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Central European Distribution (NASDAQ:CEDC)

Q3 2010 Earnings Call

November 5, 2010 8:30 a.m. 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

Douglas Lane - Jefferies & Company

Brady Martin - Citibank

Natasha Zagvozdina - Renaissance Capital

Daniel Wakerly - Morgan Stanley

Victor Dima - Bank of America/Merrill Lynch

Andrzej Knigawka - ING Groep N.V.

Edward Mundy from Nomura

Matthew Webb from JP Morgan

Operator

Good day and welcome to the CEDC Third Quarter 2010 Earnings Conference Call. This call is being recorded. At this time, I would like to turn the call over to Mr. James Archbold. Please go ahead, sir.

James Archbold

Thank you. I'd like to welcome everyone today to CEDC's third quarter 2010 earnings conference call. Joining me this morning are William Carey, our President, CEO and Chairman; and Chris Biedermann, our Chief Financial Officer.

Please note that the content of this call contains time-sensitive information that is accurate only as of the date of the live broadcast, November 5, 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 risks 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 quarter three conference call. To start off, I would just like to reiterate, as from the press release, that we are extremely disappointed on the results in Q3, and to be honest, we're a bit disappointed with the results for the three quarters. Hopefully, today we can put some color on the Q3 and also get into Q4, where we believe moving into next year that certainly the opportunity in front of us much more bright than what we've seen in the past three quarters.

To start off with, we'll just touch base on the macro look on our key markets. Generally speaking, the macro look is fairly positive out of Poland, Russia, projecting 3% to 4% growth through next year. Unemployment, currencies, interest rates remain fairly stable. Both markets are showing increased consumer sentiment pickup. I think generally speaking, with the recent dollar weakness and higher oil price, certainly currencies have strengthened accordingly in [inaudible] market currencies over the last two or three weeks, which again should bode well moving into our biggest quarter, the fourth quarter.

To start off with, looking at the business, we've late tailored our organic number, stripping out currency, looking at local currency. To start off with, Hungary. Hungary we are down around 8% for the quarter in terms of top line number. And that's coming from a 30% drop in the first two quarters. Quarter four we're anticipating a growth of about 3% to 4% in Q4. So the Hungarian market is improving quarter by quarter.

I think as we move into Q4 and into next year definitely Hungary has turned around and I think the numbers put out by Zwack, which is another publically listed company there, are not far off our numbers. But I think the turnaround we did in Q3, the improvement in Q3, and what we're looking at in Q4 is probably a little bit better, certainly than the market is doing. So we're quite pleased by the turnaround story that came out of Hungary.

If you look in Poland, the Poland market we're down 16% organically for the quarter. This is broken out into the various components of a market blend drop of 5% to 7%. This is mainly coming from the fact that from the drop of the market in Q2, Q3 did not really improve much. It was a little bit worse in July and August with the heat wave. It improved a bit in September, coming to around the 5% to 7% drop for the overall vodka market.

We also had a 12% loss versus a year ago in terms of market share loss, offset by a 10% gain in our import and export business, which still showed quite positive results in the third quarter. And for those three things that translated into a 16% drop in our organic number.

Now moving to Q4, we're anticipating certainly no more one-off events. We're anticipating a flat vodka market for Q4. We're still anticipating a new product launch next week. It is our biggest product launch ever we've made as a company in terms of our Żubrówka Clear.

Also we've doubled the size of the sales force in Q3 in terms of our development team, so we should see positive results coming out of this development sales force and overall we're seeing the consumer fairly stable. So what does that translate to? It translates into positive Q4 top line growth, which is quite a bit different than a 16% drop in Q3.

If we look at the Russian market, we were down 14% organically in terms of value. The market was down around 7% to 9%, the market blend. And that's coming from a bigger market drop than we had from July and August results of the overall market, as we put in the press release, down around 10% to 15%. So September came back quite nicely, but it didn't make up for the fall in July and August with the heat wave and the fires that were spreading across the key cities.

And where do we fit in that? We were down about 8% in volume that came in, finally, which is more or less in line with the market. The mix, we were down 3% in mix, mainly driven from the consumer attitude during this period of time, and also because our trade marketing program, which we started at the end of May, beginning of June, which was a three-month program to drive more aggressive trade marketing support, did not really see any top line benefit because we were putting the program out, unfortunately, during the time of this heat wave that crossed. So we didn't get the top line benefit even though we had the cost. And that cost us about 3%. Mix was about 3% and volume was about 8%, which came to your 14% organic decline.

