Form 10-Q
Table of Contents

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 

(MARK ONE)

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE TRANSITION PERIOD FROM                .

 

COMMISSION FILE NUMBER 0-24341

 


 

CENTRAL EUROPEAN DISTRIBUTION CORPORATION

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 

DELAWARE   54-18652710
(STATE OF INCORPORATION)   (IRS EMPLOYER IDENTIFICATION NO.)
1343 MAIN STREET, #301    
SARASOTA, FLORIDA   34236
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)   (ZIP CODE)

 

(941) 330-1558

(REGISTRANT’S TELEPHONE NUMBER,

INCLUDING AREA CODE)

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x    No  ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12.b.2 of the Securities Exchange Act of 1934).  Yes  x    No  ¨

 

The number of shares outstanding of each class of the issuer’s common stock as of April 30, 2004:

 

Common Stock ($.01 par value)

  10,800,746 shares

 



Table of Contents

INDEX

 

          PAGE

PART I.

   FINANCIAL INFORMATION    3

Item 1.

   Financial Statements     
     Consolidated Condensed Balance Sheets, March 31, 2004 (unaudited) and December 31, 2003    3
    

Consolidated Condensed Statements of Income (unaudited) for the three month periods ended March 31, 2004 and March 31, 2003

   4
     Consolidated Condensed Statements of Changes in Stockholders’ Equity (unaudited) as of March 31, 2004    5
    

Consolidated Condensed Statements of Cash Flows (unaudited) for the three month periods ended March 31, 2004 and March 31, 2003

   6
     Notes to Consolidated Condensed Financial Statements (unaudited)    7-12

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    13-16

Item 3.

   Quantitative and Qualitative Disclosure about Market Risk    18

Item 4.

   Controls and Procedures    18

PART II.

   OTHER INFORMATION     

Item 6.

   Exhibits and Reports on Form 8-K    20

Signatures

        21

 

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Table of Contents

PART I

FINANCIAL INFORMATION

 

CENTRAL EUROPEAN DISTRIBUTION CORPORATION

CONSOLIDATED CONDENSED BALANCE SHEETS

(in thousands, except share and per share information)

 

    

March

31, 2004


   

December

31, 2003


 
     (unaudited)        

CURRENT ASSETS

                

Cash and cash equivalents

   $ 6,534     $ 6,229  

Accounts receivable (net of allowance for doubtful accounts of $6,234 and $6,380 respectively)

     74,897       90,071  

Inventories

     27,081       35,012  

Prepaid expenses and other current assets

     4,130       5,249  

Deferred income taxes

     1,074       1,201  
    


 


TOTAL CURRENT ASSETS

   $ 113,716     $ 137,762  

Intangible assets, net

     2,319       2,506  

Goodwill, net

     36,247       35,618  

Tangible fixed assets, net

     11,786       10,115  

Deferred income taxes

     1,169       1,382  

Other assets

     171       87  
    


 


TOTAL ASSETS

   $ 165,408     $ 187,470  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY

                

CURRENT LIABILITIES

                

Trade accounts payable

   $ 49,155     $ 65,776  

Short term bank loans and overdraft facilities

     22,599       30,441  

Current portion of long term debt

     180       29  

Current portion of obligations under capital leases

     1,782       1,282  

Income taxes payable

     1,220       977  

Taxes other than income taxes

     1,176       1,230  

Other accrued liabilities

     2,062       3,011  
    


 


TOTAL CURRENT LIABILITIES

     78,174       102,746  

Long-term debt, less current maturities

     1,624       497  

Long-term obligations under capital leases

     1,206       1,173  

STOCKHOLDERS’ EQUITY

                

Preferred Stock ($0.01 par value, 1,000,000 shares authorized; no shares issued and outstanding)

     —         —    

Common Stock ($0.01 par value, 20,000,000 shares authorized, 10,909,779 and 10,876,329 shares issued at March 31, 2004 and December 31, 2003, respectively)

     109       109  

Additional paid-in-capital

     53,226       52,805  

Retained earnings

     33,646       30,536  

Accumulated other comprehensive loss

     (2,427 )     (246 )

Less Treasury Stock at cost (109,350 shares at March 31, 2004 and December 31, 2003)

     (150 )     (150 )
    


 


TOTAL STOCKHOLDERS’ EQUITY

     84,404       83,054  
    


 


TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 165,408     $ 187,470  
    


 


 

The accompanying notes are an integral part of the consolidated condensed financial statements.

