Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Craft Brew Alliance (NASDAQ:BREW)

Q1 2013 Earnings Call

May 09, 2013 11:30 am ET

Executives

Terry E. Michaelson - Chief Executive Officer

Mark D. Moreland - Chief Financial Officer and Treasurer

Andrew J. Thomas - President of Commercial Operations

Analysts

Anton Brenner - Roth Capital Partners, LLC, Research Division

Joseph P. Munda - Sidoti & Company, LLC

Vivien Azer - Citigroup Inc, Research Division

Soraya Benitez

Operator

Good day, ladies and gentlemen, and welcome to the Q1 2013 Craft Brew Alliance, Inc. Earnings Conference Call. My name is Karen, and I'll be your operator for today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. I'd now like to turn the call over to Terry Michaelson, CEO.

Terry E. Michaelson

Thank you, and good morning, everybody. I'm pleased to present the Craft Brew Alliance investor conference call to discuss our results for the first quarter of 2013. I will be addressing the general business environment; Andy Thomas, our President of Commercial Operations, will provide detailed commentary and insight into the industry; and Mark Moreland, our Chief Financial Officer, will comment on the financial results. We will then open up the call for questions. Before we begin, I will ask Mark to read our Safe Harbor statement.

Mark D. Moreland

Thanks, Terry, and good morning, everybody. As a reminder, this call may contain forward-looking statements. Forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from those described in any such forward-looking statements. The risk factor section in our most recent Form 10-K lists some of the factors that could cause Craft Brew’s actual results to differ materially from the forward-looking statements made on this call. Craft Brew undertakes no obligation to update publicly any forward-looking statements except as required by law. Terry?

Terry E. Michaelson

Thanks, Mark. Our first quarter performance reflects the critical inflection point we've discussed regarding CBA's business development, as we move from strategy development to our strategy growth phase. The loss for the quarter was disappointing but was in line with our internal expectations based on critical operating transitions we were completing that had significant onetime impacts on our financial performance. On other hand, our solid STR growth, strong initial market reception to new initiatives that will be introduced in the second quarter, and our continued improvement in cost reductions and efficiencies in our breweries, send a strong signal that we are moving into the strategy growth phase and are positioned very well to deliver significant sales and profit growth and meet our 2013 guidance.

The primary operating factor on our first quarter loss was a onetime adjustment that came as a result of our finalizing the implementation of our inventory management system. We have now implemented technical and organizational systems that allow us to manage our complex portfolio in a much more efficient and effective manner and have our production shipment, STRs and inventory levels in alignment. This will make a significant contribution over time to improve gross margin performance. The other major operating factor in the first quarter loss was the cost of reorganization to more effectively align our organization with our portfolio strategy.

It is important to note that a significant factor in the discrepancy between 2002 (sic) [ 2012], 2013 year-over-year first quarter performance was driven by historically unusual high first quarter results we experienced. 2012 performance was driven by a number of factors related to the early phase development of our market plans and inventory systems. The strong start to 2012 belied the overall strength of our business and the challenges we faced the remainder of the year. 2013 will be more consistent regards to historical quarter trends, and we expect to see our profitability build in our key selling periods. As we look beyond our operating transition factors impacting our first quarter loss, we see some very strong indicators that our strategy is working, and that we are positioned well to deliver strong sales and profit performance in 2013.

There are several key factors to note. The first and most important indicator was our 5% STR growth trend that was accelerating during the latter part of the quarter and was accomplished in one of the weakest beer industry sales quarters in decades. The strength of this trend is supported by the fact that we have 3 brands, Kona, Redhook and Omission, that had very strong sales growth at/or exceeding craft industry trends. As important as the positive sales factors are for our future financial growth, we believe that our work on short- and long-term margin improvement initiatives in the first quarter will also have a very positive profit impact over time. And our progress in restructuring our organization and developing helping strong operating systems will pay off into '13 in better execution in all areas, which will be critical in ensuring we meet our financial goals.

In addition to the substantial progress we're making on our own core brands, we are now able to begin leveraging our assets to introduce new initiatives that will strengthen our business. You will see new initiatives like our cider test and high-end collaboration reduced in the second quarter that will make positive contributions to 2013. I know that it's certainly unusual to talk so positively about the potential of our business when we are coming off a very difficult quarter from a financial standpoint. But sometimes, the scoreboard is just a snapshot of one quarter and does not deliver a clear picture of the outcome of the game. We have come a long way over the last few years in building our brands and developing our business strategy.

To provide some context to our growth story, as recent as 2010, CBA's business consisted of 2 heritage brands, Redhook and Widmer Brothers, that both had negative sales trends and a licensed brand in Kona with primary distribution on the West Coast. Today, CBA has 3 strong national growth brands, Kona, Redhook and Omission, that are all performing above industry trends, and our Widmer brand that is making progress and moving from a volume brand to a high-margin craft brand. So our discussion around being positioned well for the strong sales and profit growth into '13 is not based on hope; it is based upon our track record over the last few years of significant performance improvement and the tangible strong first quarter business fundamentals that were masked to some extent by onetime impact of major operating transitions.

We are confident that CBA is positioned to win in 2013 and deliver strong sales and profit growth and meet our annual guidance. I want to thank our entire CBA team for their passion and work in brewing great beer and providing all our customers with memorable beer experiences.

