Wineries and Retailers Speak on Congressional Hearing

FILED MARCH 19, 2010

Dear Client:

The sub-committee hearing yesterday certainly made waves in the industry, pitting wholesalers against producers. The purpose of the hearing, it seems, was to urge Congress to clarify their intent when it comes to state regulation of alcohol and the dormant Commerce Clause. Remember, the Commerce Clause (and Granholm's reading of it) says that states can't create laws which discriminate between in-state and out-of-state entities, despite the 21st Amendment which (theoretically at this point) gives states sovereign power over alcohol regulation. This difference in interpretation has put at risk self-distribution and franchise law carve-outs for craft brewers and wineries, wholesaler residency laws (anti-branch laws), out-of-state retailers shipping into states, among other common state regulations, and resulted in a number of lawsuits throughout the country. One of the major themes of the hearing was the possibility of Congress creating a federal exception for the states regarding alcohol regulations from the dormant Commerce Clause.

Advocates of direct shipping, namely wineries and wine retailers, believe states should NOT be exempt from the Commerce Clause, fearing it could jeopardize direct shipping and other initiatives. They view the hearing as a step by wholesalers to ultimately gain protection from Congress in each state. The National Beer Wholesalers Association (NBWA) has reportedly supported this hearing to help the odds of passing a federal bill which would reaffirm the power of alcohol regulation to the states (better for wholesalers, perhaps not so great for some producers). Although the Specialty Wine Retailers Association and the Wine Institute did not testify at the hearing, they issued statements after it concluded. Here are some highlights:

RETAILERS SPEAK: Specialty Wine Retailers Association executive director Tom Wark said the "hastily called" sub-committee hearing "amounted to congressional consideration of a bailout from competition for America's alcohol wholesalers who mistake competition, free trade and consumer rights for deregulation." He doesn't believe states should be immune from protectionist lawsuits. "There exists no justification to give states immunity from being sued for enacting and enforcing laws that exist solely to protect wholesalers from competition and to deny consumers access to any wines except the relatively small number of wines that wholesalers bring into the states." He also said "there is no deregulation of alcohol occurring in the states." Since wineries and retailers have been able to ship direct to consumers, "there has been no statement or testimony from any alcohol regulator or member of law enforcement that direct shipping has led to problems with minors accessing more alcohol."

SWRA will be submitting a statement for the record to the Subcommittee on Courts and Competition urging its members not to consider legislation that exempts states from lawsuits based on the Commerce Clause or exempt state alcohol regulations from federal anti-trust laws. "To do so would undoubtedly lead to immediate legislation repealing direct shipping laws and the enactment of legislation that discriminates against out-of-state wineries and retailers and profoundly restrict consumers' ability to purchase the wines they want."

WINERIES SPEAK: The Wine Institute began their statement by saying: "states' rights to regulate wine and alcohol granted by the 21st Amendment are not absolute," and pointed out a number of court decisions over the past 40 years that balance state authority with things like the Commerce Clause, Due Process and the First Amendment. "To protect their economic interests, the National Beer Wholesalers Association (NBWA) is asking Congress to grant states unlimited power to pass laws dealing with wine and alcohol. States have never had this power before and there should never be laws passed that grant license to a state to create and perpetuate an environment of discrimination and inequality."

They say that "state laws should encourage, rather than stifle, competition and any effort to control prices or distribution should not be immune from the Sherman Act and other antitrust principles. State-mandated monopolies and other anti-competitive provisions that deal with wine and alcohol should always be subject to antitrust review."

And there you have it. We'll let you know what, or if, anything comes of this hearing...

ANHEUSER-BUSCH SEEKS EXPEDITED RULING IN ILLINOIS

Ironically, on the same day that a Judicial sub-committee heard testimony on whether states should have relief from Commerce Clause claims when it comes to alcohol regulation, A-B has asked the federal court hearing their City Beverage case in Illinois to "schedule an expedited declaratory judgment hearing" on their Commerce Clause claim, they said in a motion. You'll recall that A-B was denied attempts to acquire its remaining stake in City Beverage and therefore own a major distributorship in Illinois - a move that wholesalers such as Wirtz Beverage and Southern Wine & Spirits are against, along with other brewers.

A-B goes on to write that, "although this case involves significant stakes" A-B says their Commerce Clause arguments are "straightforward" and that the "central and controlling question is whether Defendants' sudden pronouncement that the Illinois Liquor Control Act ...prohibits out-of state brewers from acting as distributors of beer, while permitting in-state brewers to do so, withstands constitutional scrutiny."

They say that the "question is clear-cut and must be answered in the negative because '[s]tate laws that discriminate against interstate commerce face 'a virtually per se rule of invalidity.'" A-B cites the Granholm decision "striking down pursuant to the dormant commerce clause alcoholic beverage laws that discriminate against out-of-state producers."

