Virginia ABC Overview of Operations and Budget Travis

Virginia ABC Overview of Operations and Budget Travis G. Hill, CEO Virginia ABC 1

Virginia Alcoholic Beverage Control Act Virginia Code Title 4. 1 - Creates the Department of Alcoholic Beverage Control…and now the Alcoholic Beverage Control Authority • • During 2018 Virginia ABC will transition from a Department to an Authority ABC Authority – 5 part-time members replacing 3 full-time members, still appointed by the Governor – Chair designated by the Governor – Receive salaries set in Code – equivalent to that of a member of the House of Delegates (chair receives compensation of a Senator) – CEO appointed by the Governor, responsible for operations of the Authority • Authority continues to function as retailer and regulator – Operate a retail organization – sole distributor and retailer (subject to a few exceptions) – Regulate the alcoholic beverage industry • • • Manufacturers Wholesalers Retailers

Virginia ABC Operations

Virginia - State. Ways Best Control State 2015

Aspects of Control State Model • Powers of Virginia ABC are expansive – Sole retailer of spirits – 4. 1 -103 and 119 • Distillery stores are private businesses operating as agents to Virginia ABC – Control of retail operations - § 4. 1 -119 • • Location of stores Product selection Product pricing – “reasonable markup” Product promotion – Local Referenda still in play - § 4. 1 -121 thru 124

Current State of the Control State Operating Expense • FY 2017: $637. 0 million • FY 2017 Operating expenses include: alcohol - 70. 8%, personnel - 17. 0%, retail occupancy - 4. 9%, and contractual (VITA, freight) - 5. 5% Employee Numbers • ABC employees 3, 794 full-time and part-time employees • 1, 110 full-time • 2, 684 part-time (increased by 556 in FY 2013 due to 29 hour cap) Mission Critical Statistics • • • FY 2017 Gross Sales of $940. 1 million (up 4. 7%) FY 2017 Profits of $172. 9 million (up 4. 7%) Retail Licenses: 19, 190 (up 1. 3%) Total Cases shipped to ABC stores: 4, 866, 666 (up 3. 62%) ABC store underage sales compliance – 99% Licensee underage sales compliance – 90%

Retail Operations • 370 Stores – open 362 days per year • May also sell mixers, garnishes, Virginia is For Lovers merchandise and Virginia Wine • Carry over 4, 000 distinct products • Operate 300, 000 square foot warehouse, shipping almost 5 million cases per year – $ 37. 9 million Bailment Inventory – $ 70. 0 million Store Inventory – $107. 9 Total Inventory

Historical Sales Growth ABC Profits and Number of Stores FY 2005 -FY 2017 Profits $200. 0 No. of Stores Number of ABC Stores 400 $180. 0 350 $160. 0 300 $140. 0 250 $120. 0 $100. 0 200 $80. 0 150 $60. 0 100 $40. 0 50 $20. 0 $0. 0 0 2005 2006 2007 2008 2009 2010 2011 2012 Fiscal Year 2013 2014 2015 2016 2017

Licensing and Enforcement • Bureau of Law Enforcement – Fully sworn and accredited law enforcement agency • Enforces Title 4. 1 and all criminal laws of the Commonwealth – 104 employees • 88 sworn agents in 9 field offices – Field agents focus on retail and banquet license investigations – Compliance agents handle wholesale and manufacturer licenses • 22 civilian staff in Licensing and Records Management – Almost 19, 000 retail licensees – 24, 000 one-day banquet licenses – Activities include site inspections, application investigations, covert observations, planned operations and criminal investigations • Hearings Division – Adjudicates almost 500 cases annually – Most frequent cases involved underage sales and mixed beverage ratio (§ 4. 1 -114)

Taxes and Revenue • Spirits Excise Tax – § 4. 1 -235 – 20% of price charged • Wine Excise Tax – § 4. 1 -234 – 40 cents per liter • Malt Beverage Excise Tax – § 4. 1 -236 – Tax rates vary by volume of container

