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Boston Beer Company Inc. (NYSE:SAM)

Q3 2013 Earnings Call

October 30, 2013 5:00 PM ET

Executives

Jim Koch – Chairman

Martin Roper – President and CEO

Bill Urich – CFO and Treasurer

Analysts

Vivien Azer – Citi

Mike Luddy – Goldman Sachs

Marc Riddick – Williams Capital

Operator

Good day, ladies and gentlemen and welcome to the Boston Beer Company Third Quarter 2013 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder, this conference call maybe recorded.

I would now like to hand the conference over to Mr. Jim Koch, Founder and Chairman. Sir, you may begin.

Jim Koch

Thank you. Good afternoon and welcome. This is Jim Koch, Founder and Chairman. And I am pleased to be here to kick off the 2013 third quarter earnings call for The Boston Beer Company. Joining the call from Boston Beer are Martin Roper, our CEO and Bill Urich, our CFO.

I will begin my remarks this afternoon with a few introductory comments, including some highlights of our results and then hand the microphone to Martin who will provide an overview of our business. Martin will then turn the call over to Bill who will focus on the financial details for the third quarter as well as review our outlook for the remainder of 2013 and our initial outlook for 2014. Immediately following Bill’s comments, we’ll open up the lines for questions.

We achieved depletions growth of 26% and record total depletions in the third quarter. I am pleased with our depletions growth, which is attributable to strong sales execution, support from our wholesalers and retailers as well as our great quality beers, innovation capability and strong brands. A lot of people work very hard to create and support this growth and I would like to personally and publicly thank all of our Boston Beer Company employees for this achievement.

I am particularly pleased with the growth in the quarter of our flagship, Sam Adams Boston Lager, which will be celebrating its 30th anniversary in 2014 and then in our fall seasonal Sam Adams OctoberFest. Our fall seasonal program also included the limited release of some excellent beers, including Sam Adams Harvest Pumpkin and an innovative small batch brew, Samuel Adams Fat Jack Double Pumpkin Ale. We remain confident about the long-term outlook for the craft category and our Sam Adams brands.

I will now pass over to Martin for a more detailed overview of the business.

Martin Roper

Thank you, Jim. Good afternoon everyone. As we state in our earnings release, some of the information we discuss in the release and that may come up on this call reflect the company’s or management’s expectations or predictions of the future. Such predictions in the like are forward-looking statements. It is important to note that the company’s actual results could differ materially from those projected in such forward-looking statements.

Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in the company’s most recent 10-K. You should also be advised that the company does not undertake to publicly update the forward-looking statements, whether as a result of new information, future events or otherwise.

In the third quarter, our depletions growth remained strong and benefited from growth in our Samuel Adams Twisted Tea and Angry Orchard brands. We believe that the strength of our main brands is reflective of strong sales execution and our increased investments in media, local marketing and point-of-sale and the efforts of our increased sales force. We have raised our expectations for full 2013 full year depletions growth to between 21% and 24% to reflect the current trends. We take advantage of the opportunities that we currently we see an expected competitive activity. We are increasing our planned investment in media, our sales force and other support behind our brands for the remainder of the year.

I would like to recognize all the employees involved at our breweries and in our operations support groups for their efforts this quarter in supporting our growth. The growth has been challenging operationally and despite our best efforts, we have had some product shortages and service issues during most of the quarter. Our supply chain struggled under the increased volume and we experienced increased operational and freight cost as we reacted. We commissioned our new bottling lines during the quarter, this line and our new can line are starting to achieve their design capacities and ease our packaging constraints. We have, however, remained tank constrained in our breweries and this is now expected to be resolved for several more weeks. To address these challenges, we initiated significant capital improvements in our breweries that will help support our growth in 2014 once completed. We expect a continued high level of brand investment and capital investment as we pursue growth and innovation. We are prepared to protect the earnings that maybe lost as a result of these investments in the short-term as we pursue long-term profitable growth.

