Form 10Q
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 SEPTEMBER 30, 2004

 

OR

 

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

 

FOR THE TRANSITION PERIOD                          TO                         

 

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 12b-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 October 28, 2004:

 

Common Stock ($.01 par value)                          16,411,942 shares

 



Table of Contents

INDEX

 

          PAGE

PART I.

  

FINANCIAL INFORMATION

    

Item 1.

   Financial Statements    3
     Consolidated Condensed Balance Sheets, as of September 30, 2004 (unaudited) and December 31, 2003    3
     Consolidated Condensed Statements of Income (unaudited) for the three and nine month periods ended September 30, 2004 and September 30, 2003    4
     Consolidated Condensed Statement of Changes in Stockholders’ Equity (unaudited) as of September 30, 2004    5
     Consolidated Condensed Statements of Cash Flows (unaudited) for the nine month periods ended September 30, 2004 and September 30, 2003    6
     Notes to Consolidated Condensed Financial Statements (unaudited)    7

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    12

Item 3.

   Quantitative and Qualitative Disclosure about Market Risk    19

Item 4.

   Controls and Procedures    20

PART II.

  

OTHER INFORMATION

    

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds    21

Item 6.

   Exhibits and Reports on Form 8-K    21

Signatures

        22

 

- 2 -


Table of Contents

PART I

FINANCIAL INFORMATION

 

CENTRAL EUROPEAN DISTRIBUTION CORPORATION

CONSOLIDATED CONDENSED BALANCE SHEETS

(in thousands, except share and per share information)

 

     September 30,
2004


    December 31,
2003


 
     (unaudited)        

CURRENT ASSETS

                

Cash and cash equivalents

   $ 11,732     $ 6,229  

Accounts receivable (net of allowance for doubtful accounts of $8,112 and $6,380 respectively)

     82,232       90,071  

Inventories

     29,998       35,012  

Prepaid expenses and other current assets

     6,068       5,249  

Deferred income taxes

     965       1,201  
    


 


TOTAL CURRENT ASSETS

   $ 130,995     $ 137,762  

Intangible assets, net

     2,236       2,506  

Goodwill, net

     43,815       35,618  

Equipment, net

     15,577       10,115  

Deferred income taxes

     1,465       1,382  

Other asset

     361       87  
    


 


TOTAL ASSETS

   $ 194,449     $ 187,470  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY

                

CURRENT LIABILITIES

                

Trade accounts payable

   $ 57,570     $ 65,776  

Short term bank loans and overdraft facilities

     25,244       30,441  

Income taxes payable

     355       977  

Taxes other than income tax

     2,642       1,230  

Other accrued liabilities

     2,476       3,011  

Current portions of obligations under capital leases

     3,162       1,282  

Current portion of long term debt

     292       29  
    


 


TOTAL CURRENT LIABILITIES

     91,741       102,746  

Long term debt, less current maturities

     1,752       497  

Long term obligations under capital leases

     1,222       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, 40,000,000 shares authorized, 16,554,731 and 10,876,329 shares issued at September 30, 2004 and December 31, 2003, respectively)

     165       109  

Additional paid-in-capital

     54,409       52,805  

Retained earnings

     43,258       30,536  

Accumulated other comprehensive income

     2,052       (246 )

Less: Treasury Stock at cost (164,025 shares at September 30, 2004 and 109,350 at December 31, 2003)

     (150 )     (150 )
    


 


TOTAL STOCKHOLDERS’ EQUITY

     99,734       83,054  
    


 


TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 194,449     $ 187,470  
    


 


 

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

 

- 3 -


Table of Contents

CENTRAL EUROPEAN DISTRIBUTION CORPORATION

 

CONSOLIDATED CONDENSED STATEMENTS OF INCOME

(in thousands, except per share information)

 

     Three months ended

    Nine months ended

 
     September 30,
2004


    September 30,
2003


    September 30,
2004


    September 30,
2003


 
     (unaudited)     (unaudited)     (unaudited)     (unaudited)  

Net sales

   $ 145,831     $ 104,844     $ 389,312     $ 289,435  

Cost of goods sold

     127,525       91,358       340,605       251,850  
    


 


 


 


Gross margin

     18,306       13,486       48,707       37,585  

Selling, general and administrative expenses, excluding amortization and depreciation

     10,821       7,961       29,523       22,432  

Depreciation of tangible fixed assets

     729       422       1,933       1,249  

Amortization of trademarks

     126       116       369       338  

Bad debt provision

     223       58       474       364  
    


 


 


 


Operating Income

     6,407       4,929       16,408       13,202  

Non operating income/(expense)

                                

Interest income

     60       55       147       137  

Interest expense

     (579 )     (303 )     (1,576 )     (1,329 )

Realized and unrealized foreign currency transaction gains

     226       4       284       105  

Other (expense)/income, net

     22       (51 )     77       (143 )
    


 


 


 


Income before taxes

     6,136       4,634       15,340       11,972  

Income tax expense

     1,040       1,030       2,618       3,005  
    


 


 


 


Net income

   $ 5,096     $ 3,604     $ 12,722     $ 8,967  
    


 


 


 