Contributions to Commonwealth Last 6 Years Total $2. 4 B FY 2017 represents a $15. 2 million increase over FY 2016 Dollars in Millions Revenue Source FY 2017 FY 2016 FY 2015 FY 2014 FY 2013 FY 2012 ABC profit transfers $171. 2 $164. 9 $152. 0 $140. 0 $134. 6 $132. 0 State taxes $154. 4 $147. 8 $139. 8 $132. 0 $126. 8 $121. 0 General sales tax $43. 3 $41. 3 $39. 2 $36. 9 $31. 3 $29. 6 Wine liter tax $36. 8 $36. 2 $35. 2 $34. 6 $34. 4 $33. 5 Malt beverage tax $42. 8 $43. 2 $42. 9 $43. 3 $42. 8 $43. 7 Total $448. 6 $433. 4 $409. 3 $386. 9 $369. 9 $359. 7

Profit Forecast

Financial Forecast – Revenue (Sales) Sales Forecast – 4. 42% Increase in FY 2018 Growing to 4. 6% in FY 2020 • • Industry Growth Rates are projected at 4. 0% for Fiscal Years 2018 – 2021 $3. 6 M of Credit Card Chargeback Indemnification in FY 2017 • • Forecast Includes Adjustments for Changes in the Number of Fridays & Saturdays vs. Sunday through Thursday (Calendar Impacts) FY 2017 Additional Hour on Sunday Sales • • FY 2017 Growth adjusted from 4. 7% to 4. 3% Indemnification ended after 1 st Qtr. FY 2018 Diminishing Impact in Future Years (13. 1% Growth in FY 2017, Increased by $7. 0 M) First Sunday with the Extra Hour was July 3 rd (Unusually High Due to Holiday) Timing of Holidays (Example: Christmas Eve & New Year’s Eve are on Sunday) YTD Sales are within 0. 1% of Forecast

Financial Forecast – Cost of Goods Sold (As a Percentage of Sales) • Cost of Goods Sold – Trend analysis has shown a slight decline from 48. 54% to 48. 08%, which amounts to $4. 8 million added to the profit forecast. This is driven by multiple factors: • • Customer Product Selection VA ABC Price Increase Eliminated QPR’s (Quarterly Price Reductions) Vendor Discount Allowances • Lower Shelf Price • Vendor Pays VA ABC for Lost Profit (Discount) 50. 0% 49. 0% 48. 0% 47. 0% 46. 0% 45. 0% FY 2015 FY 2016 FY 2017

Financial Forecast – FY 2018 Expenses Cost Increase Drivers: • • • 3% Compensation Increase New Stores IT Staffing (Backfills) Enforcement Staffing (Backfills) 8. 7% Healthcare Cost Increase Store Growth (Demand Driven Store Staffing) Clerk Positions Credit Card Fees Rent Escalation Freight Volume Increases (Sales) VITA Rate Increases Cost Decrease Drivers: • Policy & Procedure Change • Capitalization of New Store Shelving Costs • Information Technology – Infrastructure Projects • • • IT Labor Costs – Move to Work in Progress Investments in the Future (New to ABC) Capitalized Upon Project Completion

Depreciation: • Cost is spread over life of the asset Cash Basis of Accounting • • $15 M Project – Total impact is immediate Entire amount is expensed in the year the money is spent • Accrual Basis of Accounting (ABC) • • $15 M Project – Cost is spread over life of the asset Computer System with a life of 5 years – Profits are only impacted by $3 M per year. Profit Impact Cash Basis 190 180 170 160 150 140 No Depreciation 2014 2015 2016 2017 2018 2019 Accrual Basis 195 185 175 165 155 145 Before Depreciation After Depreciation 2014 2015 2016 2017 2018 2019

Financial Forecast – P & L FY 2018 Budget Book Requirement = $174 million ($104 M Profit Transfer + $70 M Miscellaneous Transfers)