Andy?

Andrew J. Thomas

Thanks, Terry, and good morning, everyone. I'd like to begin by publicly stating something that we haven't been quick to say before: We entered Q2 by far, the most excited and confident about the health of our company, our portfolio and all of our brands as we've ever been.

Before getting into some color on the quarter, I'd like to offer the following points and perspectives in support of that confidence. Firstly, in Q1 2013, Kona, Redhook and Omission picked up right where they left off in 2012 with comparably strong growth rates even in advance of significant new initiatives that will not hit until Q2 and beyond. Secondly, on the surface, Widmer Brothers decline accelerated but in fact, Hefe is continuing to moderate and the accelerated decline was driven by factors related to the replacement of Drifter by Alchemy Ale. Thirdly, in addition to supply chain process refinement, including brewing aligning with seasonality patterns, the disparity between STRs and the shipments was anticipated and was magnified by reduced shipment and depletion of volumes related to legacy products and packaging that are being replaced in Q2 and beyond.

As expected, Q1 was a busy quarter, highlighted by both significant structural activities, as well as a number of significant brand successes. Numerous peer competitors have elaborated on Q1's less than favorable industry conditions, related to weather and economic activity. But that said, for CBA, Q1 served up a materially-as-expected start to 2013. That fact is best evidenced by the confirmation of our guidance for 2013.

There's a lot to cover, so let's jump right in. Note that although Q1 2013 contained 1 less selling day than Q1 2012, to more closely align my commentary to the data contained in the Q, I'll quote calendar day performance rather than using days-adjusted results. For reference sake, on a days-adjusted basis, our business trends are generally 1.5 to 2 points more favorable than the numbers contained in our Q or this call.

For Q1, the total CBA depletion growth trend came in at a reasonable plus 5%, a modest number, but one that was in line with our internal expectations and strong relative to both the overall market performance and that of our publicly traded peer companies trading in the beer space. Kona, again, posted strong STR growth of plus 23%; Redhook maintained its plus 6% growth trend; Widmer Brothers volume slipped back minus 12%; and Omission continued to add nicely to our STR performance.

To get behind the numbers, let's start with some color on our most complex brand, Widmer Brothers. As we continue reshaping the Widmer Brothers portfolio, Q1 performance absorbed not only the continued decline in Hefeweizen, but also bore the burden of volume softness on Drifter Pale Ale, softness directly linked to Drifter's upcoming replacement by a new year-round offering called Alchemy Ale. Coupled with the Hefeweizen declines, the anticipated and closely managed volume wind down on Drifter resulted in a one-two punch that was a primary driver in accelerated Widmer Brothers declines.

Looking first at Hefe, while declines continued to be in the double digits, they are now in the very low double digits, with Hefe off minus 11% for the quarter. Regarding Drifter, in Q1, we wound down all commercial activities including allowing wholesaler and retailer inventories to largely deplete, clearing the way for Alchemy. Alchemy Ale is a new year-round offering, closest to a pale ale in style and brewed in celebration of Widmer Brothers' proprietary Alchemy hop blend. We are bullish on the potential for Alchemy, and confident in its ability to replace and surpass Drifter's volumes.

Aside from the calculated declines on Hefe and Drifter, Widmer Brothers had a solid quarter, highlighted by success on O'Reilly IPA, strong performance for our spring seasonal, Columbia Common, and continued strength in our high-end Brothers' Reserve line, which nearly doubled versus Q1 2012. Notably, both O'Reilly IPA and Columbia Common collectively debuted a new look for Widmer Brothers packaging, highlighting the signature Widmer Brothers piano key w [ph], which has been with the brand since 1984.

Kona continues to roll, benefiting in Q1 from the first significant expansion of territory in 5 years, with Kona's Liquid Aloha flowing to 5 new Midwest states for the first time ever. Buoyed by the rollout, which began late January, Kona's Q1 2013 bested Q1 2012 by plus 23%. Importantly, as successful as the Midwest expansion has been, volumes are still small and over 98% of the growth for Kona in Q1 came from existing markets.

Looking a bit deeper, Longboard and Big Wave started this year as they finished last, as a strong one-two tidal wave. Longboard grew plus 17% and Big Wave continued to grow, reaching a full 25% the size of Longboard. Notably, home market Hawaii continued to grow, contributing over 10% of the growth on the Kona brand.

Redhook started 2013 on firm ground for the first time in 5 years. And that firm ground is appropriate as it will provide a solid foundation for the onslaught of new activity planned for 2013. That avalanche began with the launch of Audible Ale in Q1. Audible Ale, developed in collaboration with Redhook partner, Dan Patrick, is what we term a crushable craft beer, aimed squarely at the cross-over drinker. Launched first in draft-only, Audible is already staking a claim as Redhook Long Hammer's clear wingmen, with Audible volumes already contributing nearly 25% of Redhook growth in Q1. Speaking of Long Hammer, volumes continued to grow, up plus 15% in Q1, keeping pace with variety packs, which also grew less 15%.

Lastly, a word about our youngest brand, Omission. Q1 saw the expansion of distribution geographically and through several national retailers, propelling Omission to nearly 2% of our overall volume, while contributing better than 10% of our growth in Q1. Further, in it's home market of Oregon, Omission extended its portfolio to include Omission IPA, yet another first ever for Omission, a classic Northwest IPA brewed with authentic beer ingredients including malted barley, then crafted to remove gluten.

