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Boston Beer Co. Inc. (NYSE:SAM)

Q4 2013 Earnings Conference Call

February 25, 2014 05:00 PM ET

Executives

Jim Koch - Founder and Chairman

Martin Roper - President and CEO

Bill Urich - CFO

Analysts

Mike Luddy - Goldman Sachs

Marc Riddick - Willams Capital

Brian Doyle - CLSA

Operator

Good day, ladies and gentlemen and thank you for standing by and welcome to the Boston Beer Company’s Fourth 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, today’s conference may be recorded.

It’s now my pleasure to turn the call over to Jim Koch, Founder and Chairman. Sir, the floor is yours.

Jim Koch

Thank you. Good afternoon and welcome. This is Jim Koch, Founder and Chairman and I'm pleased to be here to kick off the 2013 fourth 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'll begin my remarks this afternoon with a few introductory comments, including some highlights of our results and then I’ll hand the phone over 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 fourth quarter and 2013 fiscal year as well as our outlook for 2014. Immediately following Bill’s comments, we’ll open up the line for questions.

I'm pleased with our depletions growth of 20% for the quarter and 23% for the year and I’m especially gratified that our flagship Sam Adams Boston Lager, one of the original craft brews continued to grow in 2013 as we enter our 30th year of brewing this beer. I'm also pleased that The Boston Beer Company continues to help lead the craft beer industry, both in innovation and variety and that drinkers remain excited by our beers.

Our growth is also attributable to strong sales execution and support from our distributors and retailers, as well as our great quality beers innovation capability and strong brands. During the first quarter we are releasing several new beers that should continue this momentum.

Our new spring seasonal brew, Samuel Adams Cold Snap, a unique and approachable white ale brewed with a blend of exotic spices, has launched and appears to be well received by drinkers and retailers. We also began a national rollout of Samuel Adams Rebel IPA, a West Coast style IPA brewed with hops from the Pacific Northwest that created a lot of excitement in its test markets last year. It’s already receiving great support from distributors, and on and off premise retailers. We believe that these styles and packages are being favorably received by drinkers and we remain confident about the long-term outlook for the craft beer category and for our Samuel Adams brand.

I will now pass over to Martin for a more detailed overview of our 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 and 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 forward-looking statements, whether as a result of new information, future events or otherwise.

In the fourth quarter, our depletions growth remained strong and benefited from growth in our Samuel Adams Twisted Tea and Angry Orchard brands. The timing of our transition to our new Sam Adams spring seasonal Cold Snap was planned a week later than last year, and was accomplished by mid-January in most of our markets. We expect to continue to increase investments in advertising, promotional and selling expenses behind existing brands and also in innovation, commensurate with the opportunities and the increased competition that we see. With the launch of several new beers and our increased investment behind Twisted Tea and Angry Orchard, we believe we are well-positioned to maintain our momentum.

Over the past year, our supply chain struggled under the unexpected increased demand and we experienced higher operational and freight costs as we reacted. While our growth continues to challenge us operationally, we improved our service levels to our distributors during the fourth quarter and decreased our product shortages. In preparation for 2014, we have significantly increased our packaging and shipping capabilities and our tank capacity at our Breweries to address the opportunity and meet these challenges.

Given the opportunities that we see, we expect a continued high level of brand investment and capital investment as we pursue growth and innovation. We are prepared to forsake the earnings that may be lost as a result of these investments in the short term as we pursue long term profitable growth. We believe that one benefit of our Freshest Beer Program is better visibility into distributor inventories and needs. This allowed us to better allocate available product in 2013, when we were at capacity and experiencing shortages.

Overall, we remain committed to the program and continue to believe that we are benefitting by delivering better, fresher Samuel Adams beer to our drinkers while lowering distributor inventories. We also recognize that we have significant opportunities to ensure that our on-time product shipping performance meets expectations and to ensure that as we grow, we are reducing costs and improving efficiency throughout the supply chain, without the cost of lost sales.

We currently have more than 120 distributors participating in the program at various stages of inventory reduction, representing over 65% of our volume. We believe participation in the program could reach between 70% and 80% of our volume by the end of 2014. We continue to evaluate whether we can reduce distributor inventory levels even further and are making investments in our breweries to improve their service in support of the program. Based on information in hand, year-to-date depletions reported to the Company through the seven weeks ended February 15, 2014 are estimated to be up approximately 35% from the comparable period in 2013.

Now Bill will provide the financial details.

Bill Urich

Thank you, Jim and Martin. Good afternoon everyone. We reported net income of $18.1 million or $1.33 per diluted share for the fourth quarter, representing an increase of $1.2 million or $0.08 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.

