operations.

Turning to leverage. Net debt as of the end of the quarter was approximately $1.3 billion, but [indiscernible] EBIT is approximately $255 million, bringing their net debt EBITDA ratio about 4.7x and an EBIT interest coverage ratio by 2.8x. So we continue to focus on lowering our leverage and anticipating the continued strong cash flow generation. With the sale of Distribution business, we can reach the objective 2.5x net debt EBIT for the first quarter of 2012 and we believe all this is also going to improve our viewings by the credit rating agencies as this is a key point going forward in deleveraging and bringing down our debt.

For the quarter, reported operating cash flow was 33.2 million compared to 4.8 million usage last year. But this is factor in the approximately $7 million that Whitehall Group had in Q1 that we're not consolidating. Have you had this? We have operating cash flow approximately $40 million for the quarter. The primary driver we saw on cash flow this quarter was collection receivables, which generated approximately $151 million of cash inflows for the quarter. I'll now turn over back to Bill for an overview of our planned activities.

William Carey

Thanks, Chris. We'll touch a little bit on the Parliament integration. We are continuing on track and we're looking to complete the integration next month. And while that is streamlining headcount, which a lot of that started in April, a bit started in the first quarter, but most of that came in April and will be continuing through June. Also, we're getting a lot of leveraging purchase synergies coming again in the second quarter, and still on target for the $10 million to $15 million of synergies that we are looking to achieve out of this initial streamlining of the business and purchase synergies. And then of course the second part coming from potential asset disposals, and also coming from the increased distribution push that we can get through the Russian Alcohol Group, which we're all going to start to seen in April. We saw very good results in April coming from Parliament business again that is now more integrated to the overall RAG sales organization.

Also, on new product development, we are still on track to launch two new vodkas for the second of the this year, one in Poland and one in Russia. Again, this will be the mainstream sector, but we're quite encouraged by what we're going to be able to achieve out of this. At the same time, that we are still on track on our brandy development. We're launching a new brandy, this is one of the biggest brandy markets in the world and our aim is to have 10% to 15% of this very fragmented market by year three in the Russian market.

The export. We've continued to develop the overall export structure. One, we've opened our own subsidiary in Ukraine in the first quarter. We started to see sales in the second quarter, quite aggressive sales, I have to say. And we are looking for a 1 million cases in year two, that's up from 250,000 cases we did in the year 2009. Also that we were able to get a new agreement with Remy. Remy, one of the top spirit companies in the U.S., certainly working in key on-premise channel in the U.S. They're very enthusiastic, the whole team on the Zubrowka on our launch with them, which they should be putting out in July on the launch in the U.S.

Also as we said before, we're streamlining our export team over all and we are putting three structures in place, European, Russian and North America. And that will be completed in quarter two. Also on a smaller note, our RTD business in Russia is doing extremely well. We're looking at growing that business from around 3.5 million EBITDA to about 6 million this year. I have to say, in giving difficult environment of the RTD business, you have to give certainly tribute to our management team, they're doing an excellent job of growing that business.

We're still looking at some asset disposal that we talked about before, very productive assets. We will have some more color on this in quarter two call. Also on the Russian side, on the Import business, the Whitehall business, trading environment is certainly much better than it was a year ago, where we saw a lot of inventory in the marketplace in October from December '08, but we unfortunately face one key issue change in the first quarter that was now rectified, but the government changed the licensing agency for import licenses. And everyone has to get new import licenses, and that caused a lot of problems on various importers and we were not immune to that, and various importers have added stocks in Russia, and we did as well. We lost probably anywhere from two to four weeks of sales. The problem is fixed now, and we can see that also coming through our April numbers, which were up over 40% versus last year, but unfortunately, the first quarter, it wasn't, even though the trading environment was better, it was unfortunate that we lost this two to four weeks of sales.

The distribution sales that we are progressing with, the application was filed to antitrust about two and a half weeks ago. We're discussing daily with Eurocash on the overall business going forward with our distribution agreements as well in terms of benefiting the best for both parties. And again, the whole process should be completed by July depending on the antitrust permission, but we're anticipating some time in July.

