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Boston Beer Co. Inc., (NYSE:SAM)

Q2 2010 Earnings Call

August 3, 2010 5:00 p.m. ET

Executives

C. James Koch – Founder, Chairman, and Secretary

Martin Roper – Chief Executive Officer, President

William Urich – Chief Financial Officer, Principal Accounting Officer and Treasurer

Analysts

Judy Hong – Goldman Sachs

James Watson – HSBC

Andrew Kieley – Deutsche Bank

Operator

Good evening. My name is Chastity and I will be your conference operator for today. At this time I would like to welcome everyone to the Boston Beer Company’s Q2 2010 earnings conference call. (Operator instructions.)

I would now like to turn the conference over to Mr. Jim Koch, Founder and Chairman of Boston Beer Company. You may begin, sir.

C. James Koch

Thank you. Good afternoon and welcome. I’m pleased to be here to kick off the 2010 Q2 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 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 Q2 as well as our outlook for the remainder of 2010. Immediately following Bill’s comments we’ll open the lines up for questions.

We achieved depletions growth of 13% in the Q2. This record second quarter for depletions is due to our strong sales execution and continued support from our wholesalers and retailers. While we’re pleased with the results we believe some of the increase benefited from an easy comparison to the Q2 of 2009, which was up only 2% compared to the Q2 of 2008.

We continued to see expanded distribution of domestic specialty brands and local craft brands, which is increasing competition in our category. We’re happy with the health of our brand portfolio and remain positive about the future of craft beer.

I’ll now pass it 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 in 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 10K. 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.

We believe we executed well in the first half of the year, and that the business may have responded to our increased investments in local marketing and media advertising and increases in sales force personnel. However, there appeared to be slowing trends toward the end of the Q2 due to tougher comparisons and the timing of certain promotional activities. We therefore believe it is unlikely that depletions will continue at the first half growth rate for the remainder of the year, but we are working hard to maintain these trends. We have raised our full year depletions targets and earnings per share range based on the strong quarter and our current expectations of future trends.

As we look forward to 2011 we are evaluating increasing our investments in brand support in order to grow our brand appropriately given the opportunities we see. It is possible that these decisions might result in slower earnings growth as we may forsake some earnings in the short term in order to build our organizational capabilities and increase brand spending.

Year-to-date depletions through July, 2010, are estimated to be up approximately 11% from the same period in 2009. Shipments and orders in hand suggest the core shipments year-to-date through August, 2010, will be up approximately 14% compared to the same period in 2009. Actual shipments may differ, and no inferences should be drawn with respect to shipments in future periods.

Now Bill will provide the financial details.

William Urich

Thank you, Jim and Martin. Good afternoon, everyone. We reported net income of $16.3 million, or $1.13 per diluted share for the three months ended June 26th, 2010, representing an increase of $4.4 million or $0.30 per diluted share from the same period last year. The increase is primarily due to increased core shipment volume partially offset by increased selling expenses.

Core shipment volume for the three months ended June 26th, 2010, was approximately 627,000 barrels, a 9% increase versus the same period in 2009. The increase in shipments for the quarter is due to double digit increases in Twisted Tea® and Samuel Adams® Seasonals, as well as increases in Samuel Adams® Boston Lager and the Samuel Adams® Brewmaster’s Collection. We believe that wholesaler inventory levels at June 26th, 2010, were at appropriate levels.

Our Q2 2010 gross margin of 56% represented a 3 percentage point increase from the 53% gross margin realized in the Q2 of 2009. The increase reflects the lower brewing and packaging costs per core barrel at our Pennsylvania brewery, resulting from our cost-savings initiatives and pricing increases of approximately 1%, as well as the fact that the Q2 2009 had some lower margin contract production for Diageo North America Inc.

Q2 2010 advertising, promotional, and selling expenses were $3.9 million higher than those incurred in the Q2 of 2009, primarily as a result of increased investments in point of sale materials, local marketing, radio advertising, and our sales force; partially offset by lower television advertising costs.

Based on information of which we are currently aware we are increasing our projected 2010 earnings per diluted share to a range of $2.85 to $3.15. We currently project full year depletions growth of between 8% and 10% based on our analysis of year-to-date depletions versus 2009 and 2008.