In terms of Whitehall, we had a good number with Whitehall. They were up about 15% for the quarter, so again we're seeing strong continued growth coming out of the import business. Fourth quarter we're also anticipating about 15% for Whitehall growth. They saw a strong October, a little bit more than that number, so we're still looking at a good number for Whitehall.

If we're looking at Russian Alcohol Group, and our vodka business in Russia, what are we anticipating for fourth quarter? We're looking at 9% to 11% growth in volume, and that's coming from a very active support behind those numbers as well. We're seeing an increase in mix, about 4% increase in mix, and that's coming from the fact that we are doing a lot more support for our key margin products of Green Mark, Parliament, and Zhuravli.

We are putting out, versus last year, we put out 4,500 pallet displays across the country. This year we're targeting 8,000 pallet displays to put out, so we believe there will be a further mix enhancement there. And because of the pricing mechanism, which we anticipated to take up pricing July 15, but again because of what happened we decided not to put up pricing during this period of time, we put up pricing October 1. So we're looking at about a 6% growth in our pricing mix, which gives about a 19% to 21% value growth in the fourth quarter. And again, that's coming off a 9% to 11% volume growth. We're anticipating a generally stable market, because again, we don't envision any one-off situations again, so a fairly stable market on the vodka growth.

If we turn our attention to gross margins for the quarter, we are generally looking at flat gross margins in Poland, and Russia was down around 5%. That was driven from, again, the mix. That was driven from the additional trade marketing support, which we didn't get the top line, and also 1% on the gross margins on the spirit price increase. As we discussed at the last quarter call, beer pricing was going to cost us about 1% in Russia in terms of our gross margins for the increased beer prices. Nothing has changed in Poland or Russia on spirit pricing since last the last quarter. Both have remained at a higher level but fairly stable.

In terms of the SG&A cost side, we were able to reduce costs out of Poland around 15% in absolute value terms, and around 13% in Russia. So again, we're doing the necessary restructuring to bring down the overall operating costs, which we'll get to in a little bit later discussion.

And what does that translate to in EBIT number? Looking at Poland, around a 10% drop in EBIT and Russia was a bigger drop in EBIT, 25%, coming from the fact of the 14% organic drop as well as the loss in margin, offset by the reduction in cost. And what does that mean in Russia for the fourth quarter? Fourth quarter we're looking at, with a 19% to 21% value growth, we're looking at EBIT growth in Russia of over 30%, and that's driven from, again, that we're operating on a much lower cost base than the year before. So your EBIT growth we're looking at over 30% for the fourth quarter versus a year ago in Russia. And again, positive coming out of Poland as well with the positive growth in our top line as well as positive in our EBIT growth.

If we turn our attention to a little bit more on what are we doing in the market specific moving forward? If we look at Poland, like I said, we are in our biggest ever launch on our Żubrówka Clear. We're anticipating a 5% market share by year three of this product. We feel that's very doable to what we've seen that was done in the marketplace from DeLux, from our competitor, as well as from Krupnik, from our Belvedere company. And Żubrówka being the strongest brand equity in Poland, we're very, very pleased by the initial interest level from the trade. So we believe this is a very, very exciting opportunity that sits in front of us starting next week.

Also, we're moving into a new line of flavors starting in April next year. Flavors are gaining market share in Poland, and we will do what we can to certainly grab market share in the flavored category by a new line of flavor extensions, April of next year.

And where our cost base is sitting today, we still have some cost consolidation to come. Chris will mention a few things on that, but generally speaking where we sit today in Poland is that it's about market share, market share, top line profitable growth. And we believe with our product enhancement, and with our sales force development team, and the commercial team we put in place this year, we believe that you'll start to see much better results coming out of the Polish market. And at the same time we do still have some cost synergy savings still yet to come. So overall we believe the Polish market top line, bottom line numbers will be much, much improved.

If we look at the Russian market, we've done a lot of work over the last 18 months in terms of reduction of operating overhead as you know, with the integration of Parliament and the overall 1,300 people that we have let go since the start of buying this company in the middle of '08. And again, where we sit today is that we have a number of initiatives to drive the top line. Strategically, on the cost side, we don't really have much more to gain, maybe another 5% to 10% on the cost side, but generally speaking we're looking at top line, top line, and top line in terms of our management objectives coming out of Russia, not only from our new brandy launch, which was successfully put in the market last month.