Alchemy & Science, our craft brew incubator, continues to make progress with its existing brands, which include Angel City Brewery, Traveler Beer Company and the Just Beer Project. During the quarter, Alchemy & Science completed the acquisition of the Coney Island Brewery brand. Also, Alchemy & Science is currently finalizing plans to build a small brewery and beer hall in Miami, Florida named Concrete Beach Brewery. To-date, sales from Alchemy & Science brands have not been significant. Our latest 2013 financial projection includes estimated brand investments attributable to existing Alchemy & Science projects of between $4 million and $6 million and capital investments of between $7 million and $10 million, which include the brand acquisition cost of the Coney Island Brewery, but these estimates could change significantly. It is unlikely that the 2013 volume of Alchemy & Science brands will fully cover these and other expenses that could be incurred this year.

We currently have 120 wholesalers, representing over 65% of our volume in our Freshest Beer Program and believe this could reach 70% by the end of 2013. The systems and processes supporting Freshest Beer helped us significantly with product allocations during the quarter. We continue to invest in the breweries to improve their support of the program, particularly during peak selling periods. Year-to-date depletions through the 42 weeks ended October 19, 2013 are estimated to be up approximately 23% from the comparable period in 2012.

Now, Bill will provide the financial details.

Bill Urich

Thank you, Jim and Martin. Good afternoon everyone. We reported net income of $25.7 million, or $1.89 per diluted share for the third quarter, representing an increase of $4.9 million, or $0.36 per diluted share from the same period last year. This increase was primarily due to shipment increases, partially offset by increased investments in advertising, promotional and selling expenses and the $0.10 per diluted share write-down of the Freetown land.

Core shipment volume for the third quarter was approximately 993,000 barrels, a 29% increase over the third quarter of 2012. Inventory at wholesalers participating in the Freshest Beer Program was lower by an estimated 208,000 case equivalents compared to the end of the third quarter in 2012.

Our third quarter 2013 gross margin decreased to 53% from 56% in the third quarter of 2012. This was primarily driven by increased brewery processing cost, increased ingredient cost and product mix effects and the $3.3 million of customer program and incentive costs that are now recorded as reductions in revenue. In the third quarter of 2012, customer programs and incentive costs were recorded as advertising, promotional and selling expenses.

Third quarter advertising, promotional and selling expenses, excluding the 2013 customer programs and incentive cost now reported as a reduction of revenues, were $8.5 million higher than those costs incurred in the prior year. The combined increase of $11.8 million in advertising, promotion and selling and customer programs and incentive cost was primarily a result of increased costs for additional sales personnel and commissions, increased investments in local marketing and media advertising and increased freight to wholesalers due to higher volumes.

General and administrative expenses increased $3.5 million compared to the third quarter of 2012, primarily due to increases in salary and benefit cost and consulting cost. Impairment of long-lived assets increased $1.3 million compared to the third quarter of 2012 due to the write-down of land owned by the company in Freetown, Massachusetts.

Based on information of which we are currently aware, we estimate 2013 earnings per diluted share to be between $5.05 and $5.35, a decrease from our previously communicated estimate range of $5.10 and $5.40 due to the land write-down and increased brand investments that will only be partially offset by increased shipment volumes. Our actual 2013 earnings per share could vary significantly from the current projection. We now estimate 2013 shipments and depletions growth of between 21% and 24%, an increase from the previously communicated estimate of between 17% and 22%. We estimate price increases of approximately 1% that will partially offset ingredients, packaging, freight and processing cost pressures.

Full year 2013 gross margins are still expected to be between 52% and 54%. We intend to increase investments in advertising, promotional and selling expenses by between $26 million and $32 million for the full year 2013, not including any increases in freight cost for the shipment of beer products to our wholesalers, up previously from the communicated estimate of between $20 million and $26 million, primarily due to the planned increase investments behind the company’s brands. We estimate our full year 2013 effective tax rate to be approximately 38%. We continue to evaluate 2013 capital investments, mostly of which related to continued investments in our breweries and additional keg purchases in support of our growth and have narrowed our 2013 capital expenditures to between $100 million and $120 million from the previously communicated estimate of $100 million to $140 million.