 

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Table of Contents

CENTRAL EUROPEAN DISTRIBUTION CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF INCOME (UNAUDITED)

(in thousands, except share and per share information)

 

    

Three months ended

March 31, 2004


   

Three months ended

March 31, 2003


 

Net sales

   $ 110,477     $ 79,468  

Cost of goods sold

     96,711       68,985  
    


 


Gross profit

     13,766       10,483  

Selling, general and administrative expenses, excluding depreciation and amortization

     8,884       6,802  

Depreciation and amortization

     706       474  

Bad debt provision

     66       67  
    


 


Operating income

     4,110       3,140  

Non operating income/(expense)

                

Interest income

     43       27  

Interest expense

     (461 )     (553 )

Realized and unrealized foreign currency transaction (losses), net

     (46 )     (2 )

Other income/(expense), net

     20       (14 )
    


 


Income before income taxes

     3,666       2,598  

Income tax expense

     556       681  
    


 


Net income

   $ 3,110     $ 1,917  
    


 


Net income per share of common stock, basic

   $ 0.29     $ 0.21  
    


 


Net income per share of common stock, diluted

   $ 0.29     $ 0.20  
    


 


 

The accompanying notes are an integral part of the consolidated condensed financial statements.

 

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CENTRAL EUROPEAN DISTRIBUTION CORPORATION

CONSOLIDATED CONDENSED STATEMENT OF CHANGES IN

STOCKHOLDERS’ EQUITY (UNAUDITED)

(in thousands)

 

     Capital Stock

                     
    

Issued

No. of Amount
Shares


  

In Treasury

No. of Amount
Shares


   

Additional
Paid-in-

Capital


   Retained
Earnings


   Accumulated
Other
Comprehensive
Loss


   

Total

Stock-
holders
Equity


Balance at December 31, 2003

   10,876    $ 109    109    $ (150 )   $ 52,805    $ 30,536    $ (246 )   $ 83,054

Net income for the three months ended March 31, 2004

                                     3,110               

Foreign currency translation adjustment

                                            (2,181 )      
    
  

  
  


 

  

  


 

Comprehensive income for the three months ended March 31, 2004

                                     3,110      (2,181 )     929

Common stock issue in connection with acquisitions

   5                          159                     159

Common stock issued in connection with options

   28                          262                     262
    
  

  
  


 

  

  


 

Balance at March 31, 2004

   10,909    $ 109    109    $ (150 )   $ 53,226    $ 33,646    $ (2,427 )   $ 84,404
    
  

  
  


 

  

  


 

 

The accompanying notes are an integral part of the consolidated condensed financial statements.

 

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CENTRAL EUROPEAN DISTRIBUTION CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOW (UNAUDITED)

(in thousands)

 

    

Three months
ended March

31, 2004


   

Three months
ended March

31, 2003


 

OPERATING ACTIVITIES

                

Net income

   $ 3,110     $ 1,917  

Adjustments to reconcile net income to net cash provided by / (used in) operating activities:

                

Depreciation and amortization

     706       474  

Deferred income tax benefit

     (40 )     (29 )

Bad debt provision

     66       67  

Changes in operating assets and liabilities:

                

Accounts receivable

     15,320       18,075  

Inventories

     7,931       5,663  

Prepayments and other current assets

     1,119       (677 )

Trade accounts payable

     (16,621 )     (25,347 )

Income taxes and other taxes payable

     189       130  

Other accrued liabilities and other assets

     (949 )     232  
    


 


Net Cash Provided By Operating Activities

     10,831       505  

INVESTING ACTIVITIES

                

Purchases of tangible fixed assets

     (2,171 )     (98 )

Proceeds from sales of tangible fixed assets

     428       —    
    


 


Net Cash Used In Investing Activities

     (1,743 )     (98 )

FINANCING ACTIVITIES

                

(Repayments) / Borrowings of short-term borrowings and overdraft facilities

     (7,842 )     296  

Proceeds from long-term borrowings

     1,278       —    

Capital lease repayments

     (396 )     —    

Net proceeds from private placement offering of Company’s common stock

     —         (1,152 )

Stock options exercised

     262       1,004  
    


 


Net Cash (Used in) / Provided By Financing Activities

     (6,698 )     148  
    


 


Effect of exchange rate changes on cash and cash equivalents

     (2,085 )     (985 )

Net increase / (decrease) in cash and cash equivalents

     305       (430 )

Cash and cash equivalents at beginning of period

     6,229       2,237  
    


 


Cash and cash equivalents at end of period

   $ 6,534     $ 1,807  
    


 


SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING ACTIVITIES

                

Common stock issued for acquisitions

   $ 159     $  
    


 


Capital leases amounts advanced

   $ 799     $  
    


 


Supplemental disclosures of cash flow information

                

Interest paid

   $ 406     $ 543  

Income tax paid

   $ 376     $ 839  

 

The accompanying notes are an integral part of the consolidated condensed financial statements.

 

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Table of Contents

CENTRAL EUROPEAN DISTRIBUTION CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED)

(amounts in tables expressed in thousands except per share information)

 

1. ORGANIZATION AND DESCRIPTION OF BUSINESS

 

Central European Distribution Corporation (CEDC), a Delaware corporation, and its subsidiaries (collectively referred to as the Company) operates primarily as a wholesale distributor of fine wines, beers and liquors across Poland. Based in Warsaw and operating through nine distribution centers and 58 satellite branches the Company offers a 24 hour delivery service of alcoholic beverages. Since its incorporation in September 1997, the Company has acquired 100% of the outstanding common stock or 100% of the voting rights of its 12 subsidiaries.

