Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

 

 

Form 10-K

 

 

 

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

 

  FOR THE FISCAL YEAR ENDED DECEMBER 31, 2009

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   54-1865271
(State or Other Jurisdiction of
Incorporation or Organization)
  (I.R.S. Employer
Identification No.)
Two Bala Plaza, Suite #300, Bala Cynwyd, PA   19004
(Address of Principal Executive Offices)   (Zip code)

 

 

Registrant’s telephone number, including area code: (610) 660-7817

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, par value $0.01 per share

(Title of Class)

Securities registered pursuant to Section 12(g) of the Act:

Not Applicable

 

 

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    Yes  ¨    No  x

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K.    ¨.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer  x      Accelerated filer  ¨      Non-accelerated filer  ¨      Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.):    Yes  ¨    No  x

The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2009, was approximately $ 992,188,312 (based on the closing price of the registrant’s common stock on the NASDAQ Global Select Market).

As of February 22, 2010, the registrant had 69,451,680 shares of common stock outstanding.

Documents Incorporated by Reference

Portions of the proxy statement for the annual meeting of stockholders to be held on April 29, 2010 are incorporated by reference into Part III.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

     Page

PART I

  

Item 1.

  

Business

   2

Item 2.

  

Properties

   25

Item 3.

  

Legal Proceedings

   26

Item 4.

  

Submission of Matters to a Vote of Security Holders

   26

PART II

  

Item 5.

  

Market for Registrant’s Common Equity and Related Stockholder Matters

   27

Item 6.

  

Selected Financial Data

   28

Item 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operation

   29

Item 7A.

  

Quantitative and Qualitative Disclosures about Market Risk

   54

Item 8.

  

Financial Statements and Supplementary Data

   56

Item 9.

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   103

Item 9A.

  

Controls and Procedures

   103

PART III

  

Item 10.

  

Directors and Executive Officers of the Registrant

   105

Item 11.

  

Executive Compensation

   105

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management

   105

Item 13.

  

Certain Relationships and Related Transactions

   105

Item 14.

  

Principal Accountant Fees and Services

   105

PART IV

  

Item 15.

  

Exhibits, Financial Statement Schedules and Reports on Form 8-K

   106

Signatures

   107


Table of Contents

The disclosure and analysis of Central European Distribution Corporation, or the Company, in this report contain forward-looking statements, which provide the Company’s current expectations or forecasts of future events. Forward-looking statements in this report include, without limitation:

 

   

information concerning possible or assumed future results of operations, trends in financial results and business plans, including those relating to earnings growth and revenue growth, liquidity, prospects, strategies and the industry in which the Company and its affiliates operate, as well as the integration of recent acquisitions and other investments and the effect of such acquisitions and other investments on the Company;

 

   

statements about the expected level of the Company’s costs and operating expenses relative to its revenues, and about the expected composition of its revenues;

 

   

information about the impact of governmental regulations on the Company’s businesses;

 

   

other statements about the Company’s plans, objectives, expectations and intentions; and

 

   

other statements that are not historical facts.

Words such as “believes”, “anticipates” and “intends” may identify forward-looking statements, but the absence of these words does not necessarily mean that a statement is not forward-looking. Forward-looking statements are subject to known and unknown risks and uncertainties and are based on potentially inaccurate assumptions that could cause actual results to differ materially from those expected or implied by the forward-looking statements. The Company’s actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the factors described in the section entitled “Risk Factors” in this report. Other factors besides those described in this report could also affect actual results. You should carefully consider the factors described in the section entitled “Risk Factors” in evaluating the Company’s forward-looking statements.

You should not unduly rely on these forward-looking statements, which speak only as of the date of this report. The Company undertakes no obligation to publicly revise any forward-looking statement to reflect circumstances or events after the date of this report, or to reflect the occurrence of unanticipated events. You should, however, review the factors and risks the Company describes in the reports it files from time to time with the Securities and Exchange Commission, or SEC.

In this Form 10-K and any amendment or supplement hereto, unless otherwise indicated, the terms “CEDC”, the “Company”, “we”, “us”, and “our” refer and relate to Central European Distribution Corporation, a Delaware corporation, and, where appropriate, its subsidiaries.

 

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PART I

 

Item 1. Business

Central European Distribution Corporation (“CEDC”), a Delaware corporation incorporated on September 4, 1997, and its subsidiaries (collectively referred to as “we,” “us,” “our,” or the “Company”) operate primarily in the alcohol beverage industry. We are the largest producer of vodka in the world and are Central and Eastern Europe’s largest integrated spirit beverages business, measured by total volume, with approximately 30.5 million nine-liter cases produced and sold in 2009. Our business primarily involves the production and sale of our own spirit brands (principally vodka), the importation on an exclusive basis of a wide variety of spirits, wines and beers and the distribution of alcoholic beverages. Our primary operations are conducted in Poland, Russia and Hungary. We have eight manufacturing facilities located in Poland and Russia, and a total work force of more than 7,550 employees.

In Poland, we are the largest vodka producer with a brand portfolio that includes Absolwent, Zubrówka, Bols, Palace and Soplica brands, each of which we produce at our Polish distilleries. Absolwent and Bols are the top-selling vodkas in the mainstream and premium segments, respectively, in Poland.

We are also the largest vodka producer in Russia, the world’s largest vodka market. Our Green Mark brand is the top-selling mainstream vodka in Russia and the second-largest vodka brand by volume in the world and our Parliament and Zhuravli brands are the two top-selling sub-premium vodkas in Russia. We also produce and distribute Royal, the top-selling vodka in Hungary. We believe the strength of our brands is a key component to the success of our company. For the year ended December 31, 2009, our Polish and Russian operations accounted for 59.2% and 38.4% of our revenues and 49.3% and 51.7% of our operating profit, respectively.

We are a leading importer of spirits, wines and beers in Poland, Russia and Hungary, and we generally seek to develop a complete portfolio of premium imported wines and spirits in each of the markets we serve. We maintain exclusive import contracts for a number of internationally recognized brands, including Jim Beam Bourbon, Campari, Jägermeister, Remy Martin Cognac, Guinness, Corona, Budvar, E&J Gallo wines, Carlo Rossi wines, Sutter Home wines, Metaxa Brandy, Sierra Tequila, Teacher’s Whisky, Cinzano, Old Smuggler, Grant’s Whisky and Concha y Toro wines. We are also the largest distributor of alcoholic beverages in Poland, with a broad nationwide distribution network and extensive brand portfolio.

Our strong market position and broad portfolio of brands in Poland, and our platform for further expansion in the Russian spirit market established through our recent acquisitions in Russia, are two of our key competitive strengths, which we believe will enhance our position as Central and Eastern Europe’s largest integrated spirit beverage business. Through the integration of Russian Alcohol Group (which we refer to as Russian Alcohol) and the Copecresto Enterprises Limited (which we refer to as Parliament) businesses, we expect to generate significant synergies.

In addition to our operations in Poland, Russia and Hungary, our three primary markets, we have distribution agreements for our vodka brands in a number of key export markets including the United States, Japan, the United Kingdom, France and many other Western European countries. In 2009, exports represented 2.1% of our sales by value.

Our Competitive Strengths as a Group

Strong market position in PolandWe are a leading producer and importer of alcoholic beverages in Poland. Our brand portfolio includes top-selling brands that we produce as well as brands which we import on an exclusive basis. We also distribute a wide range of locally produced alcoholic beverages. Our broad portfolio of products, which includes over 700 brands of alcoholic beverages, allows us to address a wide range of consumer tastes and trends as well as wholesaler needs. Our economy brands have benefited recently from challenging economic conditions, while our premium and mainstream brands, including Absolwent and Bols, enable us to

 

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benefit from long-term premiumization trends taking place with Polish consumers. Our portfolio of top selling vodka brands and leading import brands also provides us with bargaining power in our dealings with large retail chains. Additionally, our distribution infrastructure provides us with the distribution leverage to serve independent retailers and on-trade locations.

Solid platform for further expansion in the fragmented Russian spirits marketWe are the largest vodka producer in Russia, producing approximately 18.0 million nine-liter cases in 2009. With the inclusion of Parliament, the Whitehall Group (which we refer to as Whitehall) and Russian Alcohol products, we have a large portfolio of alcoholic beverages, including Green Mark, the top-selling mainstream vodka brand in Russia and the second largest vodka brand by volume in the world, and Parliament and Zhuravli, the two top-selling sub-premium vodka brands in Russia. These brands are supported by a combined sales force of approximately 1,538 people. We believe our combined size and the geographic coverage of our sales force will contribute to market share gains and enable us to benefit from ongoing consolidation in the Russian spirits market. Furthermore, we believe we have the necessary infrastructure to take advantage of growth opportunities with minimal additional costs.

Our sales force in Russia includes approximately 1,300 people allocated to Exclusive Sales Teams, or ESTs. ESTs are employed by wholesalers that carry our vodka products but focus exclusively on the merchandising, marketing and sale of this portfolio. Because spirits advertising is heavily regulated in Russia, we believe that this structure provides us with meaningful marketing benefits as it allows us to maintain direct relationships with retailers and to ensure that our products receive prominent shelf space. Wholesalers who employ our ESTs are solely compensated through a rebate on purchases of our vodka brands. This arrangement enables us to maintain an expansive and exclusive sales force covering all regions of Russia with no associated fixed overhead costs.

Attractive import platform for international spirit companies to market and sell products in Poland, Russia and Hungary—Our existing import platform, under which we are the exclusive importer of numerous brands of spirits, wines and beers into each of our core markets, combined with our sales and marketing organizations in Poland, Russia and Hungary provide us with an opportunity to continue to expand our import portfolio. We believe we are well positioned to serve the needs of other international spirit companies that wish to sell products in these markets but lack the necessary distribution network and sales experience.

Attractive market dynamics—We believe that a combination of factors make Poland and Russia attractive markets for companies involved in the alcoholic beverage industry.

 

   

Russia and Poland rank as the largest and fourth-largest markets for vodka in the world, respectively, by volume, and vodka accounts for over 90% of all spirits consumed in both markets. Wine and beer consumption have also increased in both Poland and Russia, and we believe spirits sales value in both markets will continue to grow. As the largest producer of vodka and a leading importer of wine and beer in both countries, we are well positioned to service demand in our markets.

 

   

We believe that consumers in Poland and Russia increasingly demand a wider range of wine and spirits from mainstream to sub-premium brands, both domestically produced and imported, and we are well positioned to meet that demand in the coming years with top-selling brands in the domestic vodka mainstream and sub-premium categories. Additionally, we believe that, unlike many of our competitors, we are well positioned to meet that demand with the combination of our market-leading domestically produced products and our exclusive import portfolio.

 

   

In Poland and Russia, we believe, based on industry statistics and our own experience, that approximately 60-65% of vodka sales are still made through the so-called “traditional trade,” which consists primarily of smaller independently owned stores. The traditional trade provides our primary source of sales, which we serve in Poland through our nation-wide next day distribution platform and sales to third party wholesalers. In Russia, we believe our large, dedicated sales force, which includes both a traditional sales force and ESTs, gives us a competitive advantage over our competitors in an extremely fragmented wholesaler and retailer environment.

 

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Professional and experienced management team—Our management team, led by William Carey, has over 35 years of experience in the alcoholic beverages industry and has executed and integrated over 20 acquisitions within Poland, Russia and Hungary over the past ten years.

Growth Strategies

Realize synergies through the consolidation of our Russian businessesWe have acquired three of the leading spirit and wine businesses in Russia. With our acquisitions of Parliament and Russian Alcohol, we have the leading overall vodka position as well as the leading mainstream and sub-premium brands in Russia. Through our significant economic interest in Whitehall, we have a leading import portfolio in Russia. We intend to integrate our Russian vodka businesses, which are currently managed separately, in order to better leverage our management expertise and business relationships and also to take advantage of cross selling opportunities. We believe that opportunities exist to improve operational profitability in Russia by eliminating operating cost overlap between the companies. By combining our market leading Russian brands with Whitehall’s exclusive import portfolio, and leveraging the combined sales and distribution system of Parliament and Russian Alcohol, we believe we will be able to enhance our leading market position in Russia.

Capitalize on the Russian market consolidationThe Russian vodka market is currently fragmented, and we believe we have the necessary resources to take market share from struggling competitors. We estimate that the top five vodka producers in Russia accounted for estimated 44% of the total market share in 2009 as compared to an estimated 26% in 2006. We believe, based on our experience of consolidation trends in Poland, that the combined market share of the top five vodka producers in Russia could increase from 44% to 70-80% in the next five years as the Russian market continues to consolidate. We intend to capitalize on our leading brand position, our expansive sales and distribution network and the impact of the current economic situation to expand our market share in Russia.

Develop our portfolio of exclusive import brands—In addition to the development of our own brands, our strategy is to be the leading importer of wines and spirits in the markets where we operate. We have already developed an extensive wine and spirit import portfolio within Poland. In Russia, we intend to capitalize on the import platform of Whitehall and the combined sales and marketing strength of Parliament and Russian Alcohol by developing new import opportunities and capitalizing on the overall growth in imports. In 2009, we began to import several new brands to Russia, including DeKuyper, Jose Cuervo, Gallo and Borco and we expanded our exclusive Polish import relationship with Campari to include Hungary.

Continue to focus on sales of our domestic and export brands and exclusive import brandsWithin Poland and Hungary, we look to continue to leverage the strength of our existing and long-standing sales and distribution networks to support our higher margin, owned and exclusive import brands. We also intend to seek new export opportunities for our vodka brands, such as Zubrówka, through new export package launches and product extensions. We are also in the process of completing an extensive program to develop new packaging and marketing programs for Bols, Zubrówka, Absolwent, Royal and Palace vodka in our core markets.

Recent Acquisitions

On September 25, 2009, the Company and certain of its affiliates acquired the remaining 15% of the share capital of its subsidiary, Parliament. Parliament owns various alcoholic beverage production and distribution assets in Russia, including the Parliament vodka brand, which is a top selling sub-premium vodka brand in Russia.

On July 9, 2008, the Company, Lion Capital LLP (“Lion Capital”) and certain other investors completed an investment pursuant to which the Company acquired an indirect equity stake in Russian Alcohol of approximately 42% and Lion Capital acquired substantially all of the remainder of the equity. The Company renegotiated the terms of this investment during 2009, acquiring 100% of the equity interests in Lion/Rally Cayman 6, a Cayman Islands company that is a holding company owning 100% of the equity interests in Russian

 

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Alcohol (“Cayman 6”). Pursuant to agreements entered into in November 2009, the Company acquired all of the equity interests in Cayman 6 not held by the Company, though Lion Capital retained the sole voting share in Cayman 6 until after receipt of antimonopoly clearances for the acquisition of Russian Alcohol from the Russian Federal Antimonopoly Commission or FAS and the Antimonopoly Committee of the Ukraine. On January 20, 2010, following receipt of the required approvals, the Company acquired the sole voting share of Cayman 6 from Lion Capital and thereby acquired control of Russian Alcohol. Russian Alcohol is the largest vodka producer in Russia and produces leading vodka brands such as Green Mark, which is the number one vodka brand in Russia, and Zhuravli, a top selling premium vodka brand behind the Company’s Parliament.

Industry Overview

Poland

The total net value of the alcoholic beverage market in Poland was estimated to be approximately $7 to $9 billion in 2009. Total sales value of alcoholic beverages at current prices decreased by approximately 5% from December 2008 to December 2009. This decrease was due, for the most part, to the effects of the world-wide economic crisis. Poland fared better than most countries in the region, but was nevertheless affected. Beer and vodka account for approximately 90% of the value of sales of all alcoholic beverages.

The alcoholic beverage distribution industry in Poland is competitive. We compete primarily with other distributors and indirectly with hypermarket chains and discount chains. We compete with various regional distributors in all regions where our distribution centers and satellite branches are located. Competition with these regional distributors is greatest with respect to domestic vodka brands. The number of hypermarkets (which have been the primary threat to alcoholic beverage distributors in Western Europe because they purchase directly from producers) has stabilized in Poland. However, there has been strong growth of discount chains. With these discount chains taking a bigger and bigger market share from the traditional trade, the alcohol distribution industry is changing.

Spirits

We are one of the leading producers of vodka in Poland. We compete primarily with eight other major spirit producers in Poland, most of which are privately-owned while the remainder are still state-owned. The spirit market in Poland is dominated by the vodka market. Domestic vodka consumption dominates the Polish spirits market with over 96% market share, as Poland is the fourth largest market in the world for the consumption of vodka and one of the top 25 markets for total alcohol consumption worldwide. The Polish vodka market is divided into four segments based on quality and price(*):

 

   

Top premium and imported vodkas, with such brands as Finlandia, Absolut, Bols Excellent, Chopin, and Królewska;

 

   

Premium segment, with such brands as Bols Vodka, Sobieski, Wyborowa, Smirnoff, Maximus, and Palace Vodka;

 

   

Mainstream segment, with such brands as Absolwent, Batory, Zlota Gorzka, Luksusowa, Soplica, Zubrówka, Zoladkowa Gorzka, Polska; and

 

   

Economy segment, with such brands as Starogardzka, Krakowska, Boss, Niagara, Czysta Slaska, Prezydent, Z Czerwona Kartka, and Ludowa.

 

(*) Brands in bold face type are produced by us.

We produce vodka in all four segments and have our largest market share in the mainstream and premium segments. Though vodka brands compete against each other from segment to segment, the most competition is found within each segment. As we have a presence in each category and have four of the top ten best selling vodka brands in Poland, and have approximately a 26% market share measured by value, we are in a good position to compete effectively in all four segments.

 

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In terms of value, the top premium and imported segment accounts for approximately 6% of total sales volume of vodka, while the premium segment accounts for approximately 18% of total sales volume. The mainstream segment, which is the largest, now represents 50% of total sales volume. Sales in the economy segment currently represent 28% of total sales volume.

Wine

The Polish wine market, which grew to an estimated 95.6 million liters in 2009, is represented primarily by two categories: table wines, which account for 2% of the total alcohol market, and sparkling wines, which account for 1% of the total alcohol market. As Poland has almost no local wine production, the wine market has traditionally been dominated by imports, with lower priced Bulgarian wines representing the bulk of sales. However, over the last three years, sales of new world wines from regions such as the United States, Chile, Argentina and Australia have seen rapid growth. In 2009, it is estimated that sales of wine from these regions grew by 11% in volume. Also in 2009, our exclusive agency brand, Carlo Rossi, became the number one selling wine in Poland in value replacing wines from old Warsaw Pact nations.

We believe that consumer preference is trending towards higher priced table wines. The best selling wines in Poland previously retailed for under $3 per bottle. Currently, the best selling wines retail in the $4-$7 range.

Beer

Poland is the fourth largest beer market in Europe. Sales of beer were down an estimated 10% in volume in 2009 but still account for 50% of the total sales value of alcoholic beverages in Poland.

Three major international producers, Heineken, SAB Miller and Carlsberg, control 88% of the market through their local brands.

Russia

Russia, with its official production of approximately 1.13 billion liters in 2009, is by far the largest vodka market worldwide. The Russian vodka market is fragmented, with, in our estimation, the top five producers having a combined volume market share of approximately an estimated 44% in 2009. This number is up from 2006 when the top five producers only had an estimated 26% market share. Further sector consolidation has been ongoing in recent years, with the potential to continue in the near term despite the market being down 9% in 2009. We estimate that the number of vodka producers in the market has decreased by half over the last five years, and the number of licensed vodka manufacturers has dropped from 324 in 2004 to 145 in 2008. The Russian vodka market is well protected from foreign imports, primarily due to efficient mass production, limited advertising and high logistics costs, making it difficult to compete with local producers. In addition, the Russian government has begun to introduce new legislation to limit the impact of unofficial production which could be beneficial in the short to medium term as the unofficial production is currently estimated at 40%, which is extremely high compared to other jurisdictions in which we operate.

We believe we are well-positioned to continue to gain market share in 2010 as we have the leading brands by volume and value in the mainstream and sub-premium categories, dedicated ESTs in place and experienced management not only at the corporate level but also at the operating level. In addition, the Russian government has put in place very restrictive policies on the advertising of spirits. We believe these policies make it difficult for any competitor to buy market share by out-spending its rivals.

Spirits

Vodka consumption dominates the Russian spirits market with over 95% market share. The Russian vodka market is divided into five segments based on quality and price: top premium, premium, sub-premium, mainstream, and economy. In terms of value, the top premium segment accounts for approximately 0.1% of total

 

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sales volume of vodka, while the sub-premium and premium segment accounts for approximately 9.3% of total sales volume. The mainstream segment now represents 41.3% of total sales volume. Sales in the economy segment currently represent 49.3% of total sales volume. as consumers have traded up from economy brands to mainstream and sub-premium brands continue, a trend we expect to continue.

Vodka represented 95% of the total Russian spirits market in 2009. Although our belief is that the vodka market decreased approximately 9% in 2009 versus 2008, we believe that the market will stabilize in the first half of 2010 and that the premiumization that had occurred for 7 years before the crisis will return as wages begin to rise in Russia. As before, we believe the premiumization process should most benefit the mainstream and sub-premium brands at the expense of the economy brands. We believe we are well-positioned for this with the best selling brands in both the sub-premium and mainstream sectors. In addition, with our current capacity and relatively little capitalization expense, we plan to introduce new brands to the market to capture sales in any sector outside of the economy sector that we believe will have the most dynamic growth potential.

The Russian vodka market is quite fragmented, with the top five producers only having an estimated 43% market share in 2009 as compared to an estimated 78% market share in Poland and an estimated 80% market share in the Ukraine. We believe that the Russian market will experience trends similar to those experienced in the Polish market and will continue to see further consolidation of the market as the retail infrastructure further consolidates and develops and the effects of the economic crisis stabilize and diminish. We believe that this consolidation post crisis will increase significantly over the next 3-5 years.

Wine

According to market data, Russia has relatively low wine consumption per capita (about 8.5 liters per year). It is expected to grow at an estimated 8.6% compound annual growth rate during the period from 2007-2012. It is estimated that the Russian wine market grew by 10% in 2009 and will grow at an 8.1% compound annual growth rate in volume terms during the period 2007-2012, and even more in value terms.

Currently the fastest growing category in the Russian wine market is sparkling wine. In 2009, sparkling wine sales grew 12% by volume and 20% by value terms, according to Euromonitor. Despite the fact that domestic wines prevail on the market, the share of imported higher quality wines has been constantly growing. We believe we can benefit in the future from the growing Russian wine market through the import and distribution of high-value wines and the addition of new wines to our import and distribution portfolio in Russia. We have recently signed with Gallo to import on an exclusive basis Gallo’s Carlo Rossi wine selection. Through Whitehall, we import wines from Constellation, Concho Toro and LVMH as well as others.

Long Drinks

The Long Drinks or Ready to Drink market in Russia consists of pre-mixed beverages with 9% or less alcohol content. The key segments of the market are gin-based drinks, Alco-Energy drinks and fruit-based drinks. Our Bravo Premium distillery produces the gin-based Bravo Classic brand, which accounts for approximately 50% of our long drinks sales volume. In the gin-based segment we have a 14% market share, in the Alco-Energy segment we have a 16% and in the fruit-based segment we have a 7% market share. We have focused over the last two years in improving the profitability of these products through a combination of more targeted selling and mix improvement. The Long Drinks business has shown significant improvement in 2009 as compared to prior years.

Hungary

Spirits

The Hungarian spirit market is dominated primarily by bitters and brown spirits. Currently, the most popular spirit drinks are Jägermeister, Royal Vodka, Fütyülos, Kalinka vodka, Unicom, Metaxa, Ballantines and Johnnie Walker. The current significant trends in the Hungarian spirit market are the overall decrease in total spirit

 

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consumption and a pronounced move by the consumer to branded imported spirits. Our Royal Vodka brand is the number one selling vodka in Hungary. In addition, Hungary is now the third largest market in the world for sales of our exclusive agency brand, Jägermeister.

We believe that the total size of the spirit market in Hungary is approximately 58 million liters which has declined in 2009 by approximately 10%. However despite the decreasing total sales volume of spirits, we believe that the share of imported spirits, the segment in which we operate, is growing (increasing 5% from 2008 to 2009, and 16.2% in the past five years), while the consumption of local spirits is in decline. The increasing share of import was a result of eliminated custom duty and the improving purchasing power since the EU accession, as well as the continuous marketing and advertising activities of the imported spirit brands.

The spirit market is split into two major segments in Hungary: local producers and importers. The local producers are primarily dealing with low-cost, mainstream or below, local products, as well as with premium fruit-based spirits (palinka). The import spirit market is more competitive and relatively fragmented. The major players are the market leader Zwack Unicum Zrt (with an interest in both the local and import spirit segment), CEDC as the biggest spirit importer company, and Bacardi-Martini, Pernod Ricard Hungary, and Heinemann. Our advantage in Hungary is the combination of our wide portfolio which has the number one leading brands in the vodka, bitter and imported brandy categories, and our experienced sales and marketing team which offers premium service and builds strong brand equities.

Operations by Country

Poland

We are a leading vodka producer by value and volume in Poland, and one of the largest producers of vodka in the world. We own two production sites in Poland: Bols and Polmos Białystok. In the Bols distillery, we produce the Bols and Soplica vodka brands, among other spirit brands. Bols vodka is the number one selling premium vodka in Poland by volume and value. Soplica has consistently been one of the top ten mainstream selling vodkas in Poland. Polmos Białystok produces Absolwent, which is one of the leading vodkas in Poland for the last eight years. In addition to the Absolwent brand, Polmos Białystok also produces Zubrówka, which also is exported out of Poland to many markets around the world, including the United States, England, Japan and also France, where it is the number two imported premium vodka by volume.

We are the leading importer of spirits, wine and beer in Poland. We currently import on an exclusive basis approximately 40 leading brands of spirits, wine from over 40 producers and 5 brands of beer.

We are also the leading national distributor of alcoholic beverages in Poland by value, and we believe we offer one of the broadest portfolios of alcoholic beverages with over 700 brands. We operate in a highly fragmented market, primarily served by an estimated 50 wholesale groups. We operate the largest nationwide delivery service in Poland, and we provide next day delivery through our 18 distribution centers, 124 satellite branches and large fleet of delivery trucks. We believe that we are the leading distributor in each category of alcoholic beverages we distribute in Poland, except for beer.

Brands

We produced and sold approximately 9.0 million nine-liter cases of vodka through our Polish business in 2009 in the four main vodka segments in Poland: top premium, premium, mainstream and economy.

Our mainstream Absolwent brand has been one of the leading vodkas in Poland for the last eight years, based on volume and value. Bols vodka is the number one selling premium vodka in Poland and number two in Hungary by value. Soplica, a mainstream brand, has consistently been one of the top 10 selling vodkas in Poland. Our Zubrówka brand is the second best selling flavored and colored vodka in Poland and is exported to markets

 

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around the world. In 2009, we sold abroad approximately 184,000 nine-liter cases of Zubrówka. In addition, we produce the top selling vodka in Hungary, Royal Vodka, which we distribute through our subsidiary Bols Hungary.

Import Portfolio

We have exclusive rights to import and distribute approximately 40 leading brands of spirits, wine and beer into Poland and distribute these products throughout the country. We also provide marketing support to the suppliers who have entrusted us with their brands.

Our exclusive import brands in Poland include the following:

 

LIQUEURS

  WHITE SPIRITS   BROWN SPIRITS   VERMOUTH &
BITTERS
  WINE &
CHAMPAGNES
  BEER   NON
ALCOHOLIC

Disaronno Amaretto

  Patron Tequila   Jim Beam   Cinzano—vermouth   Sutter Home   Guinness   Evian

Sambuca

  Tequila Sierra   Camus   Campari   Miguel Torres   Kilkenny  

Amaretto Gozio

  Cana Rio Cachaca   Remy Martin   Jaegermeister   Concha y Toro   Bitburger  

Amaretto Florence

  Gin Finsbury   Metaxa     Gallo   Budweiser  

Amaretto Venice

  Nostalgia Ouzo   Brandy Torres     Carlo Rossi   Corona  

Cointreau

  Grappa Piave   Brandy St Remy     B. P. Rothschild    

Passoa

  Grappa Primavera   Whisky William’s     Frescobaldi    

Bols Liqueurs

  Tequila Sauza   Whisky Teacher’s     Codorniu    
  Gin Hendricks   Whisky Old
Smuggler
    Piper Heidsieck

Penfolds

   
    Whisky Glen
Grant
    Trivente

Rosemount

   
    Grant’s     Trinity Oaks    
    Glenfiddich     Terra d’oro    
    Balvenie     M.Chapoutier    
    Clan MacGregor     Boire Manoux    
    Rum Old Pascas     Faustino    
       

J.Moreau & Fils

 
        Kressmann    
        Laroche    
           
           

Sales Organization and Distribution

Our business involves the distribution of products that we import on an exclusive basis and products we produce from our two distilleries (Bols Poland and Polmos Białystok). In addition, we handle the distribution of a range of products from the local and international drinks companies operating in Poland for which we are the largest distributor for many of such suppliers.