We continue to believe that the current competitive pricing environment is very challenging, and we will have full year price increases of between 1% and 2% through minor price optimizations, as the competitive environment permits, but there will be no assurances that we will be able to achieve these planned revenue per barrel increases. We are committed to trying to grow market share and to maintain volume and healthy pricing, and are prepared to invest to accomplish this even if this causes short-term earnings decreases.

We continue to evaluate 2010 capital expenditures and based on our current information now expect them to be between $12 million and $18 million, primarily for continued investments in the Pennsylvania brewery as we pursue further efficiency initiatives and equipment upgrades, as well as additional keg purchases to support continued growth. The actual amount spent may well be different from these estimates as we continue to analyze our investment opportunities.

We continue to maintain a strong cash position, with $53.7 million in cash as of June 26th, 2010. This is an increase of approximately $15 million from the Q1 balance, despite repurchasing approximately $16.7 million of shares under the stock repurchase program during the quarter. On July 28th, 2010, the Board of Directors improved an increase of $25 million to the previously-approved $165 million share buyback expenditure limit, for a new limit of $190 million. We have approximately $29.9 million remaining on the $190 million share buyback expenditure limit set by the Board of Directors.

We will now open up the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions.) Your first question comes from the line of Judy Hong with Goldman Sachs.

Judy Hong – Goldman Sachs

Hi guys, how are you? Jim or Martin, I just wanted to get a little bit better understanding just in terms of your depletion trend throughout the quarter. You talked about some slowing down toward the end of the quarter and then July looks like it’s a little bit of a slowdown as well. So could you just maybe quantify the magnitude of the slowdown, and other than the comparison issue is there any other factor that’s driving the sequential slowdown in terms of your depletion trend?

Martin Roper

Sure, Judy. I think we started off the quarter very strong with a very clean cutover from Noble Pales to Summer Ale, and that certainly benefited us. We obviously in the Q1 indicated that our Noble Pales trends were very good and that led I think to a very efficient and sharp cutover early in the season, and that helped the trends early in the quarter. I think later in the quarter we had much tougher comparisons to last year and we saw those come through.

I think as it relates to the July year-to-date numbers, we’re still you know, basing our number that we disclosed on estimates and so it’s a little hard to get a really good read. But July had a day less and so we have a day less year-to-date. And then some of the July versus the Q2 trend is also due to how July 4th fell this year.

Judy Hong – Goldman Sachs

Okay. And then just in terms of the pricing environment, you’ve talked about the competitive environment being more challenging just in terms of the pricing and the outlook, yet you know, you’ve got some of the domestic players that are taking price increases again. So maybe just broadly speaking, as you think about the industry from a pricing perspective, is it just more challenging for the higher end to get pricing? How does kind of what the domestic guys are planning to do impact your ability to pick more pricing going forward?

C. James Koch

Well, I think we haven’t made any decisions yet about pricing going forward, you know, cause 2011’s a long way away and typically we’ve done most of our pricing actions in the beginning of the year. With respect to the announced plans of some of the bigger brewers, I guess I’d have to say that our pricing is going to be driven by our own costs and our own opportunities. So it’s not necessarily going to happen that we would move in lockstep with the mass domestic brewers. I think we’re somewhat in a different dynamic.

Judy Hong – Goldman Sachs

Okay. And then Bill, just in terms of the quarterly result, the G&A actually picked up in the Q2, probably it’ll be a little bit more than what we’ve seen in the past couple of quarters. Can you just talk about what drove that increase, and as you kind of look out for the balance of the year at the rate of increases at the G&A line, is that likely to continue?

William Urich

Yeah, if I understand your question – you’re saying the G&A this quarter was, grew higher than last quarter or then typical quarters?

Judy Hong – Goldman Sachs

I think it’s more… I mean the last quarter you certainly had G&A down 10%, this quarter I think it was up 12% or so. It just seemed like, maybe it was a timing issue, I’m not sure, but it seems like it was a little bit higher than what we were looking for.

William Urich

Yeah, I think the Q1 if you will remember we had a stock option expense that was reversed, and in the Q2 we had some other G&A expenses but it was pretty normal and typical expenses. There was nothing unusual. And we continue, you know, to invest in our G&A but very cautiously.