 

The Company through its various subsidiaries derives all its revenues in Poland.

 

2. BASIS OF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statements include the accounts of CEDC and its subsidiaries all of which the Company wholly owns or owns 100% of the voting rights. All inter-company accounts and transactions have been eliminated in the consolidated financial statements.

 

CEDC’s subsidiaries maintain their books of account and prepare their statutory financial statements in Polish Zloties (PLN) in accordance with Polish statutory requirements and the Accounting Act of 29 September 1994. The subsidiaries’ financial statements have been adjusted to reflect accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and disclosures required by generally accepted accounting principles in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary to fairly present our financial condition, results of operations and cash flows for the interim periods presented have been included. Operating results for the three-month period ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.

 

The balance sheet at December 31, 2003 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

 

The unaudited interim financial statements should be read with reference to the consolidated financial statements and footnotes thereto included in our annual report on Form 10-K for the year ended December 31, 2003.

 

3. COMPREHENSIVE LOSS

 

The Company’s equity investments are substantially all in Polish Zloty and gains or losses resulting from the restatement of these shareholder equity balances into U.S. Dollars are posted to the Comprehensive Loss Account. As a result of the depreciation of the Polish Zloty against the U.S. Dollar during the three-month period ending March 31, 2004, the Company incurred foreign currency translation losses of $2,181,000 on these equity investments. This movement means that the cumulative balance on the Comprehensive Loss Account was a loss of $2,427,000 as at March 31, 2004 and this has been reflected in the Consolidated Condensed Balance Sheet and Statements of Changes in Stockholder’s Equity (unaudited). The total of the accumulated other comprehensive loss consist solely of currency exchange adjustments. No tax benefit has been recorded.

 

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CENTRAL EUROPEAN DISTRIBUTION CORPORATION

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED)

(amounts in tables expressed in thousands except per share information)

 

4. EARNINGS PER SHARE

 

Net income per share of common stock is calculated under the provisions of SFAS No. 128, “Earnings per Share”. The following table sets forth the computation of basic and diluted earnings per share for the periods indicated.

 

     Three Months Ended
March 31,


     2004

   2003

Basic:

             

Net income

   $ 3,110    $ 1,917
    

  

Weighted Average shares of common stock outstanding

     10,790      9,009
    

  

Basic earnings per share

   $ 0.29    $ 0.21
    

  

Diluted:

             

Net Income

   $ 3,110    $ 1,917
    

  

Weighted Average shares of common stock outstanding

     10,790      9,009

Effect of diluted effect employee stock options based on the treasury stock method.

     106      389
    

  

Totals

     10,896      9,398
    

  

Diluted earnings per share

   $ 0.29    $ 0.20
    

  

 

During the three month period ended March 31, 2004, 28,450 stock options were exercised.

 

5. ACQUISITIONS

 

Overview

The Company’s strategy and objectives regarding its acquisition policy are to acquire regionally strong alcohol distributors in order to build market share and construct a nationwide distribution network in order to attract and retain national clients and to strengthen its buying leverage. The price paid by the Company in making its acquisitions is based on earnings projections of the acquired company operating under the Company’s business model.

 

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Table of Contents

CENTRAL EUROPEAN DISTRIBUTION CORPORATION

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED)

(amounts in tables expressed in thousands except per share information)

 

5. ACQUISITIONS (cont’d)

 

While the Company made no new acquisitions in the three months ended March 31, 2004, it made three acquisitions during 2003. Assuming consummation of these acquisitions (Dako-Galant, Panta-Hurt and Multi-Ex) and the issuance of common shares as of January 1, 2003, the unaudited pro-forma consolidated operating results for the three months ended March 31, 2003 was as follows:

 

     2003

Net sales

   $ 111,597

Net income

   $ 1,119

Net income per share data:

      

Basic earnings per share of common stock

   $ 0.12

Diluted earnings per share of common stock

   $ 0.12

 

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CENTRAL EUROPEAN DISTRIBUTION CORPORATION

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED)

(amounts in tables expressed in thousands except per share information)

 

6. BANK LOANS AND OVERDRAFT FACILITIES

 

The Company has banking facilities with six banks which are used to support both the Company’s acquisition strategy and its cash on delivery (COD) vodka purchasing requirements. During the fourth quarter of 2003, the Company secured group facilities from one of Poland leading banks so as to improve cash management throughout the group. The roll out of this group facility is expected to be completed by mid 2004.