We operate the largest nationwide next-day alcoholic beverage delivery service with 18 distribution centers and 124 satellite branches located throughout Poland. We distribute over 700 brands of alcoholic beverages consisting of a wide range of alcoholic products, including spirits, wine and beer, as well as non-alcoholic beverages.

 

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The following table illustrates the breakdown of our sales in Poland in the twelve months ended December 31, 2009, 2008 and 2007:

 

Sales Mix by Product Category

   2009     2008     2007  

Vodka

   73   76   72

Beer

   9   9   9

Wine

   10   7   8

Spirits other than vodka

   4   6   10

Other

   4   2   1
                  

Total

   100   100   100

We distribute products throughout Poland directly to approximately 25,000 outlets, including off-trade establishments, such as small and medium-size retail outlets, petrol stations, duty free stores, supermarkets and hypermarkets, and on-trade locations, such as bars, nightclubs, hotels and restaurants, where the products we distribute are consumed. These accounts are serviced by approximately 650 salespeople in Poland. One of our key objectives is to distribute more of our own products over time and, to that end, we have established an incentive compensation system for our salespeople for both products that we produce and products that we import exclusively into Poland.

Beginning in 2006, we implemented a more targeted sales approach. We narrowed the focus of our domestically located salespeople by assigning each sales person to a specific channel: key accounts (hypermarkets, discount stores and gas stations), on-trade accounts or traditional trade accounts.

The hypermarket and discount channels require a dedicated national sales team to handle their specific requirements. This team is responsible for promoting our brands in these national chains by implementing below the line activities, such as price promotions and pallet displays.

The use of a national, dedicated on-trade only sales team, the largest sales team of its kind in Poland to date, to work closely with bar, restaurant and hotel owners provides us with a key opportunity to promote and sell our brands and build brand awareness and brand equity with consumers. This is especially important given the restrictions on media advertising for spirits. The traditional trade sales force continues to focus on the channel in Poland that is still the dominant area in terms of sales volume. In addition, each of these account groups is also assigned a marketing and merchandizing team that works in conjunction with the sales team to serve the client.

The overall trend in distribution over the last number of years has been the consolidation of the hypermarkets and the growth of the discount chains and locally-owned super market chains. These stores typically go direct to the producers or importers and cut out the distribution that the traditional trade relies on. This is resulting in a more competitive landscape for distribution companies that focus on one market sector such as alcoholic beverages and not across many sectors to get the scale that will be required to keep competitive.

Export activities

With a number of brands to export from Poland and Russia and with full control of both Parliament and Russian Alcohol, we are currently restructuring our export department to expedite the positioning of the brands we believe have the greatest export potential. To that end, we have divided the export team into three regions: the ex CIS countries, which include our Green Mark and Parliament brands, among others, and Western Europe; the Middle East, Africa and Duty Free; and the third region, the Americas and Asia Pacific. The last two groups will concentrate on our Green Mark, Zubrowka and Parliament brands, among others.

During 2009, our core export brands were Parliament, which grew by 16.7% in Germany, and Zubrowka, which was primarily exported to the United Kingdom, France, Japan and the United States. In 2010, we plan to

 

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develop other markets and brands and current markets more aggressively than we have over the last few years. As an example, we are replacing our old importer of Zubrowka in the United States with Remy Cointreau USA and are in discussions with other importers to assist us in developing our brands around the world.

We are continuing to develop our third party private label export business in which we produce vodka to be sold under labels other than our own. Customers range from major retail chains in Europe to premium brand owners in the United States. For example, we currently produce Ultimat vodka (an ultra luxury vodka sold primarily in the United States) for Patron.

Sources and Availability of Raw Materials for Spirits that We Produce

The principal components in the production of our distilled spirits are products of agricultural origin, such as rectified spirit, as well as flavorings, such as bison grass for Zubrówka, and packaging materials, such as bottles, labels, caps and cardboard boxes. We purchase raw spirit, bison grass and all of our packaging materials from various sources in Poland by contractual arrangement and through purchases on the open market. Agreements with the suppliers of these raw materials are generally negotiated with indefinite terms, subject to each party’s right of termination upon six months’ prior written notice. The prices for these raw materials are negotiated every year.

We have several suppliers for each raw material in order to minimize the effect on our business if a supplier terminates its agreement with us or if disruption in the supply of raw materials occurs for any other reason. We have not experienced difficulty in satisfying our requirements with respect to any of the products needed for our spirit production and consider our sources of supply to be adequate at the present time. We do not believe that we are dependent on any one supplier in our production activities.

Employees

As of December 31, 2009, we employed in Poland 3,135 employees including 2,995 persons employed on a full time basis.

Polish labor laws require that certain benefits be provided to employees, such as a certain number of vacation days, maternity leave and retirement bonuses. The law also restricts us from terminating employees without cause and, in most instances, requires a severance payment of one to three months’ salary. Additionally, we are required to contribute monthly payments to the governmental health and pension system. Most of our employees are not unionized, and we have had no significant employee relations issues. In addition to the required Polish labor law requirements, we maintain an employee incentive stock option plan for key management and provide supplemental health insurance for qualified employees.

Government Regulations

The Company is subject to a range of regulations in Poland, including laws and regulations on the environment, trademark and brand registration, packaging and labeling, distribution methods and relationships, pricing and price changes, sales promotions and public relations, and may be required to obtain permits and licenses to operate its facilities. The Company is also subject to rules and regulations relating to changes in officers or directors, ownership or control.

The Company believes it is in compliance in all material respects with all applicable governmental laws and regulations in Poland, and expects all material governmental permits and consents to be renewed by the relevant governmental authorities upon expiration. The Company also believes that the cost of administration and compliance with, and liability under, such laws and regulations does not have, and is not expected to have, a material adverse impact on its financial condition, results of operations or cash flows.

 

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Environmental Matters

We are subject to a variety of laws and regulations relating to land use and environmental protection, including the Polish Environmental Protection Law of April 27, 2001 (Dz.U. 2006. 129.902, as amended), the Polish Waste Law of April 27, 2001 (Dz.U. 2001. 62.628 as amended), the Polish Water Management Law of April 18, 2001 (Dz.U.2005.239. 2019, as amended) and the Polish Act on Entrepreneurs’ obligations regarding the management of some types of waste and deposit charges of May 11, 2001 (Dz.U. 2001.63.639, as amended). We are not required to receive an integrated permit to operate our Polmos Białystok and Bols production plants. However, we receive certain permits for the economic use of the environment, including water permits, permits for production and storage of waste and permits for discharge of pollutants into the atmosphere. In addition, we have entered into certain agreements related to the servicing and disposal of our waste, including raw materials and products unsuitable for consumption or processing, paper, plastic, metal, glass and cardboard packaging, filtration materials (used water filter refills), used computer parts, unsegregated (mixed) residential waste, damaged thermometers and alcoholmeters, used engine and transmission oils, batteries and other waste containing hazardous substances. In addition, we pay required environmental taxes and charges related primarily to packaging materials and fuel consumption and we believe we are in material compliance with our regulatory requirements in this regard. While we may be subject to possible costs, such as clean-up costs, fines and third-party claims for property damage or personal injury due to violations of or liabilities under environmental laws and regulations, we believe that we are in material compliance with applicable requirements and are not aware of any material breaches of said laws and regulations.

Trademarks

With the acquisitions of the Bols and Polmos Białystok distilleries, we became the owners of vodka brand trademarks. The major trademarks we have acquired are: Bols vodka brand (we have a perpetual, exclusive, royalty-free and sub-licensable trademark agreement for Poland, Russia and Hungary), Soplica, which we own through Bols, and the Absolwent and Zubrówka brands, which we own through Polmos Białystok. We also have the trademark for Royal Vodka, which is produced in Poland and which we currently sell in Hungary through our Bols Hungary subsidiary. See “Risk Factors—We may not be able to protect our intellectual property rights.”

Alcohol Advertising Restrictions

Polish regulations do not allow any form of “above-the-line advertising and promotion,” which is an advertising technique that is conventional in nature and impersonal to customers, using current traditional media such as television, newspapers, magazines, radio, outdoor, and internet mass media for alcoholic beverages with greater than 18% alcohol content.

We believe we are in material compliance with the government regulations regarding above-the-line advertising and promotion. To date, we have not been notified of any violation of these regulations.

Russia

We are the leading integrated spirits beverages business in Russia with an approximate 18.8% market share in vodka production. We produce Green Mark, the number one selling vodka in Russia and as well as the leading sub-premium vodkas in Russia, Parliament and Zhuravli. We also produce Yamskaya, the number one selling economy vodka in Russia, and premixed alcohol drinks, or long drinks.

The hypermarkets and large retail chains are expanding throughout Russia with different sized formatted stores, which are expected to better cover and penetrate those areas outside of the major cities of Russia. As we have central agreements in place with these hypermarkets and large retail chains as well as the largest trademark budget for spirits in Russia and the leverage it brings, we expect to benefit from this expansion.

We hold an 80% economic interest in Whitehall, which holds the exclusive rights to the import of such premium wine brands as Concha y Toro and Constellation brands, as well as certain Gruppo Campari brands.

 

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The company is also involved in a joint venture with Moet Hennessy—the French spirits and champagne business of LVMH. In addition to these import activities, Whitehall is also the owner of distribution centers in Moscow, Saint Petersburg, Rostov and Siberia as well as a wine and spirits retail network located in Moscow.

Brands

We produced and sold approximately 18.0 million nine-liter cases of vodka through our Russian business in 2009 in the main vodka segments in Russia: top premium, premium, sub-premium, mainstream, and economy. In addition we produced and sold approximately 3.3 million nine-liter cases of long drinks

In the main stream segment we produce Green Mark, the number one selling brand in Russia, as well as the two leading sub-premium brands, Zhuravli and Parliament. In the first half of 2008 we introduced Yamskaya, which was the number one selling economy vodka in Russia in 2009. In the second half of 2009, we also introduced Gerovaya and Urozhay, both lower mainstream brands.

Import Portfolio

We are one of the leading importers of wine and spirits in Russia through our investment in the Whitehall. Whitehall has exclusive rights to import and distribute a number of brands of spirits and wines into Russia. Exclusively imported brands include the following:

 

BROWN SPIRITS

 

WHITE

  

CHAMPAGNES

  

WINES

Hennessy Jose   Cuervo    Krug    Asti Mondoro
Cortel Brandy      Veuve Clicquot    Concha y Toro
Glenmorangie      Dom Perignon    Hardy’s
Ardbeg      Moet & Chandon    Robert Mondavi
Old Smuggler         Paul Masson
Glen Grant         Nobilo
Gautier         Fine wine collection

Sales Organization and Distribution

In Russia, we have a strong sales team that sells directly to the key retail accounts and primarily relies on third-party distribution through wholesalers to reach the small to medium sized outlets. For sales of our vodka brands we also have ESTs that were introduced back in 2006. We staff over 1,300 people to ESTs that currently cover the majority of Russia. The mission of these teams is to maintain direct relationships with retailers and ensure that the Company’s products are properly positioned on the shelf. Members of ESTs are generally on the distributors’ payrolls,which are indirectly remunerated by us via discounts granted to distributors. ESTs exclusively deal with our vodka products and currently control deliveries to approximately 53,000 points-of-sale (which is about 44% of all points-of-sale in Russia).

The following table illustrates the breakdown of our sales in Russia:

 

Sales Mix by Product Category

   2009     2008  

Vodka

   68   49

Wine and spirits other than vodka

   32   51
            

Total

   100   100

Sources and Availability of Raw Materials for Spirits that We Produce

The principal components in the production of our distilled spirits are products of agricultural origin, such as rectified spirit and packaging materials, such as bottles, labels, caps and cardboard boxes. We purchase raw

 

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spirit and all of our packaging materials from various sources in Russia by contractual arrangement and through purchases on the open market. Agreements with the suppliers of these raw materials are generally negotiated with indefinite terms, subject to each party’s right of termination upon six months’ prior written notice. The prices for these raw materials are negotiated every year. We have several suppliers for each raw material in order to minimize the effect on our business if a supplier terminates its agreement with us or if disruption in the supply of raw materials occurs for any other reason. We have not experienced difficulty in satisfying our requirements with respect to any of the products needed for our spirit production and consider our sources of supply to be adequate at the present time. We do not believe that we are dependent on any one supplier in our production activities.

Employees

As of December 31, 2009 we directly employed 4,284 individuals in Russia.

Government Regulations

The Company is subject to a range of regulations in Russia, including laws and regulations on the environment, trademark and brand registration, packaging and labeling, distribution methods and relationships, pricing and price changes, sales promotions and public relations, and may be required to obtain permits and licenses to operate its facilities. The Company is also subject to rules and regulations relating to changes in officers or directors, ownership or control.

In 2009, the Russian government also introduced further restrictions on the selling of lower alcohol content products namely beer and ready to drink alcoholic beverages. As a result, these types of beverages can no longer be consumed legally on the street and can no longer legally be bought at street kiosks. In addition minimum pricing for spirits was introduced with a half liter bottle of spirit (including vodka) having a minimum required retail shelf price of eighty-nine rubles. These restrictions are the initial steps that the government is taking to reduce the presence of the unofficial market. We expect the government to continue with this program. For those of us in the official market, these are welcomed changes.

The Company believes it is in compliance in all material respects with all applicable governmental laws and regulations in Russia, and expects all material governmental permits and consents to be renewed by the relevant governmental authorities upon expiration. The Company also believes that the cost of administration and compliance with, and liability under, such laws and regulations does not have, and is not expected to have, a material adverse impact on its financial condition, results of operations or cash flows.

Alcohol Advertising Restrictions

Russian regulations do not allow any form of “above-the-line advertising and promotion,” which is an advertising technique that is conventional in nature and impersonal to customers, using current traditional media such as television, newspapers, magazines, radio, outdoor signage , and internet mass media, for alcoholic beverages with greater than 18% alcohol content.

We believe we are in material compliance with the government regulations regarding above-the-line advertising and promotion. To date, we have not been notified of any violation of these regulations.

Trademarks

With the acquisition of Parliament and Russian Alcohol we became the owners of vodka brand trademarks in Russia. The main trademarks we have are Parliament, Green Mark and Zhuravli vodka brands. We also have trademarks with other brands we own in Russia. See “Risk Factors—We may not be able to protect our intellectual property rights.”

 

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Hungary

Brands

In July of 2006, we acquired the trademark for Royal Vodka, which we produce in Poland and which we currently sell in Hungary through our Bols Hungary subsidiary. Royal Vodka is the number one selling vodka in Hungary with market share of approximately 27.6%.

Exclusive imported brands to Hungary include the following:

 

CEDC BRANDS

 

VERMOUTH and
BITTERS

 

LIQUEURS

 

WHITE VODKAS

 

BROWN SPIRITS

Bols Vodka   Campari   Jaegermeister   Jose Cuervo   Cognac Remy Martin
Zubrówka   Cinzano   Bols Liqueurs   Silver Top Dry Gin   Metaxa
Royal Vodka     Cointreau   Calvados Boulard   Brandy St Remy
    Carolans     Grant’s
    Passoa     Glenfiddich
    Galliano    

Tulamore Dew

Old Smuggler

    Irish Mist    

Sales Organization and Distribution

In Hungary, we employ approximately 25 salespeople who cover primarily on-trade and key account customers throughout the country.

Employees

As of December 31, 2009, we employed 49 employees including 47 persons employed on a full time basis.

Government Regulations

The Company is subject to a range of regulations in Hungary, including laws and regulations on trademark and brand registration, packaging and labeling, distribution methods and relationships, pricing and price changes, sales promotions and public relations. The Company is also subject to rules and regulations relating to changes in officers or directors, ownership or control.

The Company believes it is in compliance in all material respects with all applicable governmental laws and regulations in Hungary, and expects all material governmental permits and consents to be renewed by the relevant governmental authorities upon expiration. The Company also believes that the cost of administration and compliance with, and liability under, such laws and regulations does not have, and is not expected to have, a material adverse impact on its financial condition, results of operations or cash flows.

Corporate Operations and Other

The Corporate Operations and Other division includes traditional corporate-related items including executive management, corporate development, corporate finance, human resources, internal audit, investor relations, legal and public relations.

Taxes

We operate in the following tax jurisdictions: Poland, the United States, Hungary, Russia, and the Netherlands. In Poland, Russia and Hungary we are primarily subject to Value Added Tax (VAT), Corporate Income Tax, Payroll Taxes, Excise Taxes and Import Duties. In the United States we are primarily subject to Federal and Pennsylvania State Income Taxes, Delaware Franchise Tax and Local Municipal Taxes. We believe we are in material compliance with all relevant tax regulations.

 

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Excise taxes comprise significant portions of the price of alcohol and their calculations differ by country. In Poland and Russia, where our production takes place, the value of excise tax rates for 2009 amounted to PLN 49.6 ($17.60) and RUB 191 ($6.36) per liter of 100% alcohol.

Research and Development

We do not have a separate research and development unit, as new product developments are primarily performed by our marketing department. Our activity in this field is generally related to improvements in packaging and extensions to our existing brand portfolio, or revised production processes, leading to improved taste.

Available Information

We maintain an Internet website at http://www.cedc.com. Please note that our Internet address is included in this annual report as an inactive textual reference only. The information contained on our website is not incorporated by reference into this annual report and should not be considered part of this report.

We file annual, quarterly and current reports, proxy statements and other information with the SEC. We make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports and most of our other SEC filings available free of charge through our Internet website as soon as reasonably practicable after we electronically file these materials with the SEC. You may read and copy any document we file with the SEC at the SEC’s public reference room at 100 F Street, N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. These filings are also available to the public over the Internet at the SEC’s website at http://www.sec.gov. In addition, we provide paper copies of our SEC filings free of charge upon request. Please contact the Corporate Secretary of the Company at 1-610-660-7817 or at our address set forth on the cover page of this annual report.

We have adopted a code of ethics applicable to all of our officers, directors and employees, including our Chief Executive Officer and Chief Financial Officer (who is also our Principal Accounting Officer). The code of ethics is publicly available on the investor relations page of our website at http://www.cedc.com. We intend to disclose any amendment to, or waiver from, any provision in our code of ethics that applies to our Chief Executive Officer and Chief Financial Officer by posting such information in the investor relations section of our website at http://www.cedc.com and in any required SEC filings.

 

Item 1A. Risk Factors.

Risks Related to Our Business

We operate in highly competitive industries, and competitive pressures could have a material adverse effect on our business.

The alcoholic beverages production and distribution industries in our region are intensely competitive. The principal competitive factors in these industries include product range, pricing, distribution capabilities and responsiveness to consumer preferences, with varying emphasis on these factors depending on the market and the product.

In Poland, we face significant competition from various regional distributors and wholesalers, who compete principally on price. The effect of this competition could adversely affect our results of operations. The majority of alcohol sales in Poland are still made through traditional trade outlets. Other sales are made in hypermarkets and large discount stores.

In Russia, hypermarket and large retail chains continue to grow their share of the trade. Traditional trade outlets typically provide us with higher margins from sales as compared to hypermarkets and large retail chains. There is a risk that the expansion of hypermarkets and large retail chains will continue to occur in the future, thus

 

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reducing the margins that we may derive from sales to wholesalers that primarily serve the traditional trade. This potential margin reduction, however, will be partially offset by lower distribution costs due to direct, bulk deliveries associated with sales to the modern trade.

As a manufacturer of vodka in Poland and Russia, we face competition from other local producers. We compete with other alcoholic and nonalcoholic beverages for consumer purchases in general, as well as shelf space in retail stores, restaurant presence and distributor attention. In addition, we compete for customers on the basis of the brand strength of our products relative to our competitors’ products. Our success depends on maintaining the strength of our consumer brands by continuously improving our offerings and appealing to the changing needs and preferences of our customers and consumers. While we devote significant resources to the continuous improvement of our products and marketing strategies, it is possible that competitors may make similar improvements more rapidly or effectively, thereby adversely affecting our sales, margins and profitability.

Our results are linked to economic conditions and shifts in consumer preferences, including a reduction in the consumption of alcoholic beverages.

Our results of operations are affected by the overall economic trends in Poland, Russia and Hungary, the level of consumer spending, the rate of taxes levied on alcoholic beverages and consumer confidence in future economic conditions. The current negative economic conditions and outlook, including volatility in energy costs, severely diminished liquidity and credit availability, falling equity market values, weakened consumer confidence, falling consumer demand, declining real wages and increased unemployment rates, have contributed to a global recession. The effects of the global recession in many countries, including Poland and Russia, have been quite severe and it is possible that an economic recovery in those countries will take longer to develop.

During the current period of economic slowdown, reduced consumer confidence and spending may result in reduced demand for our products and limitations on our ability to increase prices and finance marketing and promotional activities. A continued recessionary environment would likely make it more difficult to forecast operating results and to make decisions about future investments, and a major shift in consumer preferences or a large reduction in sales of alcoholic beverages could have a material adverse effect on our business, financial condition and results of operations.

Loss of key management would threaten our ability to implement our business strategy.

The management of future growth will require our ability to retain William Carey, our Chairman, Chief Executive Officer and President, as well as certain other key members of management. William Carey, who founded our company, has been a key person in our ability to implement our business plan and grow our business.

Changes in the prices of supplies and raw materials could have a material adverse effect on our business.

Prices for raw materials used for vodka production may take place in the future, and our inability to pass on these increases to our customers could reduce our margins and profits and have a material adverse effect on our business. We recently constructed storage tanks in Poland that will store up to six months’ use of raw spirit, which allows us to purchase raw spirit throughout the year at times when there are dips in raw spirit pricing. However, we cannot assure you that the price of raw spirits will not continue to increase or that we will not lose the ability to maintain our inventory of raw spirits, either of which would have a material adverse effect on our financial condition and results of operations.

 

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We are exposed to exchange rate and interest rate movements that could adversely affect our financial results and comparability of our results between financial periods.

Our functional currencies are the Polish zloty, Russian ruble and Hungarian forint. Our reporting currency, however, is the U.S. dollar, and the translation effects of fluctuations in exchange rates of our functional currencies into U.S. dollars may materially impact our financial condition and net income and may affect the comparability of our results between financial periods.

In addition, our senior secured notes and our convertible senior notes are denominated in euros and U.S. dollars and the proceeds of the note issuances have been on-lent to certain of our operating subsidiaries that have the Polish zloty and Russian ruble as their functional currency. Movements in the exchange rate of the euro and U.S. dollar to Polish zloty and Russian ruble could therefore increase the amount of cash, in Polish zloty, that must be generated in order to pay principal and interest on our notes.

The impact of translation of our notes could have a material adverse effect on our reported earnings. The table below summarizes the pre-tax impact of a one percent movement in each of the exchange rate which could result in a significant impact in the results of the Company’s operations.

 

Exchange Rate

  

Value of notional amount

  

Pre-tax impact of a 1%

movement in exchange rate

USD-Polish zloty

   $426 million    $4.3 million gain/loss

USD-Russian ruble

   $264 million    $2.6 million gain/loss

EUR-Polish zloty

   €625 million or approximately $901 million    $9 million gain/loss

The table above includes €245 million for the Senior Secured Notes that were redeemed on January 4, 2010, thus there will not be any foreign exchange impact from them after this date.

Foreign exchange rates may be influenced by various factors, including changing supply and demand for a particular currency; government monetary policies (including exchange control programs, restrictions on local exchanges or markets and limitations on foreign investment in a country or on investment by residents of a country in other countries); changes in trade balances; trade restrictions; and currency devaluations and revaluations. Additionally, governments from time to time intervene in currency markets, directly or by regulation, in order to influence prices. These events and actions are unpredictable and could materially and adversely impact our results of operations and financial condition.

Weather conditions may have a material adverse effect on our sales or on the price of grain used to produce spirits.

We operate in an industry where performance is affected by the weather. Changes in weather conditions may result in lower consumption of vodka and other alcoholic beverages. In particular, unusually cold spells in winter or high temperatures in the summer can result in temporary shifts in customer preferences and impact demand for the alcoholic beverages we produce and distribute. Similar weather conditions in the future may have a material adverse effect on our sales which could affect our financial condition and results of operations. In addition, inclement weather may affect the availability of grain used to produce raw spirit, which could result in a rise in raw spirit pricing that could negatively affect margins and sales.

We are subject to extensive government regulation; changes in or violations of law or regulations could materially adversely affect our business and profitability.

Our business of producing, importing and distributing alcoholic beverages in Poland and Hungary is subject to regulation by national and local governmental agencies and European Union authorities. In addition, our business in Russia is subject to extensive regulation by Russian authorities. These regulations and laws address such matters as licensing and permit requirements, competition and anti-trust matters, trade and pricing practices,

 

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taxes, distribution methods and relationships, required labeling and packaging, advertising, sales promotion and relations with wholesalers and retailers. Additionally, new or revised regulations or requirements or increases in excise taxes, customs duties, income taxes, or sales taxes could materially adversely affect our business, financial condition and results of operations.

In addition, we are subject to numerous environmental and occupational, health and safety laws and regulations in the countries in which we operate. We may incur significant costs to maintain compliance with evolving environmental and occupational, health and safety requirements, to comply with more stringent enforcement of existing applicable requirements or to defend against challenges or investigations, even those without merit. Future legal or regulatory challenges to the industry in which we operate or our business practices and arrangements could give rise to liability and fines, or cause us to change our practices or arrangements, which could have a material adverse effect on us, our revenues and our profitability. Governmental regulation and supervision as well as future changes in laws, regulations or government policy (or in the interpretation of existing laws or regulations) that affect us, our competitors or our industry generally strongly influence our viability and how we operate our business. Complying with existing regulations is burdensome, and future changes may increase our operational and administrative expenses and limit our revenues. For example, we are currently required to have permits to produce and import products, maintain and operate our warehouses, and distribute our products to wholesalers. Many of these permits, such as our general permit for wholesale trade, must be renewed when they expire. Although we believe that our permits will be renewed upon their expiration, there is no guarantee that such will be the case. Revocation or non-renewal of permits that are material to our business could have a material adverse affect on our business. Our permits could also be revoked prior to their expiration date due to nonpayment of taxes or violation of health requirements. Additionally, governmental regulatory and tax authorities have a high degree of discretion and may at times exercise this discretion in a manner contrary to law or established practice. Such conduct can be more prevalent in jurisdictions with less developed or evolving regulatory systems like Russia. Our business would be materially and adversely affected if there were any adverse changes in relevant laws or regulations or in their interpretation or enforcement. Our ability to introduce new products and services may also be affected if we cannot predict how existing or future laws, regulations or policies would apply to such products or services.

We may not be able to protect our intellectual property rights.

We own and license trademarks (for, among other things, our product names and packaging) and other intellectual property rights that are important to our business and competitive position, and we endeavor to protect them. However, we cannot assure you that the steps we have taken or will take will be sufficient to protect our intellectual property rights or to prevent others from seeking to invalidate our trademarks or block sales of our products as a violation of the trademarks and intellectual property rights of others. In addition, we cannot assure you that third parties will not infringe on or misappropriate our rights, imitate our products, or assert rights in, or ownership of, trademarks and other intellectual property rights of ours or in marks that are similar to ours or marks that we license and/or market. In some cases, there may be trademark owners who have prior rights to our marks or to similar marks. Moreover, Russia generally offers less intellectual property protection than in Western Europe or North America. We are currently involved in opposition and cancellation proceedings with respect to marks similar to some of our brands and other proceedings, both in the United States and elsewhere. If we are unable to protect our intellectual property rights against infringement or misappropriation, or if others assert rights in or seek to invalidate our intellectual property rights, this could materially harm our future financial results and our ability to develop our business.

Our import contracts may be terminated.

As a leading importer of major international brands of alcoholic beverages in Poland and Hungary, we have been working with the same suppliers in those countries for many years and either have verbal understandings or written distribution agreements with them. In addition, we have recently acquired distribution contracts in Russia through our significant economic interest in Whitehall. Where a written agreement is in place, it is usually valid for between one and five years and is terminable by either party on three to six months’ notice.