Also on the M&A front, we were chosen to participate in the second round of the Nemiroff financing. We're currently conducting due diligence. Again, we think there's a great fit for overall portfolio and market leverage, tremendous synergies between our group. Certainly, but on the same side as Chris mentioned, we're very committed a reducing our debt ratios. At the same time, we're not looking to put certainly any type of dilution that we saw last year coming out of equity offerings. So we're very committed to look at this asset, but at the same time we're not going to overpay for this asset, as I said in the last call and again, that it must be accretive in year one to earnings. And I think that the overall process should be some finalization of this process should be more clear in quarter three of this year.

On the Russian government regulation, there's been numerous articles put out over the last few months on what's happening on the government regulation. Obviously, the 200% excise increase on beer, obviously, it's not helping the beer market very much, but if we look at the vodka market, the minimum price that they put in, what we're seeing in the market place, generally, is more cheap vodka coming in to the official channel. We're not seeing the black market -- we're seeing the black market reduce a bit, but really only in the very cheap end. The government is also stepping up their control over raw spirit manufacturers, beer producers and retailers, and they also, in the last few weeks, had put a new concept of putting much tougher imprisonment on those offenders that deal with black market, which we think is all good news. They've put some new procedures in to obtain excise strip stamps to make it much tougher to obtain excise stript stamps for the companies that are not very transparent, that make it more difficult for them and again, we think this is good news, overall.

And there's many other small things the government is doing, which I really won't go into. But overall, what we're seeing is that the government is very adamant about reducing this black market percentage. The effect that we're seeing so far is really only on the cheap end, and it's not success yet, as evidence from the market is still showing declines as I mentioned earlier. But I think over time, this will have a positive effect over the next one to three years and I think this is all good news.

If we look at kind of the outlook that we're looking for the remainder of this year, and into '11, but we're looking for markets generally to improve slightly in the second of '10 and should be trading out weekly to consumer to have more of a trading-up from their current trading pattern into the first half of '11. We believe our company is well positioned with our portfolio, including the new product that we want to launch to benefit from some consumer change as they move into more of a mainstream subpremium portfolio. We've been very aggressive on streamlining the company, and we'll continue to look at taking out cost savings out of the business on top of the synergies that were related currently from the Parliament and Russian Alcohol Group integration.

The distribution spin-off, yes, there is some dilution there, but positioning the company as a brand owner importer accelerating the deleveraging of the company and really position the company and getting a better capital return utilizing these cash. If you look at quality asset, like something like Nemiroff. We believe this is the right way to go as a company, and we believe looking back years down the road this will be looked at as a very important and right step for our company.

So yes, we believe the company will be very well positioned in two years time. The company will be looking at continued strong cash flow, a conservative maturity profile of a debt restructure we did last fall, and we look at the potential given the potential of dividend, share buyback, bill keeping and leverage ratio and the 2.5:3 net debt leverage ratio. As we believe, as the consumer comes back, we believe, again, that we are very well positioned as a company to benefit from this medium to longer-term outlook.

Thank you. I'll now open the floor to questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll hear first from Doug Lane with Jefferies & Company.

Douglas Lane - Jefferies & Company, Inc.

The softness in the first quarter. I mean, I understand it's a seasonally-small quarter, typically anyway now, even more so with Russia, but with any other sort of unusual events in the first quarter and then towards that end in the second quarter here, will the tragedy with the Polish government impact business in the second quarter?

William Carey

Yes. I think generally, Doug, I think, no, we didn't see anything else other than what I've mentioned on the Whitehall company was unfortunate on the import license, the change of the import agency. But again, that's been rectified, and we're showing strong results in April. But yes, that was a sort of a one-off event in the first quarter that impacted -- you saw the equity line negative on Whitehall. On the President, here in April, yes, certainly the week of mourning here, that certainly there was some softness in the market during that week. The markets come back fine, it was a good finish up in April, but yes, there was some softness for that week of mourning here in Poland.

Douglas Lane - Jefferies & Company, Inc.

Now I would have figured there would've been. Would you update us on -- you mentioned a $10 million to $15 million in synergies is on track from RAG-Parliament combination, what you think the total synergies could be? And when do you think it'll be able to read them?