 

The credit lines are only denominated Polish zloty:

 

     March
31, 2004


   December
31, 2003


PLN (restated in U.S. Dollar equivalent)

   $ 24,403    $ 30,967
    

  

     $ 24,403    $ 30,967
    

  

 

These facilities are disclosed in the financial statements as:

 

     March
31, 2004


   December
31, 2003


Overdrafts

   $ 22,599    $ 30,441

Long term debt – current portion

     180      29

Total long term debt less current portion

     1,624      497
    

  

Total

   $ 24,403    $ 30,967
    

  

 

Principal repayments for the followings years


   March
31, 2004


   December
31, 2003


               

2004

   $ 22,599    $ 30,441

2005

     180      29

2006

     180      497

2007

     180      —  

2007 plus

     1,264      —  
    

  

Total

   $ 24,403    $ 30,967
    

  

 

Within the total overdraft facilities agreed as at March 31, 2004, $18.1 million remains available. These overdraft facilities are subject to renewal between April and December 2004 and the Company has not historically encountered any difficulties in successfully renegotiating them.

 

7. LEASE OBLIGATIONS

 

In November 2000, the Company entered into a non-cancelable five-year operating lease, for its main warehouse and office in Warsaw, which stipulated monthly payments of $130,000. In February 2003, the Company renegotiated this lease by signing a seven-year agreement starting from May 1, 2003 at a lower rent of $96,000 per month. The following is a schedule by years of the future rental payments under the non-cancelable operating lease as of March 31, 2004:

 

2004

   $ 864

2005

     1,152

2006

     1,152

2007

     1,152

2008

     1,152
    

Thereafter

     1,752
    

     $ 7,224
    

 

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CENTRAL EUROPEAN DISTRIBUTION CORPORATION

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED)

(amounts in tables expressed in thousands except per share information)

 

7. LEASE OBLIGATIONS (cont’d)

 

The Company also has rental agreements for all of the regional offices and warehouse space. Monthly rentals range from approximately $2,000 to $11,670. All of the regional office and warehouse leases can be terminated by either party within two or three month’s prior notice. The retail shop leases have no stated expiration date, but can be terminated by either party with three months to six months prior notice.

 

The Company continues its policy of renewing its transportation fleet by way of capital leases. The future minimum lease payments for the assets under capital lease at March 31, 2004 are as follows:

 

2004

   $ 1,889  

2005

     1,279  
    


     $ 3,168  

Less interest

     (180 )
    


     $ 2,988  
    


 

8. INCOME TAXES

 

Total income tax expense varies from expected income tax expense computed at enacted Polish statutory rates (19% in 2004 and 27% in 2003) as follows:

 

     March 31,

 
     2004

    2003

 

Tax at the Polish statutory rate

   $ 697     $ 701  

Temporary differences, net, U.S. tax losses

     (50 )     (107 )

Movement in allowance for doubtful debts

     22       46  

Movements in accruals

     (19 )     (75 )

Effect of foreign currency exchange rates on net deferred tax assets

     (94 )     113  

Permanent differences

             3  
    


 


Total income tax expense

   $ 556     $ 681  
    


 


 

Tax liabilities (including corporate income tax, Value Added Tax (VAT), social security and other taxes) of the Company’s Polish subsidiaries may be subject to examinations by Polish tax authorities for up to five years from the end of the year the tax is payable. CEDC’s U.S. federal income tax returns are also subject to examination by the U.S. tax authorities. As the application of tax laws and regulations, and transactions are susceptible to varying interpretations, amounts reported in the consolidated financial statements could be changed at a later date upon final determination by the tax authorities.

 

9. STOCK OPTION PLANS AND WARRANTS

 

The Company has elected to follow APB 25. Under APB 25, no compensation expense is recognized when the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of grant.

 

The Company’s 1997 Stock Incentive Plan (“Incentive Plan”) provides for the grant of stock options, stock appreciation rights, restricted stock and restricted stock units to directors, executives, and other employees (“employees”) of the Company and to non-employee service providers of the Company. The Incentive Plan authorizes, and the Company has reserve for future issuance, up to 1,072,725 shares of Common Stock (subject to anti-dilution adjustment in the event of a stock-split, recapitalization, or similar transaction). The Compensation Committee of the Board of Directors of the Company administers the Incentive Plan.

 

The option exercise price for stock options granted under the Incentive Plan may not be less than fair market

 

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CENTRAL EUROPEAN DISTRIBUTION CORPORATION

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED)

(Amounts in tables expressed in thousands except per share information)

 

9. STOCK OPTION PLANS AND WARRANTS (cont’d)

 

value but in some cases may be in excess of the market price of Common Stock on the date of grant. The Company sets the stock option price based on the closing price of the Common Stock on the day before the date of grant if such price is not materially different than the opening price of the Common Stock on the date of grant. Accordingly, there is no compensation expense recorded for options granted under the Incentive Plan to employees. Stock options may be exercised up to 10 years after the date of grant except as otherwise provided in the particular stock option agreement. Payment for the shares purchased under the Incentive Plan must be in cash, which must be received by the Company prior to any shares being issued.