 

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Although we believe we are currently in compliance with the terms and conditions of our import and distribution agreements, there is no assurance that all our import agreements will continue to be renewed on a regular basis, or that, if they are terminated, we will be able to replace them with alternative arrangements with other suppliers. Moreover, our ability to continue to distribute imported products on an exclusive basis depends on some factors which are out of our control, such as ongoing consolidation in the wine, beer and spirit industry worldwide, or producers’ decisions from time to time to change their distribution channels, including in the markets in which we operate.

Our results of operations and financial condition may be adversely affected if we undertake acquisitions of businesses that do not perform as we expect or that are difficult for us to integrate.

At any particular time, we may be in various stages of assessment, discussion and negotiation with regard to one or more potential acquisitions, not all of which will be consummated. We make public disclosure of pending and completed acquisitions when appropriate and required by applicable securities laws and regulations.

Acquisitions involve numerous risks and uncertainties. If we complete one or more acquisitions, our results of operations and financial condition may be affected by a number of factors, including: the failure of the acquired businesses to achieve the financial results we have projected in either the near or long term; the assumption of unknown liabilities; the fair value of assets acquired and liabilities assumed; the difficulties of imposing adequate financial and operating controls on the acquired companies and their management and the potential liabilities that might arise pending the imposition of adequate controls; the challenges of preparing and consolidating financial statements of acquired companies in a timely manner; the difficulties in integration of the operations, technologies, services and products of the acquired companies; and the failure to achieve the strategic objectives of these acquisitions. In addition, we may acquire a significant, but non-controlling, stake in a business, which could expose us to the risk of decisions taken by the acquired business’ controlling shareholder. For example, we do not currently have a majority of the voting power in Whitehall and although we have negotiated contractual rights to board representation and other matters of corporate governance, we are subject to decisions of the controlling shareholder in a way that we are not with our subsidiaries that we wholly-own or control and cannot assure you that our contractual rights will in all instances be sufficient to protect our interests.

Acquisitions in developing economies, such as Russia, involve unique risks in addition to those mentioned above, including those related to integration of operations across different cultures and languages, currency risks and the particular economic, political, and regulatory risks associated with specific countries.

Future acquisitions or mergers may result in a need to issue additional equity securities, spend our cash, or incur debt, liabilities or amortization expenses related to intangible assets, any of which could reduce our profitability.

Sustained periods of high inflation in Russia may materially adversely affect our business there.

Russia has experienced periods of high levels of inflation since the early 1990s. Despite the fact that inflation has remained relatively stable in Russia during the past few years, our profit margins from our Russian business could be adversely affected if we are unable to sufficiently increase our prices to offset any significant future increase in the inflation rate.

We may fail to realize the anticipated benefits of the Russian Alcohol transaction

The success of the Russian Alcohol transaction will depend on, among other things, our ability to realize anticipated cost savings and our ability to combine the businesses of the Company and Russian Alcohol in a manner that does not materially disrupt existing relationships or otherwise result in decreased productivity. If we are unable to achieve these objectives, the anticipated benefits of the merger may not be realized fully or at all or may take longer to realize than expected.

 

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The integration process could result in the loss of key employees, the disruption of our or Russian Alcohol’s ongoing businesses or inconsistencies in standards, controls, procedures or policies that could adversely affect our ability to maintain relationships with third parties and employees or to achieve the anticipated benefits of the transaction. To realize the benefits of the transaction, we must retain Russian Alcohol’s key employees. Among other things, in order to realize the anticipated benefits of the merger we must identify and eliminate redundant operations and assets across a geographically dispersed organization.

Integration efforts between the two companies could also divert management attention and resources. An inability to realize the full extent of, or any of, the anticipated benefits of the transaction, as well as any delays encountered in the integration process, could have an adverse effect on the Company.

In addition, the actual integration may result in additional and unforeseen expenses, and the anticipated benefits of the integration plan may not be realized. Actual cost synergies, if achieved at all, may be lower than we expect and may take longer to achieve than we anticipate. If we are not able to adequately address these challenges, the Company may be unable to successfully integrate the operations of Russian Alcohol, or to realize the anticipated benefits of the integration of the two companies.

The developing legal system in Russia creates a number of uncertainties that could adversely affect our Russian business.

Russia is still developing the legal framework required to support a market economy, which creates uncertainty relating to our Russian business. We have limited experience operating in Russia, which could increase our vulnerability to the risks relating to these uncertainties. Risks related to the developing legal system in Russia include:

 

   

inconsistencies between and among the Constitution, federal and regional laws, presidential decrees and governmental, ministerial and local orders, decisions, resolutions and other acts;

 

   

conflicting local, regional and federal rules and regulations;

 

   

the lack of judicial and administrative guidance on interpreting legislation;

 

   

the relative inexperience of judges and courts in interpreting legislation;

 

   

the lack of an independent judiciary;

 

   

a high degree of discretion on the part of governmental authorities, which could result in arbitrary or selective actions against us, including suspension or termination of licenses we need to operate in Russia;

 

   

poorly developed bankruptcy procedures that are subject to abuse; and

 

   

incidents or periods of high crime or corruption that could disrupt our ability to conduct our business effectively.

The recent nature of much of Russian legislation, the lack of consensus about the scope, content and pace of economic and political reform and the rapid evolution of this legal system in ways that may not always coincide with market developments place the enforceability and underlying constitutionality of laws in doubt and result in ambiguities, inconsistencies and anomalies. Any of these factors could adversely affect our Russian business.

An unpredictable tax system in Russia gives rise to significant uncertainties and risks that complicate our tax planning and decisions relating to our Russian business.

The tax system in Russia is unpredictable and gives rise to significant uncertainties, which complicate our tax planning and decisions relating to our Russian business. Tax laws in Russia have been in force for a relatively short period of time as compared to tax laws in more developed market economies and we have less experience operating under Russian tax regulations than those of other countries.

 

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Russian companies are subject to a broad range of taxes imposed at the federal, regional and local levels, including but not limited to value added tax, excise duties, profit tax, payroll-related taxes, property taxes, taxes or other liabilities related to transfer pricing and other taxes. Russia’s federal and local tax laws and regulations are subject to frequent change, varying interpretations and inconsistent or unclear enforcement. It is not uncommon for differing opinions regarding legal interpretation to exist both between companies subject to such taxes and the ministries and organizations of the Russian government and between different branches of the Russian government such as the Federal Tax Service and its various local tax inspectorates, resulting in uncertainties and areas of conflict. Tax declarations are subject to review and investigation by a number of tax authorities, which are enabled by law to impose penalties and interest charges. The fact that a tax declaration has been audited by tax authorities does not bar that declaration, or any other tax declaration applicable to that year, from a further tax review by a superior tax authority during a three-year period. As previous audits do not exclude subsequent claims relating to the audited period, the statute of limitations is not entirely effective. In some instances, even though it may potentially be considered unconstitutional, Russian tax authorities have applied certain taxes retroactively. Within the past few years the Russian tax authorities appear to be taking a more aggressive position in their interpretation of the legislation and assessments, and it is possible that transactions and activities that have not been challenged in the past may be challenged. As a result, significant additional taxes, penalties and interest may be assessed. In addition, our Russian business is and will be subject to periodic tax inspections that may result in tax assessments and additional amounts owed by us for prior tax periods. Uncertainty relating to Russian transfer pricing rules could lead tax authorities to impose significant additional tax liabilities as a result of transfer pricing adjustments or other similar claims, and could have a material adverse effect on our Russian businesses and our company as a whole.

Russian Alcohol was not required to comply with the provisions of Sarbanes-Oxley and, therefore, we cannot assure you that the financial results of Russian Alcohol do not contain deficiencies in their control over financial reporting that could lead to a material weakness.

In the second quarter of 2009 we began reporting Russian Alcohol’s financial results on a consolidated basis with ours. As a private company, Russian Alcohol has not historically complied with the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”).

While we have evaluated the financial results of Russian Alcohol, we have not integrated Russian Alcohol’s internal controls with our Sarbanes-Oxley compliant internal controls and cannot ensure that Russian Alcohol’s controls will comply with the rules applicable to U.S. public companies. Therefore, we cannot assure you that the financial results of Russian Alcohol do not contain deficiencies in their control over financial reporting that could lead to a material weakness.

Risks Related to Our Indebtedness

Our substantial debt could adversely affect our financial condition or results of operations and prevent us from fulfilling our obligations under our notes.

We are highly leveraged and have significant debt service obligations. As of December 31, 2009 our indebtedness under our notes, other credit facilities and capital leases amounted to approximately $1,798 million.

Our substantial debt could have important consequences. For example, it could:

 

   

make it difficult for us to satisfy our obligations with respect to our notes and for the guarantors of our notes to satisfy their obligations with respect to the guarantees;

 

   

require us to dedicate a substantial portion of our cash flows from operations to payments on our debt, which will reduce our cashflow available to fund capital expenditures, working capital and other general corporate purposes;

 

   

place us at a competitive disadvantage compared to our competitors that have less debt than we do;

 

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limit our flexibility in planning for, or reacting to, changes to our industry;

 

   

increase our vulnerability, and reduce our flexibility to respond, to general and industry specific adverse economic conditions; and

 

   

limit our ability to borrow additional funds, increase the cost of any such borrowing and/or limit our ability to raise equity funding.

We may incur substantial additional debt in the future. The terms of the indentures governing our notes restrict our ability to incur, but will not prohibit us from incurring, additional debt. If we were to incur additional debt, the related risks we now face could become greater.

We require a significant amount of cash to service our indebtedness. Our ability to generate sufficient cash depends on a number of factors, many of which are beyond our control.

Our ability to make payments on or repay our indebtedness will depend on our future operating performance and ability to generate sufficient cash. This depends, to some extent, on general economic, financial, competitive, market, legislative, regulatory and other factors discussed in these “Risk Factors,” many of which are beyond our control.

Historically, we met our debt service and other cash requirements with cash flows from operations and our existing revolving credit facilities. As a result of certain acquisitions and related financing transactions, however, our debt service requirements have increased significantly. We cannot assure you that our business will generate sufficient cash flows from operating activities, or that future debt and equity financing will be available to us in an amount sufficient to enable us to pay our debts when due or to fund our other financing needs.

If our future cash flows from operations and other capital resources are insufficient to pay our obligations as they mature or to fund our liquidity needs, we may be forced to:

 

   

reduce or delay our business activities and capital expenditures;

 

   

sell assets;

 

   

obtain additional debt or equity capital; or

 

   

restructure or refinance all or a portion of our debt, including our notes, on or before maturity.

In addition, the terms of the indentures governing our notes limit our ability to pursue any of these alternatives. If we obtain additional debt financing, the related risks we now face would intensify.

Furthermore, significant changes in market liquidity conditions resulting in a tightening in the credit markets and a reduction in the availability of debt and equity capital could impact our access to funding and our related funding costs, which could materially and adversely affect our ability to obtain and manage liquidity, to obtain additional capital and to restructure or refinance any of our existing debt.

We must rely on payments from our subsidiaries to make cash payments on our notes, and our subsidiaries are subject to various restrictions on making such payments.

We are a holding company and hold most of our assets at, and conduct most of our operations through, direct and indirect subsidiaries. In order to make payments on our notes or to meet our other obligations, we depend upon receiving payments from our subsidiaries. In particular, we may be dependant on dividends and other payments by our direct and indirect subsidiaries to service our obligations. Investors in our notes will not have any direct claim on the cash flow or assets of our non-guarantor operating subsidiaries and our non-guarantor operating subsidiaries have no obligation, contingent or otherwise, to pay amounts due under our notes or the subsidiary guarantees, or to make funds available to us for those payments. In addition, the payment

 

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of dividends and the making of loans and advances to us by our subsidiaries may be subject to various restrictions. Existing and future debt of certain of these subsidiaries may prohibit the payment of dividends or the making of loans or advances to us. In addition, the ability of our subsidiaries to make payments, loans or advances to us may be limited by the laws of the relevant jurisdictions in which such subsidiaries are organized or located. Any of the situations described above could make it more difficult for a subsidiary guarantor to service its obligations and therefore adversely affect our ability to service our obligations in respect of our notes. If payments are not made to us by our subsidiaries, we may not have any other sources of funds available that would permit us to make payments on our notes.

Covenant restrictions under the indentures governing our notes impose significant operating and financial restrictions on us and may limit our ability to operate our business and consequently to make payments on our notes.

The indentures governing our notes will contain, and other financing arrangements that we may enter into in the future may contain, covenants that restrict our ability to finance future operations or capital needs or to take advantage of other business opportunities that may be in our interest. These covenants restrict our ability to, among other things:

 

   

incur or guarantee additional debt;

 

   

make certain restricted payments;

 

   

transfer or sell assets;

 

   

enter into transactions with affiliates;

 

   

create certain liens;

 

   

create restrictions on the ability of restricted subsidiaries to pay dividends or other payments;

 

   

issue guarantees of indebtedness by restricted subsidiaries;

 

   

enter into sale and leaseback transactions;

 

   

merge, consolidate, amalgamate or combine with other entities;

 

   

designate restricted subsidiaries as unrestricted subsidiaries; and

 

   

engage in any business other than a permitted business.

Events beyond our control, including changes in general business and economic conditions, may affect our ability to meet these requirements. A breach of any of these covenants could result in a default under the indentures governing our notes.

Enforcing legal liability against us and our directors and officers might be difficult.

We are organized under the laws of the State of Delaware of the United States. Therefore, investors are able to effect service of process in the United States upon us and may be able to effect service of process upon our directors and executive officers. We are a holding company, however, and substantially all of our operating assets are located in Poland, Hungary and, in connection with our recently completed acquisitions, Russia. Further, most of our directors and executive officers, and those of most of our subsidiaries, are non-residents of the United States, and our assets and the assets of our directors and executive officers are located outside the United States. As a result, you may not be able to enforce against our assets (or those of certain of our directors or executive officers) judgments of United States courts predicated upon the civil liability provisions of United States laws, including federal securities laws of the United States. In addition, awards of punitive damages in actions brought in the United States or elsewhere may not be enforceable in Poland or Russia.

 

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Item 2. Properties.

Our significant properties can be divided into the following categories:

Production and rectification facilities. Our production facilities in Poland comprise two plants with one located in Białystok, Poland for Polmos Białystok and the other one located in Oborniki Wielkopolskie, Poland for Bols. The Białystok facility is located on 78,665 square meters of land which is leased from the government on a perpetual usufruct basis. The production capacity of our plant in Bialystok is approximately 24 million liters of 100% alcohol per year and currently, we use approximately 60% to 65% of its production capacity. In the Polmos Białystok distillery we produce Absolwent and its taste variations, Batory, Białowieska, Cytrynówka, Czekoladowa, Kompleet, Vodka, Liberty Blue, Lider, Ludowa, Nalewka Wisniowa, Nalewka Miodowa and Palace Vodka, Winiak Białostocki, Winiak Pałacowy, Wódka Imbirowa, Zubrówka. The plot on which the Białystok facility is located is unencumbered.

The Bols facility is located on 80,519 square meters of which 58,103 square meters are owned by us and 22,416 square meters are leased from the government on a perpetual usufruct basis. The production capacity of our plant in Oborniki Wielkopolskie is 34.2 million liters of 100% alcohol per year. Currently we use about 60-65%of the plant’s production capacity. In the Bols distillery we produce Bols Excellent, Bols Vodka and its taste variations, Soplica, Soplica Szlachetna Polska, Soplica Tradycyjna Polska, Soplica Wisniowa Polska, Soplica Staropolska, Boss, Slaska, Niagara and Royal Vodka. The plot on which the Bols facility is located in unencumbered.

The Topaz Distillery is part of Russian Alcohol, and became part of the CEDC group in 2008. The distillery is one of the most advanced enterprises in Russia. It is certified to be in compliance with ISO 9001 and HACCP. The factory has ten, modern, hi-tech filling lines, its own rectifying equipment for processing raw spirit, and a unique “stream” processor. The “stream” processor is an automated, hi-tech apparatus for the manufacturing of vodka, without any human intervention in the process. In the course of “stream” processing, vodka passes through both silver and platinum filters. The Topaz distillery produces, among others, the Green Mark, Zhuravli, Yamskaya and Kalinov Lug brands. The plant was founded in 1995 and has a production capacity of over 150 million liters annually.

The Parliament production plant uses an exceptional biological milk purification method. Milk, added at a certain stage of production, absorbs all impurities and harmful substances. The milk is then removed in a multistage filtration process, leaving an absolutely pure vodka of the highest quality.

The First Kupazhniy Factory is part of Russian Alcohol, and became part of the CEDC group in 2008. The company is developing the two fundamental components of its business activities: the manufacture of vodka and the extraction and bottling of natural mineral water from artesian wells. Four bottling lines have been installed at the factory, including a line for the exclusive 0.05 liter, 0.2 liter, and 0.5 liter PET containers. All vodka production at First Kupazhniy Factory takes place using the “stream” system, which completely automates the process. In this facility, we produce the Marusia and Zhuravli brands. The plant was founded in 1976 and its production capacity reaches 35 million liters annually. The quality control system at First Kupazhniy Factory conforms to the international standard, ISO 9001.

The Bravo Premium distillery was the first in Russia to bottle alcoholic cocktails, beer and non-alcoholic beverages in aluminum cans. The company has been affiliated with Russian Alcohol since 2005 and became part of the CEDC Group in 2008. In recent years Bravo Premium has gone through an intensive modernization of the manufacturing process, has purchased new pouring lines, built new plant facilities and expanded its distribution network. Today, Bravo Premium is a premier facility for the production of alcoholic cocktails, with three pouring lines for cans, plastic bottles and glass containers. The factory produces such cocktails as Funky Juz, China Town and Bravo Classic. The factory is certified to be in compliance with ISO 9001.

Office, distribution, warehousing and retail facilities. We own five warehousing and distribution sites located in various regions of Poland as well as nine retail facilities located in various regions of Poland. In Russia we own the land and buildings in Balahikha, Moscow Region where the Parliament facilities are located.

 

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Leased Facilities. Our primary corporate office is located in Warsaw, Poland, and we have a rented corporate office in Budapest Hungary. In addition we operate over 85 warehousing and distribution sites and 45 retail facilities located in various regions of Poland. In Russia we lease over 10 office, warehouse and retail locations primarily related to the Whitehall business. The lease terms expire at various dates and are generally renewable.

Research and Development, Intellectual Property, Patents and Trademarks

We do not have a separate research and development unit. Our activity in this field is generally related to improvements in packaging and extensions to our existing brand portfolio or revised production processes, leading to improved taste.

 

Item 3. Legal Proceedings.

From time to time we are involved in legal proceedings arising in the normal course of our business, including opposition and cancellation proceedings with respect to trademarks similar to some of our other brands, and other proceedings, both in the United States and elsewhere. We are not currently involved in or aware of any pending or threatened proceedings that we reasonably expect, either individually or in the aggregate, will result in a material adverse effect on our consolidated financial condition or results of operations.

 

Item 4. [Reserved.]

 

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PART II

 

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters.

Market Information

The Company’s common stock has been traded on the NASDAQ National Market, and its successor, the NASDAQ Global Select Market, under the symbol “CEDC” since June 1999. Prior thereto it traded on the NASDAQ Small Cap Market since our initial public offering in July 1998. On September 22, 2008 the Company’s stock was added to the NASDAQ Q-50 Index. The following table sets forth the high and low bid prices for the common stock, as reported on the NASDAQ Global Select Market, for each of the Company’s fiscal quarters in 2008 and 2009. These prices represent inter-dealer quotations, which do not include retail mark-ups, mark-downs or commissions and do not necessarily represent actual transactions.

 

     High    Low

2008

     

First Quarter

   $ 62.52    $ 46.50

Second Quarter

     75.47      56.32

Third Quarter

     77.48      28.95

Fourth Quarter

     46.52      17.16

2009

     

First Quarter

   $ 24.87    $ 5.97

Second Quarter

     33.13      10.47

Third Quarter

     34.70      21.92

Fourth Quarter

     36.41      26.44

On February 24, 2010, the last reported sales price of our common stock was $32.75 per share.

Holders

As of February 24, 2010, there were approximately 28,891 beneficial owners and 52 shareholders of record of common stock.

Dividends

CEDC has never declared or paid any dividends on its capital stock. The Company currently intends to retain future earnings for use in the operation and expansion of its business. Future dividends, if any, will be subject to approval by the Company’s board of directors and will depend upon, among other things, the results of the Company’s operations, capital requirements, surplus, general financial condition and contractual restrictions and such other factors as the board of directors may deem relevant. In addition, the indenture for the Company’s outstanding Senior Secured Notes due in 2016 may limit the payment amount of cash dividends on its common stock to amounts calculated in accordance with a formula based upon our net income and other factors.

The Company earns the majority of its cash in non—USD currencies and any potential future dividend payments would be impacted by foreign exchange rates at that time. Additionally the ability to pay dividends may be limited by local equity requirements, therefore retained earnings are not necessarily the same as distributable earnings of the Company.

 

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Equity Compensation Plans

The following table provides information with respect to our equity compensation plans as of December 31, 2009:

Equity Compensation Plan Information

 

Plan Category

   Number of Securities to be
Issued Upon Exercise of
Outstanding Options,
Warrants and Rights
   Weighted-Average
Exercise Price of
Outstanding Options,
Warrants and Rights
   Number of Securities
Remaining Available for
Future Issuance Under
Equity Compensation Plans
(Excluding Securities
Reflected in Column (a))
     (a)    (b)    (c)

Equity Compensation Plans Approved by Security Holders

   1,560,624    $ 28.70    999,890

Equity Compensation Plans Not Approved by Security Holders

   —        —      —  

Total

   1,560,624    $ 28.70    999,890

 

Item 6. Selected Financial Data

The following table sets forth selected consolidated financial data for the periods indicated and should be read in conjunction with and is qualified by reference to “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, the consolidated financial statements, the notes thereto and the other financial data contained in Items 7 and 8 of this report on Form 10-K.

 

Statement of Operations data:    2005     2006     2007     2008     2009  

Net sales

   $ 749,415      $ 944,108      $ 1,189,822      $ 1,647,004      $ 1,507,139   

Cost of goods sold

     627,368        745,721        941,060        1,224,899        1,012,543   
                                        

Gross profit

     122,047        198,387        248,762        422,105        494,596   

Sales, general and administrative expenses

     70,404        106,805        130,677        223,373        278,448   
                                        

Operating income

     51,643        91,582        118,085        198,732        216,148   

Non-operating income / (expense), net

          

Interest (expense), net

     (15,828     (31,750     (35,829     (53,447     (80,213

Other financial income / (expense), net

     (7,678     17,212        13,594        (132,936     21,864   

Amortization of deferred charges

     —          —          —          —          (38,501

Other income / (expense), net

     (262     1,119        (1,770     410        824   
                                        

Income before taxes, equity in net income from unconsolidated investments and noncontrolling interests in subsidiaries

     27,875        78,163        94,080        12,759        120,122   

Income tax (expense)

     (5,346     (13,986     (15,910     (11,872     (22,905
                                        

Equity in net earnings of affiliates

     —          —          —          (9,002     (13,102
                      

Net income / (loss)

   $ 22,529      $ 64,177      $ 78,170      ($ 8,115   $ 84,115   
                                        

Less: Net income / (loss) attributable to noncontrolling interests in subsidiaries

     2,261        8,727        1,068        3,680        2,708   
                                  

Less: Net income / (loss) attributable to redeemable noncontrolling interests in Whitehall Group

     —          —          —          6,803        3,078   
                      

Net income /(loss) attributable to CEDC

   $ 20,268      $ 55,450      $ 77,102      ($ 18,598   $ 78,329   
                                        

Net income / (loss) per common share,

          

Basic

   $ 0.72      $ 1.55      $ 1.93      ($ 0.42   $ 1.46   
                                        

Net income / (loss) per common share, diluted

   $ 0.70      $ 1.53      $ 1.91      ($ 0.42   $ 1.45   
                                        

Average number of outstanding shares of common stock at year end

     28,344        35,799        39,871        44,088        53,772   
Balance Sheet Data:    2005     2006     2007     2008     2009  

Cash and cash equivalents

   $ 60,745      $ 159,362      $ 87,867      $ 107,601      $ 152,177   

Restricted cash

     —          —          —          —          481,419   

Working capital

     85,950        182,268        170,913        205,712        391,877   

Total assets

     1,084,472        1,326,033        1,782,168        2,483,686        4,446,893   

Long-term debt and capital lease obligations, less current portion

     369,039        394,564        469,958        806,362        1,312,881   

Stockholders’ equity

     374,942        520,973        815,436        956,629        1,685,162   

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation

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

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995 Regarding Forward-Looking Information.

This report contains forward-looking statements, which provide our current expectations or forecasts of future events. These forward-looking statements may be identified by the use of forward-looking terminology, including the terms “believes,” “estimates,” “anticipates,” “expects,” “intends,” “may,” “will” or “should” or, in each case, their negative, or other variations or comparable terminology, but the absence of these words does not necessarily mean that a statement is not forward-looking. These forward-looking statements include all matters that are not historical facts. They appear in a number of places throughout this report and include, without limitation:

 

   

information concerning possible or assumed future results of operations, trends in financial results and business plans, including those relating to earnings growth and revenue growth, liquidity, prospects, strategies and the industry in which the Company and its affiliates operate, as well as the integration of recent acquisitions and other investments and the effect of such acquisitions and other investments on the Company;

 

   

statements about the expected level of our costs and operating expenses, and about the expected composition of the Company’s revenues;

 

   

information about the impact of governmental regulations on the Company’s businesses;

 

   

statements about local and global credit markets, currency exchange rates and economic conditions;

 

   

other statements about the Company’s plans, objectives, expectations and intentions; and

 

   

other statements that are not historical facts.

By their nature, forward-looking statements involve known and unknown risks and uncertainties because they relate to events and depend on circumstances that may or may not occur in the future. We caution you that forward-looking statements are not guarantees of future performance and that our actual results of operations, financial condition and liquidity, the development of the industries in which we operate, and the effects of acquisitions and other investments on us may differ materially from those anticipated in or suggested by the forward-looking statements contained in this report. In addition, even if our results of operations, financial condition and liquidity, and the development of the industry in which we operate, are consistent with the forward-looking statements contained in this report, those results or developments may not be indicative of results or developments in subsequent periods.

We urge you to read and carefully consider the items of this and other reports and documents that we have filed with or furnished to the SEC for a more complete discussion of the factors and risks that could affect our future performance and the industry in which we operate, including the risk factors described elsewhere in this Annual Report on Form 10-K. In light of these risks, uncertainties and assumptions, the forward-looking events described in this report may not occur as described, or at all.

You should not unduly rely on these forward-looking statements, because they reflect our views only as of the date of this report. The Company undertakes no obligation to publicly update or revise any forward-looking statement to reflect circumstances or events after the date of this report, or to reflect on the occurrence of unanticipated events. All subsequent written and oral forward-looking statements attributable to us or to persons acting on our behalf are expressly qualified in their entirety by the cautionary statements referred to above and contained elsewhere in this report.

 

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

Overview

The Company is the world’s largest vodka producer and Central and Eastern Europe’s largest integrated spirit beverages business with its primary operations in Poland, Russia and Hungary. During 2009 the Company continued its investment strategy in Russia by restructuring its purchase agreement with Lion Capital in April, 2009 and subsequently buying out the remainder of Russian Alcohol in December, 2009. As a result, the Company began to consolidate the full activities of Russian Alcohol starting from the second quarter of 2009. Additionally the Company purchased the remaining minority interests in Parliament in Russia, thus acquiring full ownership of its vodka producing assets and brands.

In connection with the completion of these investments the Company completed three capital raising initiatives comprised of two public equity offerings, with net proceeds of approximately $491 million, and a notes offering with net proceeds of approximately $930 million. The primary use of the equity proceeds was to fund the remaining buyout of Parliament and to partially fund the remaining buyout of Russian Alcohol. The proceeds from the notes offering were used to fund a portion of the buyout of Russian Alcohol, and to refinance the Company’s outstanding Senior Secured Notes due in 2012, approximately $390 million as well as the debt in place in Russian Alcohol, approximately $264 million. As a result of the notes offering the Company has extended the maturities of a significant portion of its debt to 2016 as well as settling the majority of its payment obligations to Lion Capital for the purchase of Russian Alcohol.

Significant factors affecting our consolidated results of operations

Effect of Acquisitions of Production Subsidiaries

During 2008 and 2009, the Company continued its acquisition strategy outside of Poland and Hungary with its investments into the production and importation of alcoholic beverages in Russia, completing a number of acquisitions and investments, as described below, all of which have had an impact on our consolidated results of operations beginning in the periods in which we first acquired an interest in the relevant entities.