If we look at Ukraine, we've entered Ukraine this year with a 2% share already in the marketplace. We are targeting 5% by year three. That's mainly driven by Green Mark and Parliament and Zhuravli. And basing it on where the government will put their minimum pricing decision on the minimum ruble price of vodka from 89 to a new price, which we should know in the next 30 to 45 days.

We will be extending our portfolio quite aggressively from regional brands as well as national brands. And that's something that, with only four key brands today, plus two auxiliary brands, it's not enough to grow in a fast-moving consolidating market, and certainly we need to extend the portfolio regionally and nationally. It doesn't mean we are not doing anything with the existing portfolio. Our existing portfolio certainly we believe where the consumer is trending today and what's happening in Russia is that the premise that we brought into Russia two years ago we believe certainly mainstream and sub-premium will come back to the trendsetters in the marketplace as it was the previous five years from '03 to '08. And we believe with our portfolio and our in-house portfolio, we'll be able to certainly grab significant share of this consumer move to mainstream and sub-premium where the last 18 months has been a lot driven from lower mainstream and the value sector.

In terms of the Whitehall, we are as discussed last quarter, we are in continued negotiations with Whitehall and Moet Hennessy on a potential deal on the table to do an early call on our stake in the Whitehall, the 20% stake that we don't own. There's an ongoing negotiation, which I can't really get into too much detail, because it's under confidentiality rules with the parties, but it is a win-win for the different parties, and if you look at the purchase price, what we're looking at is around $70 million to $75 million, and it's with about a $35 million, $40 million EBIT coming out of the Whitehall group. And the anticipated purchase would come in the form of cash and debt.

There's also on the cost optimization, we still have probably another 150 people yet to go over the next 12 months as well as we are looking to close our plant, which is also moving forward, and you will see something on that in 2011.

If we look at what the government regulation is doing in the marketplace, the government has continued to take their initiative on reduction of small players in the marketplace. That's across all segments of producers as well as wholesalers, which it's our belief that that's going to speed up the consolidation of the market, where large players will continue to benefit. In terms of the excise, there is no excise in Poland scheduled for next year. And in Russia the excise will be 10% as previously communicated.

Beer advertising, it looks like the government is going to [move] beer advertising similar to spirits, which should be good news for us, whereby it is quite restrictive. And the biggest catalyst we see in the market is this minimum pricing discussion of moving the ruble from 89. Do they move it up just with excise to 95, or do they move it up higher, which they're currently contemplating. Moving it up higher would be great news for us, as the largest player in the marketplace, because actually you can do much more volume and actually make some very good money and out of a very large fixed-cost infrastructure that we have, with the largest spirits sales force in the market. So certainly our anticipation is for a higher than excise minimum price, and we should know this in the next 30 to 45 days.

Other than that, the government has been fairly quiet. They're proceeding with also putting guarantees in place for excise, which is no problem for us but again it hurts the small player. So a lot of the initiatives that you're seeing and hearing is mainly targeted at these small players because these are the players that are also moonlighting with black market spirits. So the government wants a smaller, less number of players so they can control better in terms of this black market move.

I'll now turn it over to Chris Biedermann, who will take you through a number of the balance sheet and other initiatives.

Christopher Biedermann

Thanks Bill. Just a few [inaudible] in the balance sheet and cash for the quarter. In terms of the balance sheet, we continue to see improvements in our working capital levels from year-end. Also reflecting the seasonality of our business, receivables and inventories are both down from year-end. And general working capital trends are in line with prior years. All of this contributing to a healthy cash flow from operations, about $75 million for the nine months ending. However, with the revised guidance, we have revised our leverage targets for Q1 '11 to a net debt EBITDA range of 4 to 4.5.

In addition to a lot of the initiatives Bill talked about now, about top line, there's a number of areas we're looking at to streamline and improve the business. One of the things in terms of reporting and disclosures, again following the final disposition of our distribution business, and evolution into a full spirit producer, we're looking to incrementally improve and change our disclosures. This month we expect to release a fully restated 2009 three year 10KA to reflect the disposition of the distribution business as well as the change in accounting treatment of [y vo - ph], which I think a lot of people have requested and will help.

We'll also begin to revise the structure of our MD&A and our reports to focus more on industry-standard benchmarks such as volume and value sales changes as well as the impact of product mix of our key segments.