 

Pro forma information regarding net income and earnings per share is required by Statement 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of Statement 123. The fair value of these stock options were estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions: risk-free interest rate of 1.90%, dividend yields of 0.0%; volatility factors of the expected market price of the Company’s common stock of 1.25; and a weighted-average expected life of the option of 3.4 years.

 

The Black-Scholes option valuation method was developed for use in the estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee stock option have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate.

 

For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period. The Company’s pro forma information follows:

 

     Three Months to
March 31,


     2004

   2003

Net income as reported

   $ 3,110    $ 1,917

Pro forma net income

   $ 2,766    $ 1,863

Pro forma earnings per share:

             

Basic

   $ 0.26    $ 0.21

Diluted

   $ 0.26    $ 0.20

 

10. SUBSEQUENT EVENTS

 

There have been no subsequent events since March 31, 2004.

 

11. RECLASSIFICATIONS

 

Certain amounts in the 2004 consolidated condensed financial statements have been reclassified to be consistent with the 2003 financial statements. These reclassifications do not have a material effect on the financial statements.

 

12. COMMITMENTS AND CONTINGENT LIABILITIES

 

The Company is involved in litigation from time to time and has claims against it in connection with matters arising in the ordinary course of business. In the opinion of management, the outcome of these proceedings will not have a material adverse effect on the Company’s operations.

 

During 2003, the Company received a decision regarding a tax dispute in one of its subsidiaries which resulted in a tax obligation of $146,000, which was paid and expensed in the fourth quarter of 2003. The Subsidiary is still disputing the basis of the decision though should it fail to successfully argue its case there is a risk of a subsequent adjustment totaling $181,000.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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

 

This Form 10-Q, including, but not limited to the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by forward-looking statements. Investors are cautioned that forward-looking statements are not guarantees of future performance and that undue reliance should not be placed on such statements. The Company undertakes no obligation to publicly update or revise any forward-looking statements or to make any other forward-looking statements, whether as a result of new information, future events or otherwise unless required to do so by the securities laws.

 

The following discussion and analysis provides information which management believes is relevant to the reader’s assessment and understanding of the Company’s results of operations and financial condition and should be read in conjunction with the Consolidated Financial Statements and the notes thereto elsewhere in this report. Investors are also referred to the Risk Factors in the Company’s Form 10-K for the fiscal year ended December 31, 2003.

 

Overview

 

In order to aid understanding, we have prepared tables which segment our income statement information as presented in the financial statements into those elements which relate to operations acquired during the reporting period and those which relate to operations owned in both reporting periods. Key definitions are:

 

  Total Operations Q1 2004: This is an extract from the income statement for total operations for the quarter ended March 31, 2004.

 

  Operations Acquired 2003: This is the elimination of the amounts generated in the first quarter 2004 from operations acquired in 2003.

 

  Continuing Operations Q1 2004: The results from elements of the Company which were owned for the first quarter of each reported year.

 

  Total Operations Q1 2003: This is an extract from the income statement for total operations for the quarter ended March 31, 2003.

 

  Core growth: the growth rates achieved between results from continuing operations as reported in the current year versus the continuing operations of the previous year.

 

Readers will also find frequent references to the term cash on delivery (COD). Normal trade terms from our Polish Vodka suppliers are 60 days; however, we are offered by some of these suppliers significant discounts off the invoice price if we pay for goods when delivered. The discounts offered are considerably in excess of the effective rate we would pay for 60 day terms under our bank facilities.

 

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Results of Operations

 

Three Months Ended March 31, 2004 Compared to Three Months Ended March 31, 2003

 

“Operations acquired 2003” include the first quarter results for Dako-Galant (acquired April 5, 2003), Panta-Hurt (acquired September 15, 2003) and Multi-Ex (acquired November 15, 2003). These results have been excluded from continuing operations Q1 2004 to show the impact of a common three month period of ownership in both years.

 

     Total
operations
Q1 2004


    Operations
acquired
2003


    Continuing
operations
Q1 2004


    Total
operations
Q1 2003


    Growth
% from
continuing
operations


 
     ($ in thousands)  

Net Sales

   $ 110,477     22,392     88,085     79,468     10.8 %

Cost of goods sold, including excise taxes

     96,711     19,607     77,104     68,985     11.8 %

Gross profit

     13,766     2,785     10,981     10,483     4.8 %

as a percentage of sales

     12.5 %   12.4 %   12.5 %   13.2 %      

Selling, general and administrative expenses

     8,884     1,723     7,161     6,802     5.3 %

Depreciation and amortization

     706     131     575     474     21.3 %

Bad debt provision

     66     (118 )   184     67     174.6 %

Operating income

     4,110     1,049     3,061     3,140     (2.5 %)

as a percentage of sales

     3.7 %   4.7 %   3.5 %   4.0 %      

Non operating income / (expense)

                                

Interest income

     43     5     38     27     40.7 %

Interest expense

     (461 )   (198 )   (263 )   (553 )   (52.4 %)

Realized and unrealized foreign exchange losses

     (46 )   —       (46 )   (2 )      