Before previewing the excitement of Q2 and beyond, I'd like to summarize gainers and decliners, offer a few geographic and channel insights, touch upon our international results, and update some structural changes mentioned in the last call. Regarding gainers and decliners, Q1 saw the healthiest ratio of gainers to decliners for CBA in years. In Q1, gainers outpaced decliners by better than 2:1, posting the healthiest ratio thus far for our portfolio.

Quickly highlighting geographies. The East remained a growth engine for the company in Q1 with plus 30% growth, driven by all brand families, and in particular, the launch of Kona in the Midwest division. The mature West, which still comprises nearly 80% of our business and absorbs more than 90% of the Widmer Brothers' losses, was flat for the quarter.

On the channel front, and encouragingly so, while off-premise continues to drive our performance, 3 of our 4 brands posted on-premise growth in Q1, with Kona, Redhook and Omission all showing positive trends in the increasingly competitive on-premise channel. We view this as not only a validation of our strategy but as a positive indicator of brand health and performance. Our international expansion continues to pick up steam, with over 20 containers representing all of our brand families, headed to some 10 international destinations.

To briefly update several structural changes announced last quarter, our commercial reorganization has been a clear success, and will continue to show dividends throughout the year. Notably, the $0.5 million in reorganization costs have been fully absorbed in SG&A spend in the quarter. Our innovation team is up and running with our recently announced launch of Square Mile Cider Company already providing tangible evidence of the value and speed with which this team impacts our business. Square Mile Cider will be launched with 14 West Coast test wholesalers beginning late in Q2. Developed in collaboration with a small family-owned cidery in Oregon, Square Mile Cider will launch initially with 2 versions: an original Northwest apple cider and a dry-hopped apple cider called Spur and Vine.

In closing, let's look forward for a few moments. As a reaffirmation of our guidance suggests, we are bullish about 2013 across geographies, channels and brands.

Some specifics. On Kona, Q2 will see the launch of our new Kona custom 12-ounce bottle across the entire portfolio, the full force of our national expansion of Big Wave and the launch of several can packages, including a 10 pack of 16-ounce cans, aptly named the Hang-10 Pack, and a 24-ounce can. Can packages will be targeted at can-appropriate venues and convenience stores.

On Widmer Brothers, armed with a full redesign of all secondary packaging in the initial force of the Alchemy Ale launch, Widmer Brothers will continue it's deliberate march to a higher-value brand, highlighted by exciting collaborations such as the home market collaboration of a Green & Gold Kölsch with the Portland Timbers soccer team, and a first-ever high-end collaboration with emerging Florida craft brewer, Cigar City, in Tampa, Florida.

On Redhook, expect acceleration of the Audible Ale launch as it is joined by Redhook Game Changer, Redhook's first-ever collaboration with the national on-premise powerhouse, Buffalo Wild Wings, a partner uniquely positioned to help Redhook develop further relevance and awareness with the cross-over craft drinker. Redhook Game Changer will be available on draft at Buffalo Wild Wings locations nationally starting late Q2.

And notably, look for continued focus on Omission expansion and the second coming of our industry-only cross-brand seasonal variety pack, this time in a form of a summer variety pack, offering Widmer Brothers Citra Blonde Summer Ale and Alchemy Ale, Kona Wailua ale and Redhook Wise Cracker Wit.

In closing, we are confident that the success of Q1 will become ever increasingly apparent. I'm reminded of the old metaphor of replacing the engine while the plane is flying at 40,000 feet. While we're far from declaring mission accomplished, we are unabashedly confident of our progress and direction.

And as final proof of that confidence, I'd like to share some preliminary April numbers and let them speak for themselves. Preliminarily, on a days-unadjusted basis, total CBA April STRs are up in the midteens, propelled by a sharp acceleration of Redhook, evidencing the impact of Audible, a further acceleration of Kona demonstrating the growing impact of Big Wave and encouragingly, a still negative but improved trend on Widmer Brothers, driven by the introduction of Alchemy and in continued moderation of Hefeweizen. While 1 month does not a quarter nor a year make, it is nonetheless solid, empirical validation of the confidence underpinning our guidance.

On to Mark.

Mark D. Moreland

Thanks, Andy. In my comments, I'll cover the key financial dynamics of the quarter and discuss our 2013 guidance. While we generated solid depletion growth of 5% in the quarter, we posted financial results that were in line with our expectations including a sales decline of 5% on a shipment volume decline of 8% and a net loss of $0.09 per share. As much as management team dislikes posting the loss for the quarter, we believe the quarter's financial performance does not reflect the underlying strength of the business, and we look forward to discussing strong results in the upcoming quarters. The quarterly loss reflects significant impacts from both improvements to our supply chain, which affected our gross profit margin and reorganization costs, which impact our SG&A expenses.

As we discussed in prior calls and our year-end press release, we have made substantial improvements to our supply chain processes during the past year, including both the implementation of a new supply chain computer system and new forecast and inventory management processes. During the first quarter, we made strides to better align our supply chain inventories with the seasonality of our sales. As a result of these adjustments, we have significantly lowered brewing and shipping volumes than historical norms would indicate. This combination of lower shipping and brewing volumes resulted in low capacity utilization that drove our gross margin rate approximately 600-basis-points lower than last year. The flip side of this coin is that our shipping and brewing volumes reflect better alignment with our sales throughout the rest of the year. As a result, we continue to expect significantly -- significant quarterly variances when comparing 2013's performance to last year with the understanding that the later quarters will swing to the positive.