Also, A-B says the case is simple because Illinois "freely admit that the Liquor Control Act permits in-state beer producers to operate a distributorship but does not permit out-of-state beer producers to do the same. Therefore, the only conceivably open question is whether the law at issue here meets the very narrow exception to the "virtual[] per se rule of invalidity" by "advanc[ing] a legitimate local purpose that cannot be adequately served by reasonable nondiscriminatory alternatives'", citing Granholm. A-B says Illinois hasn't "even attempted to proffer a legitimate local purpose for this discrimination against out-of-state interests, but even if they were able to manufacture such a justification, it is extremely doubtful that they could meet this extraordinarily high standard."

But to get a declaratory judgment, A-B has to also prove that it will be substantially harmed. "A substantial transaction involving a large business with hundreds of employees already has been put on hold because of Defendants' Declaratory Ruling.....and, thus, is at great risk." A-B says it is "avoiding certain other business commitments, and other opportunities remain unexplored or already lost."

WHOLESALERS EXPECT SOME RECOVERY IN COMING MONTHS

UBS came out with its second US spirits wholesaler survey today, which covers 14% of all US spirits wholesalers. A key takeaway is that UBS believes premiumization will return once the economy improves, despite fears in the industry that trading up is out the window at least for the next several years. Wholesalers are not as confident but show improved optimism from the last survey in December. Both UBS and wholesalers expect that pricing will likely be slow to recover but that volumes will improve. Senior UBS analyst Kaumil Gajrawala believes "current volume trends are stable compared to 3 months ago, especially at the on-premise," although "price/mix remains a headwind." As a whole, wholesalers are still seeing trading down and increased promotional activity.

PRICE/MIX TO STABILIZE. More wholesalers expect price/mix to stabilize (not increase) over the next 3 months than they did before. In fact 48% of respondents are seeing more promo activity currently compared to this time last year. Forty percent of wholesalers expect decreasing price/mix, which is 6% lower than the previous survey.

When it comes to pricing, 60% of wholesalers expect it to be flat over the next 3 months, which is an improvement from the last survey. No one expects pricing to increase in the next 3 months.

VOLUMES EXPECTED TO NORMALIZE. Seventy-seven percent are seeing consumers purchase lower priced brands but they also expect volumes to stabilize or increase in the next 3 months. However, no wholesalers in the survey currently see consumers trading up.

INVENTORY LEVELS IMPROVED. Furthermore, 60% of wholesalers surveyed say inventory is "stable," compared to only 37% in the previous survey. However, 34% still see inventory levels decreasing which "may mean there are still some pockets of destocking for the market," said UBS.

A FEW COMMON THEMES popped up in wholesaler commentary, where 10 of the 35 respondents shared their views. Not surprisingly, there is concern about trading down and some worry that trading down from premium brands to the mid-priced brands "may stick." Spirits wholesalers also believe that employment must improve before the spirits industry improves. They worry that future price increases and reduced promotional activity would come too soon.

UBS echoed the sentiment that the unemployment rate is "the key issue to watch for the US spirits market," assuming employed Americans will resume spending habits." UBS expects consumers to return to their preferred brands over cheap brands once the job market improves although "we do share some concern about premium vodka as a category, the other categories should see a return to positive mix over time."

UBS forecasts 1% volume growth and 0.5% price/mix in 2010, with more growth in the second half. In the mid-term, they believe the US spirits market can return to 2% volume and 2% price/mix growth.

B-F UPGRADED. The firm also upgraded Brown-Forman shares to "neutral" because "we believe fundamentals going forward are likely to improve and the valuation premium vs. its peers has narrowed." For one, B-F's brands had stabilized in Q3, including Jack Daniel's which saw improved trends on-premise in the US.

INDUSTRY LOOSES LEGEND FESS PARKER

Fess Parker, a beloved member of the Santa Barbra wine industry, passed away March 18 at his home in the Santa Ynez Valley. He was 85 years old. Fess was born and raised in Texas and served in the US Navy during WWII. After returning from the war and graduating from the University of Texas, Fess moved to California and was cast in Walt Disney's "Davy Crockett, King of the Wild Frontier" in the early 50's. He followed that movie with the prequel "Davy Crockett and the River Boat Pirates" as well as The Great Locomotive Chase" and "Smoky."

In 1989 Fess and his family created The Fess Parker Winery, which is a popular destination on the Foxen Canyon wine trail in Los Olivos, CA.

He is survived by his wife Marcella, with whom he recently celebrated their 50th wedding anniversary, along with their son Eli and daughter Ashley, as well as 11 grandchildren and one great grandchild. We give our condolences to his friends and family.


Until Monday, Megan

"Happiness is when what you think, what you say, and what you do are in harmony."
Mahatma Gandhi

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