Net income per share of common stock, basic

   $ 0.31     $ 0.23     $ 0.78     $ 0.60  
    


 


 


 


Net income per share of common stock, diluted

   $ 0.31     $ 0.22     $ 0.77     $ 0.58  
    


 


 


 


 

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

 

- 4 -


Table of Contents

CENTRAL EUROPEAN DISTRIBUTION CORPORATION

 

CONSOLIDATED CONDENSED STATEMENTS OF CHANGES

IN STOCKHOLDERS’ EQUITY

(in thousands)

 

     Capital Stock

    Additional
Paid-in-
Capital


    Retained
Earnings


   Accumulated
Other
Comprehensive
Loss


     
     Issued

   In Treasury

           Total

     No. of
Shares


   Amount

   No. of
Shares


    Amount

          

Balance at December 31, 2003

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

Net income for the nine months ended September 30, 2004

                                       12,722              12,722

Foreign currency translation adjustment

                                              2,298       2,298
                                             


 

Comprehensive income for the nine months ended September 30, 2004

                                       12,722      2,298       15,020

Effect of stock split June 1, 2004

   5,438      54    (55 )             (54 )                     

Stock issued for acquisitions

   30                           673                      673

Stock options/warrants exercised by employees and non-employees

   210      2                    985                      987
    
  

  

 


 


 

  


 

Balance at September 30, 2004

   16,554      165    (164 )   $ (150 )   $ 54,409     $ 43,258    $ 2,052     $ 99,734
    
  

  

 


 


 

  


 

 

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

 

- 5 -


Table of Contents

CENTRAL EUROPEAN DISTRIBUTION CORPORATION

 

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOW

(in thousands)

 

     Nine months ended
September 30, 2004


    Nine months ended
September 30, 2003


 
     (unaudited)     (unaudited)  

OPERATING ACTIVITIES

                

Net income

   $ 12,722     $ 8,967  

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

                

Depreciation and amortization

     2,302       1,587  

Deferred income tax (benefit)/expense

     (157 )     35  

Bad debt provisions

     474       364  

Foreign exchange losses

     5       (22 )

Changes in:

                

Accounts receivable

     10,658       16,825  

Inventories

     7,446       6,022  

Prepaid expenses and other current assets

     (148 )     (223 )

Trade accounts payable

     (17,325 )     (27,523 )

Income and other taxes

     799       376  

Other accrued liabilities and other current liabilities

     (679 )     (1,330 )
    


 


Net Cash Provided By Operating Activities

     16,097       5,078  

INVESTING ACTIVITIES

                

Purchase of tangible fixed assets

     (4,213 )     (1,467 )

Disposal of tangible fixed assets

     275       280  

Acquisition of business, net of cash acquired

     (1,402 )     (2,581 )
    


 


Net Cash Used In Investing Activities

     (5,340 )     (3,768 )

FINANCING ACTIVITIES

                

Payment of overdraft facility

     (4,029 )     (3,440 )

Short term borrowings

     —         —    

Payment of short term borrowings

     (3,842 )     (2,013 )

Long term borrowings

     1,518       —    

Payments of long term borrowings

     —         (9,480 )

Payment of capital leases

     (1,733 )     (386 )

Net proceeds from Private Placement issuance of share

     —         19,307  

Net proceeds from exercise of employee and non-employee options

     987       1,784  
    


 


Net Cash (Used in)/Provided By Financing Activities

     (7,099 )     5,772  
    


 


Effect of exchange rate changes on cash and cash equivalents

     1,845       (1,003 )

Net increase in cash and cash equivalents

     5,503       6,079  

Cash and cash equivalents at beginning of period

     6,229       2,237  
    


 


Cash and cash equivalents at end of period

   $ 11,732     $ 8,316  
    


 


SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING ACTIVITIES AND FINANCING ACTIVITIES

                

Common stock issued in connection with acquisition of subsidiaries

   $ 673     $ 1,124  
    


 


Capital lease amounts advanced

   $ 1,933     $ 1,192  
    


 


Debt assumed in acquisition of businesses

   $ 2,674     $ 1,771  
    


 


Supplemental disclosures of cash flow information

                

Interest paid

   $ 1,576     $ 1,329  

Income tax paid

   $ 3,425     $ 3,070  

 

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

 

- 6 -


Table of Contents

CENTRAL EUROPEAN DISTRIBUTION CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(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 11 distribution centers and 65 satellite branches, the Company offers a 24 hour delivery service of alcoholic beverages to both the on and off trade. Since its incorporation in September 1997, the Company has acquired 100% of the outstanding common stock or 100% of the voting rights of its 14 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, this Form 10-Q does 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 and nine-month periods ended September 30, 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 Income

 

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 Income Account. As a result of the appreciation of the Polish Zloty against the U.S. Dollar during the nine-month period ending September 30, 2004, the Company earned foreign currency translation gains of $2,298,000 on these equity investments. This movement means that the cumulative balance on the Comprehensive Income Account is $2,052,000 as at September 30, 2004 and this has been reflected in the Consolidated Condensed Balance Sheet and Statements of Changes in Stockholders’ Equity. The total of the accumulated other comprehensive profit consist solely of currency exchange adjustments. No tax benefit has been recorded.