William Carey

Yes, I think that we're looking for the $10 million to $15 million synergies coming from an annual base this year obviously, from an annualized base a little bit more. Now we're looking at the next wave of synergies. One, we're looking at around $4 million to $5 million coming from the Parliament, increased distribution gains coming from the Russian Alcohol Group sales force, the bigger sale force pushing Parliament. We're looking at a 10-point pickup in the distribution reach of Parliament throughout Russia, which is still a bit -- it's currently, I think, is around low-60s, mid-60s where Green Mark is up around 90%. We're not looking to get to 90% but certainly, we believe Parliament can get around 75% distribution coverage, which will be coming in the next six to nine months after June. And also that we do have the opportunity, one of the asset disposals, which, again, I can give you some more color on that but that's other about $8 million or $9 million, but that says to be coming from that asset disposal pickup. But we're certainly right in the middle of the whole project so I can give you some more color on that in the August call.

Douglas Lane - Jefferies & Company, Inc.

Does that mean one of your production facilities or are you talking about something else in the asset?

William Carey

Yes, we're looking at one of the production facilities.

Douglas Lane - Jefferies & Company, Inc.

So that's still to be determined at this point?

William Carey

Yes.

Douglas Lane - Jefferies & Company, Inc.

I guess lastly, and maybe it's early days but what do you think about the timing of being able to do something with Whitehall? And how does the LVMH agreement play into that?

William Carey

Yes, certainly that the LVMH is certainly important in the overall discussion and they are part of the overall three-way discussion ourselves, Mark Kaufman and Moët Hennessy. So there is a three-way discussion going on. So yes, certainly that any decision would be taken would be in the best interest from all parties.

Douglas Lane - Jefferies & Company, Inc.

It sounds like the LVMH though is at least warm to the idea and so you could possibly hook up something sooner rather than later. It's not going to be a 2013 thing for sure?

William Carey

Correct.

Operator

We'll take our next question from Margaret Kalvar with Harding, Loevner.

Margaret Kalvar - Harding Loevner Management

I just wanted to probe a little bit more on the consumer behavior in terms of their trading down and then relative to your comments to see the minimum price actually resulted in more cheap vodka coming into the official channel at a time when indeed the consumer was looking there more anyway. Was that a significant -- was the impact of the more cheap vodka coming in more significant or was it simply the consumers' trade down? And do you think that this is going to be a trend going forward? Because we've been looking for positives from the regulation and this seems like it was a little bit of an unexpected negative impact, may be short-term, but that's what I'd like to know...

William Carey

No, I think generally speaking, if you think about the black market to begin with, they're looking at a black market that is generally in the very cheap -- they're looking at an 82-ruble way of starting economy-priced or value-priced vodka. If you had black market you can buy out in the kiosks out in the different areas for 50 rubles to 80 rubles. So obviously if you were the consumer and if it's changing, then you're going to be looking at the minimum price of 80 rubles, you're going to be looking to pay 80 rubles. So some of that black market, there was more production coming, some new producers came online that were probably operating before in that other channel and now came in and are producing this lower-range vodka for that 80-ruble price point. So for the consumer, relatively they're just switching a bit from the black market to the legal market, which we pretty much anticipated. And really, until you don't go down into a deeper level of reduction of the overall black market, you'll start to see some more positive impact on the mainstream because it's not only black market is multi-economy but also there's a lot of counterfeiting of mainstream and stock premium as well. But the initial look that we've seen for a few months, like I said, is still early days but we're seeing the initial benefit has come from the lower end, which is not a surprise to be honest. And for the overall consumer trade down, they started to trade down last year as you recall, and we have thought that maybe they could start to move back up a bit but what we're saying is a continued sort of purchasing level in the overall value sector. Probably, I can tell, I think, we're looking for a slightly improvement in the second half of '10 but any bigger improvement not really, probably coming into the first half of '11.

Operator

We'll move next to Vadim Kovshov with Discovery Capital.

Vadim Kovshov

A couple of questions. Number one, and I missed the part of your presentation at the beginning and I like to start with the effects of security on your business. Would you mind going at how it affects the future work on the income statement and balance sheet right now, considering after the consolidation?

William Carey

As written in the press release, our business now without the Distribution business will be roughly, if you're looking at a net income basis, about 70% weighted Russia, 30% weighted Poland. So you just got to put the exchange rate movement proportionally to that 70%, 30% split. And that in essence, on the net income line that essence gives you your reduction or benefit from any FX movements according to numerous parties [ph] (48:05)...

Vadim Kovshov

Right, but significantly, more of your overheard is in Poland right?.