Looking forward to 2014, we are in the process of completing our 2014 planning process and will provide further detailed guidance when we present our full year 2013 results. Based on information of which we are currently aware, we are targeting depletions and shipment percentage growth in the mid-teens and national price increases per barrel of between 2% and 3% to offset anticipated upward pressure on ingredients, packaging and freight as well as increased investments behind our brands. Full year 2014 gross margins are currently expected to be between 52% and 54%.

We intend to increase advertising, promotional and selling expenses by between $34 million and $42 million for the full year 2014, not including any increase in freight cost for the shipment of products to our wholesalers. We estimate increased expenditures of between $3 million and $5 million for continued investment in existing brands developed by Alchemy & Science. These expenditures are included in our full year estimated increases in advertising, promotional and selling expenses. Brand investments in Alchemy & Science brands could vary significantly from current estimates. We estimate our full year 2014 effective tax rate to be approximately 38%. We are currently evaluating 2014 capital expenditures and our initial estimates are between $140 million and $180 million and increases in the range from the previously communicated estimate of $100 million to $130 million.

Based on information currently available, we believe that our capacity requirements for 2014 can be covered by our breweries and existing contracted capacity at third-party brewers. We expect that our cash balance at $43.7 million as of September 28, 2013 along with future operating cash flow and our unused line of credit of $50 million will be sufficient to fund future cash requirements.

During the third quarter and the period from September 29, 2013 through October 25, 2013, we did not repurchase any shares of our Class A Common Stock. As of October 25, 2013, we had approximately $25.5 million remaining on the $325 million share buyback expenditure limit set by our Board of Directors.

We will now open up the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from Vivien Azer from Citi.

Jim Koch

Good afternoon.

Martin Roper

Good afternoon.

Vivien Azer – Citi

In terms of your 2014 outlook for shipments and depletions I mean my goodness so healthy at mid-teens rate but as I look back at your guidance historically I don’t think we have seen you guys start of the year with such an optimistic outlook for several years now. So I was hoping you could dig a little bit deeper into what’s on bolstering your confidence as you head into the next fiscal year?

Martin Roper

Hey Vivien, it’s Martin I will respond and if Jim want to comment on the top he can. I think obviously it’s still early in our planning process, we can only project based on what we currently know. I think we see a number of positive signs not least of which is a return to growth of Sam Adams, Boston Lager and the general health of the Sam Adams brand. And on top of that we have Twisted Tea growing and Angry Orchard well lapping first year numbers still showing healthy growth. And as we project that out to next year and the activities that we have planned next year we are pretty optimistic.

On the other hand, I think there are some headwinds notably a competitive activity some of it announced, some of it rumored that could impede that growth. And so at this point in time we are just trying to balance all those factors and come up with our best guess and obviously we will have a better feel for it in February.

Vivien Azer – Citi

Absolutely and to follow-up on that it sounds like you are right now as you see 2014 looks to be a nicely balanced year across your portfolio which raises the question in mind about your outlook for net revenue per barrel increases plus 2% to 3%. As we think back to your guidance progression of 2013 that’s come down a bit I thought because of the negative mix shift from Angry Orchard and Twisted Tea, so am I – should I think that you guys are actually going to take better than that pricing on the beer portion of the portfolio to get total net revenue per barrel of plus 2% to 3% if you got to offset that negative mix shift?

Martin Roper

Well, I think when we give that projection that’s sort of an average sort of mix adjusted number as opposed to off the mix. So I think as we look at it we are faced with a number of cost pressures. On the beer side, we got ingredients pressures plus there is some move to perhaps more flavorful beers, more happy beers and beers with higher cost structures for us to cover on the tea side. And on the sector side, we have got some cost pressures there and that’s not the margins that makes the most amount of sense for the capital we are putting in. So our intent is to try and take some price to cover those things and obviously the last few years we haven’t been able to I think there are awesome signs in the industry that the big brewers have announced price increases. It’s totally unclear how much of that is sticking. And as we put our plans together next year, we are expecting to be able to take some price where we aren’t competitively priced or and also where the ingredients costs have gone up so we have to whether we can achieve that or not it’s currently just a planning number.