 

4. Earnings per share

 

Earnings 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

   Nine Months Ended

     September 30,
2004


   September 30,
2003


   September 30,
2004


   September 30,
2003


Basic:

                           

Net income

   $ 5,096    $ 3,604    $ 12,722    $ 8,967
    

  

  

  

Weighted average shares of common stock outstanding

     16,363      15,909      16,264      14,985
    

  

  

  

Basic Earnings Per Share

   $ 0.31    $ 0.23    $ 0.78    $ 0.60
    

  

  

  

Diluted:

                           

Net Income

   $ 5,096    $ 3,604    $ 12,722    $ 8,967
    

  

  

  

Weighted average shares of common stock outstanding

     16,363      15,909      16,264      14,985

Net effect of diluted stock options-based on the treasury stock method

     125      179      358      599

Totals shares outstanding – fully diluted

     16,488      16,088      16,622      15,584
    

  

  

  

Diluted Earnings Per Share

   $ 0.31    $ 0.22    $ 0.77    $ 0.58
    

  

  

  

 

- 7 -


Table of Contents

CENTRAL EUROPEAN DISTRIBUTION CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

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

 

5. Acquisitions

 

During the second quarter of 2004, the Company acquired 100% of the voting rights of Miro Sp. z o.o. based in western Poland. The Company also acquired from Saol Sp. z o.o. the assets and liabilities pertaining to alcohol distribution in the Krakow region. During the third quarter, the Company acquired from Urdom Sp. z o.o. certain trading assets and liabilities pertaining to alcohol distribution in the Czestochowa region. These acquisitions have been accounted for as a business combination. The Goodwill assumed and the assets acquired are outlined in the table below.

 

Table 5.2 Fair value of assets purchased and liabilities assumed

 

     Nine months ended
September 30, 2004


 

Current Assets

        

Cash and cash equivalents

   $ 217  

Other Current Assets

     7,723  

Equipment, net

     420  

Current Liabilities

     (9,226 )

Bank loans and overdraft facilities

     (2,674 )

Net identifiable assets and liabilities

     (3,540 )

Goodwill on acquisition

     5,208  

Consideration paid, satisfied in shares

     (299 )

Consideration paid, satisfied in cash

     (1,369 )
    


Cash (acquired)

   $ 217  
    


Net Cash Outflow

   $ 1,152  

 

During the period being reported the Company paid additional consideration towards acquisitions made in 2003 and against the original share purchase agreements. The additional compensation was made in cash, $250,000, and in shares of common stock, $374,000.

 

Assuming the consummation of the Dako-Galant, Panta-Hurt, Multi-Ex (acquired in 2003), Miro, Saol and Urdom (acquired in 2004) acquisitions and the issuance of common shares as of January 1, 2003, the unaudited pro-forma consolidated operating results for the three and nine months ended September 30, 2003 and September 30, 2004 were as follows:

 

     Three months ended

   Nine months ended

     September 30,
2004


   September 30,
2003


   September 30,
2004


   September 30,
2003


Net sales

   $ 145,831    $ 146,430    $ 408,115    $ 426,121

Net income

     5,096      1,140      12,302      4,662

Net income per share data:

                           

Basic EPS

   $ 0.31    $ 0.07    $ 0.75    $ 0.31

Diluted EPS

   $ 0.31    $ 0.07    $ 0.75    $ 0.30

 

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’s leading banks so as to improve cash management throughout the group.

 

All the Company’s banking facilities are denominated in Polish Zloty (though restated here as U.S. Dollar equivalents) and consist of:

 

     September 30,
2004


   December 31,
2003


Overdrafts

   $ 14,940    $ 23,184

Short term debt

     10,304      7,257

Long term debt – Current portion

     292      29

Total long term debt less current portion

     1,752      497
    

  

Total

   $ 27,288    $ 30,967
    

  

 

- 8 -


Table of Contents

CENTRAL EUROPEAN DISTRIBUTION CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

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

 

Principal repayments for the followings years.


   September 30,
2004


   December 31,
2003


2004

   $ 25,244    $ 30,441

2005

     292      29

2006 & beyond

     1,752      497
    

  

Total

   $ 27,288    $ 30,967
    

  

 

Within the total overdraft facilities agreed as at September 30, 2004, $36.8 million remains available. These overdraft facilities have a one year term and are subject to renewal by December 2004. The Company expects that these facilities will be renewed in due course.

 

The weighted average interest rate for the nine months ended September 30, 2004 was 6.64% and for the three months ended September 30, 2004 was 6.85%.

 

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 of the future rental payments under the non-cancelable operating lease as of September 30, 2004:

 

2004 October 1 to December 31

   $ 288

2005 Full year

     1,152

2006 Full year

     1,152

2007 Full year

     1,152

Thereafter

     2,688
    

     $ 6,432
    

 

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 with two or three months 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.