Christopher Biedermann

Not necessarily, no.

William Carey

No, not with the Distribution business going out. It's post-Distribution business.

Vadim Kovshov

But when you said the 70%, 30% split in your business, is it everything? I mean, is it fair to say that this is because of the top line [ph](48:36)...

William Carey

Yes, that's all in net income line. And that incorporates everything our net income line.

Vadim Kovshov

Another thing and I might have missed it at the beginning, as far as the distribution is concerned, you haven't closed on a deal yet, right?

William Carey

We have a binding agreement in place...

Vadim Kovshov

And when do you expect to close...

William Carey

It should close in July, yes. It's about a $20 million penalty to walk away.

Vadim Kovshov

Another thing is I think what's happening with Whitehall is -- my impression is that it indicates a little bit of an EBIT change in strategy or change of circumstances. And honestly speaking, I don't understand what is going on because my impression was that you wanted to bring it under your management control, and instead, right now, you'd be consolidating it and bring it on an equity line.

Christopher Biedermann

Yes, that has nothing to do with our strategy, that's purely a new accounting pronouncement taking place January 1. The old model is based upon who's the primary economic beneficiaries. They're the ones who consolidate. A new model came in place and said it's really pure control-based. It was intended actually to capture more to make people consolidate more into these, to saying if you have control on what you do, but in our case it actually worked out with it. As you know, we have a 49.9 voting share that's been consistent. We are looking, as Bill mentioned in the call, to trying to -- since you buy that earlier. But until we can demonstrate that we have significant control over the key management decisions, we really aren't able to consolidate it. So it's really for the accounting pronouncement rather than that. It's not saying we want it to go, but it is what is and you can't really.

Vadim Kovshov

And would you be able to give us more color as to when and how you'll be able to do it? Or is it too preliminary?

Christopher Biedermann

Well, I think as Bill mentioned, we are in three-party discussions right now with Mr. Kaufman, as well as in MH, Moët Hennessy. And if we fail to try and reach an agreement, we would like to try something earlier. But at this point of time, it's hard for me to give a concrete date.

Operator

[Operator Instructions] We'll hear next from Victor Dima with OTKRITIE.

Victor Dima - OTKRITIE Financial Corporation

Question on the volumes in the Russian Vodka market. How are you doing compared to your main competition? Are you gaining market share? From main side, are you losing market share to it? And if you're losing, who are using it to?

Christopher Biedermann

In Russia, we see our volume shares up slightly. But we've seen, as I said, the overall markets were down significantly. The build notice 79%, within that, we've seen our share rose slightly.

Victor Dima - OTKRITIE Financial Corporation

Where would you put your market share? And how in Russia in terms volumes, value, whatever it is?

William Carey

It's still around the 18.5% to 19%.

Victor Dima - OTKRITIE Financial Corporation

And how are the small regional producers are feeling and are gaining market share from them? Because they're still feeling, sort of, they're still fairly weakened out to manage probably crisis, and sort of going out of business, many of them. Are you seeing the opportunity there by using this opportunity?

William Carey

Yes, absolutely. We feel over the medium term that a lot of small producers are really going out of business. It's just a matter of time before you still see the consolidation of benefit that we see out of our business in Russia. From a consolidation opportunity of having less players, having more market share for to date is still fragmental with all the small producers. And these small producers, as you very well know, are operating in the lower value sector. But they are staying alive because of the sort of short term, because of the sort of trend that's happening right now. But you cannot sustain any type of business model operating in that environment. And we believe over the medium term, these people will step-by-step go out of business. But it's not a rush to the door right now, but it will be over -- we're looking at a three- to five-year period, there's to be substantially less of these small regional producers in business.

Victor Dima - OTKRITIE Financial Corporation

And just on the market weakness, you mentioned that the markets are down in 7% to 9% in the core markets. If you talk about the Russia, does your estimate include the black markets or that's purely the legal markets?

William Carey

That's purely the legal markets.

Victor Dima - OTKRITIE Financial Corporation

You mentioned and I might be wrong, but you mentioned you're planning to increase your market share in Poland in Vodka?

William Carey

Yes.

Victor Dima - OTKRITIE Financial Corporation

By how much? And do you know how exactly do you plan to do this?