The Parliament Acquisition

On March 11, 2008, the Company and certain of its affiliates entered into a Share Sale and Purchase Agreement and certain other agreements with White Horse Intervest Limited, a British Virgin Islands Company (“White Horse”), and certain of White Horse’s affiliates, relating to the Company’s acquisition from White Horse of 85% of the share capital of Parliament. In connection with this acquisition, the Company paid a consideration of approximately $180 million in cash and 2.2 million shares of our common stock. On September 25, 2009, we amended the Share Sale and Purchase Agreement and entered into a Minority Acquisition Share Sale and Purchase Agreement. Under the terms of the Minority Acquisition Share Sale and Purchase Agreement, we acquired the remaining 15% of the share capital of Parliament for total cash consideration of $70.2 million on September 25, 2009. Under the terms of the amendment, we were required to pay cash consideration of approximately $16.7 million. The Company paid $9.9 million of that amount on October 30, 2009 and paid the remainder on December 16, 2009.

The Whitehall Acquisition

On May 23, 2008, the Company and certain of its affiliates entered into, and closed upon, a Share Sale and Purchase Agreement and certain other agreements whereby the Company acquired shares representing 50% minus one vote of the voting power, and 75% of the economic interests in Whitehall. Whitehall is a leading importer of premium spirits and wines in Russia. The aggregate consideration paid by the Company was $200 million, paid in cash at the closing. In addition, on October 21, 2008, the Company issued 843,524 shares of its

 

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common stock to the seller. On February 24, 2009, the Company and the seller amended the terms of the Stock Purchase Agreement governing the Whitehall acquisition to satisfy the Company’s obligations to the seller pursuant to a share price guarantee in the original Stock Purchase Agreement. As a result of the amended agreement and the payments due thereunder, the economic interest of the Company in Whitehall increased from 75% to 80%.

The Company has consolidated its investment in Whitehall as of May 23, 2008, on the basis that Whitehall is a Variable Interest Entity and the Company has been assessed as being the primary beneficiary.

In June 2009, the FASB issued ASC Topic 810, which changes how a company determines whether an entity should be consolidated. The adoption of this standard may impact the current treatment of the Whitehall Group by the Company and the Company is current assessing this treatment and potential impact on the financial statements. See “Recently Issued Accounting Pronouncements” for more detailed information on this topic.

Included within Whitehall is a 50/50 joint venture with Möet Hennessy (the “MHWH J.V.”). This joint venture is accounted for using the equity method and is recorded on the face of the balance sheet in investments which were initially recorded at fair value. The current term of the joint venture is until June 2013, at which point Möet Hennessy will have the option to acquire the remaining shares of the entity.

The Russian Alcohol Acquisition

On July 9, 2008, the Company completed an investment with Lion Capital and certain of Lion Capital’s affiliates and certain other investors, pursuant to which the Company, Lion Capital and such other investors acquired all of the outstanding equity of Russian Alcohol. In connection with that investment, the Company acquired an indirect equity stake in Russian Alcohol of approximately 42%, and Lion Capital acquired substantially all of the remainder of the equity of Russian Alcohol. The agreements governing that investment gave the Company the right to acquire, and gave Lion Capital the right to require the Company to acquire, Lion Capital’s equity stake in Russian Alcohol (the “Prior Agreement”). On April 24, 2009, the Company entered into new agreements with Lion Capital to replace the Prior Agreement, which would permit the Company, through a multi-stage equity purchase, to acquire over the next five years (including 2009) all of the equity interests in Russian Alcohol held by Lion Capital.

As a result of these agreements, the Company assessed Russian Alcohol as a variable interest entity, with the Company being the primary beneficiary. Pursuant to this change, the Company began to consolidate Russian Alcohol as of the second quarter of 2009 and recorded a non-controlling interest of 9.4%, representing equity not held by the Company or Lion Capital. From the accounting perspective, the Company treated the acquisition of Russian Alcohol equity interests held by Lion Capital as if this acquisition had happened on April 24, 2009. As of this date CEDC recorded at fair value all future payments due under these agreements as a liability. The total present value of deferred consideration as of April 24, 2009, amounted to $447.2 million and was determined using a 14.5% discount rate. The present value of the liability was amortized over the period of time ending on the date the last payment is made which was initially expected to be in 2013, with recognition of a non cash interest expense every quarter in the statement of operations. The discount amortization charge for the period from April 24, 2009 to December 31, 2009 amounted to $38.5 million.

On July 29, 2009, the Company entered into an agreement with Lion Capital pursuant to which Lion/Rally Cayman 7 L.P. (“Cayman 7”), a Cayman Exempted Limited Partnership, of which the Company holds 100% of the economic interests and is a limited partner, acquired an additional 6% indirect equity interest in Russian Alcohol from certain minority investors in Russian Alcohol in exchange for $30,000,000 in cash funded by the Company. After giving effect to this acquisition, the Company held approximately 58% of the equity interests in Russian Alcohol. In addition, on August 3, 2009, pursuant to the new agreements referenced above, the Company acquired additional indirect equity interests in Russian Alcohol giving it a total ownership interest of 59.8%.

 

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On September 15, 2009, in connection with the Russian Alcohol acquisition, the Company entered into a Settlement Agreement with Cirey Holdings Inc. (“Cirey”), a private company domiciled in the British Virgin Islands and the ultimate controlling party of Russian Alcohol, pursuant to which (i) Cirey received $50,000,000, $17,500,000 of which was funded by the Company, (ii) the Company issued to Cirey 479,499 shares of our common stock and (iii) the Company received $32,500,000 additional limited partnership interests in Cayman 7.

On November 9, 2009, the Company entered into an agreement with Lion Capital and Kylemore International Invest Corp. (“Kylemore”), an indirect minority stockholder of Russian Alcohol, for the acquisition of Kylemore’s indirect equity interests in Russian Alcohol. On November 10, 2009, the Company issued to Kylemore 949,034 shares of our unregistered common stock, and Kylemore transferred all of its indirect equity interests in Russian Alcohol to Lion/Rally Cayman 6 (“Cayman 6”), a Cayman Islands investment vehicle through which the Company and Lion Capital own our interests in Russian Alcohol. As a result, the Company, Lion Capital and certain co-Investors indirectly owned 100% of the equity in Russian Alcohol, and its total indirect equity interest in Russian Alcohol increased to 62.25%. Pursuant to the agreement with Kylemore, on receipt of approval from the FAS and the Antimonopoly Committee of the Ukraine for CEDC’s acquisition of control over Russian Alcohol, the Company paid Kylemore $5,000,000 on January 11, 2010, and will pay further $5,000,000 on February 1, 2011. Also pursuant to this agreement, Peter Levin, one of the original owners of Russian Alcohol, will continue to be involved in the Russian Alcohol’s business as a non-executive member of the Operating Board of Russian Alcohol and as Chairman of the Board of our Topaz distillery.

On December 9, 2009 the Company accelerated the terms set up in the Lion Option Agreement and the Co-Investor Option Agreement, each dated April 24, 2009, and completed the Lion Option and the Co-Investor Option, respectively, thereby purchasing the remaining indirect equity interests in Cayman 6, less the sole voting share of Cayman 6, comprising the remaining equity interest in Russian Alcohol that was not owned by the Company, from affiliates of Lion Capital.

In consideration of the Co-Investor Option, the Company made cash payments of $131,800,000 and €23,650,000 to Lion Capital. In consideration of the Lion Option, the Company (1) made cash payments of $184,347,666 and €105,839,852 to Lion Capital; (2) deposited in an escrow account the amount of $23,991,072 and €51,315,337, which was released and paid to Lion Capital on January 11, 2010 upon receiving of antimonopoly clearances for the acquisition from the FAS and the Antimonopoly Committee of the Ukraine; and (3) paid to Lion Capital the additional amounts of (a) $2,375,354 and €5,080,727 on the Escrow Release Date and (b) undertook to pay $10,689,092 and €22,863,269 on June 1, 2010, or at the election of Lion Capital, on any earlier date between April 20, 2010 and June 1, 2010. The Company used a portion of the proceeds from the offering of its common stock, completed November 18, 2009, and the offering of its Senior Secured Notes due 2016, completed December 2, 2009, in order to fund such cash payments.

On January 20, 2010, after the receipt of antimonopoly clearances for the acquisition from the FAS and the Antimonopoly Committee of the Ukraine, the Company purchased the sole voting share of Cayman 6 from an affiliate of Lion Capital and thereby acquired control of Russian Alcohol. The Company began consolidating all profit and loss results for Russian Alcohol beginning April 1, 2009.

During 2009 and continuing this year, we have been active in integrating the production companies into our Group. The acquisition and integration of these businesses into our operations have had a significant effect on our results of operations. As discussed below, these acquisitions have impacted our net sales, cost of goods sold, operating profit and equity earnings from affiliates.

Effect of Debt Refinancing

In December 2009, the Company issued new euro and U.S. dollar Senior Secured Notes due in 2016 with net proceeds of approximately $930 million. Of these proceeds approximately $380.4 million was used to redeem our previously outstanding Senior Secured Notes due in 2012. Notice of redemption was given in December, 2009 and the proceeds were funded to the trustee, however the actual repayment of the notes did not take place

 

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until January, 2010. Therefore, as at December 31, 2009, the full amounts of the Senior Secured Notes due 2012 remained as a short term liability and the cash funded to the trustee was on the balance as restricted cash. Additionally as a result of this the Company recognized interest expense in December, 2009 for both the new and old note issuances.

In the process of refinancing the debt of Russian Alcohol through the proceeds of the 2016 Notes, the Company recognized a one-time charge of approximately $13.9 million related to the write-off of capitalized financing cost and net charge of $3 million related to the closure of hedges associated with the prior financing. These charges are reflected in Other Financial Expenses.

As these notes were funded in U.S. dollars and euro’s and lent to Polish zloty and Russian ruble reporting entities, the Company is exposed to exchange rate movements as described in the following section.

Effect of Exchange Rate and Interest Rate Fluctuations

Substantially all of Company’s operating cash flows and assets are denominated in Polish zloty, Russian ruble and Hungarian forint. This means that the Company is exposed to translation movements both on its balance sheet and statement of operations. 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 statement of operations is by the movement of the average exchange rate used to restate the statement of operations from Polish zloty, Russian ruble and Hungarian forint to U.S. dollars. The amounts shown as exchange rate gains or losses on the face of the statement of operations relate only to realized gains or losses on transactions that are not denominated in Polish zloty, Russian ruble or Hungarian forint.

Because the Company’s reporting currency is the U.S. dollar, the translation effects of fluctuations in the exchange rate of our functional currencies have impacted the Company’s financial condition and results of operations and have affected the comparability of our results between financial periods.

The Company also has borrowings including its Senior Secured Notes due 2012, Convertible Notes due 2013 and Senior Secured Notes 2016 that are denominated in U.S. dollars and euro’s, which have been lent to its operations where the functional currency is the Polish zloty and Russian ruble. The effect of having debt denominated in currencies other than the Company’s functional currencies is to increase or decrease the value of the Company’s liabilities on that debt in terms of the Company’s functional currencies when those functional currencies depreciate or appreciate in value, respectively. As a result of this, the Company is exposed to gains and losses on the re-measurement of these liabilities. The table below summarizes the pre-tax impact of a one percent movement in each of the exchange rate which could result in a significant impact in the results of the Company’s operations.

 

Exchange Rate

  

Value of notional amount

   Pre-tax impact of a 1%
movement in exchange rate

USD-Polish zloty

   $426 million    $4.3 million gain/loss

USD-Russian ruble

   $264 million    $2.6 million gain/loss

EUR-Polish zloty

   €625 million or approximately $901 million    $9 million gain/loss

The table above includes €245 million for the Senior Secured Notes that were redeemed on January 4, 2010, thus there will not be any foreign exchange impact from them after this date.

 

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Twelve months ended December 31, 2009 compared to twelve months ended December 31, 2008

A summary of the Company’s operating performance (expressed in thousands except per share amounts) is presented below.

 

     Year ended December 31,  
   2009     2008  

Sales

   $ 2,197,542      $ 2,136,570   

Excise taxes

     (690,403     (489,566

Net Sales

     1,507,139        1,647,004   

Cost of goods sold

     1,012,543        1,224,899   
                

Gross Profit

     494,596        422,105   
                

Operating expenses

     278,448        223,373   
                

Operating Income

     216,148        198,732   
                

Non operating income / (expense), net

    

Interest (expense), net

     (80,213     (53,447

Other financial income / (expense), net

     21,864        (132,936

Amortization of deferred charges

     (38,501     —     

Other non operating income, net

     824        410   
                

Income before taxes, equity in net income from unconsolidated investments and noncontrolling interests in subsidiaries

     120,122        12,759   
                

Income tax expense

     (22,905     (11,872

Equity in net earnings of affiliates

     (13,102     (9,002
                

Net income / (loss)

   $ 84,115      ($ 8,115
                

Less: Net income attributable to noncontrolling interests in subsidiaries

     2,708        3,680   

Less: Net income attributable to redeemable noncontrolling interests in Whitehall Group

     3,078        6,803   

Net income /(loss) attributable to CEDC

   $ 78,329      ($ 18,598
                

Net income / (loss) per share of common stock, basic

   $ 1.46      ($ 0.42
                

Net income / (loss) per share of common stock, diluted

   $ 1.45      ($ 0.42
                

Net Sales

Net sales represents total sales net of all customer rebates, excise tax on production and imports, and value added tax. Total net sales decreased by approximately 8.5%, or $139.9 million, from $1,647.0 million for the twelve months ended December 31, 2008 to $1,507.1 million for the twelve months ended December 31, 2009. This decrease in sales is due to the following factors:

 

Net Sales for twelve months ended December 31, 2008

   $ 1,647,004   

Increase from acquisitions

     357,531   

Sales reduction in Polish distribution

     (153,991

Other business sales change

     5,015   

Impact of foreign exchange rates

     (348,420
        

Net sales for twelve months ended December 31, 2009

   $ 1,507,139   

Factors impacting our business sales for the twelve months ending December 31, 2009 include the decline in the Polish distribution business which was impacted by our program of reducing our wholesaling of lower margin SKUs, primarily beer, the shifting of consumers purchasing to larger retail outlets and lower depletions

 

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during the first quarter of 2009 as a result of higher inventory levels in the market in Poland at the beginning of the quarter. These higher inventory levels in the market at the beginning of the year, which impacted primarily the first quarter of 2009, were driven by the nine percent excise tax increase in Poland on December 31, 2008 which prompted customers to purchase additional product prior to December 31, 2008 at the lower excise tax.

Based upon average exchange rates for the twelve months ended December 31, 2009 and December 31, 2008, our functional currencies meaning primarily Polish zloty and Russian ruble depreciated against the U.S. dollar, by approximately 30% and 28% respectively. This resulted in a decrease of $348.4 million of sales in U.S. dollar terms. These decreases were partially offset by the consolidation of net sales of Russian Alcohol.

Our business split by segment, which represents our primary geographic locations of operations, Poland, Russia and Hungary, is shown below:

 

     Segment Net Revenues Twelve
months ended December 31,
     2009    2008

Segment

  

Poland

   $ 892,121    $ 1,305,629

Russia

     578,433      297,892

Hungary

     36,585      43,483
             

Total Net Sales

   $ 1,507,139    $ 1,647,004

Gross Profit

Total gross profit increased by approximately 17.2%, or $72.5 million, to $494.6 million for the twelve months ended December 31, 2009, from $422.1 million for the twelve months ended December 31, 2008, reflecting the increase in gross profit margins percentage in the twelve months ended December 31, 2009. Gross margin increased from 25.6% of net sales for the twelve months ended December 31, 2008 to 32.8% of net sales for the twelve months ended December 31, 2009. The primary factor resulting in the improved margin was the full year inclusion of the newly acquired businesses in Russia, Parliament and Whitehall, as well as the first time consolidation of the results of Russian Alcohol, which, as producers and importers, operate on a higher gross profit margin than the Polish business, which is significantly impacted by lower margin distribution operations.

Operating Expenses

Operating expenses as a percent of net sales increased from 13.6% for the twelve months ended December 31, 2008 to 18.5% for the twelve months ended December 31, 2009. Total operating expenses increased by approximately 24.6%, or $55.0 million, from $223.4 million for the twelve months ended December 31, 2008 to $278.4 million for the twelve months ended December 31, 2009. Approximately $114.6 million of this increase resulted from the effects of the acquisition of Russian Alcohol in July 2008. Approximately $19.9 million resulted from the lower operating costs in our existing business, which include certain one off transaction related gains and losses described below. The depreciation of the functional currencies against the U.S. dollar resulted in a $49.9 million reduction in our operating expenses for the twelve months ended December 31, 2009 as compared to the same period in the prior year.

 

Operating expenses for twelve months ended December 31, 2008

   $ 223,373   

Increase from acquisitions

     124,908   

Decrease from existing business growth

     (19,909

Impact of foreign exchange rates

     (49,924
        

Operating expenses for twelve months ended December 31, 2009

   $ 278,448   

 

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The table below sets forth the items of operating expenses.

 

     Twelve Months Ended
December 31,
     2009    2008
     ($ in thousands)

S,G&A

   $ 221,560    $ 168,584

Marketing

     46,534      43,954

Depreciation and amortization

     10,354      10,835
             

Total operating expense

   $ 278,448    $ 223,373

S,G&A increased by approximately 31.4%, or $53.0 million, from $168.6 million for the twelve months ended December 31, 2008 to $221.6 million for the twelve months ended December 31, 2009. Approximately $100.0 million of this increase resulted primarily from the consolidation of the results of Russian Alcohol and the remainder of the increase resulted primarily from the growth of the business, which increases were offset by the depreciation of the Polish zloty against the U.S. dollar.

Included in S,G&A are certain one off gains and losses including, a one-time gain in the twelve month period ended December 31, 2009, amounting to $225.6 million in operating income based on the re-measurement of previously held equity interests in Russian Alcohol to fair value, which was partially offset by certain one-ff charges including a $162.0 one off charge related to non amortized discount of deferred consideration resulting from accelerated buyout of Lion Capital’s interest in Russian Alcohol, a $15.0 million post closing cash settlement made to the original sellers for the Russia Alcohol Group, an impairment charge of $20.3 million related to the Company’s trademarks , as well as legal and advisory fees related to acquisitions.

Depreciation and amortization decreased by approximately 3.7%, or $ 0.4 million, from $10.8 million for the twelve months ended December 31, 2008 to $10.4 million for the twelve months ended December 31, 2009 due to the impact of foreign exchange translation.

Operating Income

Total operating income increased by approximately 8.8%, or $17.4 million, from $198.7 million for the twelve months ended December 31, 2008 to $216.1 million for the twelve months ended December 31, 2009. This increase resulted primarily from the consolidation of the results of Russian Alcohol, from which the Company recognized a one-time gain in the twelve month period ended December 31, 2009, amounting to $225.6 million in operating income based on the re-measurement of previously held equity interests in Russian Alcohol to fair value, which was partially offset by $162.0 of one off charge related to non amortized discount of deferred consideration resulting from accelerated buyout of Lion’s interest in Russian Alcohol, a $15 million post closing cash settlement made to the original sellers for Russian Alcohol and an impairment charge of $20.3 million related to the Company’s trademarks.

 

     Operating Profit
Twelve months ended
December 31,
 
     2009     2008  

Segment

  

Poland

   $ 107,987      $ 124,920   

Russia

     110,363        73,374   

Hungary

     6,149        7,641   

Corporate Overhead

    

General corporate overhead

     (4,570     (3,353

Option Expense

     (3,781     (3,850
                

Total Operating Profit

   $ 216,148      $ 198,732   

 

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Operating profit in Poland as a percent of net sales was 12.1% for the twelve months ended December 31, 2009 as comparing to 9.6% in the same period in 2008. However this includes certain one off transaction related gains and losses as described above related to the acquisition of Russian Alcohol. These items impacted the Polish Segment as a Polish subsidiary was the parent company for the Russian Alcohol acquisition. Excluding the impact of these items the operating profit in Poland as a percent of net sales was 8.9% for the twelve months ended December 31, 2009, as compared to 9.6% in 2008. This reduction is primarily driven by lower margins in our distribution business as well as having lower distribution sales going through the fixed assets cost base.

The operating profit margin as a percent of net sales in Russia declined from 24.6% for the twelve months ended December 31, 2008 to 19.1% for the twelve months ended December 31, 2009, reflecting the impact of the consolidation of Russian Alcohol. Russian Alcohol operates primarily in the mainstream segment as compared to Parliament which is a sub-premium vodka and has sales of ready to drink alcoholic beverages (long drinks) which operate on a lower margin than vodka’s. Additionally the import products from Whitehall were impacted by higher purchase prices due to the impact of the devaluation of the Russian ruble.

In Hungary there was a decline in operating profit as a percent of net sales from 17.6% for the twelve months ended December 31, 2008 to 16.8% for the twelve months ended December 31, 2009. This decline was due primarily to higher local currency import costs in the first quarter of 2009 as the Hungarian business sales constitute only imported spirits which have prices denominated primarily in euro.

Non Operating Income and Expenses

Total interest expense increased by approximately 50.2%, or $26.8 million, from $53.4 million for the twelve months ended December 31, 2008 to $80.2 million for the twelve months ended December 31, 2009. This increase resulted from the consolidation of the financial results of Russian Alcohol commencing in the second quarter of 2009 and additional borrowings to finance the investment in Russian Alcohol in July 2008.

The Company recognized $21.9 million of other financial income in the twelve months ended December 31, 2009, as compared to $132.9 million of losses for the twelve months ended December 31, 2008. This change is primarily related to the impact of movements in exchange rates on our USD and EUR denominated acquisition financing, as well as from the bank charges related to early repayment of debt by Russian Alcohol that was subsequently refinanced from Senior Secured Notes due 2016 proceedings as costs of closing of hedges associated to this bank debt. The total impact of these transactions amounted to $16.9 million.

The present value of the deferred consideration related to acquisition in Russian Alcohol was amortized over the period of time up to December 8, 2009 when the Company accelerated the terms set up on the Option Agreement dated April 24, 2009 and purchased the remaining equity interest in Russian Alcohol that was not owned by the Company. Up to this date the Company was recognizing a non cash interest expense every quarter in the statement of operations. The discount amortization charge for the twelve month period ended December 31, 2009 amounted to $38.5 million.

Other non operating items for the twelve months ended December 31, 2009 show net income of $0.8 million in comparison to gains of $0.4 million in the twelve months ended December 31, 2008.

Income Tax

Our effective tax rate for the twelve months ending December 31, 2009 was 19.1%, which is mainly driven by the blended statutory tax rates rate of 19% in Poland and 20% in Russia.

Non-controlling Interests and Equity in Net Earnings

Minority interest for the twelve months ending December 31, 2009 represents non-controlling interests held by third parties, consisting primarily of a 20% minority interest in Whitehall, a 15% interest in Parliament prior

 

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to September 25, 2009 (when we acquired that minority stake) and approximately $2.5 million of minority interest related to certain minority shareholders of Russian Alcohol, whose full stake was purchased by the Company in December, 2009.

Equity in net earnings for the twelve months ending December 31, 2009 include CEDC’s proportional share of net loss from its investments accounted for under the equity method. This includes $17.7 million of losses from the investment in Russian Alcohol for the first quarter 2009, primarily due to the devaluation of Russian ruble against U.S. dollar, while this investment was accounted for using the equity method, which was partially offset by $4.6 million of gain from the investment in the MHWH J.V. for the twelve months ended December 31, 2009.

Twelve months ended December 31, 2008 compared to twelve months ended December 31, 2007

A summary of the Company’s operating performance (expressed in thousands except per share amounts) is presented below.

 

     Twelve months ended
December 31,
 
     2008     2007  

Sales

   $ 2,136,570      $ 1,483,344   

Excise taxes

     (489,566     (293,522

Net Sales

     1,647,004        1,189,822   

Cost of goods sold

     1,224,899        941,060   
                

Gross Profit

     422,105        248,762   
                

Operating expenses

     223,373        130,677   
                

Operating Income

     198,732        118,085   
                

Non operating income / (expense), net

    

Interest (expense), net

     (53,447     (35,829

Other financial (expense), net

     (132,936     13,594   

Other non operating income / (expense), net

     410        (1,770
                

Income before taxes, equity in net income from unconsolidated investments and noncontrolling interests in subsidiaries

     12,759        94,080   
                

Income tax (expense)

     (11,872     (15,910

Equity in net earnings of affiliates

     (9,002     —     
                

Net income / (loss)

   ($ 8,115   $ 78,170   
                

Less: Net income / (loss) attributable to noncontrolling interests in subsidiaries

     3,680        1,068   

Less: Net income / (loss) attributable to redeemable noncontrolling interests in Whitehall Group

     6,803        —     

Net income /(loss) attributable to CEDC

   ($ 18,598   $ 77,102   

Net income / (loss) per share of common stock, basic

   ($ 0.42   $ 1.93   
                

Net income / (loss) per share of common stock, diluted

   ($ 0.42   $ 1.91   
                

 

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Net Sales

Net sales represents total sales net of all customer rebates, excise tax on production and value added tax. Total net sales increased by approximately 38.4%, or $457.2 million, from $1,189.8 million for the twelve months ended December 31, 2007 to $1,647.0 million for the twelve months ended December 31, 2008. This increase in sales is due to the following factors:

 

Net Sales for twelve months ended December 31, 2007

   $ 1,189,822   

Increase from acquisitions

     346,826   

Existing business sales growth

     43,321   

Excise tax reduction

     (97,089

Impact of foreign exchange rates

     164,124   
        

Net sales for twelve months ended December 31, 2008

   $ 1,647,004   

Factors impacting our existing business sales for the twelve months ending December 31, 2008 include the growth of our key vodka brands, with Bols Vodka, our flagship premium vodka, growing by 12% and Soplica by 14% in volume terms as compared to the twelve months ending December 31, 2007. Also impacting our sales growth has been our focus on reducing lower margin SKU’s, primarily beer, and reducing as well the related sales and distribution costs for these products. We plan to continue the streamlining process going into 2009.

As of January 2008, sales of products which we produce at Polmos Bialystok and Bols to certain key accounts were moved from our distribution companies to the producer, Polmos Bialystok and Bols in order to reduce distribution costs. When a sale is reported directly from a producer, excise tax is eliminated from net sales and when a sale is made from a distribution company the sales are recorded gross with excise tax. Therefore the movement of the sales contracts from a distributor to the producer reduces the amount of net sales reported through the elimination of excise tax and also increases gross profit as a percent of sales. The impact of this sales reduction for the twelve months ended December 31, 2008 was $97.1 million.

Based upon average exchange rates for the twelve months ended December 31, 2008 and 2007, the Polish zloty appreciated by approximately 13%. This resulted in an increase of $164.1 million of sales in U.S. dollar terms. However, as discussed above, the Polish zloty and Russian ruble recently have depreciated sharply against the U.S. dollar. As the Polish zloty and Russian ruble depreciate, sales will decrease in U.S. dollar terms.

As a result of our recent acquisitions in Russia, we have moved to a segmental approach to our business split by our primary geographic locations of operations, Poland, Russia and Hungary. Included in the sales growth from acquisitions of $346.8 million was $297.9 million of sales related to the newly acquired Russian businesses of Parliament and Whitehall, which is reflected in the Segment entitled “Russia” in the below table.

 

     Segment Net Revenues
Twelve months ended
December 31,
     2008    2007

Segment

     

Poland

   $ 1,305,629    $ 1,152,601

Russia

   $ 297,892      —  

Hungary

   $ 43,483    $ 37,221
             

Total Net Sales

   $ 1,647,004    $ 1,189,822

Gross Profit

Total gross profit increased by approximately $173.3 million, to $422.1 million for the twelve months ended December 31, 2008, from $248.8 million for the twelve months ended December 31, 2007, reflecting sales growth for the factors noted above in the twelve months ended December 31, 2008. Gross margin increased from

 

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20.9% of net sales for the twelve months ended December 31, 2007 to 25.6% of net sales for the twelve months ended December 31, 2008. Factors impacting our margins include improved sales mix, lower spirit costs, the impact of excise tax as described above as well as the consolidation of Parliament and Whitehall from the first quarter and second quarter of 2008 respectively. Parliament and Whitehall which, as producer and importer, operate on a higher gross profit margin than the Polish business, which is more heavily impacted by lower margin distribution operations. Margins were further improved from lower spirit pricing for the twelve months ended December 31, 2008 as well as the growth of the exclusive import brands.

