United Spirits Ltd

A. INDUSTRY OVERVIEW:

Alcoholic Beverages have been a part of Indian folklore, with ‘Somras’ beingthe nectar to the Gods in ancient India. However, the industry as we know it today cameinto being during the British Raj with the establishment of a number of trading companiesto import and supply Western spirits to the British troops and the establishment of a fewmanufacturing facilities to produce similar beverages in India.

The industry today is a combination of branded liquors across multiple price points anda commodity space operating at the lowest price point in the market. Locally producedproducts like Indian Made Foreign Liquor (IMFL), Beer and Wine operate in the brandedspace, apart from imported Bottled In Origin (BIO) products.

The global spirits industry is estimated at over 2 billion cases - with the Indianindustry accounting for about 12% at 236 mio cases.

Your Company is by far, the lead player in India with sales in excess of 100 mio casesand is currently ranked as the world’s Second largest distilled spirits marketeer byvolume. The Indian spirits industry has grown at a CAGR of 14% over the last 5 years,while USL has out performed the market with growth of 20% during the same period.

The Indian spirits industry is predominantly a ‘browns’ market with Whisky,Rum and Brandy being the prominent flavours and White Spirits (Gin & Vodka) havingonly 5% share. This is contrary to International trends, where ‘Whites’ have apredominant presence.

With a large and growing number of youth coming into the legal drinking age category,the outlook for the industry is buoyant. In sharp contrast to countries like the USA andChina which have an ageing population, and have passed the ‘demographic window’,India is still comparatively ‘young’ with over half the 1.2 billion populationunder 25 years of age. The increasing trend of urbanization and exposure to global lifestyles will further accelerate growth.

B. REGULATORY ENVIRONMENT:

The Constitution of India places the regulation and taxation of alcoholic beverages inthe domain of the State rather than of the Federal Government. Even though the FederalGovernment is entrusted with the authority to licence greenfield manufacturing units andlevy duties on imports, all other activities related to this industry like production,sale, stocking and taxation are controlled by the State Government. Your Company with itspan India presence operates in 28+ markets, each with its differing characteristics andits own labyrinth of regulations, policies and taxes.

The proposed GST regime could have played a part in smoothening Inter-State trade andcommerce but with the States reluctant to give up their financial autonomy, particularlytheir control on the alcoholic beverages industry, a common alcoholic beverage market forIndia still seems a distant dream.

C. BUSINESS ANALYSIS:

During fiscal 2010, costs of Extra Neutral Alcohol (ENA), the company’s primaryingredient, saw a step-up from the average price of the previous fiscal. However, on thepositive side, prices during the year remained by and large flat and your Company did notexperience the spikes witnessed during the previous fiscal. Concious initiatives likelong-term contracts, switching between alternative feedstock like grain and molasses andcapitalizing on the increased availability of molasses during the 2009-10 crushing seasonhelped your Company to reduce the impact of high molasses/ENA prices.

The reduction in Central excise duties introduced as a fiscal relief measure by theGovt. during 2009-10 has brought about some savings in the cost of packaging materials. Aconstant review of brand-wise profitability helped to ensure that sales of low-end brandswere undertaken only on a very selective basis and on sound economic justification.Consequently, while main-line products added on 10.2 mio cases during fiscal 2010, thelow-end products added on only 1.7 mio cases in sales. However, with the sales of the mainline brands at 91% of the total sales, it will be imperative for your Company to focus onprofitable growth even if it is at the lower end of the market.

Sales of your Company’s brands grew to 100.2 Million cases, an increase of 14%over the 88.3 mio cases of the previous fiscal. Together with the brands of theinternational subsidiaries, the sales volume crossed 102 Million cases.

D. MARKETING:

The McDowell’s No.1 range of alcoholic beverages, comprising whisky, brandy andrum, ended fiscal 2010 with sales of 35.7 mio cases, up 13% from the 31.5 mio cases of theprevious fiscal, thereby retaining its pride of place as the largest umbrella brand inalcoholic beverages.

No.1 McDowell’s Whisky occupies the 3rd spot internationally in the whiskyrankings. McDowell’s No.1 Brandy continues to be the largest selling brandy in theworld with sales of 9.8 mio cases. McDowell’s No.1 Celebration Rum has far out soldits competition in India with sales of 12.2 mio cases and is currently ranked as the 3rdlargest rum in the world.

Bagpiper Whisky ended the year in the numero-uno position as the largest whisky in theworld, with sales of over 16 mio cases.

During the year your Company added on its 20th Millionaire (a brand that sells morethan a million cases in a fiscal year) in Bagpiper Rum. Your Company has now 3 brands thatsell over 10 mio cases each in addition to two that sell between 5 and 10 mio cases eachand every fiscal year.

Your company believes in giving the consumer a better experience and to this end, hasconstantly upgraded both the packaging and the blends of its brands. During the year thecompany introduced the Black Dog 18-Year Old Whisky – the packaging and blend haveboth received outstanding reviews from consumers.

The Company’s leading brands and key markets have contributed significantly to thesales growth. In order to economically source the ever-growing volumes, your company hastied up additional capacities through new contract manufacturing arrangements wherever itsown capacities have been insufficient to meet the demand.

Sales of the company’s overseas subsidiaries viz., Whyte & Mackay, BouvetLadubay and Liquidity Inc. have registered good growth in international markets as also inthe Indian market where they have been launched through the USL network. Whyte &Mackay Special, a mid-range Scotch, was launched in the Indian market as a Bottled inIndia product to very favourable response.