William Carey

Yes, one is that we're looking about 26% today, I think 25.8% today and we're looking into increase that 28%, 30% over the next two years. One is we have a major launch coming up in a major mainstream project that we're coming out in the second half of this year. I can't give you a lot more details on that because I'm sure our competitors are listening. But also that we are going to be more aggressive in the traditional trade channel. With the distribution spinoff, we're going to be hiring more developers in the marketplace to attack more aggressively in the traditional trade channels as well, which is still the bulk of this market. We are all very well represented in some of the other channels. But the traditional trade, we need to be much more represented there and to be more aggressive on that channel. So that's really the two main drivers of getting that market share up.

Victor Dima - OTKRITIE Financial Corporation

And you also mentioned that you're planning to launching up a new brand in Russia towards the end of the year?

William Carey

Yes.

Victor Dima - OTKRITIE Financial Corporation

Where would you put it in terms of, like, divisioning? Where the mainstream?

William Carey

It will be positioned between Green Mark and Zhuravli.

Operator

We'll take our next question from Julien Martin with BofA Merrill Lynch.

Julien Martin - BofA Merrill Lynch

My first question would be on the, I think, $65 million or $45 million of softness being built in the new guidance for this year, and maybe you can go from that figure. And basically, what kind of assumptions in terms of maybe volume growth and value growth in the Poland and Russian markets that's being built for the remainder of the year? That's my first question.

William Carey

Generally speaking, we're looking at the markets to recover a bit in the second half of the year, probably getting down to anywhere from flat to 2% down. We're estimating more in the second half of the year. In the second quarter, it slightly improved from first quarter, probably down about 5% or down in the second quarter. On the overall...

Julien Martin - BofA Merrill Lynch

That's in value or in volume?

William Carey

That's in volume. And because we are taking some price increases through as well, you will see some opportunity on some uplift on the second to fourth quarter on more value because of the price increases as well.

Julien Martin - BofA Merrill Lynch

And price increases are in the range of, what? 5-percent something?

William Carey

No, the range is about 2% to 3%.

Julien Martin - BofA Merrill Lynch

And in terms of deleveraging target for the end of this is charting, following previous guidance, you were expecting mid-3, sort of 3.5x EBIDTA by the end of this year. What would be the new target if we include the deconsolidation of Whitehall but also the sale of the Polish business?

William Carey

We would still include Whitehall first in EBITDA. With a decrease of the business, a slightly decrease -- it might go up maybe 10 basis points, maybe 15 but not much more than that.

Christopher Biedermann

Probably, in the mid-3 though.

William Carey

So targeting mid-3s?

Julien Martin - BofA Merrill Lynch

And so in terms of Whitehall, does that company distribute a dividend to you?

Christopher Biedermann

Yes, it does.

Julien Martin - BofA Merrill Lynch

So effectively they distribute what, 50% of the earnings or more than that?

William Carey

90%.

Julien Martin - BofA Merrill Lynch

Can I ask you if you hedge the proceeds or the likely proceeds you would get on the Polish Distribution business? The $400 million?

William Carey

We did not hedge that given the uncertainty. However, we specialized it as far as to hedge a certain position like that. But a reasonable thought, we did not hedge.

Julien Martin - BofA Merrill Lynch

And maybe if I can try this question, on your compensation structure, obviously, you are, I think, strongly biased as well to delever the business with bonus and stock options being based on net debt EBITDA. Can you share with us, maybe not obviously the exact figure, if you can, that's wonderful. If you can't whether that's in line with your deleveraging target for this year and Q1 '12 as well in terms of 2.5x in the net debt EBITDA.

William Carey

Yes, I think that the Board is taking a very aggressive look in terms of making sure that we're compensated on the two items that mean really the most for investors, and that's certainly EBITDA, performance and cash flow. And that's something that we are bonus now about half on the cash flow and half on EBITDA. So for us, yes, it's important but for us it's more important as a businessman. Not necessarily make or break my bank account, the bonus [indiscernible](59:24) or not. But for me, it's important for the business that we move the business in the right direction, and that's eventually moving into -- it's down the road but our RA eventually, longer term is invested in a great company.

Julien Martin - BofA Merrill Lynch

And I'm just proving probably on the dynamics on the Russian vertical market, I'm just wondering why you wouldn't try and move down yourself a bit more towards the economy segment? If long-term, you think the black market with this minimum price would be moving towards the minimum price, this is a significant amount of people possibly moving on to this part of the segment. Wouldn't it make sense to try and build up a little bit more presence in that area for you?