Operating Expenses

Operating expenses consist of selling, general and administrative, or “S,G&A” expenses, advertising expenses, non-production depreciation and amortization, and provision for bad debt. Total operating expenses increased by approximately 70.9%, or $92.7 million, from $130.7 million for the twelve months ended December 31, 2007 to $223.4 million for the twelve months ended December 31, 2008. Approximately $31.4 million of this increase resulted from the effects of the acquisition of Parliament in March 2008, approximately $24.9 million of this increase resulted from the effects of the acquisition of Whitehall, approximately $5.5 million of this increase resulted from the effects of the acquisition of PHS completed in September 2007 and the remainder of the increase resulted primarily from the growth of the business and the impact of foreign exchange expenses as detailed below.

 

Operating expenses for twelve months ended December 31, 2007

   $ 130,677

Increase from acquisitions

     61,797

Increase from existing business growth

     10,322

Impact of foreign exchange rates

     20,577
      

Operating expenses for twelve months ended December 31, 2008

   $ 223,373

The table below sets forth the items of operating expenses.

 

     Twelve Months Ended
December 31,
     2008    2007
     ($ in thousands)

S,G&A

   $ 168,584    $ 106,401

Marketing

     43,954      16,937

Depreciation and amortization

     10,835      7,339
             

Total operating expense

   $ 223,373    $ 130,677

S,G&A increased by approximately 58.5%, or $62.2 million, from $106.4 million for the twelve months ended December 31, 2007 to $168.6 million for the twelve months ended December 31, 2008. Approximately $47.1 million of this increase resulted primarily from the effects of the acquisitions discussed above and the remainder of the increase resulted primarily from the growth of the business and the appreciation of the Polish zloty against the U.S. dollar. However, as discussed above, the Polish zloty and Russian ruble recently have depreciated sharply against the U.S. dollar. As the Polish zloty and Russian ruble depreciate, S,G&A will decrease in U.S. dollar terms. As a percent of sales, S,G&A has increased from 8.9% of net sales for the twelve months ended December 31, 2007 to 10.2% of net sales for the twelve months ended December 31, 2008.

Depreciation and amortization increased by approximately 47.9%, or $ 3.5 million, from $7.3 million for the twelve months ended December 31, 2007 to $10.8 million for the twelve months ended December 31, 2008. This increase resulted primarily from our existing business growth and the acquisitions of Parliament and Whitehall.

Operating Income

Total operating income increased by approximately 68.2%, or $80.6 million, from $118.1 million for the twelve months ended December 31, 2007 to $198.7 million for the twelve months ended December 31, 2008.

 

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Operating income as a percent of sales increased from 9.9% for the twelve months ended December 31, 2007 to 12.1% for the twelve months ended December 31, 2008. This increase resulted primarily from the factors described under “Net Sales” above. The table below summarizes the segmental split of operating profit.

 

     Operating Profit
Twelve months ended
December 31,
 
     2008     2007  

Segment

    

Poland

   $ 124,920      $ 116,862   

Russia

     73,374        —     

Hungary

     7,641        7,491   

Corporate Overhead

    

General corporate overhead

     (3,353     (4,398

Option Expense

     (3,850     (1,870
                

Total Operating Profit

   $ 198,732      $ 118,085   

Income Tax

Our effective tax rate for the twelve months ending December 31, 2008 was 93.0%, which was driven by a combination of the blended statutory tax rates in the tax jurisdictions in which we operate, as well as a true up of our deferred tax asset. The Company has taken an additional non-cash provisions for tax loss carry forwards in the Carey Agri subsidiary. Due to the level of foreign exchange losses incurred in 2008 as described above, management has determined that a portion of prior period tax losses will not be utilized in the future. As of December 31, 2008, the Company has provided for approximately $7 million, or 50%, of the available tax loss carry forwards in its Carey Agri subsidiary. Effective January 1, 2009, the statutory tax rate in Russia has been reduced from 24% to 20%.

Non-controlling Interests and Equity in Net Earnings

Non-controlling interest for the twelve months ending December 31, 2008 relates primarily to minority stakes of 25% in Whitehall Group and 15% in Parliament.

Equity in net earnings for the twelve months ending December 31, 2008 include CEDC’s proportional share of net income from its investments accounted for under the equity method. This includes $8.5 million of income from the investment in the MHWH J.V. and $17.5 million of losses from the investment in Russian Alcohol. Included in the results of Russian Alcohol were non cash foreign exchange losses related to the revaluation of debt instruments denominated in U.S. dollars.

Non Operating Income and Expenses

Total interest expense increased by approximately 49.2%, or $17.6 million, from $35.8 million for the twelve months ended December 31, 2007 to $53.4 million for the twelve months ended December 31, 2008. This increase resulted from a combination of additional borrowings to finance the purchase of Russian Alcohol shares completed in July 2008, the issuance of our Convertible Senior Notes to finance the Parliament acquisition and the Whitehall acquisition and increased interest rates in 2008 as compared to 2007.

The Company recognized $131.0 million of unrealized foreign exchange rate loss in the twelve months ended December 31, 2008, primarily related to the impact of movements in exchange rates on our Senior Secured and Senior Convertible Notes, as these borrowings have been lent down to entities that have the Polish zloty as the functional currency, as compared to $23.9 million of gains for the twelve months ended December 31, 2007.

 

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Statement of Liquidity and Capital Resources

During the periods under review, the Company’s primary sources of liquidity were cash flows generated from operations, credit facilities, equity offerings, the Convertible Senior Notes offering, the 2009 Senior Secured Notes offering and proceeds from options exercised. The Company’s primary uses of cash were to fund its working capital requirements, service indebtedness, finance capital expenditures and fund acquisitions. The following table sets forth selected information concerning the Company’s consolidated cash flow during the periods indicated.

 

     Twelve months
ended
December 31, 2009
    Twelve months
ended
December 31, 2008
    Twelve months
ended
December 31, 2007
 
     ($ in thousands)  

Cash flow from operating activities

   92,961      72,196      23,084   

Cash flow used in investing activities

   (1,069,745   (667,928   (159,122

Cash flow from financing activities

   991,417      646,210      56,923   

Fiscal year 2009 cash flow

Net cash flow from operating activities

Net cash flow from operating activities represents net cash flow from operations and interest. Net cash provided by operating activities for the twelve months ended December 31, 2009 was $93.0 million as compared to $72.2 million for the twelve months ended December 31, 2008. Working capital movements contributed $11.9 million of cash inflows for the twelve months ended December 31, 2009 as compared to $64.0 million of cash outflow for the twelve months ended December 31, 2008. As the Company experienced lower organic growth rates in 2009 as compared to 2008, due to the global economic crisis, the business was able to reduce working capital requirements thus improving cash flows from working capital movements.

Net cash flow used in investing activities

Net cash flows used in investing activities represent net cash used to complete our investments in entities that were not fully owned, acquire fixed assets, deposit the cash required to fund our 2012 Senior Secured Notes redemption, and pay the substantial majority of deferred payment for Russian Alcohol. For the twelve months ended December 31, 2009, $573.5 million was used to complete the remaining purchase in Parliament and Russian Alcohol. Of this approximately $93.4 million was used to fund the remaining minority buy out of Parliament Group and $455.6 million was paid for the remaining interest of Russian Alcohol, with $110 million deferred until final anti-trust approval was obtained in January 2010 and $45 million, payable in cash or shares, deferred until April, 2010 at the earliest. Of the $110.5 million, $101.0 million was funded into escrow and is shown in the cash outflow for changes in restricted cash. The remaining cash outflow in restricted cash of $380.5 million related to depositing with the trustee the amounts necessary to fund the early redemption of our 2012 Senior Secured Notes, which took place in January 2010.

Net cash flow from financing activities

Net cash flow from financing activities primarily represents cash inflows from borrowings under credit facilities, and offerings of debt and equity issuances, as well as cash used for servicing indebtedness. Net cash provided by financing activities for the twelve months ending December 31, 2009 was $991.4 million as compared to $646.2 million for the twelve months ending December 31, 2008. The primary sources of cash flow from financing activities were two public equity offerings completed in July and November 2009, raising net proceeds of $491.0 million as well as the issuance of new Senior Secured Notes due 2016 raising net proceeds of $929.6 million. Offsetting these cash inflows was the repayment of debt, primarily the debt of Russian Alcohol of $35.0 million and $251.0 million for short and long term portions of this debt respectively. Additional amounts include the payment of pre-acquisition tax penalties of Russian Alcohol, which is to be reimbursed by the sellers and has been netted off with loans from the sellers.

 

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Fiscal year 2008 cash flow

Net cash flow from operating activities

Net cash flow from operating activities represents net cash from operations and interest. Net cash provided by operating activities for the twelve months ended December 31, 2008 was $72.2 million as compared to $23.1 million for the twelve months ended December 31, 2007. The primary drivers for the change were overall growth in the business and improved working capital management. Working capital movements utilized $64.0 million of cash outflows for the twelve months ended December 31, 2008 as compared to $72.1 million of cash outflows for the twelve months ended December 31, 2007. Also included in working capital movements was a significant utilization of cash flow from the Parliament entities acquired in Russia which were newly formed legal entities with no receivables, inventory and accounts payable balances as of acquisition date. Therefore approximately $27 million was funded into the business during the 12 months ending December 31, 2008 in order to build up a normalized working capital base. Adding back the funding provided to Parliament of $27 million, our adjusted cash flow from operations would have been $99.2 million. Additionally the company acquired 75% of the economic interest in the Whitehall Group in May 2008. Furthermore the first quarter of the year traditionally is the highest cash flow generation period and the last quarter traditionally is the highest cash utilization period. Therefore, in 2008 the Company experienced the higher cash utilization in the fourth quarter in connection with its Russian acquisitions, but not the higher cash generation in the first quarter.

Net cash flow used in investing activities

Net cash flows used in investing activities represent net cash used to acquire subsidiaries and fixed assets as well as proceeds from sales of fixed assets. Net cash used in investing activities for the twelve months ended December 31, 2008 was $667.9 million as compared to $159.1 million for the twelve months ended December 31, 2007. The primary cash outflows from investing activities for the twelve months ended December 31, 2008 were the cash consideration and expenses related to the Parliament, Whitehall and Russian Alcohol acquisitions and the acquisition of $103.5 million in subordinated exchangeable notes in connection with the investment in Russian Alcohol.

Net cash flow from financing activities

Net cash flow from financing activities represents cash used for servicing indebtedness, borrowings under credit facilities and cash inflows from private placements and exercise of options. Net cash provided by financing activities was $646.2 million for the twelve months ended December 31, 2008 as compared to $56.9 million for the twelve months ended December 31, 2007. The primary source of cash from financing activities was the Company’s offering of $310 million of Convertible Secured Notes to fund the Parliament and Whitehall acquisition, which resulted in net proceeds of $304.4 million, and the proceeds from the common equity offering of $233.8 million, which were used to fund the investment in Russian Alcohol, completed in July 2008.

The Company’s Future Liquidity and Capital Resources

Financing Arrangements

Bank Facilities

As of December 31, 2009, $49.8 million remained available under the Company’s overdraft facilities. These overdraft facilities are renewed on an annual basis.

As of December 31, 2009, the Company had utilized approximately $84.2 million of a multipurpose credit line agreement in connection with the 2007 tender offer in Poland to purchase the remaining outstanding shares of Polmos Bialystok. The Company’s obligations under the credit line agreement are guaranteed through promissory notes issued by certain subsidiaries of the Company and are secured by 33.95% of the share capital of Polmos Bialystok. The indebtedness under the credit line agreement of $63.2 million matures on February 24, 2011 and of $21.0 million on August 11, 2010.

 

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On April 24, 2008, the Company signed a credit agreement with Bank Zachodni WBK SA in Poland to provide up to $50 million of financing to be used to finance a portion of the Parliament and Whitehall acquisition, as well as general working capital needs of the Company. The agreement provides for a $30 million five year amortizing term facility and a one year $20 million short term facility with annual renewal. In the second quarter of 2009 this facility was converted into Polish zloty. The maturity of term loan was extended to May 2013 and the maturity of the short term facility was extended to May 2010. The loan is guaranteed by the Company, Bols Sp. z o.o, a wholly owned subsidiary of the Company (“Bols”) and certain other subsidiaries of the Company, and is secured by all of the capital stock of Bols and 60% of the capital stock of Parliament.

On July 2, 2008, the Company entered into a Facility Agreement with Bank Handlowy w Warszawie S.A., which provided for a term loan facility of $40 million, of which $33.3 million was outstanding as at December 31, 2009. The term loan matures on July 4, 2011 and is guaranteed by CEDC, Carey Agri and certain other subsidiaries of the Company and is secured by all of the shares of capital stock of Carey Agri and subsequently will be further secured by shares of capital stock in certain other subsidiaries of CEDC.

The Company obtained all required waivers from its banks in connection with the Senior Secured Notes due 2016 offering.

Senior Secured Notes due 2012

In connection with the Bols and Polmos Bialystok acquisitions, on July 25, 2005 the Company completed the issuance of €325 million 8% Senior Secured Notes due 2012 (the “2012 Notes”), of which approximately €245 million remained payable as of December 31, 2009. Interest was due semi-annually on the 25th of January and July, and the 2012 Notes are guaranteed on a senior basis by certain of the Company’s subsidiaries.

On December 2, 2009, the Company issued a notice of redemption for the remaining outstanding portion of 2012 Notes and deposited €263.9 million (approximately US$380.4 million) of cash that we received upon the issuance of new Senior Secured Notes due 2016 (described below), representing the redemption price, call premium plus all interest that will be payable on the settlement date, in an account with the trustee for the 2012 Notes. In connection with the notice of redemption and deposit, the indenture governing the 2012 Notes was discharged. Although this discharge removes substantially all of the restrictions imposed by that indenture and makes the likelihood that further payments will be required of us with respect to the 2012 Notes remote, we concluded that it did not meet the definition of “legally released” in paragraph 16(b) of FAS 140 (ASC 405-20-40-1(b)) and therefore we will not recognize the extinguishment of the remaining liability until January 4, 2010. Additionally the cash on deposit was recorded as Restricted Cash on the balance sheet as of December 31, 2009. On January 4, 2010, the final redemption for these 2012 Notes was completed and all funds were remitted to the noteholders, discharging the Company of all remaining obligations.

Senior Secured Notes due 2016

On December 2, 2009, the Company issued and sold $380 million 9.125% Senior Secured Notes due 2016 and €380 million 8.875% Senior Secured Notes due 2016 (the “2016 Notes”) in an offering to institutional investors that was not required to be registered with the SEC. The Company used a portion of the net proceeds from the 2016 Notes to redeem the Company’s outstanding 2012 Notes, having an aggregate principal amount of €245,440,000 on January 4, 2010. The remainder of the net proceeds from the 2016 Notes was used to (i) purchase Lion Capital’s remaining equity interest in Russian Alcohol by exercising the Lion Option and the Co-Investor Option, pursuant to the terms and conditions of the Lion Option Agreement and the Co-Investor Option Agreement, respectively (ii) repay all amounts outstanding under the Russian Alcohol credit facilities; and (iii) repay certain other indebtedness.

The 2016 Notes are guaranteed on a senior basis by certain of the Company’s subsidiaries. We are required to ensure that subsidiaries representing at least 85% of our consolidated EBITDA, as defined in the indenture,

 

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guarantee the notes. The notes are secured, directly or indirectly, by a variety of our and our subsidiary’s assets, including shares of the issuer of the notes and subsidiaries in Poland, Cypress, Russia, the Netherlands, Cayman Islands and Luxembourg, certain intercompany loans made by the issuer of the notes and our Russian finance company in connection with the issuance of the notes, trademarks related to the Soplica brand registered in Poland and the European Union trademarks in the Parliament brand registered in Germany, and bank accounts over US$5.0 million. We are also required to use our reasonable best efforts to provide mortgages over our Polmos and Bols production plants and the Russian Alcohol Siberian and Topaz Distilleries within specified time frames. The indenture governing the 2016 Notes contains certain restrictive covenants, including covenants limiting the Company’s ability to: incur or guarantee additional debt; make certain restricted payments; transfer or sell assets; enter into transactions with affiliates; create certain liens; create restrictions on the ability of restricted subsidiaries to pay dividends or other payments; issue guarantees of indebtedness by restricted subsidiaries; enter into sale and leaseback transactions; merge, consolidate, amalgamate or combine with other entities; designate restricted subsidiaries as unrestricted subsidiaries; and engage in any business other than a permitted business.

The 2016 Notes are secured, directly or indirectly, by a variety of our and our subsidiary’s assets, including shares of the issuer of the notes and subsidiaries in Poland, Cyprus, Hungary, Russia, the Netherlands, Cayman Islands, Luxembourg and Delaware, certain intercompany loans made by the issuer of the 2016 Notes and further intercompany loans from the proceeds of the issuance of the 2016 Notes, trademarks related to the Soplica brand registered in Poland and the European Union, trademarks in the Parliament brand registered in Germany, bank accounts over US$5.0 million in cash balances and mortgages over our Polmos Bialystok and Bols production plants in Poland. We are also required to use our reasonable best efforts to provide mortgages over our Russian Alcohol Siberian and Tula Distilleries within specified time frames.

Convertible Senior Notes

On March 7, 2008, the Company completed the issuance of $310 million aggregate principal amount of 3% Convertible Senior Notes due 2013 (the “Convertible Notes”). Interest is due semi-annually on the 15th of March and September, beginning on September 15, 2008. The Convertible Notes are convertible in certain circumstances into cash and, if applicable, shares of our common stock, based on an initial conversion rate of 14.7113 shares per $1,000 principle amount, subject to certain adjustments. Upon conversion of the notes, the Company will deliver cash up to the aggregate principle amount of the notes to be converted and, at the election of the Company, cash and/or shares of common stock in respect to the remainder, if any, of the conversion obligation. The proceeds from the Convertible Notes were used to fund the cash portions of the acquisitions of Parliament and Whitehall.

Equity Issuances

On February 24, 2009, the Company and the seller amended the terms of the Stock Purchase Agreement governing the Whitehall acquisition to satisfy the Company’s obligations to the seller under a share price guarantee in the original Stock Purchase Agreement. Pursuant to the terms of this amendment, the Company issued to the seller 2,100,000 shares of its common stock, made certain cash payments to the seller, and is obligated to make certain other cash payments to the seller in the future, all as described under “The Company’s Future Liquidity and Capital Resources,” below.

On July 24, 2009, the Company consummated the offer and sale of 9,185,000 shares of the Company’s common stock (including over-allotment shares in a public offering), of which 7,685,000 shares were issued and sold by the Company. The Company received $179.6 million from the offering after deducting underwriting discounts and estimated offering expenses payable by the Company.

On September 2, 2009, the Company filed a prospectus supplement with the SEC pursuant to a Registration Statement on Form S-3 registering for resale 540,873 shares of the Company’s common stock issued to Cayman 5 in connection with the Russian Alcohol acquisition.

 

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On September 15, 2009, the Company issued to Cirey Holdings, in connection with the Russian Alcohol acquisition, 479,499 shares of the Company’s common stock as earn-out payment.

On November 10, 2009, the Company issued to Kylemore 949,034 shares of the Company’s common stock in exchange for the remaining indirect equity interest in Russian Alcohol that was not held by Lion Capital or CEDC, or approximately 3.76% of the equity ownership of Russian Alcohol.

On November 24, 2009 the Company consummated an offer and sale of an aggregate of 10,250,000 shares of the Company’s common stock, at a price of $31.00 per share. The Company received $308 million from the offering after underwriting discounts and estimated offering expenses payable by the Company.

Whitehall Acquisition

Pursuant to the Whitehall shareholders’ agreement, Polmos Bialystok has the right to purchase, and the other shareholder has the right to require Polmos Bialystok to purchase, all (but not less than all) of the shares of Whitehall capital stock held by such shareholder. Either of these rights may be exercised at any time, subject, in certain circumstances, to the consent of third parties. The aggregate price that the Company would be required to pay in the event either of these rights is exercised will fall within a range determined based on Whitehall’s EBIT as well as the EBIT of certain related businesses, during two separate periods: (1) the period from January 1, 2008 through the end of the year in which the right is exercised, and (2) the two full financial years immediately preceding the end of the year in which the right is exercised, plus, in each case, the time-adjusted value of any dividends paid by Whitehall. Subject to certain limited exceptions, the exercise price will be (A) no less than the future value as of the date of exercise of $32.0 million and (B) no more than the future value as of the date of exercise of $89.0 million, plus, in each case, the time-adjusted value of certain dividends paid by Whitehall.

Russian Alcohol Group Acquisition

On January 20, 2010, after the receipt of antimonopoly clearances for the acquisition from the Russian Federal Antimonopoly Commission, the Antimonopoly Committee of the Ukraine, the Company purchased the sole voting share of Lion/Rally Cayman 6 (“Cayman 6”) from an affiliate of Lion Capital and thereby acquired control of Russian Alcohol. The company also paid $110 million in January, 2010, to Lion Capital by releasing $100 million from escrow, which is included in the restricted cash payment on the balance sheet as of December 31, 2009 and paid up the remaining $10 million from cash. The Company still has an obligation to make the last remaining payment to Lion in April, 2010 of $45 million, which can be payable in cash or CEDC shares.

Capital Expenditure

Our net capital expenditure on tangible fixed assets for the twelve months ending December 31, 2009, 2008, and 2007 was $14.8 million, $15.6 million and $23.1 million, respectively. Capital expenditures during the twelve months ended December 31, 2009 were used primarily for production equipment and fleet. Capital expenditures during the twelve months ended December 31, 2008 were used primarily for production equipment and fleet. Capital expenditures during the twelve months ended December 31, 2007 were used primarily for investments in rectification of approximately $16 million, as well as fleet, information systems and plant maintenance.

We have estimated that maintenance capital expenditure for 2010, 2011 and 2012 for our existing business combined with our acquired businesses will be approximately $10.0 to $15.0 million per year. Future capital expenditure is expected to be used for our continued investment in information technology, trucks, and routine improvements to production facilities. Pursuant to our acquisition of Polmos Bialystok, the Company is required to ensure that Polmos Bialystok will make investments of at least 77.5 million Polish zloty (approximately $27.2 million based on year end exchange rate) during the five years after the consummation of the acquisition. As of December 31, 2009 the company has completed 91.7% of these investment commitments.

 

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A substantial portion of these future capital expenditure amounts are discretionary, and we may adjust spending in any period according to our needs. We currently intend to finance all of our capital expenditure through cash generated from operating activities.

Contractual Obligations

The following table summarizes our contractual obligations as of December 31, 2009:

 

     Payments due by period
   Total    Less than
1 year
   1-3
years
   3-5
years
   More than
5 years
  

(unaudited)

($ in thousands)

Long-term debt obligations

   $ 1,311,511    $ —      $ 96,427    $ 305,789    $ 909,295

Interest on long-term debt

     628,048      100,393      191,679      176,338      159,638

Short-term debt obligations

     483,209      483,209      —        —        —  

Interest on short-term debt

     26,588      26,588      —        —        —  

Deferred payments related to acquisitions

     160,880      160,880      —        —        —  

Operating leases

     48,399      13,815      17,383      17,201      —  

Capital leases

     3,095      1,724      1,371      —        —  

Contracts with suppliers

     5,362      4,385      961      16      —  
                                  

Total

   $ 2,667,092    $ 790,994    $ 307,821    $ 499,344    $ 1,068,933
                                  

Approximately $380 million of the $483.2 million of short term debt obligations were fully repaid on January 4, 2010 as part of the redemption of the Senior Secured Notes due in 2012.

Effects of Inflation and Foreign Currency Movements

Actual inflation in Poland was 3.5% in 2009, compared to inflation of 4.2% in 2008. In Russia and Hungary respectively, the actual inflation for 2009 was at 8.8% and 5.6%, compared to actual inflation of 13.3% and 6.8% in 2008.

Substantially all of Company’s operating cash flows and assets are denominated in Polish zloty, Russian ruble and Hungarian forint. This means that the Company is exposed to translation movements both on its balance sheet and statement of operations. 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 statement of operations is by the movement of the average exchange rate used to restate the statement of operations from Polish zloty, Russian ruble and Hungarian forint to U.S. dollars. The amounts shown as exchange rate gains or losses on the face of the statement of operations relate only to realized gains or losses on transactions that are not denominated in Polish zloty, Russian ruble or Hungarian forint.

The average zloty/dollar and ruble/dollar exchange rates used to create our statement of operations depreciated by approximately 30% and 28% respectively. The actual year end zloty/dollar and ruble/dollar exchange rates used to create our balance sheet appreciated by approximately 4% and 2% as compared to December 31, 2008 respectively. Should this trend continue, our results of operations may be positively impacted due to a increase in revenue in U.S. dollar terms from the currency translation effects of that appreciation. This may be partially offset by a similar increase in costs in U.S. dollar terms. Conversely if the trend reverses our results of operations may be negatively impacted due to a decrease in revenue in U.S. dollar terms from the currency translation effects of that depreciation.

The Company has borrowings including its Senior Secured Notes due 2012, Convertible Notes due 2013 and Senior Secured Notes due 2016 that are denominated in U.S. dollars and euros, which have been lent to its operations where the functional currency is the Polish zloty and Russian ruble. The effect of having debt

 

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denominated in currencies other than the Company’s functional currencies is to increase or decrease the value of the Company’s liabilities on that debt in terms of the Company’s functional currencies when those functional currencies depreciate or appreciate in value respectively. As a result of this, the Company is exposed to gains and losses on the re-measurement of these liabilities. The table below summarizes the pre-tax impact of a one percent movement in each of the exchange rate which could result in a significant impact in the results of the Company’s operations.

 

Exchange Rate

  

Value of notional amount

 

Pre-tax impact of a 1%
movement in exchange rate

USD-Polish zloty

   $426 million   $4.3 million gain/loss

USD-Russian ruble

   $264 million   $2.6 million gain/loss

EUR-Polish zloty

   €625 million or approximately $901 million   $9 million gain/loss

The table above includes €245 million for the Senior Secured Notes due in 2012 that were redeemed on January 4, 2010, thus there will not be any foreign exchange impact from them after this date.

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 net sales, 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

Revenues of the Company include sales of its own produced spirit brands, imported wine, beer and spirit brands as well as other third party alcoholic products purchased locally in Poland, the sale of each of these revenues streams are all processed and accounted for in the same manner. For all of its sources of revenue, the Company recognizes revenue when persuasive evidence of an arrangement exists, delivery of product has occurred, the sales price charged is fixed or determinable and collectability is reasonably assured. This generally means that revenue is recognized when title to the products are transferred to our customers. In particular, title usually transfers upon shipment to or receipt at our customers’ locations, as determined by the specific sales terms of the transactions.

Sales are stated net of sales tax (VAT) and reflect reductions attributable to consideration given to customers in various customer incentive programs, including pricing discounts on single transactions, volume discounts, promotional listing fees and advertising allowances, cash discounts and rebates. Net sales revenue includes excise tax except in the case where the sales are made from the production unit or related to imported goods, in which case it is recorded net of excise tax.

Goodwill and Intangibles

Following the adoption of ASC Topic 805 and ASC Topic 350, goodwill and certain intangible assets having indefinite lives are no longer subject to amortization. Their book values are tested annually for impairment, or more frequently, if facts and circumstances indicate the need. Fair value measurement techniques, such as the discounted cash flow methodology, are utilized to assess potential impairments. The testing is performed at each reporting unit level. In the discounted cash flow method, the Company discounts forecasted performance plans to their present value. The discount rate utilized is the weighted average cost of capital for the

 

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reporting unit. US GAAP requires the impairment test to be performed in two stages. If the first stage does not indicate that the carrying values of the reporting units exceed the fair values, the second stage is not required. When the first stage indicates potential impairment, the company has to complete the second stage of the impairment test and compare the implied fair value of the reporting units’ goodwill to the corresponding carrying value of goodwill.

Intangibles are amortized over their effective useful life. In estimating fair value, management must make assumptions and projections regarding such items as future cash flows, future revenues, future earnings, and other factors. The assumptions used in the estimate of fair value are generally consistent with the past performance of each reporting unit and are also consistent with the projections and assumptions that are used in current operating plans. Such assumptions are subject to change as a result of changing economic and competitive conditions. If these estimates or their related assumptions change in the future, the Company may be required to record an impairment loss for the assets. The fair values calculated have been adjusted where applicable to reflect the tax impact upon disposal of the asset.

In connection with the Bols, Polmos Bialystok, Parliament and Russian Alcohol acquisitions, the Company has acquired trademark rights to various brands, which were capitalized as part of the purchase price allocation process. As these brands are well established they have been assessed to have an indefinite life. These trademarks rights will not be amortized; however, management assesses them at least once a year for impairment.

We recorded an impairment charge of $20.3 million during the second quarter of 2009 that included an impairment to the carrying values of our trademarks.