Our core shipment volume for the fourth quarter was approximately 941,000 barrels, a 29% increase over the fourth quarter of 2012. Fourth quarter shipment growth rates were higher than depletion growth rates, primarily due to productions shortages of certain brands experienced during the third quarter that were filled in the fourth quarter as distributor inventories were rebuilt. We believe distributor inventory levels at December 28, 2013 were at appropriate levels. Inventory at distributors participating in the Freshest Beer Program was lower by an estimated 212,000 case equivalents compared to the end of the fourth quarter in 2012.

Our fourth quarter 2013 gross margin decreased to 51% from 52% in the prior year. The margin decrease is a result of increases in ingredient cost, product mix effects and brewery processing costs, which were only partially offset by price increases.

Advertising, promotion and selling expenses were $19.1 million higher than costs incurred in the fourth quarter of the prior year. This increase was offset by a decrease of $1.5 million in customer programs and incentive cost. The combined net increase of $17.6 million in advertising, promotion and selling, and customer programs and incentive cost was a primarily result of increased costs for additional sales personnel and commissions, increased investments in point of sale, local marketing and media advertising, and increased freight to distributors due to higher volumes.

General and administrative expenses increased $3.5 million compared to the fourth quarter of 2012, primarily due to increases in salary and benefit cost and consulting fees. Our full year 2013 core shipment volume was approximately 3.4 million barrels, a 25% increase from the prior year.

Full year 2013 gross margin decreased to 52% from 54% in the prior year. The gross margin decrease is a result of increases in ingredient cost, product mix effects, increased brewery processing costs and an increase in customer programs and incentives, which were only partially offset by price increases.

Full year advertising, promotion and selling expenses, excluding the 2013 customer program and incentive cost of $13.4 million that were reported as a reduction in revenue, were $38.6 million higher than costs incurred in prior year. The combined net increase of $45.6 million in advertising, promotion and selling and customer programs and incentive cost was primarily result of increased costs for sales personnel and commissions, increased local marketing, point of sale and media advertising, and increased freight to distributors due to higher volumes.

General and administrative expenses increased by $12.2 million from the prior year, due to increases in salary and benefit costs and consulting fees. Impairment of long term assets increased $1.4 million [ph] from the prior year, due to the further write down of land owned in Freetown, Massachusetts.

Looking forward to 2014, based on information which we are currently aware, we are targeting 2014 earnings per diluted share of between $6 and $6.40, but actual results could vary significantly from this target. We are currently planning 2014 shipments and depletions growth of between 16% and 20%. We are targeting national price increases per barrel of approximately 2% to offset increases in ingredients, packaging and freight cost, and increased investments behind our brands.

Full year 2014 gross margins are currently expected to be between 51% and 53%. We intend to increase investments in adverting promotion and selling expenses by between $34 million and $42 million for the full year of 2014, not including any increases in freight cost for the shipment of beer products to our distributors.

We estimate 2014 brand investments attributable to existing Alchemy & Science projects to be between $5 million and $7 million, which are included in our full year estimate increases in advertising, promotion and selling expenses. These estimates could change significantly and 2014 volumes from these brands is unlike to cover these and other expenditures that could be incurred. We believe that our 2014 effective tax rate will be approximately 38%. We are continuing to evaluate 2014 capital expenditures and currently estimate investments of between $160 million and $220 million, which could be significantly higher depending on capital required to meet future growth.

These investments relate to continued investments in our breweries and additional keg purchases to support our growth and increase complexity. Based on the information currently available, we believe that our capacity requirements for 2013 can be covered by our breweries and existing contractive capacity at third party powers. These estimates include capital investments for existing Alchemy & Science projects of between $7 million and $9 million. During January 2014, we amended our line of credit to increase the amount available from $50 million to $150 million and extended the schedule exploration date to March 31, 2019.

Our amended line of credit has terms and covenants similar to the previous line of credit. We expect that our December 28, 2013, cash balance of $49.5 million, together with our future operating cash flow and a $150 million line of credit will be sufficient to fund future cash requirements.

During the fiscal yearend December 28, 2013, we repurchased approximately 196,000 shares of our class A common stock for a total cost of $29.6 million. From December 29, 2013 through February 14, 2014 we did not purchase any additional shares. We have approximately $25.5 million remaining on the $325 million share buyback expenditure limit set by the Board of Directors.

We’ll now open up the call for questions.

Question-and-Answer Session

Operator

Thank you, sir. [Operator Instructions] All right, and it looks our first phone question will come from the line of Michael Luddy with Goldman Sachs. Please go ahead. Your line is open.