William Carey

A bit of problem is that you have -- once you get the lower 100 rubles shelf price, there's really not any money from a producer standpoint to be honest. We have the number the one value brand today. We have Skyy, which is growing very dynamically, which, okay, that's what the market is dictating today, but still we don't want to load up the truck with -- load up our business model with products where we don't make any money with. You lie to your working capital, taking receivable risks, et cetera, et cetera. And we honestly believe that the consumer will come back. It's not going to remain forever sitting down at a value sector. We believe that they will start to improve in getting back to a more normalized mainstream sub-premium growth. And yes, maybe the economy sector grows as well with the decline of the black market. But if you ask me that in three years and the market is still the same, we might have to relook a bit. But right now, we don't really see, really, the need to do any aggressive push into something that we really not going to make much money with down below 100 rubles.

Operator

And Daniel Wakerly with Morgan Stanley has our next question.

Daniel Wakerly - Morgan Stanley

On the 7% and 9% decline in the market volumes, as you say, is better than it was last year. I understand the point about mix in the market, but obviously, the volumes are down. Why? What's the fundamental reason? Are people cutting back on consumption? Or is there still a switch from legal to the illegal market?

William Carey

I think, Daniel, we don't have a lot of clarity right now seeing the day on this whole black market change with the government regulation. But as I said before, I think we need to give a six to nine months to really get a good look and handle what's happening in the overall marketplace. I think today, it's just a snapshot. These changes came in January, some retailers didn't even put them in until February. So it's a bit early for us to get a true picture on what's happening with the overall black market versus official channel and what's really happening with the overall consumer.

Daniel Wakerly - Morgan Stanley

Is your gut feels that consumers might still be consuming similar amounts of vodkas before? And it is a switch, I mean if you're seeing like a lot in terms of people cutting back in consumption.

William Carey

Yes, again, I think we can get some more color, and all I can see right now is still early to give a best guess on that.

Daniel Wakerly - Morgan Stanley

In terms of the EBIT, which I think was close to $27 million in the first quarter, can you just tell us what the Whitehall and the Polish Distribution EBITs would have been so that we can sort of see what the EBIT would've been if it had been sort of fully consolidated?

Christopher Biedermann

We had given on a full year basis, and we can basically see, on a full year basis, what the impact is. It's in the press release. In Q1, it still mentioned in Whitehall, we had some issues that it was relatively flat, if you will...

Daniel Wakerly - Morgan Stanley

Sorry, I didn't catch that. On Whitehall?

Christopher Biedermann

Whitehall is relatively, basically, flat for the quarter.

Daniel Wakerly - Morgan Stanley

And what was the part of Distribution...

Christopher Biedermann

In Q4, as I had mentioned, we had some -- we were surprised by the negative -- we lost about a month of sales due to the problem with the import licenses. And Whitehall is very much a, as I mentioned, as Q4 business. So through all year, it's really make or break in the back half of the year. And Distribution, again, as we mentioned, we took the opportunity to clean up restructuring and prepare IT for sale by the negative to flat. Really not hurting much in the first quarter?

Daniel Wakerly - Morgan Stanley

Will you be publishing a restated full year '09 set of accounts so that we know what the basis in terms of excluding Whitehall from the Distribution...

Christopher Biedermann

We will be publishing -- each quarter will continue to rethink the quarter, the comparable quarter.

Daniel Wakerly - Morgan Stanley

The comparable? So does that mean we won't get the full year '09 until...

Christopher Biedermann

No, we won't right now due to the special preparation of fully restated '09. I don't think we there's a requirement to do that.

Daniel Wakerly - Morgan Stanley

So when you've given the full year numbers in your release, they refer to 2010. I'm just wondering what we should strip out. Or I suppose it doesn't really matter, we're suppose to just need to go and make sure we strip it out in 2010. And my final question...

Christopher Biedermann

I think we've given up flavor in '10 to really give you an idea of what will be all stripped out. We've pretty much felt that it's going to be stripped out.

Daniel Wakerly - Morgan Stanley

And then the last one is just on covenants. Is there any impact on the calculation because of Whitehall. Do you know exactly the Whitehall net debt and the Whitehall EBITDA? Or is there any implication? Or is...