As required by ASC Topic 350, we tested for impairment our unamortized intangible assets at June 30, 2009, between the required annual tests, because we believed events had occurred and circumstances changed that would more likely than not reduce the fair value of our trademarks and goodwill below their carrying amounts.

In order to perform the test of the impairment for goodwill and indefinite lived intangible assets, it requires the use of estimates. We based our calculations as at December 31, 2009 on the following assumptions:

 

   

Risk free rates for Poland, Russia and Hungary used for calculation of discount rate were based upon current market rates of long term Polish Government Bonds rates, long term Russian Government Bonds rates and long term Hungarian Government Bonds. When estimating discount rates to be used for the calculation we have taken into account current market conditions in Poland, Russia and Hungary separately. As a result of our assumptions and calculations, we have determined discount rates of 8.59%, 11.88% and 10.24% for Poland, Russia and Hungary, respectively. Factoring in a deviation of 10% for the discount rate as compared to management’s estimate, there would still be no need for an impairment charge against goodwill.

 

   

We have tested goodwill for impairment separately for the following reporting units: Poland Vodka Production, Domestic Distribution, Hungary Distribution, Russia Vodka Production (including Parliament and Russian Alcohol) and Whitehall Group.

 

   

We estimated the growth rates in projecting cash flows for each of our reporting generating unit separately, based on a detailed five year plan related to each reporting unit.

Taking into account estimations supporting our calculations under current market trends and conditions we believe that no impairment charge is considered necessary through the date of the accompanying financial statements.

Accounting for Business Combinations

The acquisition of businesses is an important element of the Company’s strategy. Acquisitions made prior to December 31, 2008 were accounted for in accordance with SFAS No. 141, “Business Combinations”

 

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(“SFAS 141”). Effective January 1, 2009, all business combinations will be accounted for in accordance with ASC Topic 805 “Business Combinations.”

We account for our acquisitions made in 2008 under the purchase method of accounting in accordance with SFAS 141, Business Combinations, and allocate the assets acquired and liabilities assumed based on their estimated fair values at the acquisition date. The determination of the values of the assets acquired and liabilities assumed, as well as associated asset useful lives, requires management to make estimates. The Company’s acquisitions typically result in goodwill and other intangible assets; the value and estimated life of those assets may affect the amount of future period amortization expense for intangible assets with finite lives as well as possible impairment charges that may be incurred.

The calculation of purchase price allocation requires judgment on the part of management in determining the valuation of the assets acquired and liabilities assumed.

The Company has consolidated the Whitehall Group as a business combination, on the basis that the Whitehall Group is a Variable Interest Entity in accordance with ASC Topic 810 “Consolidation” and the Company has been assessed as being the primary beneficiary.

Involvement of the Company in variable interest entities (“VIEs”) and continuing involvement with transferred financial assets.

Whitehall Group

On May 23, 2008, the Company and certain of its affiliates, entered into, and closed upon, a Share Sale and Purchase Agreement and certain other agreements whereby the Company acquired shares representing 50% minus one vote of the voting power, and 75% of the economic interests, in the Whitehall Group. In consideration for additional payments made to the seller on February 24, 2009, the Company received an additional 375 Class B shares of Whitehall, which represents an increase of the Company’s economic stake in Whitehall Group from 75% to 80%.

Transfers of Financial Assets

Except for the amount of $7.5 million that was lent at market rates as a working capital by the Company to the Whitehall Group there were no transfers of financial assets to VIE as the Whitehall Group is a self financing body. Including the $7.5 million transfer, the Company does not have any continuing involvement with transferred financial assets that allow the transferors to receive cash flows or other benefits from the assets or requires the transferors to provide cash flows or other assets in relation to the transferred financial assets.

Variable Interest Entities

CEDC consolidated the Whitehall Group as a business combination as of May 23, 2008, on the basis that the Whitehall Group is a Variable Interest Entity (“VIE”) and the Company has been assessed as being the primary beneficiary. Included within the Whitehall Group is a 50/50 joint venture with Möet Hennessy. This joint venture is accounted for using the equity method and is recorded on the face of the balance sheet in investments with minority interest initially recorded at fair value on the face of the balance sheet. The current term of the joint venture is until June 2013 at which point Möet Hennessy will have the option to acquire the remaining shares of the entity.

Based upon the review of Paragraph 4 CEDC management has concluded that its interest in Peulla Enterprises, the special purpose vehicle (“SPV”), being a Cyprus company in which CEDC has 49.9% voting power, would not fall under any of scope exceptions. Therefore CEDC has evaluated whether the SPV is a variable interest entity under the provisions of Paragraph 5 and thus the SPV subject to consolidation accounting.

 

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In determining the accounting treatment if the Whitehall Group is a VIE and needs to be consolidated by CEDC, we considered the conditions outlined in ASC Topic 810.

 

   

Equity Investment at Risk—We concluded that the SPV would not meet the requirement of a VIE based upon Paragraph 5(a) as the interest would be classified as equity under US GAAP, the at risk equity is sufficient to permit the entity to finance its activities. Neither equity holder will provide any additional material capital into the SPV. The SPV will be utilized solely as a holding company with its economics determined by the underlying Whitehall Group.

 

   

Controlling Financial Interests—Both shareholders, Mark Kaoufman acting through a Jersey trust (“the Trust”) and CEDC, are able to direct the activities and operations of the Whitehall Group through their roles on the Board of Directors and their responsibilities for selection of executive level officers. However, the ultimate obligation to absorb losses of the entity or right to receive the residual benefits will lie with CEDC at the time the put/call term ends. Should the business not perform, the Trust will have the right to put his shares to CEDC with a pre-agreed floor on the value of the put option. Thus the Company is at risk of absorbing a greater portion of losses upon the Trust’s exit than the Trust itself. Conversely at the end of the term, CEDC can call and if the business has over performed, the amount paid to the Trust on the call is capped at a pre-agreed amount. As such, because the Trust is both limited in its losses and returns through the terms of the put/call with caps and floors, this criterion is met and would cause Whitehall Group to be considered a VIE.

 

   

Disproportionate Voting Rights—The voting rights of the Trust and CEDC (50.1% and 49.9%) are not proportionate to their economic interests (20% and 80%). In this structure, it appears CEDC has disproportionately fewer voting rights in relation to its economic rights.

Further, the below activities of the entity that are more closely associated with the activities of CEDC, thereby having substantially of the entity’s activities conducted on its behalf. As CEDC has disproportionately fewer rights while substantially all of Whitehall’s activities are for CEDC, this would indicate that Whitehall Group lacks characteristic:

 

   

The operations of Whitehall Group are substantially similar in nature to the activities of CEDC;

 

   

CEDC has a call option to purchase the interests of the other investors in the entity;

 

   

The Trust has an option to put his interests to CEDC.

Both the Trust and CEDC are precluded from transferring its interests in the SPV to any third-party without consent from the other party. Transfers are subject to an absolute other party discretion standard, other than limited permitted transfers (i.e., to affiliates). As such, it appears a de facto relationship exists.

The primary factor to be considered here is the design and intent of the variable interest entity. The SPV that holds the Whitehall Group and the related shareholders agreement were created with the clear intent to maximize the financial exposure that CEDC has to the Whitehall Group business and to ultimately allow CEDC to take full control of the business in 2013. CEDC bears the greatest level of economic share of the entities performance, both in terms of profit allocation (80%) and valuation of the put/call option at the end with a clear floor and cap on payment. The put/call structure in place provide near assurance that at the end of the term CEDC will take full ownership of the business. Should the business perform at or above plan, CEDC valuation is capped therefore would elect to call, and should the business under perform, the Trust will put the shares receiving the guaranteed minimum valuation.

In June 2009, the FASB issued ASC Topic 810, which changes how a company determines whether an entity should be consolidated. The adoption of this standard may impact the current treatment of the Whitehall Group by the Company and the Company is current assessing this treatment and potential impact on the financial statements. See “Recently Issued Accounting Pronouncements” for more detailed information on this topic.

 

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Russian Alcohol Group

On January 20, 2010, the Company completed its acquisition of Russian Alcohol. For further details on the whole structure of this acquisition please refer to Note 2 of the accompanying financial statements attached herein.

At the lowest level of the existing structure, all of Russian Alcohol companies are consolidated based on the fact that these are 100% wholly-owned companies. Therefore, we have evaluated and considered Cayman 7 as a variable interest entity for CEDC in the structure.

Transfers of Financial Assets

There were no transfers of financial assets to a VIE as Russian Alcohol is a self financing body. The Company does not have any continuing involvement with transferred financial assets that allow the transferors to receive cash flows or other benefits from the assets or requires the transferors to provide cash flows or other assets in relation to the transferred financial assets.

Variable Interest Entities

Cayman 7 is a company in which Cayman 2 and CEDC are the sole limited partners and an affiliate of Lion Capital is the general partner. CEDC has 100% of the economic interests in Cayman 7, but Lion Capital retains control of Cayman 7 through Cayman 2’s ownership of a single voting share with de minimis economic rights (the “Golden Share”) but voting control of Cayman 7. As Cayman 7 has the right to call capital from CEDC to settle obligations under the Option Agreement, CEDC has evaluated whether Cayman 7 is a variable interest entity under the provisions ASC Topic 810.

Based upon the review of Paragraph 4 CEDC’s management has concluded that its direct interest in Cayman 7, as well as its indirect interest through Carey Agri and Cayman 2, would not fall under any of these scope exceptions. Therefore CEDC has evaluated whether Cayman 7 is a variable interest entity under the provisions of Paragraph 5 of ASC Topic 810 and thus subject to consolidation accounting.

In determining the accounting treatment if Cayman 7 and, effectively, the whole Russian Alcohol is a VIE and needs to be consolidated by CEDC, we considered the conditions outlined in ASC Topic 810.

 

   

Equity Investment at Risk—We concluded that as the contribution made by Cayman 2 was the only one that required substantial investment, Cayman 2 should be defined as having its equity at risk. Moreover as Cayman 7 is not able to finance its operations without funds received from CEDC, we believe that Cayman 7 would meet the requirement of a VIE based upon Paragraph 5(a).

 

   

Controlling Financial Interests—CEDC concluded that the equity investment at risk does not meet the last item in Paragraph 5(b) as all dividends from the business are passed to CEDC with CEDC not having its equity investment at risk. These dividends then reduce CEDC’s payment obligations to Lion Capital (if dividends paid to CEDC by Russian Alcohol exceed the call option price, Lion Capital has to return the excess as CEDC’s call option obligations have been met). However, Lion Capital is not entitled to receive any dividends from Cayman 7 directly as CEDC has 100% of the economic interests, with Lion Capital having voting control through voting rights. Therefore we believe that Paragraph 5(b) would cause Cayman 7 to be treated as a VIE.

 

   

Disproportionate Voting Rights—We believe that both criteria, including lack of voting rights and the requirement that substantially all activities of Cayman 7 involve or are conducted on behalf of CEDC (as Cayman 7 is a company created solely to facilitate CEDC’s funding of the exercise of call options to purchase shares of Cayman 6), we believe that this would require Cayman 7 to be treated as a VIE.

 

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The conclusion of CEDC management is that Cayman 7, including its interest in Cayman 6 and indirectly in Russian Alcohol, is a VIE. CEDC, as the party most closely associated with Cayman 7 receiving all economic benefits from Russian Alcohol thorough the chain of subsidiaries, would be considered the primary beneficiary of Cayman 7 and must therefore consolidate Cayman 7 together with all of Russian Alcohol as a business combination under ASC Topic 805.

On December 9, 2009 we accelerated the terms set up on the Option Agreement dated April 24, 2009 and purchased the remaining equity interest in Russian Alcohol that was not owned by the Company. As a result of this Russian Alcohol is no longer treated as a VIE, but rather consolidated as a fully owned subsidiary.

Share Based Payments

As of January 1, 2006, the Company adopted ASC Topic 718 “Compensation—Stock Compensation” requiring the recognition of compensation expense in the Consolidated Statements of Operations related to the fair value of its employee share-based options.

Grant-date fair value of stock options is estimated using a lattice-binomial option-pricing model. We recognize compensation cost for awards over the vesting period. The majority of our stock options have a vesting period between one to three years.

See Note 12 to our Consolidated Financial Statements for more information regarding stock-based compensation.

Recently Issued Accounting Pronouncements

In August 2009, the Financial Accounting Standards Board (“FASB”) issued FASB Accounting Standards Update No. 2009-05, Fair Value Measurements and Disclosures (“ASU 2009-05”), which is effective for financial statements issued for interim and annual periods ending after August 2009. ASU 2009-05 amends FASB Accounting Standards Codification (“FASB ASC”) Topic 820-10 (“FASB ASC 820-10”). The update provides clarification on the techniques for measurement of fair value required of a reporting entity when a quoted price in an active market for an identical liability is not available. This update had no impact on the Company’s financial position, results of operations or cash flows.

In June 2009, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 168, The FASB Accounting Standards Codification )™ and the Hierarchy of Generally Accepted Accounting Principles—a replacement of FAS No. 162 (“SFAS No. 168”), which is effective for financial statements issued for interim and annual periods ending after September 15, 2009. SFAS No. 168 codified as ASC Topic 105-10 (“FASB ASC 105-10”). FASB ASC 105-10 identifies the sources of accounting principles and the framework for selecting principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with US GAAP (the GAAP hierarchy). This standard had no impact on the Company’s financial position, results of operations or cash flows.

In June 2009, the FASB issued ASC Topic 810, “Amendments to FASB Interpretation No. 46(R)” (“ASC 810”). ASC 810 is a revision to FIN 46(R) and changes how a company determines whether an entity should be consolidated when such entity is insufficiently capitalized or is not controlled by the company through voting (or similar rights). The determination of whether a company is required to consolidate an entity is based on, among other things, the entity’s purpose and design and the company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. ASC 810 retains the scope of FIN 46(R) but added entities previously considered qualifying special purpose entities, or QSPEs, since the concept of these entities is eliminated in ASC Topic 860. ASC 810 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2009. The Company is still in process of evaluating the potential impact of adoption of ASC 810 on its consolidated financial position and results of operations. Should the company determine that the requirements for consolidating the Whitehall

 

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Group are not met under SFAS 167, the deconsolidation of this Group may result in a material impact on the presentation of the Company’s results of operations. Specifically the lines of revenues and costs before Income before taxes, equity in net income from unconsolidated investments and non-controlling interest in subsidiaries would be reduced, however the final net income or loss attributable to CEDC would remain unchanged. Similarly the individual lines of the balance sheet will be effect however total equity would remain the same.

In April 2009, the FASB issued FASB Staff Position (“FSP”) No. SFAS 115-2 and SFAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (“FSP No. SFAS 115-2 and SFAS 124-2”), which is codified in FASB ASC Topic 320-10. FSP No. SFAS 115-2 and SFAS 124-2 provides guidance to determine whether the holder of an investment in a debt security for which changes in fair value are not regularly recognized in earnings should recognize a loss in earnings when the investment is impaired. This FSP also improves the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the consolidated financial statements. This guidance is effective for interim reporting periods ending after June 15, 2009. The adoption of FSP FAS 115-2 and FAS 124-2 did not have a material impact on our consolidated financial statements.

In April 2009, the FASB issued FSP No. SFAS 107-1 and Accounting Principles Board (“APB”) Opinion No. APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (“FSP No. SFAS 107-1 and APB 28-1”). FSP No. SFAS 107-1 and APB 28-1, which is codified in FASB ASC Topic 825-10-50, require disclosures about the fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. The Company adopted FSP No. SFAS 107-1 and APB 28-1 beginning April 1, 2009. This FSP had no impact on the Company’s financial position, results of operations or cash flows.

In April 2009, the FASB issued FSP No. SFAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (“FSP No. SFAS 157-4”). FSP No. SFAS 157-4, which is codified in FASB ASC Topics 820-10-35-51 and 820-10-50-2, provides additional guidance for estimating fair value and emphasizes that even if there has been a significant decrease in the volume and level of activity for the asset or liability and regardless of the valuation technique(s) used, the objective of a fair value measurement remains the same. The Company adopted FSP No. SFAS 157-4 beginning April 1, 2009. This FSP had no material impact on the Company’s financial position, results of operations or cash flows.

In December 2008, the FASB issued FSP No. SFAS 132(R)-1, Employers’ Disclosures about Postretirement Benefit Plan Assets, (“FSP No. SFAS 132(R)-1”) which is codified in FASB ASC Topic 715-20-50. FSP No. SFAS 132(R)-1 requires enhanced disclosures about the plan assets of a Company’s defined benefit pension and other postretirement plans intended to provide financial statement users with a greater understanding of: 1) how investment allocation decisions are made; 2) the major categories of plan assets; 3) the inputs and valuation techniques used to measure the fair value of plan assets; 4) the effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period; and 5) significant concentrations of risk within plan assets. The disclosure requirements are annual and do not apply to interim financial statements and are required by us in disclosures related to the year ended December 31, 2009. We do expect the adoption of FSP SFAS 132R-1 to result in additional annual financial reporting disclosures and we are continuing to assess the potential effects of this pronouncement.

 

Item 7A. Quantitative and Qualitative Disclosure about Market Risk

Our operations are conducted primarily in Poland and Russia and our functional currencies are primarily the Polish zloty, Hungarian forint and Russian ruble and the reporting currency is the U.S. dollar. Our financial instruments consist primarily of cash and cash equivalents, accounts receivable, accounts payable, inventories, bank loans, overdraft facilities and long-term debt. All of the monetary assets represented by these financial instruments are located in Poland, Russia and Hungary. Consequently, they are subject to currency translation movements when reporting in U.S. dollars.

 

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If the U.S. dollar increases in value against the Polish zloty, Russian ruble or Hungarian forint, the value in U.S. dollars of assets, liabilities, revenues and expenses originally recorded in Polish zloty, Russian ruble or Hungarian forint will decrease. Conversely, if the U.S. dollar decreases in value against the Polish zloty, Russian ruble or Hungarian forint, the value in U.S. dollars of assets, liabilities, revenues and expenses originally recorded in Polish zloty, Russian ruble or Hungarian forint will increase. Thus, increases and decreases in the value of the U.S. dollar can have a material impact on the value in U.S. dollars of our non-U.S. dollar assets, liabilities, revenues and expenses, even if the value of these items has not changed in their original currency.

The Company has borrowings including its Senior Secured Notes due 2012, Convertible Notes due 2013 and Senior Secured Notes 2016 that are denominated in U.S. dollars and euro’s, which have been lent to its operations where the functional currency is the Polish zloty and Russian ruble. The effect of having debt denominated in currencies other than the Company’s functional currencies is to increase or decrease the value of the Company’s liabilities on that debt in terms of the Company’s functional currencies when those functional currencies depreciate or appreciate in value respectively. As a result of this, the Company is exposed to gains and losses on the re-measurement of these liabilities. The table below summarizes the pre-tax impact of a one percent movement in each of the exchange rate which could result in a significant impact in the results of the Company’s operations.

 

Exchange Rate

  

Value of notional amount

  

Pre-tax impact of a 1%
movement in exchange rate

USD-Polish zloty

   $426 million    $4.3 million gain/loss

USD-Russian ruble

   $264 million    $2.6 million gain/loss

EUR-Polish zloty

   €625 million or approximately $901 million    $9 million gain/loss

The table above includes €245 million for the Senior Secured Notes due in 2012 that were redeemed on January 4, 2010, thus there will not be any foreign exchange impact from them after this date.

 

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Item 8. Financial Statements and Supplementary Data

Index to consolidated financial statements:

 

Report of Independent Registered Public Accounting Firm

   57

Consolidated Balance Sheets at December 31, 2009 and 2008

   59

Consolidated Statements of Operations for the years ended December 31, 2009, 2008 and 2007

   60

Consolidated Statements of Changes in Stockholders’ Equity for the years ended December  31, 2009, 2008 and 2007

   61

Consolidated Statements of Cash Flows for the years ended December 31, 2009, 2008 and 2007

   62

Notes to Consolidated Financial Statements

   63

 

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of

Central European Distribution Corporation

In our opinion, the accompanying consolidated balance sheets and the related consolidated statement of operations, stockholders’ equity and cash flows present fairly, in all material respects, the financial position of Central European Distribution Corporation (“CEDC” or the “Company”) and its subsidiaries at December 31, 2009 and December 31, 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

As discussed in Notes 1 and 2 to the consolidated financial statements, the Company changed the manner in which it accounts for non-controlling interests, debt with conversion features and business combinations in 2009.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

As described in the Management ‘s Report in Internal Control over Financial Reporting appearing under Item 9A, management has excluded the Russian Alcohol Group from its assessment of internal control over financial reporting as of December 31, 2009 because it was acquired by the Company in a purchase business

 

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combination during the year ended December 31, 2009. We have also excluded the Russian Alcohol Group from our audit of internal control over financial reporting. The Russian Alcohol group is a wholly-owned subsidiary whose total assets and total revenues represent 20.0% and 21.2%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2009.

/s/ PricewaterhouseCoopers Sp. z o. o.

Warsaw, Poland

March 1, 2010

 

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CENTRAL EUROPEAN DISTRIBUTION CORPORATION

CONSOLIDATED BALANCE SHEET

Amounts in columns expressed in thousands

(except share information)

 

     December 31,
2009
    December 31,
2008

(as adjusted)
 
ASSETS     

Current Assets

    

Cash and cash equivalents

   $ 152,177      $ 107,601   

Restricted cash

     481,419        —     

Accounts receivable, net of allowance for doubtful accounts of $56,090 and $22,156 respectively

     631,005        430,683   

Inventories

     221,417        180,304   

Prepaid expenses and other current assets

     46,654        22,894   

Deferred income taxes

     83,458        24,386   
                

Total Current Assets

     1,616,130        765,868   

Intangible assets, net

     778,828        570,505   

Goodwill, net

     1,726,625        745,256   

Property, plant and equipment, net

     231,098        92,221   

Deferred income taxes

     27,123        12,886   

Equity method investment in affiliates

     67,089        189,243   

Subordinated loans to affiliates

     —          107,707   
                

Total Non-Current Assets

     2,830,763        1,717,818   
                

Total Assets

   $ 4,446,893      $ 2,483,686   
                
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current Liabilities

    

Trade accounts payable

   $ 266,071      $ 234,948   

Bank loans and overdraft facilities

     124,266        109,552   

Income taxes payable

     4,935        7,227   

Taxes other than income taxes

     207,168        125,774   

Other accrued liabilities

     100,266        80,270   

Short-term obligations under Senior Notes

     358,943        —     

Current portions of obligations under capital leases

     1,724        2,385   

Deferred consideration

     160,880        —     
                

Total Current Liabilities

     1,224,253        560,156   

Long-term debt, less current maturities

     106,043        170,510   

Long-term obligations under capital leases

     1,371        2,194   

Long-term obligations under Senior Notes

     1,205,467        633,658   

Long-term accruals

     3,214        5,806   

Deferred income taxes

     198,495        106,485   
                

Total Long Term Liabilities

     1,514,590        918,653   

Redeemable noncontrolling interests in Whitehall Group

     22,888        33,642   

Stockholders’ Equity

    

Common Stock ($0.01 par value, 80,000,000 shares authorized, 69,411,845 and 47,344,874 shares issued at December 31, 2009 and December 31, 2008, respectively)

     694        473   

Additional paid-in-capital

     1,296,391        816,490   

Retained earnings

     264,917        186,588   

Accumulated other comprehensive income / (loss)

     123,310        (46,772

Less Treasury Stock at cost (246,037 shares at December 31, 2009 and December 31, 2008, respectively)

     (150     (150
                

Total CEDC Stockholders’ Equity

     1,685,162        956,629   

Noncontrolling interests in subsidiaries

     —          14,606   
                

Total Equity

     1,685,162        971,235   
                

Total Liabilities and Stockholders’ Equity

   $ 4,446,893      $ 2,483,686   
                

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

 

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CENTRAL EUROPEAN DISTRIBUTION CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

Amounts in columns expressed in thousands

(except per share information)

 

     Year ended December 31,  
   2009     2008     2007  
           (as adjusted)        

Sales

   $ 2,197,542      $ 2,136,570      $ 1,483,344   

Excise taxes

     (690,403     (489,566     (293,522

Net Sales

     1,507,139        1,647,004        1,189,822   

Cost of goods sold

     1,012,543        1,224,899        941,060   
                        

Gross Profit

     494,596        422,105        248,762   
                        

Operating expenses

     278,448        223,373        130,677   
                        

Operating Income

     216,148        198,732        118,085   
                        

Non operating income / (expense), net

      

Interest (expense), net

     (80,213     (53,447     (35,829

Other financial income / (expense), net

     21,864        (132,936     13,594   

Amortization of deferred charges

     (38,501     —          —     

Other non operating income / (expense), net

     824        410        (1,770
                        

Income before taxes, equity in net income from unconsolidated investments and noncontrolling interests in subsidiaries

     120,122        12,759        94,080   
                        

Income tax expense

     (22,905     (11,872     (15,910

Equity in net earnings of affiliates

     (13,102     (9,002     —     
                        

Net income / (loss)

   $ 84,115      ($ 8,115   $ 78,170   
                        

Less: Net income / (loss) attributable to noncontrolling interests in subsidiaries

     2,708        3,680        1,068   

Less: Net income / (loss) attributable to redeemable noncontrolling interests in Whitehall Group

     3,078        6,803        —     

Net income / (loss) attributable to CEDC

   $ 78,329      ($ 18,598   $ 77,102   
                        

Net income per share of common stock, basic

   $ 1.46      ($ 0.42   $ 1.93   
                        

Net income per share of common stock, diluted

   $ 1.45      ($ 0.42   $ 1.91   
                        

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

 

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CENTRAL EUROPEAN DISTRIBUTION CORPORATION

CONSOLIDATED STATEMENT OF CHANGES IN

STOCKHOLDERS’ EQUITY

Amounts in columns expressed in thousands

(except per share information)

 

    Common Stock     Additional
Paid-in
Capital
    Retained
Earnings
    Accumu-
lated other
comprehen-
sive income
    Non-
controlling
interest in
subsidiaries
    Total  
  Common Stock   Treasury Stock                                
  No. of
Shares
  Amount   No. of
Shares
  Amount                                

Balance at December 31, 2006

  38,692   $ 387   246   ($ 150   $ 374,985      $ 128,084      $ 17,667      $ 21,395      $ 542,368   
                                                             

Net income for 2007

  —       —     —       —          —          77,102        —          1,068        78,170   

Foreign currency translation adjustment

  —       —     —       —          —          —          162,773        (21,982     140,791   
                                               

Comprehensive income for 2007

  —       —     —       —          —          77,102        162,773        (20,914     218,961   

Common stock issued in public placement

  1,554     16   —       —          42,338        —          —          —          42,354   

Common stock issued in connection with options

  272     3   —       —          5,538        —          —            5,541   

Common stock issued in connection with acquisitions

  48     0   —       —          1,693        —          —          —          1,693   

Refundable purchase price related to Botapol acquisition

  —       —     —       —          5,000        —          —          —          5,000   

Balance at December 31, 2007

  40,566   $ 406   246   ($ 150   $ 429,554      $ 205,186      $ 180,440      $ 481      $ 815,917   
                                                             

Net income for 2008

  —       —     —       —          —          (16,591     —          3,680        (12,911

Foreign currency translation adjustment

  —       —     —       —          —          —          (227,212     10,445        (216,767
                                               

Comprehensive income for 2008

  —       —     —       —          —          (16,591     (227,212     14,125        (229,678

Common stock issued in public placement

  3,576     36   —       —          233,809        —          —          —          233,845   

Common stock issued in connection with options

  121     1   —       —          5,739        —          —          —          5,740   

Common stock issued in connection with acquisitions

  3,082     30   —       —          134,601        —          —          —          134,631   

Balance at December 31, 2008
(as reported)

  47,345   $ 473   246   ($ 150   $ 803,703      $ 188,595      ($ 46,772   $ 14,606      $ 960,455   
                                                             

Adoption of ASC 470-20

  —       —     —       —          12,787        (2,007     —          —          10,780   

Balance at December 31, 2008
(as adjusted)

  47,345   $ 473   246   ($ 150   $ 816,490      $ 186,588      ($ 46,772   $ 14,606      $ 971,235   
                                                             

Net income / (loss) for 2009

  —       —     —       —          —          78,329        —          2,708        81,037   

Foreign currency translation adjustment

  —       —     —       —          —          —          170,082        (4,018     166,064   
                                               

Comprehensive income for 2009

  —       —     —       —          —          78,329        170,082        (1,310     247,101   