Michael Luddy - Goldman Sachs

So really just want to get a little bit more color on your quarter-to-date depletions being a very large 35% number and you feel your guidance not coming up as much as you perhaps would think given that quarter-to-date number. So is there anything with the wholesale inventory or anything going on there that is inflating that number artificially?

Martin Roper

Sure, let me ask; both inherent questions in there. One is we're already six weeks - seven weeks into the year and historically we’ve not found that to be a great indicator for full year trends. So historically we have not adjusted a full-year range on the basis of basically a month and a little bit. And then as it relates to the number, obviously its existing but this is actually a pretty slow time for the business for craft and tea inside a -- generally this is slow month. We’ve launched a couple of new products into that time period in Cold Snap and in Rebel. So there is a fair amount of pipeline fill going on that again would cause us to be a little reluctant to project those numbers out on a full term. So we’re just sort of waiting and expect the numbers to settle down a little bit once that pipeline fill has sorted itself out.

Bill Urich

In trial.

Martin Roper

In trial, yes

Mike Luddy - Goldman Sachs

Right and then on pricing and margins guidance -- gross margin guidance both coming down a little bit, I presume a lot of that is perhaps Angry Orchard doing better than you had initially forecasted for the year. But is there anything on the pricing side I guess unrelated to that that has changed versus your previous guidance?

Martin Roper

No, I think the pricing outlook looks much like it did when we spoke to you last. Our intent is to shoot for 2% on average-across the board but obviously it will vary by market to cover both the ingredients and processing cost increases and freight increases that we see. I think if there has been any change on margin, it more relates to we continue to struggle a little bit on the operational side to get the leverage that we anticipated from the volume. Frankly, we’re focused just servicing the customers with shipping beer, cider and tea to them as they need it and we’re not so focused on the cost side right now. We’re basically supporting the growth and I think that probably would be our expectation for most of the year. That is what the primary focus of the company will be operationally. So we’re not expecting to see some of the cost leverage we might have expected. Obviously we‘d like to see that long term but we don’t expect to see it this year.

Operator

Thank you sir, our next phone question will come from the line of Marc Riddick with Williams Capital. Please go ahead, your questions please.

Marc Riddick - Willams Capital

Quick question about, one of the things that caught my attention during the prepared remarks was Jim mentioning the term approachable in talking about Cold Snap and I thought that was kind of interesting because for those who have introduced it to and that type of thing it seems to be - I don’t know if it's the best way to put it but it’s almost the sort of an entry -- kind of an entry level offering for some folks who maybe having -- had a lot of experience with craft beers, not maybe as strong and as flavorful as some of the more hardcore things. So I was wondering if you could sort of talk about that a little bit, because it seems as though the offering is something that would really sort of get a little bit more mass appeal for those who are not already in the space. And then I have a couple of follow-ups.

Jim Koch

Yes, they, I used the term approachable because it is a beer that has a quite different flavor profile. It’s obviously based on the tradition of Belgian white ales, which have substituted various spices for hops. So instead of hop character and bitterness you’re going to get spice character, traditionally coriander which in a beer tends to have a sort of bergamot Earl Gray tea kind of character to a lot of people, and then orange zest and we added eight other spices for a very complex, intriguing sort of spice package in that beer and it seems to have hit the right note this time of year. It’s been a pretty cold first few months of the year and we might have wondered, that a lighter more spice forward beer where that would fit but so far we’ve been very pleased.

Marc Riddick - Willams Capital

And I was wondering as far as some of the thoughts going forward with cans and forgive me if I missed this because I did lose a little connection here on my end, but I was wondering if you could sort of give an update on maybe what we would expect to see as far as whether it’s seasonal or having sort of -- maybe an update on sort of where you see cans this year.

Martin Roper

Sure, we launched you know Boston Lager in the Sam Adams can last April, we did a little bit of summer ale in New England, just to see how it would play out and then rolled October Fest nationally in the can in August and went to lager and Cold Snap rule. So rolled, I would say that the can volume has sort of met what our expectations were, which perhaps were lower than other peoples. If you look at you know craft beer generally, somewhere between 3% and 8% of a brand's volume is in cans, somewhat depending on the market they’re in and the season that they do well in, and that’s certainly been the range that we’ve seen, matching what our prior research had been from the IRA data. So it’s basically met our expectations. It's added some occasions, some venues, but it’s been helpful and it certainly contributed to the growth but it hasn’t perhaps been as big as some of the people were projecting it would be.

Marc Riddick - Willams Capital

And one last question as far as on the marketing side and I just want to get a sense of you know the mix of marketing, what have you. Clearly the commercials are certainly resonating; certainly seem to be helpful from the standpoint of top line growth. I want to just make sure of that, are you really looking at a similar mix of marketing spending, sort of how you’re allocating the marketing and advertising dollars this year? Is it similar to last year or should we expect any meaningful changes to that type of mix?