In terms of the overall business structure, we've made a lot of improvements this year in terms of streamlining and structure, and we'll continue to do so. We're now in the process of merging of our Polish entities into one legal structure that not only provides for simplification of the business and cost savings as Bill mentioned earlier, but also some significant tax advantages, and this will greatly reduce our future cash outlays in the future for our corporate tax payments.

In terms of cash management, we're now in the final stages of putting a tender for our full banking operations in Poland, which will improve not only our interest expense, but again increase the efficiency of our business. We will begin to roll this tender process out as well for the Russian operations.

Finally, in terms of [inaudible] in our Russian operation, there's been a lot of work done there. We believe we're fully on plan now to get full [inaudible] implementation by year end on the Russian alcohol, and we are expecting unqualified opinion related to this as well.

Having said that, now I'll turn it back to Bill for a final wrap up.

William Carey

Thanks, Chris. I think just to summarize where we are as a business, as I said earlier, certainly I'm not happy with the Q3 results. We've done a lot of work and invested really a lot of our balance sheet and a lot of our company equity into Russia in the first half of '08. As I've discussed with many of you investors, obviously the timing couldn't have been worse. Even though we believe we have very strong assets in Russia, obviously we haven't seen that coming through in the underlying financials. And we've had a lot of work to restructure in terms of minority buyout, contingent liabilities. There's been debt, equity placements, and everything is restructured, behind us, and when we look at the company today our focus is on top line, top line, and top line, because our cost structure is fairly sufficient, even though there is some improvement. We need to drive more product through the fixed cost infrastructure, and like I said that's our top focus.

I think that you will see much improved results coming out of our business model. Thank you and I'll open the call to any questions.

Question-and-Answer Session

Operator

[Operator Instructions.] And we'll take our first question from Douglas Lane from Jefferies & Company.

Douglas Lane - Jefferies & Company

Just a couple questions. First, just bigger picture on the markets, particularly in Russia. We have seen oil improve, and it sounds like the markets are firming, but can you give us some qualitative examples of why you're more upbeat about the Russian consumer and some sort of insight into when you think the premiumization trend, which was so prevalent pre-recession, may come back into the marketplace?

William Carey

We're thinking increased wage inflation coming out of Russia, and like I said from '03 to '08 there was a tremendous shift from the economy sector into mainstream and sub-premium during a faster growth period coming out of Russia. We believe that Russia's entering, again, a fairly structured, sustainable growth phase for the consumer, and I believe that you will see, again, that the mainstream and sub-premium again start to take some market share away from the economy sector.

Unfortunately, for the last year and a half, or since late '08, the economy sector has grown over the mainstream and sub-premium. So there has been a negative mix coming out of Russia in terms of what happened the previous five years. But we believe that returns to what we saw the previous five years from what we're seeing in the marketplace.

And that's pretty evident also in what we're seeing coming out of the Whitehall numbers. When we bought the Whitehall company in '08 the company was delivering 15%, 20% annual compounded growth rate. And again, we're seeing those same type of growth rates coming back now, which again for me it's a clear sign also of where the consumer is. So for us it's pretty evident that we're on the right track. We need to have a bigger portfolio for this consolidation coming into the Russian market as well as doing more enhancement in terms of our key mainstream and sub-premium products.

Douglas Lane

And how are the new products in Russia? You mentioned the brandy. Has the new vodka in Russia been launched yet?

William Carey

No, we will be launching the new vodkas in Russia in the first quarter of the year. We have a number of projects ready. We just want to see what the government is doing on their minimum pricing decision in the next 30 to 45 days.

Douglas Lane

And I did hear you say that the production facility closure in Russia is still on the table. Do you have a cost estimate for a savings number from the -

William Carey

About $6 million.

Douglas Lane

And then just lastly, I saw that you filed an 8K and [inaudible] just what's going on there?

William Carey

Sergei was on the board back from the acquisition. We promised one board seat, which he took, and I think it was never a long-term position. It was more to look at the first few years, and as it was, Doug, you remember back with the Polish directors as well, they were involved for the initial two, three years, and then eventually they kind of went their own way. It's no different with Sergei. He's got another business interest. And he wasn't involved in the local business.

Douglas Lane

So your vodka production in Russia is pretty much out of Russian Alcohol Group now, and Sergei came from Parliament?

William Carey

Yes.