Common stock issued in public placement

  17,935     179   —       —          486,967        —          —          —          487,146   

Common stock issued in connection with options

  63     1   —       —          4,634        —          —          —          4,635   

Common stock issued in connection with acquisitions

  4,069     41   —       —          81,156        —          —          —          81,197   

Acquisition of Russian Alcohol

  —       —     —       —          —          —          —          50,000        50,000   

Purchase of Russian Alcohol shares from noncontrolling interest

  —       —     —       —          (29,401     —          —          (52,382     (81,783

Purchase of Whitehall Group shares from noncontrolling interest

  —       —     —       —          (20,195     —          —          —          (20,195

Gross up on trademarks in Parliament

  —       —     —       —          —          —          —          15,993        15,993   

Purchase of Parliament Group shares from noncontrolling interest

  —       —     —       —          (43,260     —          —          (26,907     (70,167

Valuation adjustment

  —       —     —       —          —          —          —          —          —     

Balance at December 31, 2009

  69,412   $ 694   246   ($ 150   $ 1,296,391      $ 264,917      $ 123,310      ($ 0   $ 1,685,162   
                                                             

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

 

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CENTRAL EUROPEAN DISTRIBUTION CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOW

Amounts in columns expressed in thousands

 

     Twelve months ended December 31,  
   2009     2008     2007  
           (as adjusted)        

Operating Activities

      

Net income

   $ 84,115      ($ 8,115   $ 78,170   

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

      

Depreciation and amortization

     14,652        14,786        9,968   

Deferred income taxes

     (32,378     (19,282     9,957   

Unrealized foreign exchange (gains) / losses

     (38,760     133,528        (23,940

Cost of debt extinguishment

     —          1,156        11,864   

Stock options expense

     3,782        3,850        1,866   

Hedge revaluation

     9,160        —          —     

Equity income in affiliates

     13,101        9,002        —     

Gain on remeasurement of previously held equity interest, net of impairment

     (12,418     —          —     

Amortization of deferred charges

     38,501       

Other non cash items

     1,333        1,314        7,284   

Changes in operating assets and liabilities:

      

Accounts receivable

     (53,483     (121,589     (38,812

Inventories

     1,268        (41,712     (21,986

Prepayments and other current assets

     28,859        17,100        5,865   

Trade accounts payable

     (2,049     62,459        (880

Other accrued liabilities and payables

     37,278        19,699        (16,272
                        

Net Cash provided by Operating Activities

     92,961        72,196        23,084   

Investing Activities

      

Investment in fixed assets

     (18,696     (22,572     (25,787

Proceeds from the disposal of fixed assets

     3,874        6,943        2,670   

Changes in restricted cash

     (481,419     —          —     

Purchase of financial assets

     —          (103,500     —     

Refundable purchase price related to Botapol acquisition

     —          —          5,000   

Acquisitions of subsidiaries, net of cash acquired

     (573,504     (548,799     (141,005
                        

Net Cash used in Investing Activities

     (1,069,745     (667,928     (159,122

Financing Activities

      

Borrowings on bank loans and overdraft facility

     37,399        120,586        13,225   

Borrowings on long-term bank loans

     —          43,192        122,508   

Payment of bank loans, overdraft facility and other borrowings

     (146,567     (31,935     (30,153

Payment of long-term borrowings

     (265,517     —          8   

Net Borrowings of Senior Secured Notes

     929,569        —          —     

Payment of Senior Secured Notes

     —          (26,996     (95,440

Repayment of obligation to former shareholders

     (28,814     —          —     

Hedge closure

     (14,417     —          —     

Movements in capital leases payable

     (1,430     1,216        445   

Issuance of shares in public placement

     490,974        233,845        42,354   

Transactions with equity holders

     (7,876     —          —     

Net Borrowings on Convertible Senior Notes

     —          304,403        —     

Dividends paid to minority shareholders

     (2,758     —          —     

Options exercised

     854        1,899        3,976   
                        

Net Cash provided by Financing Activities

     991,417        646,210        56,923   
                        

Currency effect on brought forward cash balances

     29,943        (30,744     7,620   

Net Increase / (Decrease) in Cash

     44,576        19,734        (71,495

Cash and cash equivalents at beginning of period

     107,601        87,867        159,362   
                        

Cash and cash equivalents at end of period

   $ 152,177      $ 107,601      $ 87,867   
                        

Supplemental Schedule of Non-cash Investing Activities

      

Common stock issued in connection with investment in subsidiaries

   $ 81,197      $ 134,631      $ 1,693   
                        

Supplemental disclosures of cash flow information

      

Interest paid

   $ 84,694      $ 55,426      $ 40,136   

Income tax paid

   $ 28,118      $ 33,919      $ 21,362   
                        

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

 

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CENTRAL EUROPEAN DISTRIBUTION CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Amounts in tables expressed in thousands, except per share information

1. Organization and Significant Accounting Policies

Organization and Description of Business

Central European Distribution Corporation (“CEDC”), a Delaware corporation, and its subsidiaries (collectively referred to as “we,” “us,” “our,” or the “Company”) operate primarily in the alcohol beverage industry. The Company is Central Europe’s largest integrated spirit beverages business. The Company is also the largest vodka producer by value and volume in Poland and Russia and produces the Absolwent, Zubrowka, Bols, Parliament, Green Mark, Soplica and Zhuravli brands, among others. In addition, it produces and distributes Royal Vodka, the number one selling vodka in Hungary. As well as sales and distribution of its own branded spirits, the Company is the leading distributor and the leading importer of spirits, wine and beer in Poland and a leading exclusive importer of wines and spirits in Poland, Russia and Hungary.

Significant Accounting Policies

The significant accounting policies and practices followed by the Company are as follows:

Basis of Presentation

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. Our Company consolidates all entities that we control by ownership of a majority voting interest. We also consolidated the Whitehall Group, in which the Company controls 49.9% of voting interest, and Russian Alcohol, where we obtained full voting control in January 2010. All inter-company accounts and transactions have been eliminated in the consolidated financial statements.

In June 2009, the FASB issued ASC Topic 810, which changes how a company determines whether an entity should be consolidated. The adoption of this standard may impact the current treatment of the Whitehall Group by the Company and the Company is current assessing this treatment and potential impact on the financial statements. See “Recently Issued Accounting Pronouncements” for more detailed information on this topic.

CEDC’s subsidiaries maintain their books of account and prepare their statutory financial statements in their respective local currencies.

The subsidiaries’ financial statements have been adjusted to reflect accounting principles generally accepted in the United States of America (U.S. GAAP).

Effective January 1, 2009, we adopted the following pronouncements which require us to retrospectively restate previously disclosed consolidated financial statements. As such, certain prior period amounts have been reclassified in the unaudited consolidated financial statements to conform to the current period presentation.

 

   

We adopted the provisions of Accounting Standards Codification (“ASC”) Topic 810-10, “Consolidation”, which establishes and expands accounting and reporting standards for minority interests (which are recharacterized as noncontrolling interests) in a subsidiary and the deconsolidation of a subsidiary. As a result of our adoption of this standard, amounts previously reported as minority interests in other partnerships on our balance sheets are now presented as noncontrolling interests in other partnerships within equity. Minority interests in Whitehall Group continue to be included in the mezzanine section (between liabilities and equity) on the accompanying consolidated balance sheets because of the redemption feature of these units.

As a result of adoption of ASC Topic 810-10, as at December 31, 2008, NCI related to our shareholding in Parliament and Polmos Bialystok amounting to $14.6 million would be reported as part

 

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CENTRAL EUROPEAN DISTRIBUTION CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Amounts in tables expressed in thousands, except per share information

 

of equity and the amount of $33.6 million related to Whitehall Group would be disclosed in the mezzanine section.

ASC Topic 810-10 applies prospectively, except for presentation and disclosure requirements, which are applied retrospectively.

The changes in redeemable noncontrolling interests for the twelve months ended December 31, 2009 are shown below:

 

Balance at December 31, 2008

   $ 33,642   

Net income for 2009

     3,078   

Foreign currency translation adjustment

     (4,013

JV Revaluation into RUR as a functional currency

     (3,091

Purchase of shares from noncontrolling interests

     (6,728

Balance at December 31, 2009

   $ 22,888   

 

   

We adopted ASC Topic 470-20, “Debt with Conversion and Other Options” that is effective for our $310.0 million aggregate principal amount of 3.00% Convertible Senior Notes (“CSN”) and requires retrospective application for all periods presented. The ASC Topic 470-20 requires the issuer of convertible debt instruments with cash settlement features to separately account for the liability ($290.3 million as of the date of the issuance of the CSNs) and equity components ($19.7 million as of the date of the issuance of the CSNs) of the instrument. The debt component was recognized at the present value of its cash flows discounted using a 4.5% discount rate, our borrowing rate at the date of the issuance of the CSNs for a similar debt instrument without the conversion feature. The equity component, recorded as additional paid-in capital, was $12.8 million, which represents the difference between the proceeds from the issuance of the Debentures and the fair value of the liability, net of deferred taxes of $6.9 million as of the date of the issuance of the CSNs.

ASC Topic 470-20 also requires an accretion of the resultant debt discount over the expected life of the CSNs, which is March 7, 2008 to March 15, 2013. The consolidated statement of operations were retroactively modified compared to previously reported amounts as follows (in thousands, except per share amounts):

 

     Twelve months ended
December 31, 2008
 

Additional pre-tax non-cash interest expense

     3,087   

Additional deferred tax benefit

     1,080   

Retroactive change in net income and retained earnings

     (2,006

Change to basic earnings per share

   ($ 0.05

Change to diluted earnings per share

   ($ 0.05

For the twelve months ended December 31, 2009, the additional pre-tax non-cash interest expense recognized in the consolidated statement of operations was $3.9 million. Accumulated amortization related to the debt discount was $7.0 million and $3.1 million as of December 31, 2009 and December 31, 2008, respectively. The annual pre-tax increase in non-cash interest expense on our consolidated statements of operations to be recognized until 2013, the maturity date of the CSNs, is as follows (in thousands):

 

     Pre-tax increase in non-cash
interest expense

2010

   4,098

2011

   4,282

2012

   4,285

 

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CENTRAL EUROPEAN DISTRIBUTION CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Amounts in tables expressed in thousands, except per share information

 

The FASB has issued FASB Statement No. 168, The “FASB Accounting Standards Codification™” and the Hierarchy of Generally Accepted Accounting Principles codified as ASC Topic 105 “Generally Accepted Accounting Principles”. ASC Topic 105 establishes the FASB Accounting Standards Codification™ (Codification or ASC) as the single source of authoritative U.S. generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The Codification supersedes all existing non-SEC accounting and reporting standards. All other non-grandfathered, non-SEC accounting literature not included in the Codification will become non-authoritative.

Following the Codification, the Board will not issue new standards in the form of Statements, FASB Staff Positions or Emerging Issues Task Force Abstracts. Instead, it will issue Accounting Standards Updates, which will serve to update the Codification, provide background information about the guidance and provide the basis for conclusions on the changes to the Codification.

GAAP is not intended to be changed as a result of the FASB’s Codification project, but it will change the way the guidance is organized and presented. As a result, these changes will have a significant impact on how companies reference GAAP in their financial statements and in their accounting policies for financial statements issued for interim and annual periods ending after September 15, 2009. CEDC adopted the Codification in this quarterly report by providing references to the Codification topics alongside references to the existing standards.

The Company has performed an evaluation of subsequent events through March 1, 2010, which is the date the financial statements were issued.

Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results may differ from those estimates and such differences may be material to the consolidated financial statements.

Foreign Currency Translation and Transactions

For all of the Company’s subsidiaries the functional currency is the local currency. Assets and liabilities of these operations are translated at the exchange rate in effect at each year-end. The Statement of Operations are translated at the average rate of exchange prevailing during the respective year. Translation adjustments arising from the use of differing exchange rates from period to period are included as a component of stockholders’ equity. Transaction adjustments arising from operations as well as gains and losses from any specific foreign currency transactions are included in the reported net income/(loss) for the period.

The accompanying consolidated financial statements have been presented in U.S. dollars.

 

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CENTRAL EUROPEAN DISTRIBUTION CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Amounts in tables expressed in thousands, except per share information

 

Tangible Fixed Assets

Tangible fixed assets are stated at cost, less accumulated depreciation. Depreciation of tangible fixed assets is computed by the straight-line method over the following useful lives:

 

Type

   Depreciation life
in years

Transportation equipment including capital leases

   5

Production equipment

   10

Software

   5

Computers and IT equipment

   3

Beer dispensing and other equipment

   2-10

Freehold land

   Not depreciated

Freehold buildings

   40

Leased equipment meeting appropriate criteria is capitalized and the present value of the related lease payments is recorded as a liability. Amortization of capitalized leased assets is computed on a straight-line method over the useful life of the relevant assets.

Where the cost of equipment is approximately $1,500 per transaction, it is expensed to the statement of operations as incurred.

The Company periodically reviews its investment in tangible fixed assets and when indicators of impairment exist, an impairment loss is recognized.

Goodwill

Following the adoption of ASC Topic 805 and ASC Topic 350, goodwill and certain intangible assets having indefinite lives are no longer subject to amortization. Their book values are tested annually for impairment, or more frequently, if facts and circumstances indicate the need. Fair value measurement techniques, such as the discounted cash flow methodology, are utilized to assess potential impairments. The testing is performed at each reporting unit level. In the discounted cash flow method, the Company discounts forecasted performance plans to their present value. The discount rate utilized is the weighted average cost of capital for the reporting unit. US GAAP requires the impairment test to be performed in two stages. If the first stage does not indicate that the carrying values of the reporting units exceed the fair values, the second stage is not required. When the first stage indicates potential impairment, the company has to complete the second stage of the impairment test and compare the implied fair value of the reporting units’ goodwill to the corresponding carrying value of goodwill.

Involvement of the Company in variable interest entities (“VIEs”) and continuing involvement with transferred financial assets.

Whitehall Group

On May 23, 2008, the Company and certain of its affiliates, entered into, and closed upon, a Share Sale and Purchase Agreement and certain other agreements whereby the Company acquired shares representing 50% minus one vote of the voting power, and 75% of the economic interests, in the Whitehall Group. In consideration for additional payments made to the seller on February 24, 2009, the Company received an additional 375 Class B shares of Whitehall, which represents an increase of the Company’s economic stake in Whitehall Group from 75% to 80%.

 

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Transfers of Financial Assets

Except for the amount of $7.5 million that was lent at market rates as a working capital by the Company to the Whitehall Group there were no transfers of financial assets to VIE as the Whitehall Group is a self financing body. Including the $7.5 million transfer, the Company does not have any continuing involvement with transferred financial assets that allow the transferors to receive cash flows or other benefits from the assets or requires the transferors to provide cash flows or other assets in relation to the transferred financial assets.

Variable Interest Entities

CEDC consolidated the Whitehall Group as a business combination as of May 23, 2008, on the basis that the Whitehall Group is a Variable Interest Entity (“VIE”) and the Company has been assessed as being the primary beneficiary. Included within the Whitehall Group is a 50/50 joint venture with Möet Hennessy. The current term of the joint venture is until June 2013 at which point Möet Hennessy will have the option to acquire the remaining shares of the entity.

Based upon the review of Paragraph 4 CEDC management has concluded that its interest in Peulla Enterprises, the special purpose vehicle (“SPV”), being a Cyprus company in which CEDC has 49.9% voting power, would not fall under any of scope exceptions. Therefore CEDC has evaluated whether the SPV is a variable interest entity under the provisions of Paragraph 5 and thus the SPV subject to consolidation accounting.

In determining the accounting treatment if the Whitehall Group is a VIE and needs to be consolidated by CEDC, we considered the conditions outlined in ASC Topic 810.

 

   

Equity Investment at Risk—We concluded that the SPV would not meet the requirement of a VIE based upon Paragraph 5(a) as the interest would be classified as equity under US GAAP, the at risk equity is sufficient to permit the entity to finance its activities. Neither equity holder will provide any additional material capital into the SPV. The SPV will be utilized solely as a holding company with its economics determined by the underlying Whitehall Group.

 

   

Controlling Financial Interests—Both shareholders, Mark Kaoufman acting through a Jersey trust (“the Trust”) and CEDC, are able to direct the activities and operations of the Whitehall Group through their roles on the Board of Directors and their responsibilities for selection of executive level officers. However, the ultimate obligation to absorb losses of the entity or right to receive the residual benefits will lie with CEDC at the time the put/call term ends. Should the business not perform, the Trust will have the right to put his shares to CEDC with a pre-agreed floor on the value of the put option. Thus the Company is at risk of absorbing a greater portion of losses upon the Trust’s exit than the Trust itself. Conversely at the end of the term, CEDC can call and if the business has over performed, the amount paid to the Trust on the call is capped at a pre-agreed amount. As such, because the Trust is both limited in its losses and returns through the terms of the put/call with caps and floors, this criterion is met and would cause Whitehall Group to be considered a VIE.

 

   

Disproportionate Voting Rights—The voting rights of the Trust and CEDC (50.1% and 49.9%) are not proportionate to their economic interests (20% and 80%). In this structure, it appears CEDC has disproportionately fewer voting rights in relation to its economic rights.

Further, the below activities of the entity that are more closely associated with the activities of CEDC, thereby having substantially of the entity’s activities conducted on its behalf. As CEDC has disproportionately fewer rights while substantially all of Whitehall Group’s activities are for CEDC, this would indicate that Whitehall Group lacks characteristic:

 

   

The operations of Whitehall Group are substantially similar in nature to the activities of CEDC;

 

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CEDC has a call option to purchase the interests of the other investors in the entity;

 

   

The Trust has an option to put his interests to CEDC.

Both the Trust and CEDC are precluded from transferring its interests in the SPV to any third-party without consent from the other party. Transfers are subject to an absolute other party discretion standard, other than limited permitted transfers (i.e., to affiliates). As such, it appears a de facto relationship exists.

The primary factor to be considered here is the design and intent of the variable interest entity. The SPV that holds the Whitehall Group and the related shareholders agreement were created with the clear intent to maximize the financial exposure that CEDC has to the Whitehall Group business and to ultimately allow CEDC to take full control of the business in 2013. CEDC bears the greatest level of economic share of the entities performance, both in terms of profit allocation (80%) and valuation of the put/call option at the end with a clear floor and cap on payment. The put/call structure in place provide near assurance that at the end of the term CEDC will take full ownership of the business. Should the business perform at or above plan, CEDC valuation is capped therefore would elect to call, and should the business under perform, the Trust will put the shares receiving the guaranteed minimum valuation.

In June 2009, the FASB issued Statement of Financial Account Standards no. 167, which changes how a company determines whether an entity should be consolidated. The adoption of this standard may impact the current treatment of the Whitehall Group by the Company and the Company is current assessing this treatment and potential impact on the financial statements. See “Recently Issued Accounting Pronouncements” for more detailed information on this topic.

Russian Alcohol Group

On April 24, 2009, the Company entered into new agreements with Lion, to replace the Prior Agreement, which will permit the Company, through a multi-stage equity purchase, to acquire over the next five years (including 2009) all of the equity interests in Russian Alcohol held by Lion (the “Acquisition”), including a Note Purchase and Share Subscription Agreement between the Company, Carey Agri, Cayman 2, and Cayman 5. For further details on the whole structure of this acquisition please refer to Note 2 of the accompanying financial statements attached herein.

At the lowest level of the existing structure, all of Russian Alcohol companies up to the level of Lion/Rally Lux1 are consolidated based on the fact that these are 100% wholly-owned companies. Therefore, we have evaluated and considered Cayman 7 as a variable interest entity for CEDC in the structure.

Transfers of Financial Assets

There were no transfers of financial assets to a VIE as Russian Alcohol is a self financing body. The Company does not have any continuing involvement with transferred financial assets that allow the transferors to receive cash flows or other benefits from the assets or requires the transferors to provide cash flows or other assets in relation to the transferred financial assets.

Variable Interest Entities

Cayman 7 is a company in which Cayman 2 and CEDC are the sole limited partners and an affiliate of Lion is the general partner. CEDC has 100% of the economic interests in Cayman 7, but Lion retains control of Cayman 7 through Cayman 2’s ownership of a single voting share with de minimis economic rights (the “Golden Share”) but voting control of Cayman 7. As Cayman 7 has the right to call capital from CEDC to settle obligations under the Option Agreement, CEDC has evaluated whether Cayman 7 is a variable interest entity under the provisions ASC Topic 810.

 

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Based upon the review of Paragraph 4 CEDC’s management has concluded that its direct interest in Cayman 7, as well as its indirect interest through Carey Agri and Cayman 2, would not fall under any of these scope exceptions. Therefore CEDC has evaluated whether Cayman 7 is a variable interest entity under the provisions of Paragraph 5 of ASC Topic 810 and thus subject to consolidation accounting.

In determining the accounting treatment if Cayman 7 and, effectively, the whole Russian Alcohol is a VIE and needs to be consolidated by CEDC, we considered the conditions outlined in ASC Topic 810.

 

   

Equity Investment at Risk—We concluded that as the contribution made by Cayman 2 was the only one that required substantial investment, Cayman 2 should be defined as having its equity at risk. Moreover as Cayman 7 is not able to finance its operations without funds received from CEDC, we believe that Cayman 7 would meet the requirement of a VIE based upon Paragraph 5(a).

 

   

Controlling Financial Interests—CEDC concluded that the equity investment at risk does not meet the last item in Paragraph 5(b) as all dividends from the business are passed to CEDC with CEDC not having its equity investment at risk. These dividends then reduce CEDC’s payment obligations to Lion (if dividends paid to CEDC by Russian Alcohol exceed the call option price, Lion has to return the excess as CEDC’s call option obligations have been met). However, Lion is not entitled to receive any dividends from Cayman 7 directly as CEDC has 100% of the economic interests, with Lion having voting control through voting rights. Therefore we believe that Paragraph 5(b) would cause Cayman 7 to be treated as a VIE.

 

   

Disproportionate Voting Rights—We believe that both criteria, including lack of voting rights and the requirement that substantially all activities of Cayman 7 involve or are conducted on behalf of CEDC (as Cayman 7 is a company created solely to facilitate CEDC’s funding of the exercise of call options to purchase shares of Cayman 6), we believe that this would require Cayman 7 to be treated as a VIE.

The conclusion of CEDC management is that Cayman 7, including its interest in Cayman 6 and indirectly in Russian Alcohol, is a VIE. CEDC, as the party most closely associated with Cayman 7 receiving all economic benefits from Russian Alcohol thorough the chain of subsidiaries, would be considered the primary beneficiary of Cayman 7 and must therefore consolidate Cayman 7 together with all of Russian Alcohol as a business combination under ASC Topic 805.

On December 9, 2009 we accelerated the terms set up on the Option Agreement dated April 24, 2009 and purchased the remaining equity interest in Russian Alcohol that was not owned by the Company. As a result of this Russian Alcohol is no longer treated as a VIE, but rather consolidated as a fully owned subsidiary.

Intangible assets other than Goodwill

Intangibles consist primarily of acquired trademarks relating to well established brands, and as such have been deemed to have an indefinite life. In accordance with ASC Topic 350, intangible assets with an indefinite life are not amortized but are reviewed at least annually for impairment. Additional intangible assets include the valuation of customer contracts arising as a result of acquisitions, these intangible assets are amortized over their estimated useful life of 8 years.

Equity investments

If the Company is not required to consolidate its investment in another company, the Company uses the equity method if the Company can exercise significant influence over the other company. Under the equity

 

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method, investments are carried at cost, plus or minus the Company’s equity in the increases and decreases in the investee’s net assets after the date of acquisition and certain other adjustments. The Company’s share of the net income or loss of the investee is included in equity in earnings of equity method investees on the Company’s Consolidated Statements of Operations. Dividends received from the investee reduce the carrying amount of the investment. Equity investments are reviewed for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of the investments may not be recoverable.

Impairment of long lived assets

In accordance with ASC Topic 805 and ASC Topic 350, the Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount of an asset exceeds its fair value.

Revenue Recognition

Revenues of the Company include sales of its own produced spirit brands, imported wine, beer and spirit brands as well as other third party alcoholic products purchased locally in Poland, the sale of each of these revenues streams are all processed and accounted for in the same manner. For all of its sources of revenue, the Company recognizes revenue when persuasive evidence of an arrangement exists, delivery of product has occurred, the sales price charged is fixed or determinable and collectability is reasonably assured. This generally means that revenue is recognized when title to the products are transferred to our customers. In particular, title usually transfers upon shipment to or receipt at our customers’ locations, as determined by the specific sales terms of the transactions.

Sales are stated net of sales tax (VAT) and reflect reductions attributable to consideration given to customers in various customer incentive programs, including pricing discounts on single transactions, volume discounts, promotional listing fees and advertising allowances, cash discounts and rebates. Net sales revenue includes excise tax except in the case where the sales are made from the production unit or are related to imported goods, in which case it is recorded net of excise tax.

Revenue Dilution

As part of normal business terms with customers, the Company provides for additional discounts and rebates off our stand list price for all of the products we sell. These revenue reductions are documented in our contracts with our customers and are typically associated with annual or quarterly purchasing levels as well as payment terms. These rebates are divided into on-invoice and off-invoice discounts. The on-invoice reductions are presented on the sales invoice and deducted from the invoice gross sales value. The off-invoice reductions are calculated based on the analysis performed by management and are provided for in the same period the related sales are recorded. Discounts or fees that are subject to contractual based term arrangements are amortized over the term of the contract. For the twelve months ending December 31, 2009, the Company recognized $117.9 million of off invoice rebates as a reduction to net sales.

Certain sales contain customer acceptance provisions that grant a right of return on the basis of either subjective criteria or specified objective criteria. Where appropriate a provision is made for product return, based upon a combination of historical data as well as depletion information received from our larger clients. The

 

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Company’s policy is to closely monitor inventory levels with our key distribution customers to ensure that we do not create excess stock levels in the market which would result in a return of sales in the future. Historically sales returns from customers has averaged less than 1% of our net sales revenue.

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 costs of goods sold. Shipping and handling costs associated with distribution are recorded in Selling, General and Administrative (S,G&A) costs.

Accounts Receivable

Accounts receivables are recorded based on the invoice price, inclusive of VAT (sales tax), and where a delivery note has been signed by the customer and returned to the Company. The allowances for doubtful accounts are based upon the aging of the accounts receivable, whereby the Company makes an allowance based on a sliding scale. The Company typically does not provide for past due amounts due from large international retail chains (hypermarkets and supermarkets) as there have historically not been any issues with collectability of these amounts. However, where circumstances require, the Company will also 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.

Inventories

Inventories are stated at the lower of cost (first-in, first-out method) or market value. Elements of cost include materials, labor and overhead and are classified as follows:

 

     December 31,
2009
   December 31,
2008

Raw materials and supplies

   $ 35,922    $ 18,352

In-process inventories

     2,914      1,698

Finished goods and goods for resale

     182,581      160,254
             

Total

   $ 221,417    $ 180,304
             

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 net realizable value in their relevant condition.

Cost includes customs duty (where applicable), and all costs associated with bringing the inventory to a condition for sale. These costs include importation, handling, storage and transportation costs, and exclude rebates received from suppliers, which are reflected as reductions to closing inventory. Inventories are comprised primarily of beer, wine, spirits, packaging materials and non-alcoholic beverages.

Cash and Cash Equivalents

Short-term investments which have a maturity of three months or less from the date of purchase are classified as cash equivalents.

 

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Income Taxes and Deferred Taxes

The Company computes and records income taxes in accordance with the liability method. Deferred tax assets and liabilities are recorded based on the difference between the accounting and tax basis of the underlying assets and liabilities based on enacted tax rates expected to be in effect for the year in which the differences are expected to reverse.

Employee Retirement Provisions

The Company’s employees are entitled to retirement payments and in some cases payments for long-service (“jubilee awards”) and accordingly the Company provides for the current value of the liability related to these benefits. A provision is calculated based on the terms set in the collective labor agreement. The amount of the provision for retirement bonuses depends on the age of employees and the pre-retirement time of work for the Company and typically equals one months salary.

The Company does not create a specific fund designated for these payments and all payments related to the benefits are charged to the accrued liability. The provision for the employees’ benefits is calculated annually using the projected unit method and any losses or gains resulting from the valuation are immediately recognized in the statement of operations.

The Company also contributes to State and privately managed defined contribution plans. Contributions to defined contribution plans are charged to the statement of operations in the period in which they are incurred.

Employee Stock-Based Compensation

The Company adopted ASC Topic 718 “Compensation—Stock Compensation” requiring the recognition of compensation expense in the Consolidated Statements of Operations related to the fair value of its employee share-based options.