Operating Budget Items

Budget Proposals Request FY 2019 FY 2020 Description Cost of Goods Sold $20. 1 $54. 9 Based on projected sales increase of 4. 42% per year. Point of Sale/Sales Audit $7. 7 Initiates replacement of the point of sale system and supported hardware. Transition from VITA email and Share. Point Services $0. 7 $0. 6 Funds ABC’s transition from VITA email and collaboration services as an Authority Positions for new and high-performing stores $2. 8 $5. 7 Adds 19 positions in first year and 38 in the second year to staff new stores and high volume sales stores PT to FT employee conversion $0. 5 $1. 0 Adds 25 full time positions each year to replace current part-time positions Enforcement Activities $1. 9 Provides additional enforcement operations funded by revenue generated from license fee increases All NGF funds; represented in millions

Point of Sale/Sales Audit • Entirety of ABC’s Point of Sale and Sales Audit System end of life in two years – ABC must replace over 1, 000 “lanes” of equipment and 400 store servers • Extending current life not feasible – – Higher costs incurred with extended life contracts Higher failure rates Shortage of equipment – delay or prevent store openings Non-compliant with security standards – jeopardizes ability to take credit card payment (60% of sales) • New system gives modern retailing opportunities – Multi-channel sales (ecommerce) – Real-time inventory – Customer programs – loyalty, coupons, mobile payment, etc.

Email and Share. Point Transition • ABC shifting to Office 365 rather than transition with Commonwealth to Google g-mail • Moving to Office 365 enables ABC to: – Gain access to technologies needed for future projects at no additional cost – Consolidate its operations on fewer technologies – Reduce long-term complexity and the costs to run Virginia ABC’s enterprise • ABC anticipates lower ongoing costs following the transfer

FTEs for New and High-Performing Stores • Approximately one-third of year over year revenue growth attributable to opening new stores • ABC targets opening 8 new stores each year and needs staff to support these stores • As same store sales grow, the highest performing stores need additional positions to account for higher customer counts and sales volume

PT to FT Conversion of Employees • Virginia ABC greatly impacted by 29 hour rule with passage of ACA – Hired almost 600 additional PT employees to cover needed hours – Hour limitations make it more difficult to retain and schedule employees • Turnover of part-time workforce at 50% annually – High turnover diminishes customer experience and wastes valuable training time and resources – Training cost is about $500 per employee; Retail typically hires around 1, 000 PT employees each year. • Proposal’s approach seeks to slowly replace part-time positions with full-time positions while assessing proper mix of employees • Conversion approach working thus far – 50 positions created last biennium – only 4 resignations and 8 promotions

Enforcement Activities • Virginia ABC conducted licensee fee study in 2017 – found fee revenue did not cover cost of enforcement. • Current fees generate $14. 5 M in revenue while the budget appropriation provides $18 M. • ABC estimates it costs approximately $22. 6 M for current enforcement, hearings and compliance activities. • Last comprehensive license fee increase in 2004 did not go to cover enforcement activities. • Licensee numbers continue to grow dramatically (over 19, 000 annual and 24, 000 one-day) while the number of field agents is in decline (about 80 across state) • The additional $1. 9 M is the first step in addressing the shortfall – Will go to covering existing costs, increasing enforcement personnel and focused enforcement of direct shipping laws • During 2018 Virginia ABC will work with stakeholders to review other fees

Virginia ABC Capital Needs

ABC Warehouse and Central Office • ABC has outgrown its existing warehouse and central office – confirmed by internal and external analysis • ABC and DGS worked together in 2017, pursuant to budget language, to go to market with an RFP for a turnkey solution – Considered use of state land, use of current site and financing options • RFP process demonstrated interest in the project, gave greater confidence in cost estimates and reduced the projected overall cost • Budget language directs ABC and DGS to proceed with the private developer option to acquire a new warehouse and central office • ABC and DGS working together to shortlist developers and refine project scope, cost and financing to further inform budget decisions.