Operator

Moving on, we'll take our next question from Brady Martin from Citibank

Brady Martin - Citibank

A few questions. First, just on your outlook into Q4. You're looking for some pretty aggressive volume growth in Q4 year-on-year after having a pretty weak first nine months. What can you tell us to give us some comfort that that's going to happen? Can you tell us something about the September numbers that you said were much better, or maybe even October? And what exactly you're doing to get the volumes to come back?

William Carey

October we're up about 6%. September we were up more than that, which offset the decline a bit in July and August. As you remember, we were up about 9% in Q2 I think. So for us, like I said, we have a much more tailor-made promotional schedule out in the marketplace. Like I said, we're doubling the number of pallets in the marketplace from 4,500 up close to over 8,000. And generally speaking, the work we're doing with the retailers as well as the wholesalers, there's a lot of increased, targeted work this year versus last year with the sales force into the trade. So I think it's a much more structured approach than it was the year before, which is driving a lot of that, plus the consumer is what's going to be driving those types of numbers. There's a lot more detail behind that. If you want to take it off line or meet with our Russian team, they can probably give you some more clarity on specific actions we're doing in these specific channels.

Brady Martin

Right, but in Q3 you mentioned some failed trade marketing. Can you explain exactly what went wrong there and how are we not going to see - what have you done to reduce the risk that we have a repeat of the failed new marketing initiatives in Q4?

William Carey

The initiatives were there, but unfortunately the consumer wasn't. During this 10% to 15% decline in the market we're out there pushing product that we - obviously we did better than we would have done, but we didn't get the uplift that we anticipated that we were starting to see from the end of May into June. We continued to do this program as scheduled and unfortunately it was not received because of the heat wave and we didn't get the uplift that was anticipated, even though the [inaudible] were there.

Brady Martin

Right. You said you basically think you grew in line with the market in Russia in volumes. Was there some kind of regional effect? Did you have a much weaker performance in, say, Moscow, or was there something specific - because I would think even though your marketing was mistimed, the fact that you're just growing along with the market seems like there's more than just timing of your efforts.

William Carey

A lot of our sales do come out of - even though we have natural sales, and Green Mark is the highest distributed in terms of numerical distribution. Still, a lot of our sales do come out of the western part of Russia, where the fires were more prevalent. So we got hit harder than those who might have a little bit farther east in terms of our performance. We were more heavily weighted to the area that got affected.

Brady Martin

And maybe just one final question on Poland. Did I understand you right? You said you thought you lost 12 share points in Poland in Q3?

William Carey

No, 12%. We lost 4 points over the last 18 months, and around 3 points over the last 12 months, and that 3 points translated to a 12% decline in volume.

Brady Martin

Okay, so 12% volume decline.

Operator

Moving on, we'll take our next question. We would like to remind everyone to please limit yourself to three questions. [Operator Instructions.] We'll take our next question from Natasha Zagvozdina from Renaissance Capital.

Natasha Zagvozdina - Renaissance Capital

I had difficulty hearing what you did in terms of Polish business [inaudible]. I understand your volumes were down [inaudible] versus the market being down [3%]. Is that correct?

William Carey

In the Polish market we were down 16% organically, and that translated into a 5% to 7% market drop for the quarter, and we had a 12% loss of volume in terms of market share loss. And we had a 10% increase in our import and export business, which gave the overall average of 16% drop. And as we look to the Q4, we're explaining that the import export should remain quite positive. The market should stabilize. We've increased our sales force double in the third quarter. New product development - we're launching our new product in November next week, as well as stabilization of the consumer as well. We don't have these one-off negatives, which is all translating into a positive Q4 top line and bottom line number.

Natasha Zagvozdina

My apology William. I'm still not getting it quite right I think. So what was the local revenue decline in Poland please last quarter?

William Carey

Our organic decline was 16% in local currency, and that was a combination of the 5% to 7% drop of the market and a 12% loss of volume of share loss versus the previous year. And then a 10% growth in our import and export business. So the combination of those three make your negative 16%.

Natasha Zagvozdina

And then in Russia you were at the negative 14%, right? From [inaudible] 8% volume decline and the rest in price, including the mix?

William Carey

In Russia we were down 14%, which was an 8% volume, 3% mix, and 3% additional trademarking support that was put in that we didn't see the top line benefit from this. Well, there was some top line benefit, because we would have been down more, but it wasn't what we had anticipated when we started the program back at the end of May. And Whitehall was up 15%.

Natasha Zagvozdina

Yes, 15% year-to-date, in local currency.

William Carey

For the quarter, yes.