Martin Roper

I think the principles are similar but some of the brand spend is a little different. We always start with a strong sales organization and we continue to invest in the appropriate markets where we need to and the appropriate cost of trade where we have opportunities to add talented people to help us with the business and that remains the number one priority. I think the secondary priority would be the point of sale and promotional support at retail and again we continue to increase that.

And then on the media side I think -- which is where perhaps the biggest change this year versus last year is last year is -- last year we had media spend for Sam Adams and Twisted Tea and only for Angry Orchard just in the fourth quarter and thus year we anticipate supporting all those brands with media spend for the majority of the year.

Operator

Thank you sir. [Operator Instructions]. And it looks like our next phone question will come from the line of Caroline Levy with CLSA. Please go ahead. Your line is now open.

Brian Doyle - CLSA

This is Brian Doyle in for Caroline. We were just wondering on IPA how you think about the potential revenue opportunity, maybe just in terms relative to sat Angry Orchard and then related to that as it were margin accretive, at least on a gross margin line versus base Boston Lager?

Martin Roper

Sure. It’s really too early to tell because we are just sort of seeing pipeline fill and as Jim mentioned early trial to project a volume number for Rebel IPA and so I'm really hesitant to do that. From a product cost margin perspective, the beer features obviously hops of various northwestern varieties at relatively high levels and those hops have been reasonably expensive over the last couple of years due to supply-demand issues. So, from margin perspective it’s probably not as exciting as we would like, but obviously we need to go where the drink is going and the drinker seems to be interested in more unique or different flavors perhaps than they were five years ago. We've seen some interest in Pseudo which have some similar margin issues, then obviously growth of the IPA category within craft has been very healthy and that I think also had some margin issues. So, net-net I think we expect if Rebel was to be significant for us, that it would probably have a negative impact on margin.

Brian Doyle - CLSA

I just had one follow up and that was on your comment around complexity, as a sort of headwind on gross margin. Is that -- I'm thinking in terms of like kind of three buckets; if one is the package complexity, obviously the rollout of cans and then another is between categories with Angry Orchard and versus beer and then within beer, what’s kind of the biggest -- of those three what are the kind of bigger drivers of the gross margin pressure from a complexity standpoint?

Martin Roper

I would actually sort of say the biggest driver is probably just the sheer volume growth in us racing to keep up with it from a supply perspective has not allowed us to get the efficiencies we would like. Obviously, we have a pretty complex portfolio relative to -- I'm going to choose a point, 15 years ago. But we have invested in both the people and some of the equipment to deal with that within our breweries. That’s not to say that it isn’t difficult and I will certainly take this opportunity to tip my cap to everybody in the breweries for last year’s performance, which was truly incredible, given the volume acceleration that we experienced in Q2, Q3. So, I would say its part of the issue, but the bigger issue is really that we are adding capacity really fast and we are trying to keep up with demand and that proposed certainly some challenges in Q3 last year.

Operator

Thank you sir. [Operator Instructions] All right and it looks like we do have another question. And our next question will come from Marc Riddick with Williams Capital. Please go ahead sir.

Marc Riddick - Williams Capital

Just one quick follow-up that I wanted to go over with. I was wondering if you could give a sense now versus last year, if you are getting any sense of retailer feedback and sort of what you are experiencing with them, as far as changes within the industry, if there is anything that you would see as different from what they are looking for, the kind of feedback that you're getting from them, maybe not just as far as sales base but just as a general use of the craft industry? Thank you.

Jim Koch

Well, I think retail, both on-premise and off, remain very positive about craft beer. It is the major source of volume growth and profit growth for them. And they are seeing the same double-digit growth that we are and that’s a very exciting thing for retailers. They are probably struggling a little bit with how to configure the SKUs that they carry, how to make decisions among all the possible SKUs that are out there, how much to expand there, coolers if at all, should they put in warm space for beer, where should that be.

So this is a new world for them in terms of merchandizing beer almost like wine with lots of different SKUs and then trying to rationalize it around brands, which they don’t do with wine. So I think retailers are excited to support the continued growth of craft beer and will be evolving their merchandizing strategies going forward.

Operator

Thank you. And presenters, at this time I'm currently showing no additional phone questioners in queue. I'd like to turn the program back over to management for any additional or closing remarks.

Martin Roper

Thank you everyone for joining our call and we will talk to you next quarter. Cheers.

Jim Koch

Cheers.

Operator

Thank you gentlemen and thank you ladies and gentlemen. This does conclude today’s call. Thank you for your participation and have a wonderful day. Attendees, you may log off at this time.

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