Other income / (expense), net

     20     15     5     (14 )      

Income before taxes

     3,666     871     2,795     2,598     7.6 %

as a percentage of sales

     3.3 %   3.9 %   3.2 %   3.3 %      

Income tax expense

     556     109     447     681        

Net income

     3,110     762     2,348     1,917     22.5 %

as a percentage of sales

     2.8 %   3.4 %   2.7 %   2.4 %      

 

Net Sales

 

Total net sales for the three months ended March 31, 2004, increased by 39.0%, or $31.0 million, to $110.5 million. Net sales from continuing operations increased by 10.8%, or $8.6 million, to $88.1 million from $79.5 million for the same period in 2003. The increase in sales has been driven by the competitive pricing strategy we have applied over the past few months. The objective of this strategy has been to gain market share from our competitors.

 

Gross Profit

 

Total gross profit on net sales increased by 31.3% or $3.3 million. When expressed as a percentage of sales, total gross margins decreased from 13.2% to 12.5%. This overall reduction is due to two factors. Firstly we are addressing the market in an assertive manner so as to gain market share from our competitors. Secondly, the impending EU accession has meant that the supply chain is running down its inventories of EU sourced imported product while waiting for changes to import duty classifications due to come into effect from May 1, 2004.

 

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Table of Contents

Operating Expenses

 

     Total
operations
Q1 2004


    Operations
acquired
2003


    Continuing
operations
Q1 2004


    Total
operations
Q1 2003


 

Selling, general and administrative expenses, as a percentage of net sales

   8.0 %   7.7 %   8.1 %   8.6 %

Bad debt expense, as a percentage of net sales

   0.1 %   (0.5 %)   0.2 %   0.1 %

 

Total selling, general and administrative expenses (SG&A) increased by 30.6% from $6.8 million in the first quarter of 2003 to $8.9 million in the first quarter of 2004. When expressed as a percentage of net sales, SG&A fell from 8.6% to 8.0%. This improvement is attributable to the roll out of our cost reduction program based on centralization of core overhead supplies and the initial re-organization of the depot structure.

 

Total bad debt expense stayed constant year on year at around $66,000. As previously disclosed, in the absence of any special circumstances, the Company reserves for doubtful accounts are based on the ageing of the total accounts receivable.

 

Operating Income

 

Total operating income increased by 30.9%, or $1.0 million, to $4.1 million for the three months ended March 31, 2004. When expressed as a percentage of sales, total operating income was 3.7% for the three months ended March 31, 2004, as compared to 4.0% for the same period of 2003. Operating income from continuing operations decreased by 2.5% to $3.1 million for the three months ended March 31, 2004. As a percentage of sales, operating income from continuing operations decreased to 3.4% for the three months ended March 31, 2004 as compared to 4.0% for the same period of 2003. The increase in operating income was due to the factors noted above namely increased sales and margin combined with an increase of selling, general and administrative expenses.

 

Interest Expense

 

Total interest expense decreased $92,000, or 16.6%, from $553,000 for the three months ended March 31, 2003 to $461,000 for the three months ended March 31, 2004. Interest cover, being the number of times interest expense is “covered” by operating income and calculated as operating income divided by interest expense, has increased from 5.7 times in the first quarter of 2003 to 9.2 times in the first quarter of 2004. As mentioned in the overview, the Company makes extensive use of COD rebates when the discount offered is significantly better than the effective rate of bank borrowing.

 

Net Realized and Unrealized Foreign Currency Losses

 

The net change relating to foreign exchange losses increased from $2,000 in the first quarter of 2003 to $46,000 in the first quarter of 2004. These losses were the result of translation movements on trade payables to non Polish suppliers offset by opposite movements in inventories denominated in currencies other than the Polish zloty and held in the Company’s bonded warehouse.

 

Income Tax

 

The total tax charge for the period ending March 31, 2004 was $556,000, or 15.2% of pre-tax profits. For the same period in 2003, the charge was $681,000, or 26.2% of pre-tax profits. This reduction in effective rate is due to the change in base corporation tax rates from 27% down to 19%. This change came into effect from January 1, 2004.

 

Net Income

 

Total net income increased by 62.2% from $1,917,000 in the first quarter of 2003 to $3,110,000 in the first quarter of 2004. Net income from continuing operations increased by 22.5%. These increases were due to the factors noted above.

 

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Statement of Liquidity and Capital Resources

 

During the three months ended March 31, 2004, the Company’s operating activities generated cash of $10.8 million compared to generating $0.5 million of cash during the three months ended March 31, 2003. Operating cash flows are generated by :

 

  cash earnings defined as net earnings as adjusted for non-cash expense/income items such as depreciation.

 

  movements in working capital, primarily the movements of trade receivables and payables as well as inventory.

 

  movements in other current assets and liabilities.