 

During 2004, the Company continued its policy of renewing its transportation fleet by way of capital leases. The future minimum lease payments for the assets under capital lease at September 30, 2004 are as follows:

 

2004

   $ 897  

2005

     3,062  

2006

     1,117  
    


Total Future Repayments

   $ 5,076  

Less interest

     (602 )
    


Principle Due

   $ 4,474  
    


 

8. Income Taxes

 

The Company operates in two tax jurisdictions, Delaware in the United States of America and Poland. All Polish subsidiaries file their own corporate tax returns as well as account for their own deferred tax assets. The Company does not file a tax return in Delaware based upon its consolidated income, simply upon that income statement for transactions occurring in the United States.

 

- 9 -


Table of Contents

CENTRAL EUROPEAN DISTRIBUTION CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

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

 

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

 

     Three months
ended September 30,


    Nine months
ended September 30,


 
     2004

    2003

    2004

    2003

 

Tax at Polish statutory rate

   $ 1,166     $ 1,251     $ 2,914     $ 3,233  

Temporary differences, net

                                

U.S. Tax loss differential

     (24 )     (37 )     (97 )     (56 )

Loss recovery in Polish tax

                 (68 )      

Other temporary differences

     (68 )     (129 )     (54 )     (94 )

Effect of foreign currency exchange rates on net deferred tax assets

     (44 )     (55 )     (90 )     (78 )

Permanent differences

     10             13        
    


 


 


 


Total income tax expense

   $ 1,040     $ 1,030     $ 2,618     $ 3,005  
    


 


 


 


 

The tax liabilities of the Polish subsidiaries (including corporate income tax, Value Added Tax (VAT), social security and other taxes) 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 applications of tax laws and regulations applicable to 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 reserved for future issuance, up to 1,618,388 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 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 1.91%; 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.

 

- 10 -


Table of Contents

CENTRAL EUROPEAN DISTRIBUTION CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

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

 

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
ended September 30


   Nine Months ended
September 30


     2004

   2003

   2004

   2003

Income as reported

   $ 5,096    $ 3,604    $ 12,722    $ 8,967

Pro forma net income

   $ 4,832    $ 2,410    $ 12,161    $ 8,193

Pro forma earnings per share: Basic

   $ 0.29    $ 0.15    $ 0.75    $ 0.55

          Diluted

   $ 0.29    $ 0.15    $ 0.73    $ 0.53

 

10. Matters Affecting Equity

 

During the nine months ended September 30, 2004, several events occurred to increase the number of shares of common stock used within the earnings per share calculation. These events are briefly listed below.

 

On May 28, 2004, the Company effected a three for two stock split of its common stock to shareholders of record as of May 17, 2004. This stock split was accounted for as a stock dividend. Throughout these financial statements and the notes thereto, the amounts for share and per share data have been amended to reflect this stock split.

 

On July 14, 2004, the Company issues 11,468 shares of common stock in part consideration for its acquisition of Miro Sp. z o.o. and 8,658 shares of common stock in part consideration for its acquisition of Dako Sp. z o.o.

 

On September 23, 2004, the Company issued 2,245 shares of common stock in part consideration for the trading assets of Urdom Sp. z o.o.

 

Employee options to purchase a total of 210,000 shares were exercised during the first nine months of 2004.

 

11. Commitments and Contingent Liabilities

 

The Company is involved in litigation from time to time and has claims against it for matters arising in the ordinary course of business. In the opinion of management, the outcome of these litigations 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, should the subsidiary fail to successfully argue its case, there is a risk of a subsequent adjustment totaling $181,000.

 

12. Subsequent events

 

On October 12, 2004, the Company acquired 100% of the shares of Polnis Distribution, an alcohol distributor in the center of Poland, for an investment of approximately $2.37 million of which, 80% was paid in cash and 20% was paid in shares of common stock of CEDC. The shares of CEDC common stock will be subject to a one year lock-up period.

 

- 11 -


Table of Contents
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 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” section 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 the nine months ended September 30, 2004, Poland saw an increase in its inflation rate, which moved from 0.8% in the first nine months of 2003 to 2.4% for the nine months ending September 30, 2004. As a consequence, core-lending (3 month WIBOR) rates have increased year over year, from 5.4% as at September 30, 2003 to 7.2% as at September 30, 2004.

 

Higher real interest rates have lead to the strengthening of the Polish Zloty versus the U.S. Dollar. At December 31, 2003, the Zloty/U.S. Dollar exchange rate was 3.74, whereas at September 30, 2004, it was 3.56 an appreciation of 4.8% as opposed to a depreciation of 3.4% in the nine months ended September 30, 2003.

 

On May 1, 2004, Poland joined the European Union and, as a result, products manufactured within the EU will no longer be subject to import duties, which should have a positive impact on our future business as the pricing of our imported product portfolio becomes aligned with local product. It is important to note that while Poland joined the EU in May 2004, joining the EU does not automatically result in joining the European Monetary Union (EMU). This is a separate process with different admission requirements. Poland is currently forecasting joining the EMU in 2008.

 

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, some of these suppliers offer significant discounts if we pay for goods when delivered. The discounts offered are considerably in excess of the effective rate we would pay for 60 day term loans under our bank facilities. Thus, the Company purchases approximately 45% of all goods on a cash-on-delivery basis.

 

- 12 -


Table of Contents

Results of Operations: Nine months ended September 30, 2004 compared with nine months ended September 30, 2003

 

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: the total results as stated in our financial statements, which includes the consolidated results for all subsidiaries for the period owned in the reporting period.