IT Reinvestment Program

ABC IT Modernization • Assessment conducted as part of a 2014 review of ABC’s Operations determined aging IT infrastructure threatened operations and revenue generation – Virginia ABC operating outdated systems that are either out of support or soon to be out of support – Several more major systems, while now compliant, will become deficient – Finance, Point of Sale, Sales Audit, Inventory Management, and HR • Modernization plan presented to Administration and General Assembly in 2015 – – – • Remediate aging systems and allow for continued growth ABC estimated $65 million needed over six years for technology upgrades Figure includes the $25 million for projects approved in 2015 ABC is also progressing in closing existing VITA security exceptions and APA audit points – – – Completed projects have closed 10 of 38 security exceptions Completed projects have addressed two APA audit points Underway projects will address additional security exceptions

Expected Life of ABC Systems Compared to Current System State Major Systems Expected Life Website Ecommerce Website Content. . . Enforcement Web. . . RMS Interact Core Point of Sale Warehouse WMS Warehouse MHE Tax Management Finance Sales Audit Finance ERP HR management systems Identity Management Years beyond Expected Life 0 5 10 Years of Expected Life 15 20 25

Projects Included in Chapter 665: of the 2015 Appropriation Act Item Status Financial Management System Contract award target Summer 2018 Licensing System Project underway Website Phase II Last Module Complete by Spring 2018 Broadband for Stores Complete Electrical System Deferred

Future ABC IT Projects Item Target Completion Rationale Website Phase III 2019 Driven by Web Strategy project from FY 2018 Identity Management 2019 Obsolete components – security exception required Warehouse Management (MIPS) Tied to Building Decision Conveyor system and transportation system – needed in current or new facility – security exception required Inventory Management Tied to Building Decision Same as above – Unable to support real time inventory Tax Management 2021 Using outdated TAX software, many submissions manually keyed – security exception required Human Resource/Payroll 2022 Homegrown system with limited functionality; requires software development for updates; needs update for Authority Transition– security exception required

Private Sector Influences

Growth of Virginia Breweries 2010 -2017 300 262 250 495. 4% Increase 209 200 155 150 117 100 85 67 50 44 54 0 2011 2012 2013 2014 2015 2016 2017 (thru June)

Growth of Virginia Spirits Plants 2010 -2017 70 62 60 48 50 41 40 33 30 19 20 10 0 13 6 7 2010 2011 2012 2013 2014 2015 2016 2017 (June)

Growth of Virginia Wineries 2010 -2017 310 72. 55% increase 352 332 313 2014 2015 400 350 297 300 250 200 240 268 204 150 100 50 0 2011 2012 2013 2016 2017

A Regulator’s Nightmare Opportunity • An explosion of regulants – Since 2010 • More than 200 breweries added • Close to 150 new wineries • Almost 60 new distilleries • Each of these new producers must file multiple reports monthly or quarterly detailing inventory, production and taxes owed, plus label and formula registration. • New entrants not familiar with industry regulations • Agent numbers decreasing during this time • Enforcement revenue not keeping pace with activities

Trends – Direct Shipping • In 2016, over 5 million cases of wine were shipped directly to American consumers by suppliers – 17. 1% increase from 2015 – 70% increase from 2011 • The value of direct-to-consumer shipments rose to $2. 33 billion – 18. 5% from 2015 – 75% increase from 2012 • Direct-to-consumer sales of wine accounted for 8. 6% of total domestic off-premise sales of wine in 2016. • “Direct-To-Consumer Wine Shipping Report” - Ship Compliant https: //www. shipcompliant. com/blog/2017/02/03/record-breaking-year-direct-consumer-wine-shipments-top-trends 2016/

Direct Shipping • In 2003, Virginia was among the first to permit directing shipping to consumers without requiring that the supplier be located in a state affording reciprocal shipping privileges. • As of September 2017, there are more than 1100 out of state shippers licensed by Virginia. • According to ABC Tax Management figures, outof-state wine shipments have grown steadily in the last five years, with nearly 178, 000 cases shipped to Virginians in 2016.