Our forecast for the year had anticipated the supply chain impacts, and we confirm our original 2013 gross margin rate guidance of 28.5% to 30.5% for the full year. As a component of this guidance, we are pursuing brewery and distribution efficiency projects that will generate both near- and long-term reductions to our cost structure.

SG&A expense for the quarter was $11.8 million including a $5-million -- $0.5-million charge related to our commercial operations' reorganization, as Andy discussed. Excluding the charge, SG&A grew at 9% for the quarter.

Turning my comments to the 2013 guidance. We have confirmed our guidance for the full year, including depletion growth of 7% to 11% reflecting the continued strength of the Kona, Redhook and Omission brands and further stabilization of the Widmer Brothers brand; average price increases of approximately 1% to 2%, reflecting the competitive pricing environment; contract brewing revenue about 1/2 that generated in 2012 as a result of the termination of the Goose Island contract brewing arrangement; gross margin rate of 28.5% to 30.5%, as I discussed; SG&A expense ranging from $47 million to $49 million, reflecting leverage from the foundation built by more aggressive spending in prior years; and lastly, capital expenditures of approximately $11 million to $13 million, continuing our investments in capacity and efficiency improvements, quality initiatives and our pubs.

In summary, the CBA team is confident, both in the strength of the business and our financial guidance for the year. We look forward to discussing significantly different results with you during the second quarter call.

And with that, I open up the call for questions. Karen?

Question-and-Answer Session

Operator

[Operator Instructions] First question comes from the line of Tony Brenner of Roth Capital Partners.

Anton Brenner - Roth Capital Partners, LLC, Research Division

A couple of things. One is was there an effective year-over-year price increase in effect in Q1 or is that to come later on?

Mark D. Moreland

Tony, this is Mark. Pricing in our business right now is an interesting one. Really, from a financial standpoint, you're seeing the revenue per barrel impact. And so if you look at our financials, the revenue per barrel is impacted by shifts in geography, shifts in brands and shifts in package type, all which are very dynamic right now within our business. And so, we do have a -- we are seeing that 1% to 2% price increase in our business. At a total company revenue per barrel level, that's going to be masked somewhat quarter-to-quarter. But to make your modeling a little more simple, what I would say is we saw, if you look at the A-B sales in our Q4 numbers, look at A-B sales relative to A-B volume, you would have seen about a 2% increase in revenue per barrel. I would say that's still a good indicator to use for the full year 2013.

Anton Brenner - Roth Capital Partners, LLC, Research Division

Okay. And then second, Andy talked about the Widmer brand emphasis shifting from volume to profit margin. So I wonder if you could talk a little bit, since you've been doing that for a little while now, what the margin trend is for Widmer Brothers' Reserve and some other products with higher margin. In the face of ongoing volume decline, what is happening to the margins of that product?

Andrew J. Thomas

So, Tony, this is Andy. So overall, what I can tell you is for several quarters now, we've been continuing to see margin improvement in the Widmer Brothers brand, and that's driven by more of an emphasis on those high-end Brothers' Reserve volumes. As we have talked about very openly that the gross margin on those products is really favorable for everybody in the value chain. And we always use the wholesaler margins as proxy for it. But if you remember, wholesalers make about 10x per case of -- on a Brothers' Reserve case, 10x what they do on a domestic mainstream beer. So -- and that's relative to about 4x on our core.

So if you just go through the trends that I talked about in Q1. Moderation in Hefe, we know how that's been happening. Alchemy replacing Drifter will be a net positive to margin for 2 reasons. One, we expect to have to discount the brand less, and we believe, fundamentally, it will be a stronger brand offering. So it'll have a little bit more pricing power, hopefully, than traditionally Drifter has been. And then we'll continue to program around the high end with Brothers' Reserve. And specifically, I mentioned the Cigar City collaboration and the collaboration with the Portland Timbers. There's a couple more we have up our sleeve. We're not at liberty to disclose yet. But we'll be doing more collaborations in the high end, which will allow us to not only position the Widmer Brothers brand where can, hopefully, get more pricing power across the trademark, but we'll be doing products that get much higher margins per case than even ones that we've seen to date.

Anton Brenner - Roth Capital Partners, LLC, Research Division

So, Andy, can you compare the profit margin change versus the volume change? I mean, is it a measurable impact that we can see?

Andrew J. Thomas

I would hazard to do that right now, Tony. I think, as we have a little bit more experience through the year with the additional high-end volume development and with the collaborations, it's something we can certainly revisit. And I'll make a note to be sensitive to try and give a little bit more color on that in future calls. I just think it's too early right now to give you some hard numbers on that.

Mark D. Moreland

And Tony, this is Mark. I'll just jump in briefly. The gross margin guidance for the year does bake into it those programs. So that 28.5% to 30.5% margin rate should be good overall.

Anton Brenner - Roth Capital Partners, LLC, Research Division

Okay. One last item, the organizational changes, can you describe exactly what you've done and what it shows and impact from that is?