 

  Continuing operations: the results for elements of the Company which were owned for the first nine months of each reported year.

 

  Operations acquired: The amounts due to operations acquired in both 2003 and 2004 which are not common to both periods presented.

 

Nine Months Ended September 30


   Total
Operations
2003


    Continuing
Operations
2004


    Operations
Acquired


    Total
Operations
2004


 
     ($ in thousands)  

Net Sales

   $ 289,435     $ 312,810     $ 76,502     $ 389,312  

Cost of goods sold

     251,850       272,671       67,934       340,605  

Gross Profit

     37,585       40,139       8,568       48,707  

as a % of sales

     13.0 %     12.8 %     11.2 %     12.5 %

Total selling, general and administration expenses

     24,383       26,864       5,435       32,299  

as a % of sales

     8.4 %     8.6 %     7.1 %     8.3 %

Operating Income

     13,202       13,275       3,133       16,408  

as a % of sales

     4.6 %     4.2 %     4.1 %     4.2 %

Interest expense, net

     (1,192 )     (918 )     (511 )     (1,429 )

Realized and unrealized foreign currency gains

     105       284             284  

Other income/(expense)

     (143 )     30       47       77  

Income before tax

     11,972       12,671       2,669       15,340  

as a % of sales

     4.1 %     4.1 %     3.5 %     3.9 %

Taxes

     3,005       2,500       118       2,618  

as a % of income before tax

     25.1 %     19.7 %     4.4 %     17.1 %

Net Income

     8,967       10,171       2,551       12,722  

as a % of sales

     3.1 %     3.3 %     3.3 %     3.3 %

 

Net Sales and Gross Profit

 

Total net sales for the nine months ended September 30, 2004 increased 34.5%, or $99.9 million, to $389.3 million. Net sales from continuing operations increased by 8.1%, or $23.4 million, though this is diluted by the previously planned downsizing of a subsidiary acquired in April 2003. Excluding this subsidiary, sales from continuing operations increased by 12.0% during the nine months ended September 30, 2004.

 

Total gross profit increased 29.6%, or $11.1 million, to $48.7 million though total gross margins have declined by 0.5% to 12.5% which is in line with previously reported Company guidance. Gross profits from continuing operations increased 6.8%, or $2.6 million, however, after adjusting for the subsidiary being downsized, gross margins from continuing operations increased by 10.4%. As a percentage of sales, gross profit from continuing operations decreased 0.2% to 12.8%.

 

Operating Expenses

 

Total selling, general and administrative expenses increased by 32.5%, or $7.9 million. Total selling, general and administrative expenses from continuing operations increased by 10.2%, or $2.5 million.

 

Depreciation of fixed assets from total operations increased 54.8% as compared to the same period in 2003 primarily because of the inclusion in the nine months ended September 30, 2004 of the acquisitions. The increase attributable to continuing operations was 26.8%. During the nine months ending September 30, 2004, the Company continued to bring on line its investment in systems upgrades, fleet rotation, and its investment in a new regional distribution center all of which led to the increase in depreciation.

 

- 13 -


Table of Contents

Provisions for doubtful debts have increased in total by 30.2%. The Company’s provisioning policy is based on the age profile of the underlying trade receivables. Over the past two years, the Company has been applying this policy so as to accumulate and maintain sufficient reserves. As the Company has also been very focused on managing its debt and levels of exposure to specific client and client groups, it has been able to improve its collections.

 

Operating Income

 

Operating income from total operations increased 24.3%, or $3.2 million. Operating income from continuing operations increased 0.6%, or $73,000. After adjusting for the downsizing in one subsidiary, the general increase in operating margins from continuing operations was 4.1%. When expressed as a percentage of sales, operating income from continuing operations decreased to 4.2% compared to 4.5% for the nine months ended September 30, 2003.

 

Net Interest Expense

 

Net interest expense from total operations increased 19.8%, or $99,000, and net interest expense from continuing operations decreased 22.1%. Net interest cover for total operations has increased from 10.9 times for the nine months ended September 30, 2003 to 11.6 times for the same period in 2004.

 

Net Gains / Losses from Foreign Currency

 

The net gains from foreign currency transactions have increased from $105,000 for the nine months ended September 30, 2003 to $284,000 for the same period in 2004.

 

Income Tax

 

The total taxation charge has decreased 12.9%, or $0.4 million, to $2.6 million as a result of a reduction in the applicable tax rate (from 27% to 19%) which was partially offset by an increase in total profit before tax of $3.4 million.

 

Net Income

 

As a result of the factors noted above, total net income increased 41.9%, or $3.8 million, and net income from continuing operations increased 13.4%, or $1.2 million. When expressed as a percentage of sales, net income from total operations during the nine months ended September 30, 2003 was 3.1% where as for the nine months ended September 30, 2004, total net income was 3.3% and net income from continuing operations was 3.3%.

 

Results of Operations: Three months ended September 30, 2004 compared with three months ended September 30, 2003

 

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: the total results as stated in our financial statements, which includes the consolidated results for all subsidiaries for the period owned in the reporting period.