Vivien Azer – Citi

Yes, now I think that’s certainly reasonable. My last question has to do with the Freshest Beer Program. I think last quarter you guys were still targeting 75% by the end of the year and it looks like that’s come down a bit, can you dive into that a little bit please?

Jim Koch

I will just speak we are out at a point where we have a clear vision of who is going to be on the program by the end of the year. We are excited that wholesalers are continuing to sign off it simply requires some commitment on their part operationally and information flow wise and there continues to be people enthusiastic to join. And I just think that’s what we have – I think we would have liked it to be more I think we have just been through a quarter where we have had some operational service issues for which we have apologized to those wholesalers affected. And so we haven’t been able to bring on as many perhaps we would have liked given that. But as we look forward it’s something we are very committed to. We believe that having fresher beer in the marketplace and the best tasting beer that we and our wholesalers can deliver is an important competitive advantage. And we continued to look for ways to bring wholesaler inventories down and while still maintaining high degrees of service and the quality of our product.

Vivien Azer – Citi

Very helpful. Thank you very much.

Operator

Thank you. And our next question comes from Judy Hong from Goldman Sachs.

Mike Luddy – Goldman Sachs

Hi guys this is Mike Luddy is filling in for Judy.

Jim Koch

Hi Mike how are you doing?

Martin Roper

Hey Mike.

Mike Luddy – Goldman Sachs

So first question obviously you have seen really nice colors on Boston Lager. I think we have seen some of the other gig craft brands also start to accelerate recently. So I was wondering if you could just talk a little bit more about what you are seeing behind the acceleration of that brand. And if you are seeing more of a shift of craft demand into the bigger craft brands?

Martin Roper

Mike, it’s Martin and I will comment and then Jim can comment. I certainly think we are happy with what we are seeing and certainly the major craft brands seem to something – somewhat similar in terms of growth against their core brand. But if not universal it’s across the top 30 craft brewing companies, it’s sort of just the top three or four. And there is some other activity going on. So within craft we are still seeing some strength in volume with the tail. We are still growing pretty fast. I do think that the amount of shelf space that’s available is sort of not growing as fast as it used to and also the number of tap handles available, aren’t growing as fast as they used to. So we are starting to see some replacement of beer SKUs with other beer SKUs which – and to some churn in the middle of that. And so I think you are seeing startups doing okay and the bigger brands doing okay as maybe there is a return to quality and familiarity and in the middle of those this fight for space going on. And I will now let Jim comment.

Jim Koch

I think to support what Martin said there is starting to be the inklings of in some retailers a variety of fatigue and retailers realizing that just churning their tap handles is confuses their staff, makes the beer ordering process longer, generates more bad beer and kegs that don’t turn fast enough et cetera. And so you are starting to see a few retailers making sure that they carry the lead brands in the craft category because that’s what a lot of their consumers want. So there is still a lot of variety, there are still two or three new craft breweries opening every day. Retailers and distributors dealing with this avalanche of new SKUs finding places in warehouses and on shelves to continue to expand the variety offered to the consumers. But I think it’s a positive sign for the craft category that lead brands from the strong craft brewers brands that are well supported in the marketplace are seeing growth.

Mike Luddy – Goldman Sachs

Got it. Thank you. One other quick question just as we look at the promotion and selling line, I guess more specifically on the amount of sales people that you are using. Can you just talk a little bit more on how you think about that and how you are growing that whether it’s just kind of keeping in line with your sales growth or are you getting closer to a point where you can see more leverage on the existing sales base that you already have?

Martin Roper

Yes, I think our decisions on people are sort of based on the opportunities and what we see the future growth to be. And obviously, some markets can support salespeople and some can’t, but with this sort of growth rate, they start to be more markets that can support and justify and there is enough activity to be efficient. So we are sort of filling in, in markets where we haven’t had people before or splitting up roles. I think we are also seeing an interest from major retailers to have a more representation from us with more visibility to us and so we are putting more people into teams against the major retailers. And even we have before and so our national account team continues to grow.