Andrew J. Thomas

Sure. The highlights of it, Tony -- this is Andy again. As we move to a regional -- an unabashed regional structure with appointment of 2 general managers, 1 East and 1 West, both of whom have full accountability for all the business in their region. And that's stitched together with a national sales operation organization that deals with national accounts and deals with the overlay of things that have to be consistent.

As I joke with my guys on that, it's a little bit like federal rights and state rights sometimes. But what that's done, is the 2 GMs now can operate their regions a little bit more in a decentralized perspective, so that we're not approaching the market with a one-size-fits-all. And I think that's most evident on brands like Widmer Brothers. As I mentioned in the commentary, about 90% of the Widmer Brothers declines are being absorbed by the West. So you can imagine that our Western region GM is dealing with the Hefeweizen declines a lot more than our Eastern region GM is. And our Eastern region GM can free up more of his time and his team's time to do what we just talked about, which is developing kind of the Widmer Brothers of the future in the high end and seeding that. So the focal point was moving into a regional GM structure and eliminating just 1 national sales vice president role.

On the marketing side, we created the innovation team, as I spoke to, and we also created -- made some shifts within the brand teams to more closely align the brand managers with the brands in what was necessary there. So we kind of blew up the old marketing structure that we had and moved in that direction. But the highlight, I would say, was mostly on the sales side with the regional structure being a little bit more ingrained into what's happening.

Terry E. Michaelson

And Tony, this is Terry. I think the other critical thing is, obviously, as Andy has discussed, the reorganization. It gets us closer to our business on a regional basis, closer our business on a brand basis; gets the right people for that in the right seats, which we already see improving the execution. But also equally important to me, it gets Andy closer to the business in that those people report directly to Andy, and we don't have somebody in between the 2. So that allows us to take strategy to the market on a much more dynamic way and see that happen quicker. And as Andy said, I think we'll see the results of that, not only in our core operation, but in our innovation and how fast we are able to move on something like Square Mile Cider.

Andrew J. Thomas

And Tony, I'll just elaborate on a point Terry just made. You guys know that in any company you carry, but management talent is critical. And one thing I can assure anybody in this call and any of our shareholders, we really have very experienced senior talent in the General Manager seats and in the Head of National Sales Operations seat. The person running the Western region for us ran a $200 million wholesaler before basically taking the reins in our organization, so very well versed with the beer market, very well versed with wholesaler management and wholesaler economics in the beer market. Likewise, on the East Coast, our General Manager there has not only international experience, having been a country manager in Europe for a large company before, but also has a lot of key account experience in developing key account teams and looking at what it takes to take a high-end brand, formerly worked on an import brand national.

So talent is key to us. So as Terry said, it's not only about the right structure. But it's around -- about getting the right people in the seats, and we feel really good about that.

Operator

The next question comes from the line of Joe Munda of Sidoti.

Joseph P. Munda - Sidoti & Company, LLC

Real quick. Andy, the cider, interesting move into another market. I was wondering if you could give us some demographics regarding the market, its size and a little bit of the rollout potential that you're talking about.

Andrew J. Thomas

So it's a fledgling market. So I'll tell you, it's a little bit like a moving target, Joe. I'm smirking here because I feel like I'm going to have to answer this the way I answered the gluten-free question you asked in the last call, which was about the market and the demos. What we know is that -- I'll take a step back. As I've said very publicly, we know that the consumer of today, the alcoholic beverage consumer of today, is drinking across categories more than ever. A figure I quote is that 96% of alcohol beverage consumers report regularly drinking beer, wine and spirits. Within that, we know that kind of these emerging categories like cider or, as some of our competitors are getting involved with flavored malt beverages, is becoming increasingly important because it plays right to that variety seeking for that consumer.

So who we know is going there is, there tends to be a bit of a female skew for cider right now. If you look historically, there's been an East Coast skew, but that looks like it's more historical than rooted in demographics. So that's one of the reasons we're starting West, to be a little bit different. So a bit more female. And also somebody who is -- tends to be more of a crossover drinker, who isn't necessarily looking for the über craft beers, who is looking for a little bit more of a beer that straddles -- a little bit more of a beverage that straddles beer and wine and cocktail. So we think there's opportunity there.

In terms of scaling the business, I would hazard to throw out a market size for you right now, Joe, as we better define it. It's moving so rapidly. I mean, I think if you listen to what Boston said in their earnings call, and if you listen to what -- from what Vermont Hard Cider has said before, the historical norms on cider are probably pretty much worthless because of the growth we're seeing. So it's still small, less than 1% or 2% of the scale of the beer market, but we're eager to see where that goes and that's why we're taking a pretty deliberate approach and starting with 14 wholesalers on the West Coast. So we can monitor not only the demographics and accounts that we're getting traction in, but also, so that we can monitor the forms. Is it a bottle business or is it a packed draft business. And thirdly, so that we can model out and manage what kind of a liquid are they looking for more so. And that's why we've gone out with 2 distinct offerings, a pretty classic but I'd say outstanding Northwest apple cider and a really interesting taste twist on it which is the hop cider, which is a nice dovetail into the rest of our portfolio.

Joseph P. Munda - Sidoti & Company, LLC

Okay. And then as far as Widmer, I know in your prepared remarks or I'm sorry maybe it was in the Q, you guys talked about increased competition from multinationals on the West Coast. Can you give a little bit more color there as far as maybe who some of the players are out there that you're seeing competition from?