The Company recognizes the cost of all employee stock options on a straight-line attribution basis over their respective vesting periods, net of estimated forfeitures. The Company has selected the modified prospective method of transition; accordingly, prior periods have not been restated.

ASC Topic 718 requires the recognition of compensation expense related to the fair value of employee share-based options. Determining the fair value of share-based awards at the grant date requires judgment, including estimating the expected term that stock options will be outstanding prior to exercise, the associated volatility and the expected dividends. Judgment is also required in estimating the amount of share-based awards expected to be forfeited prior to vesting. If actual forfeitures differ significantly from these estimates, share-based compensation expense could be materially impacted. Prior to adopting ASC Topic 718, the Company applied Accounting Principles Board (“APB”) Opinion No. 25, and related Interpretations, in accounting for its stock-based compensation plans. All employee stock options were granted at or above the grant date market price. Accordingly, no compensation cost was recognized for fixed stock option grants in prior periods.

The Company’s 2007 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. Following a shareholder resolution in April 2003 and the stock splits of May 2003, May 2004 and June 2006, the Incentive Plan authorizes, and the Company has reserved for future issuance, up to 1,397,333 shares of Common Stock (subject

 

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to an anti-dilution adjustment in the event of a stock split, re-capitalization, 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 closing price of the Common Stock on the date of grant. The Company uses 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 day of the grant. 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 must be in cash, which must be received by the Company prior to any shares being issued. Stock options granted to directors and officers as part of an employee employment contract vest after 2 years. Stock options granted to general employees as part of a loyalty program vest after three years. The Incentive Plan was approved by CEDC shareholders during the annual shareholders meeting on April 30, 2007 to replace the Company’s 1997 Stock Incentive Plan (the “Old Stock Incentive Plan”), which expired in November 2007. The Stock Incentive Plan will expire in November 2017. The terms and conditions of the Stock Incentive Plan are substantially similar to those of the Old Stock Incentive Plan.

Before January 1, 2006 CEDC, the holding company, realized net operating losses and therefore an excess tax benefit (windfall) resulting from the exercise of the awards and a related credit to Additional Paid-in Capital (APIC) of $2.2 million was not recorded in the Company’s books. The excess tax benefits and the credit to APIC for the windfall should not be recorded until the deduction reduces income taxes payable on the basis that cash tax savings have not occurred. The Company will recognize the windfall upon realization.

Comprehensive Income/(Loss)

Comprehensive income/(loss) is defined as all changes in equity during a period except those resulting from investments by owners and distributions to owners. Comprehensive income/(loss) includes net income/(loss) adjusted by, among other items, foreign currency translation adjustments. The translation gains/(losses) on the re-measurements from foreign currencies (primarily the Polish zloty and Russian ruble) to U.S. dollars are classified separately as a component of accumulated other comprehensive income included in stockholders’ equity.

As of December 31, 2009, the Polish zloty exchange rate used to translate the balance sheet strengthened compared to the exchange rate as of December 31, 2008, and as a result a gain to comprehensive income was recognized.

Segment Reporting

The Company primarily operates in one industry segment, the production and sale of alcoholic beverages. As a result of the Company’s expansion into new geographic areas, namely Russia, the Company has implemented a segmental approach to the business based upon geographic locations.

Net Income per Common Share

Net income per common share is calculated in accordance with ASC Topic 260 “Earnings per Share.” Basic earnings per share (EPS) are computed by dividing income available to common shareholders by the weighted- average number of common shares outstanding for the year. The stock options and warrants discussed in Note 12 were included in the computation of diluted earnings per common share (Note 17).

 

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Recently Issued Accounting Pronouncements

In August 2009, the Financial Accounting Standards Board (“FASB”) issued FASB Accounting Standards Update No. 2009-05, Fair Value Measurements and Disclosures (“ASU 2009-05”), which is effective for financial statements issued for interim and annual periods ending after August 2009. ASU 2009-05 amends FASB Accounting Standards Codification (“FASB ASC”) Topic 820-10 (“FASB ASC 820-10”). The update provides clarification on the techniques for measurement of fair value required of a reporting entity when a quoted price in an active market for an identical liability is not available. This update had no impact on the Company’s financial position, results of operations or cash flows.

In June 2009, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 168, The FASB Accounting Standards Codification )™ and the Hierarchy of Generally Accepted Accounting Principles—a replacement of FAS No. 162 (“SFAS No. 168”), which is effective for financial statements issued for interim and annual periods ending after September 15, 2009. SFAS No. 168 codified as ASC Topic 105-10 (“FASB ASC 105-10”). FASB ASC 105-10 identifies the sources of accounting principles and the framework for selecting principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with US GAAP (the GAAP hierarchy). This standard had no impact on the Company’s financial position, results of operations or cash flows.

In June 2009, the FASB issued ASC Topic 810, “Amendments to FASB Interpretation No. 46(R)” (“ASC 810”). ASC 810 is a revision to FIN 46(R) and changes how a company determines whether an entity should be consolidated when such entity is insufficiently capitalized or is not controlled by the company through voting (or similar rights). The determination of whether a company is required to consolidate an entity is based on, among other things, the entity’s purpose and design and the company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. ASC 810 retains the scope of FIN 46(R) but added entities previously considered qualifying special purpose entities, or QSPEs, since the concept of these entities is eliminated in ASC Topic 860. ASC 810 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2009. The Company is still in process of evaluating the potential impact of adoption of ASC 810 on its consolidated financial position and results of operations. Should the company determine that the requirements for consolidating the Whitehall Group are not met under ASC 810, the deconsolidation of this Group may result in a material impact on the presentation of the Company’s results of operations. Specifically the lines of revenues and costs before income before taxes, equity in net income from unconsolidated investments and non-controlling interest in subsidiaries would be reduced, however the final net income or loss attributable to CEDC would remain unchanged. Similarly the individual lines of the balance sheet will be affected however total equity would remain the same. The Company also does not expect any material impact on debt or other contractual obligations.

In May 2009, the FASB issued SFAS No. 165, Subsequent Events (“SFAS No. 165”), codified in FASB ASC Topic 855-10, which establishes accounting and disclosure standards for events that occur after the balance sheet date but before financial statements are issued or are available to be issued. It defines financial statements as available to be issued, requiring the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date, whether it be the date the financial statements were issued or the date they were available to be issued. FAS 165 is effective for our second quarter of 2009 and has not had a material impact on our Consolidated Financial Statements.

In April 2009, the FASB issued FASB Staff Position (“FSP”) No. SFAS 115-2 and SFAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (“FSP No. SFAS 115-2 and SFAS 124-2”), which is codified in FASB ASC Topic 320-10. FSP No. SFAS 115-2 and SFAS 124-2 provides guidance to

 

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determine whether the holder of an investment in a debt security for which changes in fair value are not regularly recognized in earnings should recognize a loss in earnings when the investment is impaired. This FSP also improves the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the consolidated financial statements. This guidance is effective for interim reporting periods ending after June 15, 2009. The adoption of FSP FAS 115-2 and FAS 124-2 did not have a material impact on our consolidated financial statements.

In April 2009, the FASB issued FSP No. SFAS 107-1 and Accounting Principles Board (“APB”) Opinion No. APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (“FSP No. SFAS 107-1 and APB 28-1”). FSP No. SFAS 107-1 and APB 28-1, which is codified in FASB ASC Topic 825-10-50, require disclosures about the fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. The Company adopted FSP No. SFAS 107-1 and APB 28-1 beginning April 1, 2009. This FSP had no impact on the Company’s financial position, results of operations or cash flows.

In April 2009, the FASB issued FSP No. SFAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (“FSP No. SFAS 157-4”). FSP No. SFAS 157-4, which is codified in FASB ASC Topics 820-10-35-51 and 820-10-50-2, provides additional guidance for estimating fair value and emphasizes that even if there has been a significant decrease in the volume and level of activity for the asset or liability and regardless of the valuation technique(s) used, the objective of a fair value measurement remains the same. The Company adopted FSP No. SFAS 157-4 beginning April 1, 2009. This FSP had no material impact on the Company’s financial position, results of operations or cash flows.

In December 2008, the FASB issued FSP No. SFAS 132(R)-1, Employers’ Disclosures about Postretirement Benefit Plan Assets, (“FSP No. SFAS 132(R)-1”) which is codified in FASB ASC Topic 715-20-50. FSP No. SFAS 132(R)-1 requires enhanced disclosures about the plan assets of a Company’s defined benefit pension and other postretirement plans intended to provide financial statement users with a greater understanding of: 1) how investment allocation decisions are made; 2) the major categories of plan assets; 3) the inputs and valuation techniques used to measure the fair value of plan assets; 4) the effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period; and 5) significant concentrations of risk within plan assets.

2. Acquisitions

Acquisitions made prior to December 31, 2008 were accounted for in accordance with SFAS No. 141, “Business Combinations.” Effective January 1, 2009, all business combinations are accounted for in accordance with FAS 141R that is codified as ASC Topic 805 “Business Combinations.”

The Parliament Acquisition

On March 11, 2008, the Company and certain of its affiliates entered into a Share Sale and Purchase Agreement and certain other agreements with White Horse Intervest Limited, a British Virgin Islands Company, and certain of White Horse’s affiliates, relating to the Company’s acquisition from White Horse of 85% of the share capital of Copecresto Enterprises Limited, a Cypriot company, (which we refer to as Parliament). In connection with this acquisition, the Company paid a consideration of approximately $180 million in cash and 2.2 million shares of common stock.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Amounts in tables expressed in thousands, except per share information

 

On September 22, 2009, the Company and certain of its affiliates and Seller entered into (i) an amendment to the Original SPA (the “Amendment”) and (ii) a Share Sale and Purchase Agreement (the “Minority Acquisition SPA”). Under the terms of the Amendment, certain post-closing obligations in the Original SPA regarding payment for certain assets were finalized in order to facilitate completion of the transactions contemplated by the Original SPA, in connection with the completion of the Company’s acquisition of Copecresto pursuant to the Minority Acquisition SPA. In connection with the Amendment, the Company was required to pay to Seller the remaining consideration for such assets of approximately $16.7 million The Company paid $9.9 million of that amount on October 30, 2009 and the remaining amount was paid on December 16, 2009.

Under the terms of the Minority Acquisition SPA, upon the closing thereof on September 22, 2009, the Company, through an affiliate, acquired the remaining 15% of the share capital of Copecresto from Seller for total cash consideration of $70,167,734. In addition, on September 25, 2009, in connection with the closing of the Minority Acquisition SPA, the Shareholders Agreement, dated March 13, 2008, by and among the Company, a subsidiary of the Company, Seller and Copecresto was terminated. The Minority Acquisition SPA contains certain customary representations, warranties and covenants for a transaction of this type.

Under requirements of ASC Topic 810-10 “Consolidation” a change in ownership interests that does not result in change of control is considered an equity transaction. The identifiable net assets remain unchanged and any difference between the amount by which the NCI is adjusted, and the fair value of the consideration paid is recognized directly in equity and attributed to the controlling interest. Thus we have recorded the 15% increase in ownership interests of Copecresto as a transaction within equity. As a result of this transaction, NCI in Copecresto decreased by $26.9 million together with decrease in Additional Paid In Capital of $43.3 million, which was offset by cash outflow of $70.2 million.

The Whitehall Acquisition

On May 23, 2008, the Company and certain of its affiliates, entered into, and closed upon, a Share Sale and Purchase Agreement and certain other agreements whereby the Company acquired shares representing 50% minus one vote of the voting power, and 75% of the economic interests, in the Whitehall Group. The Whitehall Group is a leading importer of premium spirits and wines in Russia. The aggregate consideration paid by the Company was $200 million, paid in cash at the closing. In addition, on October 21, 2008 the Company issued to the Seller 843,524 shares of its common stock, par value $0.01 per share.

On February 24, 2009, the Company and the seller amended the terms of the Stock Purchase Agreement governing the Whitehall acquisition to satisfy the Company’s obligations to the seller pursuant to a share price guarantee in the original Stock Purchase Agreement. Pursuant to the terms of this amendment, the Company paid to the seller $5,876,351 in cash, and issued to the seller 2,100,000 shares of its common stock, in settlement of a minimum share price guarantee by the Company. The Company also made an additional cash payment of $2,000,000 on March 15, 2009. The first portion of deferred payments already due under the original Stock Purchase Agreement amounting to €8,050,411 was settled August 4, 2009 and the remaining portion of €8,303,630 was paid on September 15, 2009. In consideration for these payments, the Company received an additional 375 Class B shares of Whitehall, which represents an increase in the Company’s economic stake from 75% to 80%.

The Company has consolidated the Whitehall Group as a business combination as of May 23, 2008, on the basis that the Whitehall Group is a Variable Interest Entity and the Company has been assessed as being the primary beneficiary. Included within the Whitehall Group is a 50/50 joint venture with Möet Hennessy. This

 

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Amounts in tables expressed in thousands, except per share information

 

joint venture is accounted for using the equity method and is recorded on the face of the balance sheet in investments with minority interest initially recorded at fair value on the face of the balance sheet. The current term of the joint venture is until June 2013 at which point Möet Hennessy will have the option to acquire the remaining shares of the entity.

Under requirements of ASC Topic 810-10 “Consolidation” a change in ownership interests that does not result in change of control is considered an equity transaction. The identifiable net assets remain unchanged and any difference between the amount by which the NCI is adjusted, and the fair value of the consideration paid is recognized directly in equity and attributed to the controlling interest. Thus we have recorded the 5% increase in ownership interests of Whitehall Group as transaction between equity and mezzanine equity. As a result of this transaction, NCI in Whitehall Group decreased by $6.7 million together with decrease in Additional Paid In Capital of $1.1 million, which was offset by cash outflow of $7.8 million.

In June 2009, the FASB issued ASC Topic 810, which changes how a company determines whether an entity should be consolidated. The adoption of this standard may impact the current treatment of the Whitehall Group by the Company and the Company is current assessing this treatment and potential impact on the financial statements. See “Recently Issued Accounting Pronouncements” for more detailed information on this topic.

The Russian Alcohol Acquisition

On July 9, 2008, the Company completed an investment with Lion Capital and certain of Lion Capital’s affiliates and certain other investors, pursuant to which the Company, Lion Capital and such other investors acquired all of the outstanding equity of Russian Alcohol. In connection with that investment, the Company acquired an indirect equity stake in Russian Alcohol of approximately 42%, and Lion Capital acquired substantially all of the remainder of the equity of Russian Alcohol. The agreements governing that investment gave the Company the right to acquire, and gave Lion Capital the right to require the Company to acquire, Lion Capital’s equity stake in Russian Alcohol (the “Prior Agreement”).

On April 24, 2009, the Company entered into new agreements with Lion Capital to replace the Prior Agreement, which will permit the Company, through a multi-stage equity purchase, to acquire over the next five years (including 2009) all of the equity interests in Russian Alcohol held by Lion Capital. As a result of these agreements, the Company has assessed Russian Alcohol as a variable interest entity, with the Company being the primary beneficiary. Pursuant to this change, the Company has begun to consolidate Russian Alcohol as of the second quarter of 2009 and recorded a non-controlling interest of 9.4% representing equity not held by the Company or Lion Capital. From the accounting perspective, the Company treated the acquisition of the Russian Alcohol equity interests held by Lion Capital as if this acquisition had happened on April 24, 2009. As of this date CEDC recorded at fair value all future payments due under these agreements as a liability. The total present value of deferred consideration as of April 24, 2009 amounted to $447.2 million and was determined using a 14.5% discount rate. The present value of the liability is amortized over the period of time ending on the date the last payment is made which is currently expected in 2013, with recognition of a non cash interest expense every quarter in the statement of operations. The discount amortization charge for the period from April 24, 2009 to December 31, 2009 amounted to $38.5 million.

On July 29, 2009, the Company entered into an agreement with Lion Capital, pursuant to which Lion/Rally Cayman 7 L.P., a Cayman Exempted Limited Partnership, of which the Company holds 100% of the economic interests and is a limited partner, acquired an additional 6% indirect equity interest in Russian Alcohol from

 

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certain minority investors in Russian Alcohol in exchange for $30,000,000 in cash funded by the Company. After giving effect to this acquisition, the Company holds approximately 58% of the equity interests in Russian Alcohol. In addition, on August 3, 2009, pursuant to the new agreements referenced above, we acquired additional indirect equity interests in Russian Alcohol giving us a total ownership interest of 59.8%.

On November 9, 2009, the Company entered into an agreement with Lion Capital and Kylemore International Invest Corp. (“Kylemore”), an indirect minority stockholder of Russian Alcohol, for the acquisition of Kylemore’s indirect equity interests in Russian Alcohol. On November 10, 2009, we issued to Kylemore 949,034 shares of our unregistered common stock, and Kylemore transferred all of its indirect equity interests in Russian Alcohol to Lion/Rally Cayman 6 (“Cayman 6”), a Cayman Islands investment vehicle through which we and Lion Capital own our interests in Russian Alcohol. As a result, the Company, Lion Capital and certain Co-Investors indirectly own 100% of the equity in Russian Alcohol, and our total indirect equity interest in Russian Alcohol increased to 62.25%. Pursuant to the agreement with Kylemore, on receipt of approval from the Russian Anti-Trust Authority (FAS) for our acquisition of control over Russian Alcohol, the Company paid Kylemore $5,000,000 on January 11, 2010, and will pay further $5,000,000 on February 1, 2011. Also pursuant to this agreement, Peter Levin, one of the original owners of Russian Alcohol, will continue to be involved in the Russian Alcohol business as a non-executive member of the Operating Board of Russian Alcohol and as Chairman of the Board of our Topaz distillery.

On December 9, 2009 we accelerated terms set up in the Option Agreement dated April 24, 2009 and completed the Lion Option and the Co-Investor Option, respectively, under the Co-Investor Option Agreement and the Lion Option Agreement, respectively and thereby purchased the remaining indirect equity interests in Cayman 6, less the sole voting share of Cayman 6, comprising the remaining equity interest in Russian Alcohol that was not owned by the Company, from affiliates of Lion Capital LLP (“Lion”).

In consideration of the Co-Investor Option, the Company made cash payments of $131,800,000 and €23,650,000 to Lion. In consideration of the Lion Option, the Company (1) made cash payments of $184,347,666 and €105,839,852 to Lion; (2) deposited in an escrow account the amount of $23,991,072 and €51,315,337, which was released and paid to Lion on January 11, 2010 upon receiving of antimonopoly clearances for the acquisition from the Russian Federal Antimonopoly Commission and the Antimonopoly Committee of the Ukraine; and (3) paid to Lion the additional amounts of (a) $2,375,354 and €5,080,727 on the Escrow Release Date and (b) undertook to pay $10,689,092 and €22,863,269 on June 1, 2010, or at the election of Lion, on any earlier date between April 20, 2010 and June 1, 2010. The Company used a portion of the proceeds from the offering of its common stock, completed November 18, 2009, and the offering of its Senior Secured Notes due 2016, completed December 2, 2009, in order to fund such cash payments.

On January 20, 2010, after the receipt of antimonopoly clearances for the acquisition from the Russian Federal Antimonopoly Commission, the Antimonopoly Committee of the Ukraine, the Company purchased the sole voting share of Lion/Rally Cayman 6 (“Cayman 6”) from an affiliate of Lion Capital LLP (“Lion”) and thereby acquired control of Russian Alcohol.

Starting from the second quarter of 2009, the Company began consolidating all profit and loss results for Russian Alcohol.

 

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Amounts in tables expressed in thousands, except per share information

 

The fair value of the net assets acquired in connection with the 2009 Russian Alcohol Acquisition as of the acquisition date (April 24, 2009) is:

 

     Russian
Alcohol
Group
 

ASSETS

  

Cash and cash equivalents

     154,276   

Accounts receivable

     147,196   

Inventory

     43,902   

Deferred tax asset

     35,184   

Taxes

     14   

Other current assets

     52,296   

Equipment

     105,238   

Intangibles, including Trademarks

     175,334   

Investments

     25   
        

Total Assets

   $ 713,465   
        

LIABILITIES

  

Trade payables

     42,895   

Short term borrowings

     44,368   

Deferred tax

     36,694   

Other short term liabilities

     111,416   

Long term borrowings

     386,907   

Long term accruals

     50,000   
        

Total Liabilities

   $ 672,280   
        

Net identifiable assets and liabilities

     41,185   

Goodwill on acquisition

     872,490   

Consideration paid, satisfied in cash

     13,500   

Consideration paid, satisfied in Notes

     110,639   

Fair value of previously held interest

     292,289   

Deferred consideration

     447,247   

Non-controlling interest

     50,000   
        

Cash (acquired)

   $ 154,276   
        

Net Cash Inflow

   ($ 140,776

The goodwill arising out of Russian Alcohol acquisition is attributable to the expansion of our sales and distribution platform in Russia that it provides to the Company as well as expected synergies to be utilized from consolidation of our Russian operations.

The Company recorded a provision for contingent consideration at fair value for $50 million as of the acquisition date. This consideration was settled in the three month period ended September 30, 2009 through a payment by the Company of $65 million, which included an additional $15 million in earn-out payments.

Resulting from the acquisition of Russian Alcohol, the Company recognized a one-time gain on re-measurement of previously held equity interest in the six month period ended June 30, 2009. The fair value of this gain amounts to $225.6 million.

 

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During the second quarter of 2009, Russian Alcohol made payments related to pre-acquisition tax penalties amounting to $28.8 million. These costs are to be reimbursed by the sellers and have been deducted from the loans payable to them.

The following table sets forth the unaudited pro forma results of operations of the Company for the twelve month periods ending December 31, 2009 and 2008. The unaudited pro forma results of operations give effect to the Company’s acquisitions as if they occurred on January 1, 2009 and 2008. The unaudited pro forma results of operations are presented after giving effect to certain adjustments for depreciation, amortization of deferred financing costs, interest expense on the acquisition financing, and related income tax effects. The unaudited pro forma results of operations are based upon currently available information and certain assumptions that the Company believes are reasonable under the circumstances. The unaudited pro forma results of operations do not purport to present what the Company’s results of operations would actually have been if the aforementioned transactions had in fact occurred on such date or at the beginning of the period indicated, nor do they project the Company’s financial position or results of operations at any future date or for any future period.

 

     Twelve months ended
December 31,
     2009    2008

Net sales

   $ 1,587,929    $ 2,227,660

Net income

   $ 47,063    $ 138,813

Net income per share data:

     

Basic earnings per share of common stock

   $ 0.88    $ 3.15

Diluted earnings per share of common stock

   $ 0.87    $ 3.15

3. Allowances for Doubtful Accounts

Changes in the allowance for doubtful accounts during each of the three years in the period ended December 31, were as follows:

 

     Year ended December 31,  
     2009     2008     2007  

Balance, beginning of year

   $ 22,155      $ 29,277      $ 24,354   

Effect of FX movement on opening balance

     3,170        (5,143     4,696   

Provision for bad debts—reported in statement of operations

     7,702        (748     (249

Charge-offs, net of recoveries

     (4,500     (1,814     476   

Change in allowance from purchase of subsidiaries

     27,563        583        —     
                        

Balance, end of year

   $ 56,090      $ 22,155      $ 29,277   
                        

The change in allowance from purchase of subsidiaries of $27.6 million, recorded for the year ended December 31, 2009, reflects the bad debt provision assessed on the opening balance sheet of Russian Alcohol at the time of acquisition.

 

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4. Property, plant and equipment

Property, plant and equipment, presented net of accumulated depreciation in the consolidated balance sheets, consists of:

 

     December 31,  
     2009     2008  

Land and buildings

   $ 120,623      $ 43,992   

Equipment

     129,653        59,119   

Motor vehicles

     29,670        18,782   

Motor vehicles under lease

     5,301        7,421   

Computer hardware and software

     23,446        20,447   
                

Total gross book value

     308,693        149,761   

Less—Accumulated depreciation

     (77,595     (57,540
                

Total

   $ 231,098      $ 92,221   
                

5. Goodwill

Goodwill, presented net of accumulated amortization in the consolidated balance sheets, consists of:

 

     December 31,  
     2009    2008  

Balance at January 1,

   $ 745,256    $ 577,282   

Impact of foreign exchange

     93,079      (165,276

Additional purchase price adjustments

     15,800      —     

Acquisition through business combinations

     872,490      333,250   
               

Balance at December 31,

   $ 1,726,625    $ 745,256   

In the fourth quarter of 2009 the Company adjusted the value of goodwill recognized on the acquisition of Russian Alcohol due to new information as noted below.

In April 2009, when CEDC restructured its buyout agreement for Russian Alcohol with Lion and the initial put/call structure was replaced with a series of option payments that transferred ownership (“Option Agreement”) of Russian Alcohol to CEDC over time, the management incentive program was also revised between Lion and its managers. At the time Lion communicated to CEDC that the cost of this incentive payment would be approximately $20 million. Therefore in the revised option agreement it was agreed that Russian Alcohol would fund the payment of up to $20 million and any payment over this would be covered directly by Lion. At that point in time CEDC viewed the payment of $20 million payable over the period of the Option Agreement as fixed and viewed this part of the effective purchase price of Russian Alcohol. However full information on this was not available at the time of the original PPA in April 2009, therefore this expense was not allocated to the PPA. Upon obtaining full clarity on this at year end, the Company believes it should have been originally allocated to goodwill and therefore the goodwill was increased for this amount less $4 million of deferred tax asset in the fourth quarter of 2009.

When CEDC revised the purchase structure of Russian Alcohol to accelerate the option payments and acquire the remaining amount on November 19, 2009, with final change of control taking place in January 2010, upon receipt of anti-trust approval, the payment of the Management Incentive program was also accelerated with the full amount of payment ($20 million) materializing in January 2010 upon the change of control to CEDC.

 

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Moreover the Company decreased the goodwill for the amount of $6.6 in the fourth quarter of 2009. This relates to change of deferred tax liability resulting from an error in the initial goodwill calculation.

6. Intangible Assets other than Goodwill

The major components of intangible assets are:

 

     December 31,
2009
    December 31,
2008
 

Non-amortizable intangible assets:

    

Trademarks

   $ 796,749      $ 563,689   

Impairment

   ($ 22,589     —     
                

Total

     774,160        563,689   

Amortizable intangible assets:

    

Trademarks

     5,783        5,568   

Customer relationships

     7,811        7,749   

Less accumulated amortization

     (8,926     (6,501

Total

     4,668        6,816   
                

Total intangible assets

   $ 778,828      $ 570,505   
                

Management considers trademarks that are indefinite-lived assets to have high or market-leader brand recognition within their market segments based on the length of time they have existed, the comparatively high volumes sold and their general market positions relative to other products in their respective market segments. These trademarks include Soplica, Zubrówka, Absolwent, Royal, Parliament, Green Mark, Zhuravli and the rights for Bols Vodka in Poland, Hungary and Russia. Taking the above into consideration, as well as the evidence provided by analyses of vodka products life cycles, market studies, competitive and environmental trends, management believes that these brands will generate cash flows for an indefinite period of time, and that the useful lives of these brands are indefinite. In accordance with ASC Topic 350-30, intangible assets with an indefinite life are not amortized but are reviewed at least annually for impairment.

Estimated aggregate future amortization expenses for intangible assets that have a definite life are as follows:

 

2010

   $ 1,353

2011

     1,282

2012

     1,184

2013

     1,169

2014 and above

     513
      

Total

   $ 5,501
      

 

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7. Equity method investments in affiliates

We hold the following investments in unconsolidated affiliates:

 

          Carrying Value
  

Type of affiliate

   December 31,
2009
   December 31,
2008

Moet Henessy JV

   Equity-Accounted Affiliate    $ 67,089    $ 77,918

Russian Alcohol

   Fully Consolidated Affiliate*      —        111,325
                
  

Total Carrying value

   $ 67,089    $ 189,243
                

 

* As described in Note 2, from the second quarter of 2009, the Company began consolidating Russian Alcohol as a business combination. Russian Alcohol was accounted for under the equity method in prior periods.

The Company has effective voting interest in Moet Hennessy JV of 25% and obtained full voting control over Russian Alcohol in January 2010.

The summarized financial information of investments are shown in the below table with the balance sheet financial information reflecting only the Moet Hennessy Joint Venture consolidated under the equity method as of December 31, 2009. The results from operations for the twelve months ended December 31, 2009 and twelve months ended December 31, 2008 include the results of the Moet Hennessy Joint Venture together with the results of Russian Alcohol that was consolidated under the equity method until April 24, 2009.

 

     Total
December 31, 2009
    Total
December 31, 2008
 

Current assets

   $ 66,994      $ 587,031   

Noncurrent assets

     382