Natasha Zagvozdina

So 15% was year-to-date, or for the quarter?

William Carey

It's similar year-to-date.

Operator

We're going to move on next to Daniel Wakerly from Morgan Stanley

Daniel Wakerly - Morgan Stanley

First question is on - you know, Whitehall you flagged as doing quite well. Can you talk about why the income from Associates, though, is only $4 million at the 9 months, given that it was around $10 million last year? Can you just tell us what's going on with the profitability of Whitehall and/or the Moet Hennessy JV?

Christopher Biedermann

For the nine-month period, Q1, as we noted earlier in the year was down a bit if you remember, Q1 [inaudible] license issue.

William Carey

We had the license issue in Q1 where they were out of stock for like 30 days.

Daniel Wakerly

Okay, so on a 3Q and 3Q basis, I guess it's a little bit lower, but not so much. Okay, great. So my other question, you talked about this [promotion] in Russia that was unfortunately sort of ill-timed just because of the heat wave. We talked earlier in the year about - on Green Mark, in the traditional channel, and diverting some of the marketing spending to more permanent price cuts. Is that what we're talking about? Or is this another -

William Carey

Yes. That's the extra trademarking support. Yes.

Daniel Wakerly

And the final question, on Parliament [inaudible] restructuring have we got any more to come, or is that - can we draw a line under that now in terms of the P&L in the - ?

Christopher Biedermann

There may be a little bit trickling out Q4, but the vast majority of the costs associated with headcount I've been including in Q2, Q3.

William Carey

There's still some production opportunities and some other bits and pieces, but the major part's been done.

Operator

Moving on, we'll take our next question from Victor Dima from Bank of America/Merrill Lynch.

Victor Dima - Bank of America/Merrill Lynch

Question on what you already see happening in 2011, I'm referring to the volume growth. What kind of volume growth do you think we could expect from Russia? And if you could specify how much of this would come from existing brands and how much was it from the new product launches? I also want to understand what kind of price increase you plan next year? This year if you plan anything by the end of the year and next year, and how you see accounts taking this price increase. [inaudible] for the key accounts, and how much your key accounts increased as a percentage of business for the last year.

William Carey

I think on next year's numbers I'd rather refer - typically we give out year-end guidance, or next year guidance in January, which we'll probably have a call in January to go over next year guidance, which we give to a lot of these questions you're asking in terms of next year guidance. In terms of the current price increase we took, I think the last [inaudible] accepted the price increase this week, which was [inaudible]. The rest have already accepted the price increase, and what we're looking at, because our key account definition is 200 accounts. Others have different definitions. For us, it's 200 accounts we work direct with. [For next, five down to number 200.] And for us, generally they're probably growing about 3% to 4% this year.

Victor Dima

In mix, it's -

William Carey

It's not a negative mix for us, because we do have the same discount structure on average to wholesalers and to key accounts, that obviously the bigger retails a bit better, smaller retailers a bit smaller, but the average is very similar to wholesalers. So we don't really have a negative mix today in terms of the client mix. I'm sure over a five-year period it might turn negative as key accounts will probably average more. But right now it's fairly stable, our client mix in terms of profitability.

Victor Dima

In terms of Whitehall, I know that you're in the process of negotiations, but what is a realistic timeframe for this negotiation to end? Are we talking about this happening this year, or is it something that will go on until next year?

William Carey

We've been working on this for a good six months, and we'd like to get something closed in the nearest future. I can't really give you any more clarity than that, but certainly we're working to get it done in the nearest future, which I know doesn't answer your question, but -

Victor Dima

Okay, and another question on the market share. When you're talking about the market share in Russia, it hasn't changed for the last couple of years. You've pretty much stayed where you are when you acquired [inaudible]. But if you look in 3-5 years, is there an ambition in terms of gaining market share in Russia? Where would you love to see your market share?

William Carey

Again, it's got to be in the right channel of market share. Today, the economy sector makes up 50% of the market. Our market share in the other 50% is quite large, as we have very little in the 50%. Our investment thesis in Russia was that - when we invested in Russia it was around 45% economy, which grew to 50% over the last 18 months. So for us, we would like to grab certainly more market share, but it's got to be in the right channel as well. And for us it's getting a higher share in the right channel. We believe that the economy will decline over time to around 30%, much like the Polish market did over a five- to ten-year period. So we would like to put our existing product portfolio, as well as new product development, in that channel that will be capturing that market share growth.