 

The sources and uses of operating cash flows can be summarized as:

 

     Three months ended
March 31,


 
     2004

   2003

 

Cash earnings

   $ 3,842    $ 2,429  

Movements in working capital

     6,630      (1,609 )

Movements in other current assets/liabilities

     359      (315 )
    

  


Net cash generated by operating activities

   $ 10,831    $ 505  

 

The high sales concentration in December 2003 has flowed through to cash in the first quarter of 2004. Cash earnings increased 58% year on year mainly because of the increase in earnings as explained earlier. The Company’s drive for market share has been achieved through the use of pricing mechanisms as opposed to a relaxing of credit terms extended to clients. Debtor days as at March 31, 2004 (based on gross trade receivables excluding VAT) were 53.4 down from a December value of 56.0 days. Inventory rotation also improved falling from 28.5 days as at December 2003 to 24.7 days as at March 31, 2004. Our COD policy has stabilized at around 50% to 60% of domestic purchases. This means the movement of the amount invested into trade payables in the first quarter 2004 has not been as significant as it was in the first quarter of 2003.

 

The Company completed its investment in its new regional distribution center at the end of March 2004. This represents the bulk of the capital expenditure during the period.

 

Financing activities absorbed $6.7 million during the quarter as the Company reduced its short term debt following its strong sales in the fourth quarter of 2003.

 

The Company believes that its operating cash flow, together with borrowings under available credit facilities will be sufficient for its operating needs, other than future acquisitions, and debt servicing requirements as they come due.

 

As stated above, the movements on the comprehensive loss account are driven by the effect of exchange rate movements in Polish zloty denominated equity items within the balance sheet. Because of the size of the movement in this period, the Company has disclosed the item separately.

 

STATEMENT ON INFLATION AND CURRENCY FLUCTUATIONS

 

Inflation in Poland is projected at 2.4% for the whole of 2004, compared to actual inflation of 1.7% in 2003. For the first three months of 2004, the yearly inflation was 1.7%.

 

The Company’s operating cash flows and substantially all of its assets are denominated in Polish zloty. This means that the Company is exposed to translation risk both on its balance sheet and income statement. The impact on working capital items is demonstrated on the cash flow statement as the movement in exchange on cash and cash equivalents. The impact on the income statement is by the movement of the average exchange rate used to restate the income statement from Polish zloty to U.S. Dollars. The amounts shown as FX gains of losses on the face of the income statement relate only to realized gains losses on non Polish zloty denominated transactions.

 

During the three months ended March 31, 2004, the exchange rate for the Polish zloty versus the U.S. Dollar weakened from 3.7405 to 3.8813 or 3.8%.

 

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Table of Contents

Critical Accounting Policies and Estimates

 

General

 

The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of revenues, expenses, assets and liabilities. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions and conditions.

 

Revenue Recognition

 

Revenue derived from beverage distribution is recognized when goods are shipped to customers and where a delivery acceptance note is signed by the customer has been returned to the Company. Sales are stated net turnover related customer discounts, an estimate of customer returns and sales tax (VAT). Revenue derived from retail operations (less than 1% of the total revenue) is recognized at the point of sale.

 

Expenses

 

The Company recognizes expenses in the period in which either the cost is incurred or in the period in which the associated revenue and margin have been recognized.

 

Provisions for Doubtful Debt

 

Allowances for doubtful accounts are based upon the aging of the accounts receivable. The Company makes an allowance based on a sliding scale which culminates in a 100% provision once the receivable is past due over one year. Where circumstances require, the Company will make specific provisions for any excess not provided for under the general provision. When a final determination is delivered to the Company regarding the non-recovery of a receivable, the Company then charges the unrecoverable amount to the accumulated allowance.

 

Inventory

 

Inventories are stated at the lower of cost (first-in, first-out method) or market. Costs include customs duty (where applicable), and all costs associated with bringing the inventory for sale. These costs include importation, handling, storage and transport costs, and exclude rebates received from suppliers, which are reflected as reductions to closing inventory.

 

Because of the nature of the products supplied by the Company great attention is paid to inventory rotation. Where goods are estimated to be obsolete or unmarketable they are written down to a value reflecting the saleable value in their relevant condition.

 

Goodwill

 

As required by FASB 142, acquired goodwill is no longer amortized. Instead the Company assesses the recoverability of its goodwill at least once a year or whenever adverse events, changes in circumstances or business climate for individual business units may not be sufficient to support the recorded goodwill. If undiscounted cash flows are not sufficient to support the goodwill, an impairment charge will be recognized to reduce the carrying value of the goodwill to an appropriate level. No such charge has been considered necessary in the period being reported.

 

Intangible Assets

 

Intangible assets consist primarily of acquired trademarks. The trademarks are amortized on a straight-line basis over the period of expected economic benefit which is currently estimated at 10 years. The Company assesses the recoverability of its trademark at least once a year or whenever adverse events, changes in circumstances or business climate for individual business units may not be sufficient to support the recorded trademark. If undiscounted cash flows are not sufficient to support the recorded trademark, an impairment charge will be recognized to reduce the carrying value of the recorded trademark to an appropriate level. No such charge has been considered necessary in the period being reported.