Andrew J. Thomas

Yes, sure. I can talk to that. Tony, something I said last week at a conference I spoke at was as much as we in the industry might try to label certain brands as craft or a crafty or noncraft, we're big believers that craft is in the eye of the beholder. So if you take a look at what's going on with brands like Blue Moon or brands like Shock Top or a lot of other things that are happening, they clearly are trying to go after that consumer occasion that craft has typically been exclusive for. So that can't help but create a little bit more competition. And it's by no means an excuse. It's just an acknowledgment that there's more happening in that segment as you look at a lot of the big players, be it through Tenth and Blake or be it through Goose Island or be it through brands like Shock Top getting actively engaged in going after that tap handle or that placement or that consumer occasion. So no more, no less than an acknowledgment of that.

Joseph P. Munda - Sidoti & Company, LLC

Okay. Then as far as the international, you guys really didn't make mention of it. I'm just wondering how that's going as far as the exporting of some of the beers.

Andrew J. Thomas

So I mentioned, we're active now in 10 countries through the end of the first quarter. And as I said, we've got -- you deal in containers typically international. And why I say we deal in containers is we have to ship these over the Atlantic or the Pacific. So the container tends to be the unit of order, and that's why I said, we've got about 20 containers going to 10 destinations in the first quarter to seed those markets. I'll tick through a list I've done in the past, but I'll just update everybody. We are active now in Canada, Korea, Japan, Hong Kong, the U.K., Norway, Denmark, China, Ireland and Sweden. And that's across all brand families, and all of that is through our partner, Craft Can Travel!, who's our exclusive import or export agent, and we are the exclusive brand that they're dealing with as well.

Joseph P. Munda - Sidoti & Company, LLC

Right. And does cider have the opportunity to, let's say, go into the U.K. being that it's the largest cider market in the world?

Andrew J. Thomas

Yes. I think anything is possible but we're trying to be pretty deliberate. As a lot of you know, I spent 3 years in the export organization for Heineken overseas. And one thing I learned was that you need to have a healthy balance of patience and a sense of urgency. So we don't want to flood the market with a bunch of products and scream mission accomplished only to have them back up and just sit on the shelves and get dusty. So we're trying to nurture those markets and be very deliberate about the products we send over there. And we're very keen to explore new opportunities, be that cider, be that Omission, internationally, which could be another interesting play for us, or be it anything else that we develop.

Joseph P. Munda - Sidoti & Company, LLC

Okay. And then one final and I'll hop back in the queue. As far as Buffalo Wild Wings, the collaboration that you guys have there. So you're going to be rolling out -- it's going to be one handle of Game Changer in each of, I'm estimating, the 900 locations that they have. So what does that do for the other brands in your portfolio? And does that open up the opportunity for you guys to get in there?

Andrew J. Thomas

Well, so I'll take a step back and just add a little bit color. So we're excited about the work we're doing with B-Ws and I think, if you take a look at what we're trying to do with the Redhook brand, read through everything that you heard on the call and what we're doing is, we're really trying to leverage partnerships, to leverage our SG&A spend so that we can become relevant and gain awareness with consumers who traditionally wouldn't be within our reach because we don't necessarily have the deep pockets to be able to target them or to be able to communicate to them. So if I come down a level on Redhook, that's why things like Dan Patrick make a ton of sense for us, and that's why relationships to cultivate with Buffalo Wild Wings makes a ton of sense for us.

If we're looking at the crossover craft drinker, and I'll coach that in 2 ways. Be that mainstream beer drinker who finds themselves looking to drink something a little bit bigger or a little bit more full flavored or a hard-core craft drinker who finds themselves in what I call a mainstream occasion, watching the game and eating wings at a Buffalo Wild Wings, we think that is a really bull's eye target for Redhook. So that said, we endeavored, with both of those in very different ways, to be able to capitalize on that and leverage each other's respective equity. Redhook for folks like Dan Patrick and Buffalo Wild Wings, and correspondingly, Dan Patrick and Buffalo Wild Wings for Redhook. So what that means for B-Ws is we will, beyond draft nationally with Game Changer nationally in all of their accounts by the end of Q2. But it should help to develop the relationship a little bit deeper. So while I would not suggest to you that, that's going to mean we're going to get another handle in every account because we're already working there, it does start to make us a bigger player with them and helps our wholesalers have a bit more scale with our portfolio when they do call on a Buffalo Wild Wings, be that on draft or be it in the bottle segment, which we're seeing a lot of activity in.

As an interesting side note, as more and more brands try to penetrate the on-premise, tap handles become even more at a premium, and we're starting to see a lot of folks look more towards bottles. And it's something we feel we got a head start on because we've doing that in preparation for that. It's one of the reasons we went to a custom bottle on Redhook, it's one of the reasons we went to a custom bottle on Kona, is so that we were able to kind of stake claim to some bottle occasions for craft in on-premise accounts and still maintain some brand name and some distinctiveness.

Operator

The next question comes from the line of Vivien Azer of Citi.