And I think as a top-five player still operating around 45%, 48%, again, our investment thesis is a continued consolidation, where your top five players will benefit from this consolidation, moving to 75%, 80% over the five-year period. So I think just with the market move, as well as consolidation, we should be moving our market share up another eight or ten points, but it's got to come from a bigger portfolio as well. We have four core brands and two auxiliary brands that make up a fairly strong position, whereas our closest competitor, Synergy, I think has a four, five points less market share, yet they work with 46 different products. We're not looking at 46, but certainly for up - to play in this consolidation effort in Russia we need to be more aggressive on our portfolio.

Operator

Moving on, we'll take our next question from Andrzej Knigawka from ING.

Andrzej Knigawka - ING Groep N.V.

What is your expectation for the blended - Russia, Poland, everything - gross profit margin for the fourth quarter 2010?

William Carey

I don't have that number sitting in front of me. Maybe you could take it offline?

Andrzej Knigawka

That's okay. My second question is on if the government increases minimum price in Russia to, say, 95 or 96 rubles, then the share of economy in the market is going to be even bigger because then new brands will become economy brands. If they increase even more than to 95 then share is going to be even bigger, and I understand that your brands will also be relatively better priced compared to the economy segment, but are you not concerned about that economy segment in Russia being so overcrowded that it will start impacting the volumes for your brands that are positioned a notch above the economy segment?

William Carey

No. Right now you've got the minimum price at 89, and no one can make money less than 99, really, so that's why the government's looking to raise it higher, because everyone is complaining, from producers, to retailers, to wholesalers. There's really no money to make at 89 for the marketplace, and the government still has a lot of interest in the overall market. So they're really considering to raise it higher than excise, which I think excise brings it to 95.

If it comes from 89 to 95, to be honest there won't be any change in the market. That's just status quo to be honest. We don't really see any significant change for the market. But if they do move this to 105, 110 as the minimum price, this is a significant benefit, because you've got all that extra margin sitting there. So the actual ability to play at these other levels and make some decent money out of it is very significant. And that's our biggest advantage.

If they would move to 105, 110, this would be a big advantage for us, because we do have such a large infrastructure of capacity of sales and production. We could play very aggressive at these levels and make some very nice money out of it. But right now, below 100 there's no money to be made. So that's why if it does go to 105, 110 this is very good news for us, as well as some of the other leading players, including one government company. We should know this sort of direction in the next 30-45 days.

Andrzej Knigawka

And your cheapest blends at the moment, I believe they are [inaudible] and Yamskaya. They would sell at what pricing point today?

William Carey

About 110, Yamskaya.

Andrzej Knigawka

And the other question is really on the market sophistication in Russia, because I understand I missed the first five minutes of the call, but I understand your volume went down 8% in Russia. Synergy announced 16% volume increase in the third quarter, including exports, so I don't know what the domestic share increase was, but it was probably double digits, and you pointing out to the market being down 12% to 15% in Russia in third quarter -

William Carey

No, the 12-15% was July-August. The full year was 7-9%. The market improved in September because that's where the market got affected and it was around 7-9% down in the third quarter.

Andrzej Knigawka

7-9%. So that would be in line with what your volumes were?

William Carey

Correct.

Andrzej Knigawka

And what do you think makes Synergy more successful in small shops than most of the other companies? What do you think their advantage is? Geographical reach?

William Carey

Synergy is going through a massive development phase where they hired 800 new salesmen over the last 12 months. They operated with a quite small sales force and today they've more than, I think, doubled their sales force over the last 18 months. So they're getting a lot of new distribution gains, which they did not have before. My guess is they'll have another one year of growth before they sort of maximize what they're able to do with this new sales force and new distribution reach. So it's coming from a very low base, and when you hire 800 new salesmen you're going to have a significant uplift in top line, but it comes with a cost as well. That works as long as you keep sustaining top line growth.

Operator

Moving on, we'll take our next question from Edward Mundy from Nomura.

Edward Mundy - Nomura

First of all, on costs, it strikes me that a big part of the EPS downgrade today is to weaker top line, or was this a margin contraction given the negative operating leverage here? But as you look out to 2011, what do you think the scope is for a margin bounce back?

William Carey

I think the additional margin, or the additional guidance downgrade, really was coming a bit out of Hungary. In our planning for Hungary we anticipated a better number out of Hungary, and certainly out of Poland. We anticipated market share loss to subside a few quarters ago, and for us it's a bit worse performance out of Poland and Hungary. The Russian number fourth quarter was pretty much in line with our initial guidance. So it's really what's coming out of these two markets. If we look at the margin uplift, looking back at increasing our margins, again, where our cost base is it's really all about top line growth.