Christopher Biedermann

I don't see implication. We're still above the covenant limits, and the worst case is in some of the things you get the dividend credit anyway so some LIBOR coming in. So I don't see any interested in the covenant issues right now.

Operator

We'll take our next question from Andrzej Knigawka with ING.

Andrzej Knigawka - ING Groep N.V.

First one, can you give us volumes for the first quarter for Vodka in Russia and in Poland in million prices if possible? Question number two is on the decline of Vodka market in Poland. It's pretty surprising to see 7% to 9% decline there as well because first quarter this year was meant to be an easy comparison to the first quarter '09, which was post-excise tax increase and post stocking in first quarter '08, which was already down. So could you give us a little bit more color on why Poland price market was down? And...

William Carey

I don't have here with me the volume numbers. We'll probably give it you offline if that's -- if you can just call offline. In terms of the Polish market, yes, it was certainly, like I said, we were anticipating flat volume on both markets, and both markets came in quite equal. I'm not here to make excuses but generally, I think there was some impact of weather. The weather was certainly very nasty in January, February, as you very well know, you live here, which has some impact on the overall consumption. People were not going out, the same in Russia. I think it's same across a lot of Europe. But other than that, I think overall, it was just a soft overall consumer environment. I think we just speak to the beer companies, you speak to the other consumer companies, I think they generally saw the same trends. And I think the Vodka market was not really outside of the overall Consumer market here From some other factors, the consumer's good.

Andrzej Knigawka - ING Groep N.V.

On your asset assumption for long-term, I mean, it looks the year-to-date average is 2.89. Obviously, we see a bit of a sell-off in the last two days. But the all average is, your midpoint is 3.25. To get there, you're basically implying second half or rest of the year average of over 3.5, 3.6 almost. So that is very conservative, isn't it?

William Carey

Like I said, I think that we don't want to be seen chasing currency, Andrzej. I think in this environment, what we see today with this sovereign issues, I think some of the sell-off of the emerging markets, global equities, emerging markets currencies in the last few weeks or last week or so, I think, for us, we'd rather take a conservative view right now. And of course if things are better, people will invest accordingly. But I think from us, I think it's better to take a conservative view right now than an aggressive view.

Christopher Biedermann

And remember the market prior sales from the back end of the year, so when you look at it in average, you really have to sales weight the average.

Andrzej Knigawka - ING Groep N.V.

How much of the debt is to be repaid this year and next?

Christopher Biedermann

Contract [indiscernible] (01:10:11) you're probably looking at around $40 million, $50 million. In terms of negotiations with the bank, probably you're looking around $20 million to $30 million.

Andrzej Knigawka - ING Groep N.V.

So you're planning to repay $20 million to $30 million this year?

William Carey

Next year.

Andrzej Knigawka - ING Groep N.V.

Next year. And this year, $40 million to $50 million?

William Carey

Two years.

Andrzej Knigawka - ING Groep N.V.

Two years altogether for $20 million to $30 million...

William Carey

[indiscernible](01:10:39) two years.

Operator

And we'll take our final question today from Lukasz Wachelko with Deutsche Bank.

Lukasz Wachelko - Deutsche Bank AG

First one is regarding the potential deleveraging. From the current standpoints, do you find that the oughts for cutting down the debt have increased since the last quarterly call? Or you would rather go for any of just from the current perspective.

Christopher Biedermann

I think it'll be several to maintain the balance.

Christopher Biedermann

No, I think even with number off, they will be decreasing our ratios.

Lukasz Wachelko - Deutsche Bank AG

The other question would be on the non-operating income expenses on your P&L close to $80 million, can you elaborate a little bit more with there?.

Christopher Biedermann

Yes, I've mentioned that earlier, that was the cost of the euro bond. If you remember, we spawned it so last year but we actually repaid them on January 4, I believe. So when we repaid, you get the call premium and in addition, you get all the prepaid financing costs to amortize. Because that was the wright-off of all that and a 4% call premium.

Operator

And that will conclude our question-and-answer's session today. Mr. Archbold, I'll turn the conference back over to you for any additional or closing comments.

James Archbold

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

Operator

That does conclude today's call. Thank you all once again for your participation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Central European Distribution Q1 2010 Earnings Call Transcript
This Transcript
All Transcripts