 

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Table of Contents

Employee Stock Based Compensation

 

The Company accounts for grants to employees under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. For grants to employees, no stock-based employee compensation cost is reflected in net income, as all options granted under the Company’s option plan had an exercise price at least equal to the market value of the underlying common stock on the date of the grant.

 

Marketing and Promotion Costs

 

The Company does not involve itself in any direct advertising but manages the marketing and promotional budgets of suppliers for which it has exclusive distribution rights. These marketing and promotion costs, which are recorded under Selling, General and Administrative costs, are expensed as incurred and include free promotional product and point of sales merchandise. Where free product is given to a customer outside of any promotional activity it is included in cost of goods sold.

 

Shipping and Handling Costs

 

Where the Company has incurred costs in shipping goods to its warehouse facilities these costs are recorded as part of inventory and then to cost of goods sold. Shipping and handling costs associated with distribution to customers are recorded in Selling, General and Administrative costs and are expensed as incurred.

 

Deferred Taxation

 

Deferred tax assets and liabilities are recorded where there is a timing delay in accounting for an income or expense item through the Company’s statutory tax records. The deferred tax assets and liabilities are calculated on a quarterly basis and the resulting asset or liability is accounted for on the balance sheet. Where a deferred tax asset arises the Company assesses whether a valuation allowance is required to be made. Valuation allowances are provided when it is more likely than not that some or all of the deferred tax asset will not be realized in the future. The Company has concluded that a valuation allowance is not considered necessary in the period being reported.

 

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Foreign Currency Risk. Currently none of the Company’s loans are denominated in currencies other than its functional currency, the Polish Zloty. As a result in the three months ended March 31, 2004, the Company is not exposed to any risk from foreign exchange movements as regards its funding. The Company is exposed as regards its carrying of non Polish zloty balances for foreign suppliers, export sales and goods in bonded warehouses. As at March 31, 2004, these balances were not significant.

 

ITEM 4. CONTROLS AND PROCEDURES

 

CEO and CFO Certifications. Exhibits 31.1 and 31.2 of this quarterly report are the certifications of the CEO and the CFO required by Rules 13a-14 and 15d-14 the Securities Exchange Act of 1934 (the “Certifications”). This section of the quarterly report contains the information concerning the evaluation of Disclosure Controls and changes to Internal Controls referred to in the Certifications and this information should be read in conjunction with the Certifications for a more complete understanding of the topics presented.

 

Disclosure Controls and Internal Controls. Disclosure Controls are procedures that are designed for the purpose of ensuring that information required to be disclosed in the Company’s reports filed under the Securities Exchange Act of 1934 (such as this quarterly report), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Internal Controls are designed for the purpose of providing reasonable assurance that the Company’s transactions are properly authorized, recorded and reported and that the Company’s assets are safeguarded from improper use to permit the preparation of the Company’s financial statements in conformity with generally accepted accounting principles.

 

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Table of Contents

Limitations on the Effectiveness of Controls. The Company’s management, including the CEO and CFO, does not expect that the Company’s Disclosure Controls or Internal Controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. Further, the design of any control system is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Because of these inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

 

Changes to Internal Controls. In accordance with the SEC’s requirements, the CEO and the CFO note that, since the date of their last evaluation, there have been no significant changes in Internal Controls or in other factors that could significantly affect Internal Controls, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

Conclusions regarding Disclosure Controls. Based upon the required evaluation of Disclosure Controls, the CEO and CFO have concluded that, subject to the limitations noted above, the Company’s Disclosure Controls are effective to ensure that material information relating to the Company and its consolidated subsidiaries is made known to management, including the CEO and CFO, particularly during the period when the Company’s periodic reports are being prepared.

 

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Table of Contents

PART II. OTHER INFORMATION

 

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

 

(a) Exhibit

 

Exhibit

Number


  

Exhibit Description


3.1    Certificate of Amendment of Certificate of Incorporation
31.1    Certificate of the CEO pursuant to Rule 13a-15(e) or Rule 15d-15(e)
31.2    Certificate of the CFO pursuant to Rule 13a-15(e) or Rule 15d-15(e)
32.1    Certification of the CEO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2    Certification of the CFO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(b) Reports on Form 8-K

 

During the quarter ended March 31, 2004, the Company filed the following report on Form 8-K;

 

(i) February 6, 2004 – Reporting revised earnings guidance under Item 9 and filing the associated press release under Item 7.

 

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Table of Contents

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act Of 1934.

 

 

   

CENTRAL EUROPEAN

DISTRIBUTION CORPORATION

(registrant)

Date: May 10, 2004

 

By:

 

/s/    WILLIAM V. CAREY


       

William V. Carey

President and Chief Executive Officer

Date: May 10, 2004

 

By:

 

/s/    NEIL A.M. CROOK


       

Neil A.M. Crook

Chief Financial Officer

 

21