Vivien Azer - Citigroup Inc, Research Division

Just want to drill down a little bit more in terms of the gross margin cadence. I fully appreciate what accounted for the drag in the quarter. But as we think about the gross margin progression through the rest of the year, when you say a snap back, how quickly do we expect that? I mean, should margins be down again in the second quarter? This is more kind of a back-half-of-the-year type margin improvement relative to what you put up in the first quarter. If you can comment at all on that.

Mark D. Moreland

Sure, Vivien. This is Mark. We do expect a snap back. This really is a -- the supply chain impact really is a Q1 event. And from here, it's, call Q1 a bit of a housecleaning. And going forward, we'll have a nice alignment with our production, our inventories and STRs. So we feel good about the cadence there.

As far as the full year gross margin, we do feel very confident about the 28.5% to 30.5% for the year. So you will see the gross margins scaling up in the back part of the year.

Vivien Azer - Citigroup Inc, Research Division

Okay, fair enough. On ciders, one of your competitors had noted that in the past, they've had some issues sourcing apples that were up to their standards. Have you had any issues in terms of your apple sourcing?

Andrew J. Thomas

Hey, Vivien, this is Andy. Let me start out by a little bit of ingratiation. I just wanted to say thanks for the regular analysis you're sending out on the company. I share it with my team pretty broadly. We're an IRI shop so it's always nice to have the Nielsen data to compliment that, that you send out. So I want to take the opportunity to say thank you for it, because I'm a data hound and it's great to have. So just want to start out there.

With respect to cider, we're not necessarily seeing huge supply pressure right now because for 2 reasons. One, we're using a lot of hand pressed cider apples and dessert apples from this local family that we're working with. They themselves actually have apple orchards, so they grow apples themselves. They have outstanding storage facilities to maintain the quality and availability of those apples year-round, and we also going at a price point and a positioning, which will be more about value than volume. So consistent theme here, guys. So we don't necessarily see supply as a huge barrier for us because we're more interested in making sure that we have apples available year-round, good quality apples, a pure supply of those apples to be able to put into a product that can command a pretty premium price and drive some nice margins into the company, while delivering a nice product to the consumers and something that's a little bit more distinctive. So I'm not -- I wouldn't expect to see us have a mainstream cider with a lot of volume. I would expect us to see something that was more of a high-end cider with smaller volumes, but commensurately with some pretty nice margins that go along with it.

Vivien Azer - Citigroup Inc, Research Division

Understood. On the international front, I think slow and steady makes a ton of sense as you guys kind of build up your expertise in international, working with your distribution partner. I am curious, though. The 10 markets that you're in, is that kind of good enough for now? Is there a need to move forward to more markets? How are you thinking about that?

Andrew J. Thomas

So yes and yes. It's good enough for now, but there is a need to move forward, too. So I'll tell you my expectation is that in subsequent calls, I'll be telling you about additional markets that we've opened up. So there's work actively happening there. And export is a little bit like trying to grow an orchard, back to apples which we have on the mind right now. So you got to plant seeds in a number of places in order to have a robust crop. So as we plant seeds in these European countries, we'll continue to look at where it makes sense. Europe is tough. As you guys know, distribution is tied in a lot of places as oligopolies and monopolies to deal with. But we're picking our battles there, and we'll look beyond there, probably to the Pacific Rim and to some other markets for the next step. So we're happy with where we are. I want to be clear about that. It's a slow burn, but we'll continue planting seeds in a number of places.

Vivien Azer - Citigroup Inc, Research Division

Terrific. My last question just focuses on the U.S. competitive landscape. Coming through earnings season, Molson Coors yesterday or 2 days ago, I apologize. Very constructive on their new product pipeline. And I'm just curious to hear kind of what you guys think about what seems to look like a very active summer selling season across the industry. And whether you think your guidance adequately reflects potential significant step-up from your competitors.

Terry E. Michaelson

This is Terry, and I'll respond to that, and then let Andy provide some color. Our guidance does anticipate that. We expected this year to be extremely competitive. And as we've discussed, it's not disappointing from that standpoint. And to that end, we've been building our business and preparing for that kind of environment. It's why, as we talked about, not only the building of our core brands and the overall strategy we've been talking about has been so important, but the introduction of some variety into that to strengthen those brands in the core. And to continue to look at ways through the partnerships with Buffalo Wild Wings and Cigar City and introducing the cider and the imports to continue to build and leverage off of the fundamentals that we've built. So we very much expect the summer months to be very competitive. We believe we're aligned very well with the new distribution that we've sold in with the new products that we have and the organizational structure that we have to align to execute at a high level.

And I wanted, just on a broader standpoint, make a point here that probably should be obvious, but I'm not sure it is. That as a management team, we're very competitive and its very frustrating to watch that the profitability over the last few quarters hasn't been spectacular. We acknowledge that. I also want to praise this management team for paying attention to what we felt was important in building the fundamentals of this strategy and not letting short-term small profit swings impact building the strategy the right way for the future. And we really do believe that we do have an advantaged strategy, that the brands really are resonating, as we've said at this point, with the 3 brands that we have really on strong growth trends, us being able to really work with our organization. So not only do we feel good about how we're able to compete in the market for the summer months, but we feel positive about how we're going to be able to manage the gross margin and expenses. And from our standpoint, begin to get some satisfaction on our end and for the shareholders in delivering profit from this very strong strategy development.