 

  Continuing operations: the results for elements of the Company which were owned for the third quarter of each reported year.

 

  Operations acquired: The amounts due to operations acquired in both 2003 and 2004 which are not common to both periods presented.

 

- 14 -


Table of Contents

Three Months Ended September 30


   Total
Operations
2003


    Continuing
Operations
2004


    Operations
Acquired


    Total
Operations
2004


 
     ($ in thousands)  

Net Sales

   $ 104,844     $ 114,725     $ 31,106     $ 145,831  

Cost of goods sold

     91,358       99,906       27,619       127,525  

Gross Profit

     13,486       14,819       3,487       18,306  

as a % of sales

     12.9 %     12.9 %     11.2 %     12.6 %

Total selling, general and administrative expenses

     8,557       9,605       2,294       11,899  

as a % of sales

     8.2 %     8.4 %     7.4 %     8.2 %

Operating Income

     4,929       5,214       1,193       6,407  

as a % of sales

     4.7 %     4.5 %     3.8 %     4.4 %

Interest expense

     (248 )     (343 )     (176 )     (519 )

Realized and unrealized foreign currency gains

     4       226       —         226  

Other income/(expense)

     (51 )     29       (7 )     22  

Income before tax

     4,634       5,126       1,010       6,136  

as a % of sales

     4.4 %     4.5 %     3.2 %     4.2 %

Taxes

     1,030       1,025       15       1,040  

as a % of income before tax

     22.2 %     20.0 %     1.5 %     16.9 %

Net Income

     3,604       4,101       995       5,096  

as a % of sales

     3.4 %     3.6 %     3.2 %     3.5 %

 

Net Sales and Gross Profit

 

Total net sales for the three months ended September 30, 2004 increased 39.1%, or $41.0 million, to $145.8 million. Net sales from continuing operations, increased by 9.4%, or $9.9 million, though this is diluted by the previously planned downsizing of a subsidiary acquired in April 2003. Excluding the subsidiary being downsized, sales from continuing operations increased by 15.2% during the three months ended September 30, 2004.

 

Total gross profit increased 35.7%, or $4.8 million, to $18.3 million. Total gross margins have decreased to 12.6% which is in line with the Company’s previously reported guidance for the year. Gross profits from continuing operations increased 9.9%, or $1.3 million, however, after adjusting for the subsidiary being downsized, gross margins from continuing operations increased to 14.3%.

 

On May 1, 2004, Poland joined the European Union (EU). This accession finally removed all duty restrictions on goods imported from the EU as well as reducing duty rates for countries with which the EU has regional agreements. The final elimination of cross border duties has significantly increased our performance in imported product, particularly wines, sales of which increased by 42% in the third quarter 2004 over the third quarter 2003. Strong third quarter increases were also seen in imported spirits which also showed a 42% increase over the third quarter 2003. Beer sales, both of domestic and our imported brands, were flat due to unseasonably cold weather in the third quarter.

 

Three Months to September 30,    2003

   2004

   %

 

(Sales in $000’s)


                

Imported Beers

   $ 1,596    $ 1,592    —    

Imported Spirits

     1,393      1,978    42 %

Imported Wines

     2,452      3,482    42 %

Other Imported Product

     215      232    8 %
    

  

      

Total Imported Product

   $ 5,656    $ 7,284    29 %

 

Sales of domestic vodka made up 68% of the total sales mix in the third quarter 2004 which is consistent with the prior year.

 

Operating Expenses

 

Total selling, general and administrative expenses increased by 39.0%, or $3.3 million, in line with total sales increases and mainly due to the inclusion of the acquired companies. Total selling, general and administrative expenses from continuing operations increased by 12.2%, or $1.0 million.

 

Depreciation of fixed assets from continuing operations increased 41.5% over the same period in 2003. During the third quarter of 2004, the Company began depreciating its recent investment in a new regional distribution center.

 

Provisions for doubtful debts from total operations increased by $165,000, and from continuing operations increased by $150,000.

 

- 15 -


Table of Contents

Operating Income

 

Operating income from total operations increased 30.0%, or $1.5 million, primarily for the reasons mentioned above. Operating income from continuing operations increased by 5.8%. After adjusting for the downsizing in one subsidiary, the general increase in operating margins from continuing operations was 6.4%. When expressed as a percentage of sales, operating income from continuing operations decreased to 4.5% for the three months ended September 30, 2004 compared to 4.7% for the three months ended September 30, 2003.

 

Net Interest Expense

 

Net interest expense for total operations increased 109.3%, or $271,000, and net interest expense from continuing operations increased by $89,000. Net interest cover for total operations decreased from 19.9 times for the three months ended September 30, 2003 to 12.6 times for the same period in 2004.

 

Net Gains / Losses from Foreign Currency

 

The net gains from foreign currency transactions have increased from $4,000 for the three months ended September 30, 2003 to $226,000 for the same period in 2004.

 

Income Tax

 

Total taxation increased $10,000, to $1,040,000. This increase is due both to an increase in total income before tax of $1,502,000 and a reduction of the corporate income tax rate for 2004 to 19% compared to 27% in 2003.