Christopher Biedermann

And to your point, I think yeah, obviously that top line growth, with our current cost structure, resulted in significant improvements in terms of percentage margins at the EBIT level, because cost basis is not going to go up in proportion with that top line growth we were expecting.

Edward Mundy

Do you have a view as to what a realistic margin target could be like as you get more normalized growth in 2011?

William Carey

Again, coming back to Vic's question, that I think when we get into the '11 guidance in January we'll have a call and go over in detail how we're laying out 2011.

Edward Mundy

And just following up on some of the regulatory issues in Russia, could you provide a bit more color on how a bigger increase in the minimum price of vodka would impact the shifting of the trade from the black market into the legal channel, and also impact trading up?

William Carey

Because the government is doing a lot of work on taking out small players, small producers, small wholesalers, and really limiting the market to larger players. So on the one side, yes, the black market will go down under that context. And yes, you're right, if they do move it up to 105, 110, that you would justify that I'm sure you would enhance the potential that the people will find whatever means to buy whatever they can in the black market, which would offset some of this work they're doing. But at the same time the government has two interests, as they know. They also are a quite big player in the overall [inaudible] beer manufacturing as well as the [inaudible] beer [inaudible] the government company, which is losing a lot of money today. So for them it has kind of got mixed interests as well, but I think overall, in terms of the black market we think you could have a bit more black market with a move to 105, 110, but what the government's doing to bring down a lot of this you'll probably see a net net continued reduction in the black market because the sources of that supply just won't be around anymore.

Edward Mundy

And by bringing up the minimum price to let's say 105, 110, clearly that would narrow the price points between previously the cheapest and also some of your brands. How would that encourage trading up do you think to mainstream and sub-premium?

William Carey

I think the trading up effect is just the consumer having more money to spend, as it was for '03 to '08, and I think that if consumers were willing to spend 130, they're still willing to spend 130 regardless if it's 189, no price, or 110. If they're willing to spend 130, 150, 180 they're going to still have that ability in terms of the trade up. The only thing this does is give those who cannot make money today in that lower price point the ability to make money. And if the consumer is going to buy a product at 110, he's certainly going to buy a brand rather than just a label.

Edward Mundy

And just one final question, just on the incentivization of your sales force, clearly I think there's a big focus on top line, top line, top line, as you said on the call. How are you changing the incentivization of your sales force to make sure you fully capture the recovery in the Russian and Polish consumer?

William Carey

We're doing a lot of the salesman incentive programs not only with our own sales force but also with wholesalers we work with across both countries. So there is quite a bit of programs in place to incentivize more also the wholesaler trade. In terms of our sales force, they are pretty much commissioned on the top line but also that we have put more KPIs in place in terms of the standards that we want put in place in terms of making sure we get the standards in place we want because at the end of the day they're not driving the consumer to take the product off the shelf. But we have to make sure we get the shelf painted right in order for that consumer to take that choice of our products more often. So it's KPIs not only on the top line but on the merchandizing standards much more.

Operator

And at this time we'll take our final question from Matthew Webb from JP Morgan.

Matthew Webb - JP Morgan

Yes, just one quite broad-brush question please. I wonder if it's possible to break down the drivers behind the reduction in the full year guidance between temporary issues like the weather and the share loss in Poland that hopefully will come back and then the more sort of permanent issues relating to the impact that the sale of your distribution business in Poland might have had on the underlying profitability of that business.

William Carey

I think the decline was not only - the distribution business was already taken out previously in - I think in Q1 it was already taken out, the loss of the distribution business. If you look at the guidance reduction, it is coming out of the reduction of the revenue, which is coming out of the third quarter as well as coming out of the fourth quarter, a bit out of Poland, and a bit out of Hungary. Even though both markets are anticipating positive growth, still it's not in line with what we had initially planned. And that's really where the additional reduction, post-revenue reduction is coming from out of Poland and Hungary. And a bit out of Whitehall.

Matthew Webb

The guidance at Q2, which from memory was that the reassessment of the impact on your sales of the disposal of the distribution business, that that would have an immaterial impact on EBIT, that still stands. Is that correct?

Operator

And at this time I would like to turn the conference back to our speaker for any additional or closing remarks.

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.

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