Andrew J. Thomas

And Vivien, I'll just pile on a little bit. I'll tell you, we anticipate competition is going to intensify even beyond what we saw in Q1. We did anticipate it, and I submit to you that we anticipated it about 5 quarters ago. And if you take a look about -- what makes me feel so confident and makes me confident in making the statement I did at the beginning about looking at the rest of the year, is understanding the health of our portfolio and how the brands play.

So it's not by accident that you heard me talk about Audible and Long Hammer and Game Changer on Redhook or about Longboard and Big Wave on Kona. Those are brands and those are initiatives that allow us to look for sources of growth that aren't necessarily where everybody else is looking for sources of growth, with crossover drinkers with import drinkers getting into the craft category, with mainstream and import drinkers who find themselves in craft occasions and channels that others aren't ready to penetrate.

I think on Widmer Brothers, the craft -- the onslaught of competition, I think you're going to see the most in the heart of the craft category, and that's where Widmer Brothers has a one-two punch. It's not only our most complex brand and the one that's taking the longest to turnaround. It's in arguably the most competitive segment of the beer market right now. And that's why the path we've taken with it is to find the white space that we think we can win in. And that white space is not about discounting and not about volume, but it's about value and it's about distinctiveness that allows us to command premium margins for that package.

So long way of saying, we anticipated the competition. We think it's going to intensify but we're confident that, that's where really where you're going to start to see the kind of elegance of the portfolio strategy start to differentiate us, and that's why the reorganization in the first quarter was so important, is we're increasingly confident that we've got an organization, talent and resources now that are capable of actually executing that strategy in the marketplace, and that should only improve.

Operator

Next question comes from the line of Soraya Benitez of Cougar Capital

Soraya Benitez

On the COGS, can you just give some color on your expectations for the year?

Mark D. Moreland

Sure. On the cost of goods sold, for the year again, we do expect the supply chain to come back in alignment. It will be -- it is in alignment during Q2 and for future quarters. As a result, our gross margin rates will be in that 28.5% to 30.5% range for the year. We discussed previously that we are getting some pricing, 1% to 2% on the top line. And in the COGS, we have a couple of moving items, the most challenging being both glass pricing, our component input costs and distribution costs. But all those are in the 28.5% to 30.5% guidance.

Soraya Benitez

Okay. And then on the contract brewing, you talked a little about it during the prepared statements. I kind of missed it. Can you give us a little color on that?

Mark D. Moreland

Sure. Our contract brewing partner we have currently is performing very well. This year, we'll have less contract brewing by a factor of about 50%. We had 2 people we were contract brewing for last year. We did terminate one of those contracts, so they're about equal. And so will be about 50% lower in contract brewing volume this year than last year.

Soraya Benitez

Is it eventually going to 0? Or that going to be a sustained...

Mark D. Moreland

No. The contract brewing partner, we're operating very well together and expect a productive long-term relationship.

Soraya Benitez

Okay. And then just lastly on the CapEx, it's a little bit higher than it sort of been, understanding you're investing. Just curious to know what portion of that you probably consider maintenance going forward. And just free cash flow expectations, up, down, negative for the year?

Mark D. Moreland

Sure. The maintenance number we put out there is generally the $3 million to $3.5 million a year for the strict maintenance, no growth capital. And as far as free cash flow, we always manage the company annually to generate free cash, so positive would be the answer there.

Operator

The next question comes from the line of Corey Robinson [ph], an individual investor.

Unknown Attendee

A question for you is I noticed you've sunk a bunch of money into supply chain in the capital perspective. Is that what caused the supply chain to get out of the line and caused us to have such a backup?

Mark D. Moreland

It's a combination of implementing the systems and processes over the last 1.5 years. It's been a fairly long project. We've been talking about it now for about 2 years ago. And fundamentally, getting all the pieces of the supply chain well orchestrated is an exceptionally complex task. Our supply chain varies anywhere from, I believe it's at 110 days at the best, 310 days at the worst because of our -- we have to go back to our purchasing, back to our glass, for example. So it's a very long supply chain and challenging to manage. We have it in place now. Really, it's a process based on those systems that we feel keep those components of the supply chain in alignment going forward. So if you go back and look at Q1 of last year, you can argue we got a little ahead of ourselves Q1 last year. And this year, we're correcting that flight into the seasonal peak during the summer.

Unknown Attendee

Okay. Then one final question. I monitor the job boards and I noticed you have a VP of Operations, I think. Was that a result of this backup? Or it just seems like there seems to be a lot of turnover at the high ranks.

Terry E. Michaelson

Okay. I'll respond to that. That is a replacement of a position that we had in place, and that person left the company actually to move outside of the beer industry and work at a new company, a start-up. That was a very good experience for him. But in general, our turnover, and we track that internally, is lower than manufacturing. We tend to have people stay for a long time. We do have that position replaced at this point and starting, and feel extremely good about the talent that we brought in, somebody with deep knowledge and experience in the brewing industry. And believe that they'll add to our work on improving gross margin with their knowledge base. So I think ultimately, we came out with a win on that transition.

Operator

I'd now like to turn the call over to Terry Michaelson for closing remarks.

Terry E. Michaelson

Well, thank you. I appreciate everybody's continuing support of CBA and being available for this call. And we look forward to discussing some positive results next time. Thank you.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Craft Brew Alliance Management Discusses Q1 2013 Results - Earnings Call Transcript
This Transcript
All Transcripts