Direct Shipping in Virginia Wine Liters Direct Shipped to Virginians 1, 800, 000 1, 600, 000 1, 400, 000 1, 200, 000 1, 000 800, 000 600, 000 400, 000 200, 000 0 2012 2013 2014 Liters 2015 2016 2017

Direct Shipping in Virginia Out of State Wine Tax Collected 800, 000 700, 000 600, 000 500, 000 400, 000 300, 000 200, 000 100, 000 0 2012 2013 2014 2015 Tax $ Collected 2016 2017

Virginia ABC Authority Transition

Virginia ABC Authority Act • ABC Authority Act passed in 2015 and amended in 2017 converts Virginia ABC from a “Department” to an “Authority” in 2018 – Key aspects • Part-time Board • Appointed CEO • Exemption from Virginia Personnel Act (2. 2 -2900), Virginia Public Procurement Act (2. 2 -4300) and VITA policies (2. 2 -2005) • Provides for 12 month transition to an Authority • Transition activities developed through strategic planning and operational review – Virginia ABC required to submit draft policies by 1/1/2017 – Involved internal resources, outside consultants as well as review by OSIG

Authority Transition Workstreams • Draft Human Resources and Procurement Policies & Procedures – Proposals identified by analysis of the current policies that govern Virginia agencies – Identifying opportunities under a new organizational structure to enable improvements to the Authority’s agility, efficiency and profitability. • • • Develop Compensation & Salary Administration Plan Identify Board Roles & Responsibilities Define Role of CEO Plan for Authority Workforce Conversion Create a “future state” workforce model and organizational structure

Key Changes in Policies • Personnel – Employees move from “classified” to at-will – Alter leave program – Establish stand alone grievance process – Opportunities for pay for performance • Procurement – Allow for greater negotiation – Exempt from mandatory sourcing – Speed process • Expand approval limits • Push decisions into organization

Virginia ABC Authority Transition • Submitted proposed human resource and procurement policies to General Assembly on January 3, 2017 (HD 2) • New Mission, Vision, Values released to agency on November 10, 2016 • Initiate internal transition work streams, lead by Virginia ABC employees • Employee communication site launched January 19, 2017 • 20 Town Halls were held throughout the Commonwealth between September-October 2017 to explain the Authority Transition and provide a forum to questions to be asked answered

Authority Transition Workstreams HR Policies Hearings Process Update Workforce Convert VITA Transition Procure Policies Change Mgmt Documents Risk Mgmt Org Transform Talent Mgmt MVV Rollout Compensation KPIs

Organizational Transformation Virginia ABC Authority Part-Time Board (1/15/18 – 6/30/18) Commissioner (Dept) Commissioner (Authority) CEO CLEO Enforcement Licensing Security GAO Hearings Legislation Legal liaison CAO CIO HR IT Finance Procurement CCO CROO Communications Digital Web Education PPA Retail Ops Logistics Real Estate Marketing

Organizational Transformation Virginia ABC Authority Part-Time Board (post – 7/1/18) Commissioner (Authority) Commissioner (Authority) CEO CLEO Enforcement Licensing Security GAO Hearings Legislation Legal liaison CAO CIO HR IT Finance Procurement CCO CROO Communications Digital Web Education PPA Retail Ops Logistics Real Estate Marketing

Transfer Notices Issued: February 2018 Wage Wave All wage employees employed as of 3/31/2018, will become an “Authority” employee effective 4/1/2018. Wave 1 Transition Date: Aug 2018 Included: Logistics & Retail Operations Divisions Wave 2 Transition Date: Oct 2018 Included: Central Office Divisions excluding Enforcement Wave 3 Transition Date: Dec 2018 Included: Enforcement Division *Participants in the Traditional Sick Leave program will not transition until December 31, 2018 in order permit a single conversion and to minimize any accrual issues.