A Talk with Patron Spirits

FILED JANUARY 31, 2012

Dear Client:

The biggest revelation from DISCUS' annual industry review yesterday , in our mind, was the share factor. New product innovations, more advertising and increased popularity among millennials helped spirits take another three-tenths (0.3) of a share point from beer in 2011, reaching 33.6% of the total beverage alcohol market. Since 2000, spirits has taken about 5 points of market share, and the industry doesn't plan on stopping there. DISCUS is looking, long term, for spirits to get back to its heyday in the mid-1970s high of 41% market share of ethanol . Barring any unforeseeable events, "we're confident in our ability to continue to grow," said chief Peter Cressy.

Also notable is the fact that total distilled spirits revenue growth in 2011 came largely from super-premiums, which generated $377 million. So clearly premiumization is in play.

After the briefing we caught up with Patron Spirits coo John McDonnell, who gave us his thoughts on the results and also talked about the company's performance last year. The latest development from Patron is its new and first XO Coffee extension - Patron XO Cafe Dark Cocoa Coffee Liqueur. Here's what else John had to say, dear reader, in our fly on the wall interview:

WINE & SPIRITS DAILY: What are your thoughts on the briefing?

JOHN MCDONNELL: I think it's good. This is the early numbers, so if things go the way I think they are going to go then they might post slightly higher.

WSD: What do you think about pricing trends for the industry in 2012?

JOHN: I think the industry is going to do very well in 2012 but it all goes back to what they were doing to support their brands in the tough times. The fact that the ultra-premium category was up 8.9% underscores what I've been saying for the last 3 years. If you can support your brands in tough times, by the end they will come back faster than the total industry. The ultra-premium category grew 3.5 times higher than the total industry.

WSD: What has been your experience with the on-premise lately? Are you seeing things improve?

JOHN: It is without question, I'm seeing things improving. When you read the analyst outlook, fine dining is coming back. Revenue has come back almost to the pre-recession levels in restaurants. I can tell you this from personal experience. I spend most of my time in the major walking cities: Boston, New York, Chicago, San Francisco. Fine dining establishments are jam packed every night, so I'm extremely bullish that is going to continue.

WSD: How was 2011 at Patron Spirits?

JOHN: Total portfolio we were up 7.5% in volume over 2010. Patron XO Coffee was up over 20%. Every single brand in our portfolio grew last year as it has every year despite the economic downturn. We see no reason that won't continue for the foreseeable future. We have high quality brands, all hand made. We deliver on our brand promise. We support the brands with superior advertising. That's just the recipe for success.

WSD: What are some initiatives this year to help continue that growth?

JOHN: One of the things we're doing is we've increased our advertising budget this year versus the previous year. Also, our advertising mix is slightly different. Five years ago we spent 1% of our advertising spend on digital/social media. This year it's going to be over 10%. The numbers and response we're getting is very good. We're spending money on all our products - the tequila, vodka, the Patron coffee liquor and Pyrat.

WSD: Since Patron XO is doing so well, is it going to get an increased level of attention from the company?

JOHN: We're launching a new flavor, Patron XO Cafe Dark Cocoa, in the next couple of weeks. In terms of volume, Patron Silver leads the pack. But in terms of percentage growth, Patron XO Cafe is the fastest growing.

WSD: How is Ultimat doing in that luxury vodka category? It's a tough category, isn't it?

JOHN: It is a tough category. We grew 5% last year. Trust me, we would like more growth, but 5% without discounting makes that 5% number look even better. A lot of the other super/ultra-premium vodkas have slashed their prices and we haven't followed. We've maintained that price positioning just like we always have with Patron. We're not going to diminish our brand equity for short-term volume gains.

WSD: Is Pyrat benefitting from the fact that the super-premium rum category is doing well?

JOHN: Yeah, and I think Pyrat is a major contributor to the success of the super-premium rum category. What surprises me about Pyrat is consumers are discovering this brand on their own. This isn't a case of US marketing. Yes we have some social media activities, but we're allowing people to just experiment. We do tastings with it. And it's growing not just in the United States. We have pockets in Western Europe where the brand is doing extremely well. So I'm just really excited about the future.

Our international business is growing off the charts. In fact, our first order of Patron XO Cafe is on the water headed for China. It's exciting, especially with the growth of millionaires in China.

WSD: On another note, have you thought about entering some of these other fast growing categories, like Irish Whiskey for example?

JOHN: We're always looking to expand or come out with different brands, but I don't want to comment on a specific brand or category because the last time I did that I was deluged with people trying to sell me this or that [laughs]. So I learned my lesson.

WSD: A number of new competitors have entered the high-end tequila business in recent years. Does that make you nervous?

JOHN: No because it ends up growing the whole category, so the more people that come into the category the better for everybody. We're not going to change what's brought us to the party.

WSD: How will privatization in Washington affect your company?