 

Net Income

 

As a result of the factors noted above, total net income increased 41.4%, or $1.5 million, and net income from continuing operations increased 13.8%, or $497,000. When expressed as a percentage of sales, net income from total operations during the three months ended September 30, 2003 was 3.4% where as for the three months ended September 30, 2004, total net income was 3.5% and from continuing operations was 3.6%.

 

Statement of Liquidity and Capital Resources

 

During the nine months ended September 30, 2004, the Company’s operating activities generated $16.1 million of cash compared to generating $5.1 million of cash during the nine months ended September 30, 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; and

 

  movements in other current assets and liabilities.

 

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

 

     Nine months ended
September 30, 2004


    Nine months ended
September 30, 2003


 

Cash adjusted net income

   $ 15,346     $ 10,931  

Net movement in inventories, receivables and payables

     779       (4,676 )

Net movement in other current assets/liabilities

     (28 )     (1,177 )
    


 


Net cash provided by operations

   $ 16,097     $ 5,078  

 

The net cash provided by operating activities increased by $11.0 million for the first nine months of 2004 to a positive $16.1 million compared to a positive $5.1 million for the first nine months of 2003. The above table demonstrates the components of cash generated from operations. Cash adjusted net income, being net earnings as adjusted for non cash items within the income statement, increased by 42% consistent with the overall increase in net earnings. The Company has also been giving considerable focus to working capital management and hence cash generation. To reduce working capital requirements the Company has implemented:

 

  Stronger controls and guidelines over inventory rotation rates,

 

- 16 -


Table of Contents
  Stricter credit control to the point of holding back sales growth if the anticipated return is too low, and

 

  Improved terms with suppliers following increased volumes.

 

The Company completed its investment in its new regional distribution center at the end of June 2004. This represents the bulk of the capital expenditures on tangible fixed assets during the nine months ended September 30, 2004 period. The Company also acquired 100% of the voting share capital of Miro Sp. z o.o. and the net distribution assets and liabilities of Saol Sp. z o.o. relating to alcohol distribution in the Krakow Region during the second quarter 2004.

 

Financing activities absorbed $7.1 million during the nine months ended September 30, 2004 as the Company reduced its short term debt following collection on receivables generated by strong year end 2003 sales and continued monitoring of 2004 receivables.

 

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 regards future acquisitions these will be funded either from existing cash reserves or third party funding.

 

As stated above, the movements in the Comprehensive Income 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 3.0% for the whole of 2004, compared to 1.3% for 2003. For the first nine months of 2004, the inflation rate was 2.1%. The share of purchases denominated in non-Polish currencies during the first nine months of 2004 decreased resulting in lower foreign exchange exposure for purchases. The Zloty has appreciated 4.8 % against the U.S. Dollar during the first nine months of 2004.

 

Seasonality

 

The Company’s working capital requirements are seasonal, and are normally highest in the months of November and December. Liquidity normally improves when collections are made on the higher year end sales during the first quarter.

 

The Company expects to experience some variability in sales and net income on a quarterly basis.

 

Other Matters

 

The Company continues to be involved in litigation from time to time in the ordinary course of business. In management’s opinion, the litigation in which the Company is currently involved, individually and in the aggregate, is not material to the Company’s financial condition or results of operations.

 

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 of 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.

 

- 17 -


Table of Contents

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 and excise duty where applicable.

 

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 carrying value of the trademarks is 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 the carrying value of its trademarks 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 carrying value of the recorded trademarks. If undiscounted cash flows are not sufficient to support the carrying value of the recorded trademarks, an impairment charge will be recognized to reduce the carrying value of the recorded trademarks to an appropriate level. No such charge has been considered necessary in the period being reported.

 

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.

 

Shipping and Handling Costs

 

Where the Company has incurred costs in shipping imported goods to its central warehouse facility these costs are recorded as part of inventory and then as 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

 

- 18 -


Table of Contents

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. As a result of our operating primarily in Poland and our financing activities, we are exposed to changes in interest rates and foreign currency exchange rates as well as currency translation risk that may adversely affect our results of operations and financial position. During the period from December 31, 2003 to September 30, 2004, there were no developments which would result in material changes to the information provided by us regarding our exposure to these risks as of December 31, 2003.

 

The Company’s operations are conducted primarily in Poland and its functional currency is the Polish Zloty. As a result, substantially all of our financial assets (such as cash and cash equivalents, accounts receivable, accounts payable, inventories and bank debt) are subject to currency translation risk when reported in U.S. Dollars.

 

Our commercial foreign exchange exposure mainly arises from the purchase of imported alcoholic beverage in currencies other than our functional currency of the Polish Zloty. Thus, accounts payable for imported beverages are billed in various currencies and the Company is subject to short-term changes in the currency markets for product purchases. The Company also operates a bonded warehouse where the inventory acquired from foreign suppliers is recorded in its source currency. Thus, any currency movement on trade payables resulting from either a strengthening or weakening of the Polish Zloty against a foreign supplier’s currency may be partially offset by an opposite movement relating to inventories recorded in the imported currency.

 

Bank borrowings are sensitive to interest rate risks as they usually bear interest at variable rates and are denominated in various currencies. The Company does not enter into any hedging arrangements in regards to its interest risk exposure (i.e., interest rate swaps or forward rate agreements).