E. RISKS & CONCERNS, OPPORTUNITIES & THREATS:

A favourable demographic situation, increasing prosperity and disposable income coupledwith attitudinal changes towards consumption indicate strong and sustained demand for manyyears ahead. The ‘feel good’ factor among young Indians translates into steadyup-trading. The Company has witnessed double digits growth in the 1st line range ofproducts. This trend is expected to continue. There is a clearly visible, though slowprocess of deregulation taking place and over time it is expected that these will resultin increased retail penetration as also elimination of several infructuous regulationsthat add to the costs of doing business.

The Alcoholic Beverages industry is the favourite whipping boy of Governments, bothCentral & State, when they need to balance their budgets. As a result, the industrysuffers from the twin impact of over-regulation and excessive taxation. About 55-60% ofthe street price of a bottle of alcohol goes to the State and local Governments by way oftaxes and duties.

The unreasonable levels of taxation show no sign of abatement and continue to impedeprofitability despite continuing growth in market demand.

During fiscal 2010, shareholder communication had consistently referred to the sharprise in the prices of the Company’s key inputs viz., Molasses/Spirit as a result ofreduced acreage under sugarcane cultivation, unreasonable support prices fixed by localGovernments and increase in fuel costs. The runaway inflation in the rupee-dollar parityas also in the price of oil in the previous fiscal impacted both spirit and glass prices.

An oligopolistic situation in the glass industry ensured that when international pricesof oil came down, the price increase that was granted to the suppliers of glass containerswas not fully rolled back. However, excise duty concessions by the Federal Govt. in twotranches in December 2008 and February 2009 helped mitigate the situation somewhat.

In order to capitalize on an emerging segment in the alcoholic beverages space viz.wines, your Company had, in 2006, acquired M/s. Bouvet Ladubay SA, France and in fiscal2007 invested in a subsidiary M/s. Four Seasons Wines Limited. The latter company has setup a state-of-the-art winery near Baramati in Maharashtra with a capacity to produce onemillion bottles per annum. Two brands, Zinzi (Red & White) and Four Seasons (which isnow progressively available in 9 varietals) are being produced at this winery.

Increased awareness through exposure gained from the media as also from global travelcoupled with increased consumer spending has pushed up the sales at the premium end of themarket. Through a well-balanced portfolio, both domestic and international, your Companyis poised to drive significant advantages from sales of products from the Whyte &Mackay stable using the Bottled In Origin (BIO) and Bottled In India (BII) routes.

The hardening of scotch prices owing to reduced worldwide availability of matured maltof the required vintage has boosted business prospects at Whyte & Mackay. The Companyis also focusing its branded spirits activity on select geographies including travelretail as against an earlier strategy that attempted a presence in every market.

F. OUTLOOK:

A substantial portion of the Company’s sales are to monopoly distribution agenciesowned by State Governments. Consequently price increases, even to negate inflation, aredifficult to come by.

During fiscal 2010, the buying agency in the state of Andhra Pradesh granted a priceincrease after a long gap of 7 years. This has improved profitability in this largemarket. USL's leadership status across all States helps in securing price increses in someor other states.

Your Company continues its efforts to shore up profitability through a judicious blendof price increases, premiumisation in sales and cost control.

G. INTERNAL CONTROL SYSTEM:

The company has a robust system of internal control which has been incorporated in theenterprise-wide SAP system.

Additional checks of the Company’s systems are carried out by the independentauditors as also by the Company’s own Operations Review team and by the UBGroup’s Internal Audit Department.

H. INTERNATIONAL OPERATIONS:

The acquisition of Whyte & Mackay, the 4th largest producer of Scotch in the world,in fiscal 2008 has provided your Company with a perennial use of Scotch for use in theblends of its IMFL brands. Additionally, it has provided your Company with access to alarge stable of well-known brands to cater to the demand of the constantly up-tradingIndian consumer. Local bottling of these brands is also being undertaken according to acarefully calibrated plan.

Based on a review of the operations of Whyte & Mackay, a strategic plan has beenput in place to expand its share of the global branded Scotch whisky market as also to tapthe huge India growth potential in addition to that of other emerging markets. Thehitherto large business area of bulk Scotch will be focused on servicing growth in India.Whyte & Mackay would also tap opportunities in private labels in the key markets ofEurope.

Bouvet Ladubay’s expansion in capacity to 8 million bottles per annum has beencompleted. Its products continue to grow in the traditional markets of Europe and NorthAmerica. The expertise available within M/s.Bouvet Ladubay has been successfully used inthe establishment of India’s largest, and state-of-the-art, winery under yourCompany’s subsidiary Four Seasons Wines Limited at Baramati, Maharashtra.

I. HUMAN RESOURCES:

The Company’s human capital is now in excess of 7,000 employees, including factoryworkmen. There has been no loss of production at any of the manufacturing facilities dueto industrial unrest. The HR Dept. is geared to lend its support to the effort to make theCompany a ‘employer of choice’ in the Indian market place.

J. FORWARD LOOKING STATEMENTS:

This Report contains forward-looking statements that involve risks and uncertainties.Your Company undertakes no obligation to publicly update or revise any forward-lookingstatements, whether as a result of new information, future events, or otherwise. Actualresults, performances or achievements could differ materially from these expressed orimplied in such forward-looking statements. Readers are cautioned not to place unduereliance on these forward-looking statements that speak only as of their dates. ThisReport should be read in conjunction with the financial statements included herein and thenotes thereto.