JOHN: Obviously we're going to have to adjust our route to market because the citizens of Washington State decided to vote for privatization. We're going to be very interested to watch how the market develops. How will the shelf prices ultimately come out on all the brands? Will the size restrictions hold up? So I think it is very much a wait and see approach right now.

WSD: Is it pretty chaotic in the state right now or is it going relatively smoothly?

JOHN: I think the state of Washington has done a very good job of managing the transition process. Obviously right after the initiative passed there were a lot of questions and it took time to get answers to the questions, but I think that would happen in any industry or situation where the change is so dramatic. We had a contingency plan in place, so now we're just rolling with our client based on the passage and the legislation.

WSD: Who are you with in Washington?

JOHN: Southern Wine & Spirits.

WSD: Any final thoughts?

JOHN: The one comment I would make is that the millennial generation makes up 70-plus million consumers. Most of them have already reached legal drinking age, and they're starting to show a preference for spirits over beer. So I think the outlook moving forward is extremely bright for spirits and will continue to take share for beer . There are many factors that are breaking for spirits now. One of which we do not talk about enough is the science. The Centers for Disease Control publically stated that there are 4 elements for a healthy lifestyle, which includes moderate consumption of alcohol. Also, the nutrition guidelines published by the government stated that 12 ounces of beer is equal to 5 ounces of wine, which is equal to 1.5 ounces of distilled spirits. I think that the millennial generation understands that far better than the baby boomer generation and even generation Xers because it is part of the cultural they've grown up with. I think that the millennials might drink a craft beer tonight; tomorrow they're going to a vodka and the next night a tequila. I think it's all part of their repertoire.

WSD: Thank you for your time.

BEAM SIGNS WITH SOUTHERN IN WASHINGTON

Beam Inc. is the latest company to announce that it is making Southern Wine & Spirits its exclusive distributor in the state of Washington, where Southern has served as its broker since 2010. Beam is partnered with Southern in 29 states, making it Beam's single largest distribution partner. As part of the agreement, Southern will utilize a focused sales division to distribute Beam's leading brands: Jim Beam, Red Stag, Hornitos, Canadian Club, Skinnygirl, Courvoisier, Maker's Mark, Laphroaig, Kilbeggan, Cruzan and DeKuyper. The agreement takes effect March 1 for the on-premise and June 1 for the off-premise.

Just yesterday, Pernod announced it had signed with Southern in Washington, where it was their broker before privatization. Earlier this month Sidney Frank said it was leaving Young's Market for Southern in the state, joining the likes of WJ Deutsch and Ascentia Wine Estates. And don't forget that Diageo and Moet Hennessy also signed with Southern in the Pacific Northwest, which includes Washington. So it's likely we'll see more such agreements in the coming days.

WSD BRIEFS:

HOOD RIVERS DIST. IS LAUNCHING SinFire Cinnamon Whisky in order to join the flavored whisky craze. "Flavored whisky continues to be a growing category in the spirits market, and our experience and success with Canadian whiskies makes this a natural endeavor for us," said Ronald Dodge, Hood River Distillers president. "With the development of SinFire Cinnamon Whisky, our goal is to offer our distributors, on and off-premise partners a great-tasting, flavored whisky, at a great value."

VUQO VODKA IS NOW DISTRIBUTED IN CHICAGO through MidwestWine & Spirits, Inc. VuQo plans on targeting young (21-35) consumers by driving on-premise initiatives supported by off-premise programs. "Chicago has been on our target list of key markets we've aggressively pursued as part of our plan to grow VuQo into a worldwide brand," said Rich Cabael, founder and chief of VuQo.

WINERIES TAKE STEPS TO END SWEEPSTAKES BAN in California. For the last 14 years California has had a ban on sweepstakes and contests from alcoholic beverage makers, but a new bill proposing to do away with the ban is moving through the state legislature, reported the Napa Valley Register. The bill is co-sponsored by two wine trade groups and written by Senator Alex Padilla. Although opposition to the bill has said it will increase alcohol consumption, Nancy Light of the Wine Institute claimed the bill is to help wineries of all sizes build brand loyalty and recognition not increase consumption. "We don't have large advertising budgets. We do have people who are really passionate about what they do," said Nancy.

SOUTHERN APPOINTS FELIX WILLIAMS VP OF STRATEGIC ACCOUNTS. William has over 30 years of sales, marketing account management and executive experience at Gold Coast Beverage Distributors, Diageo and Southern in addition to national accounts like Publix. In the newly-created position William will report directly to George Fisher, svp of national accounts off-premise. "Felix's experience in the off-premise and his long history with Publix makes him perfectly suited for this new, strategic role at Southern," said Kevin Fennessey svp, sales & marketing.

Until tomorrow, Megan

"We are inclined to believe those whom we do not know because they have never deceived us."
Samuel Johnson

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