 

- 19 -


Table of Contents
ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

The Company’s management, including the Company’s President and Chief Executive Officer and Vice President and Chief Financial Officer, conducted an evaluation as of September 30, 2004 of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e)). Based on that evaluation, the President and Chief Executive Officer and Vice President and Chief Financial Officer concluded that, subject to the limitations noted below, the disclosure controls and procedures were effective to ensure that all material information relating to the Company or its consolidated subsidiaries required to be disclosed in the reports the Company files and submits under the Securities and Exchange Act of 1934 has been made known to them on a timely basis and that such information is properly recorded, processed, summarized and reported, as required.

 

Changes in Internal Controls

 

There have been no significant changes in the Company’s internal controls over financial reporting during the most recent fiscal quarter that materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

 

Sarbanes-Oxley Section 404 Compliance

 

Section 404 of the Sarbanes-Oxley Act of 2002 (the “Act”) will require the Company to include an internal control report from management in its Annual Report on Form 10-K for the year ended December 31, 2004 and in subsequent Annual Reports thereafter. The internal control report must include the following: (1) a statement of management’s responsibility for establishing and maintaining adequate internal control over financial reporting, (2) a statement identifying the framework used by management to conduct the required evaluation of the effectiveness of the Company’s internal control over financial reporting, (3) management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, including a statement as to whether or not internal control over financial reporting is effective, and (4) a statement that the Company’s independent auditors have issued an attestation report on management’s assessment of internal control over financial reporting.

 

Management acknowledges its responsibility for establishing and maintaining internal controls over financial reporting and seeks to continually improve those controls. In addition, in order to achieve compliance with Section 404 of the Act within the required timeframe, since 2004 the Company has been conducting a process to document and evaluate its internal controls over financial reporting. In this regard, the Company has dedicated internal resources, and adopted a detailed work plan to: (i) assess and document the adequacy of internal control over financial reporting; (ii) take steps to improve control processes where required; (iii) validate through testing that controls are functioning as documented; and (iv) implement a continuous reporting and improvement process for internal control over financial reporting. The Company believes its process for documenting, evaluating and monitoring its internal control over financial reporting is consistent with the objectives of Section 404 of the Act.

 

During the first nine months of 2004, the Company commenced testing of its internal controls. The Company’s documentation and testing to date have identified certain gaps in the documentation, design and effectiveness of internal controls over financial reporting that the Company is in the process of remediating. Given the risks inherent in the design and operation of internal controls over financial reporting, the Company can provide no assurance as to its, or its independent auditor’s conclusions at December 31, 2004 with respect to the effectiveness of its internal controls over financial reporting.

 

Limitation on the Effectiveness of Controls

 

It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the control system are met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events. Because of these and other inherent limitations of control systems, there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

 

- 20 -


Table of Contents

PART II. OTHER INFORMATION

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

  (a) Pursuant to an agreement dated September 7, 2004, the Company issued 2,245 shares of common stock, valued at $49,951 as partial consideration for the acquisition of partial distribution in the area of Czestochowa. The shares were delivered by the Company on September 23, 2004. These shares were issued pursuant to the exemption from registration provided by Regulation S under the Securities Act. The securities were issued in off-shore private placements in reliance on Regulation S to entities which are not “United States persons” as defined by Regulation S. The stock certificates for all such securities bear a legend indicating that the stock is restricted and may not be sold in the United States without registration or an exemption from such requirements. Further, the holders have agreed to a one-year lock-up period.

 

  (b) Pursuant to an agreement dated October 11, 2004, the Company issued 19,736 shares of common stock, valued at $469,125, as partial consideration for the acquisition of 100% of Polnis Distribution Sp. z o.o. The shares were delivered by the Company on October 27, 2004. These shares were issued pursuant to the exemption from registration provided by Regulation S under the Securities Act. The securities were issued in off-shore private placements in reliance on Regulation S to entities which are not “United States persons” as defined by Regulation S. The stock certificates for all such securities bear a legend indicating that the stock is restricted and may not be sold in the United States without registration or an exemption from such requirements. Further, the holders have agreed to a one-year lock-up period.

 

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

 

  (a) Exhibit

 

Exhibit number

  

Exhibit description


31.1    Certificate of the CEO pursuant to Rule 13a-14(a) or Rule 15d-14(a)
31.2    Certificate of the CFO pursuant to Rule 13a-14(a) or Rule 15d-14(a)
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 September 30, 2004, the Company filed the following report on Form 8-K:

 

  (i) August 3, 2004 – Reporting under Item 12 the announcement of the Company’s preliminary second quarter 2004 results and filing the associated press release.

 

- 21 -


Table of Contents

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

       

CENTRAL EUROPEAN

DISTRIBUTION CORPORATION

(registrant)

Date: November 9, 2004

     

By:

 

/s/ WILLIAM V. CAREY

               

William V. Carey

President and Chief Executive Officer

Date: November 9, 2004

     

By:

 

/s/ NEIL A.M. CROOK

               

Neil A.M. Crook

Chief Financial Officer

 

- 22 -