To your leverage point I think we are seeing leverage against our total salespeople costs, although there it is a competitive market and we are adding relatively quickly and we see salary increases there and other sorts of stuff that decreases that leverage. But in general I think over the last three, four years we are seeing some leverage against that number.

Mike Luddy – Goldman Sachs

Great, thanks.

Operator

Thank you. And our next question comes from Marc Riddick from Williams Capital.

Marc Riddick – Williams Capital

Hi, good evening everyone.

Martin Roper

Hi Marc.

Marc Riddick – Williams Capital

Wanted to follow-up on Sam Can and see if there was some updates that you could provide as to that and as far as the perhaps future brands and maybe some other SKUs that could sort of be utilized there? And then I have couple of follow-ups after that.

Martin Roper

Yes, Marc. I think one we are very happy with the launch both from a timing and an execution of the brewery came from the technical teams. I think we launched with Boston Lager on a national basis. And I think we have seen pretty much what we expected I think on one of the previous calls we indicated that cans as a percentage of bottles was mid low single-digits across and nearly close to where it is for mass domestic. And that’s basically what we have seen. We still have distribution opportunities. We could have launched when we have the technology as opposed to with the six-month, nine-month planning windows. And so we are still getting distribution and getting cut into the sets, but I think instead of meeting our expectations, which is I think is that perhaps were lower than other people’s expectations. We also had Summer Ale cans in New England and that did nicely for us. And we rolled that to OctoberFest in cans nationally. And again we had a bit – little bit better lead times, so we got a little bit better distribution activity, but it’s still for us will take 12 months to fill out full distribution of seasonals in cans. So we are happy. We very much like the Sam Can and the taste of the beer out of the can and think it presents the beer really well and we are still filling our distribution. And as we look at year-on-year comparables, we obviously did not have seasonals in cans last year on a national basis for the full year. So we have that to help us too.

Marc Riddick – Williams Capital

Okay, excellent. Thank you. Also, I was wondering as far as the strength of Boston Lager and we are really just at the beginning of touching on that last quarter, it was kind of a little bit of a surprise and now with an extra quarter behind you to see the strength of building there. I was wondering if there was a – was there any tie in leading into the 30th anniversary do you believe? And if not, then perhaps maybe it seems as though perhaps would be advantageous with the 30th anniversary coming up next year. Does that then change your approach or maybe strengthen it as to your marketing and advertising plans around the anniversary?

Martin Roper

Yes. We don’t think that there is any sort of recognition around this [inaudible) to help around the 30th anniversary. Certainly as we plan our brand activities and our retail execution activities, for 2014, we intend to incorporate the 30th anniversary of Jim founding the company and brewing Boston Lager into that, but we don’t think it’s the driver at this point in time in the current trends we are seeing.

Marc Riddick – Williams Capital

Okay, excellent. And then finally, I know that there is planning as far as hiring not just on the sales side, but also on the production side, I was wondering if you could give a little bit of an update and when we might seem little bit more of that as far as the timing either at the end of this year or going to into early next year? Thank you.

Martin Roper

Yes. Well, I think one of the things that we were obviously caught a little bit by surprise by the acceleration of the business in Q2 and Q3. And I think it’s fair to say that our breweries weighted through that, but we were probably under stocked and a lot of people worked a lot of days, many of them in a row. And as we look at next year and we think about the growth number that we have put out there, we recognized we need to hire and train in advance of our peak season. So we certainly will be doing that constantly over the next six months to get out ahead of it.

Marc Riddick – Williams Capital

But it’s possible that it could sort of be maybe a little more concentrated in calendar 1Q of next year?

Martin Roper

Yes. We want to get out ahead of it and have people trained. We also have needless to say a fair number of capital – sizable capital projects and we are hiring right now the project management and commissioning skills to be able to incorporate that in our plans next year so that we are effective as get to Q3.

Marc Riddick – Williams Capital

Okay, thank you very much.

Operator

Thank you. (Operator Instructions) I am showing no further questions at this time. I would like to hand the conference back over for any closing remarks.

Martin Roper

Thank you everybody and we will be speaking in another three months. Cheers.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. You may all disconnect and have a wonderful way. Moderators, please stay on the line.

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