Judy Hong – Goldman Sachs

Okay. And then just in terms of, as you think about your marketing spending, particularly on the advertising side, you’ve got again a trend where a lot of the other domestic brewers are actually reducing advertising spending. You guys obviously are increasing. So can you maybe just talk a little bit about the efficiencies of your spending and at some point do you think that you can get more operating leverage as you ramp up spending a little bit, at a lower pace than what you’ve been doing?

Martin Roper

Sure. I think philosophically as it relates to our advertising spending, our spending levels, you know, take a number of things into effect – both the cost of the media, both how effective we think the media is and both the opportunities that we’re faced with and where our brands are positioned in those markets. We think in the last two years we’ve benefited a little bit from some of the media costs coming down as the amount of media money chasing the available media has sort of declined. And we saw some, you know, attractive opportunities to buy media efficiently and effectively, and I think we’re very happy with where we are this year year-to-date relative to previous years. We’ve been able to increase our sort of share of actual voice, not just on a delivered basis but also on a dollar spent basis. But obviously on the delivered basis is more important to us.

As we look forward we’ll continue to evaluate the appropriate media spend given the opportunities that we see. We are now for Sam Adams buying TV and radio whereas two years ago it was just TV; and for Twisted Tea® we support the markets where it has strong presence with radio. As we look forward those decisions could change based on the opportunities we see and the media that we have available to us. We certainly are currently being told that there’s been some media inflation as it relates to next year versus this year’s costs. I’m sure some of that’s due to the political races that are going to be going on over the next four months and we’ll have to wait and see what happens after that for exactly how that will play out.

Judy Hong – Goldman Sachs

Okay. Thanks very much.

Operator

Thank you. Our next question comes from the line of James Watson with HSBC.

Martin Roper

Hi, James. Moderator, do you want to come back to James?

James Watson – HSBC

Hold on.

Martin Roper

Oh, hi James.

James Watson – HSBC

Hi, how are you? Sorry about that.

Martin Roper

We hope you’re enjoying your beer.

James Watson – HSBC

Not yet, not yet. That’s later on. Question for you on shelf space: I read in the last couple months statements from a few retailers saying they were either maintaining or expanding shelf space for craft beers. I was wondering what you guys have seen on that front. I’ll start there.

C. James Koch

Yes, I think over, not just this year but previously in 2008 and 2009 we’ve seen a significant increase in shelf space for craft beer, typically at a greater rate than the sales. So your craft beer certainly benefited from more shelf space; the shelf space has grown faster than the sales. That eventually has to come to an end because sales per SKU or per foot of craft beer space have been declining as the category has expanded itself.

So I think we, you know, we may be at an inflection point where the rate of increase for craft shelf space may slow down, maybe it’ll, I’d certainly hope that it would match the volume growth of the category. But it can’t exceed it forever.

James Watson – HSBC

Okay, but looking at it in that way, I mean that still implies craft beer shelf space expanding. You’re just saying that the rate is going to slow?

C. James Koch

Yes, that’s right. And assuming that you know, the category grows in volume then I would expect the shelf space to continue to grow. But just maybe it might grow a little less than the volume growth, whereas for the past probably three years it’s grown in excess of the volume growth.

James Watson – HSBC

Okay. And you know, if we were to think about the possible price increase coming from some of the big brewers, they said on mainstream but especially value brands – does that you know, do you see that affecting shelf space? Do you see that taking away from the bigger brands or…?

C. James Koch

You know, I don’t know because you know, one would assume that there’s price elasticity. So if the prices went up the volume would go down, but the dollars may… While the volume may go down the dollars may go up, and retailers are really looking at dollar turnover per SKU or per linear foot. So it’s not clear to me which way that will work itself out.

James Watson – HSBC

Okay. Switching tracks a little bit – on the Miller quarter call this morning they mentioned increase in freight costs and that there was some sort of capacity restraints around you know, trucks for shipping. And I was wondering if you guys had seen any of that. Obviously it didn’t really seem to be in the Q2 numbers but if that’s something that might be an issue for you?

Martin Roper

I didn’t have a chance to you know, review the reports of the call so I’m not totally sure of the specifics of what they were saying. But to just as it specifically relates to us, I think we’ve seen some fuel surcharge increase which is somewhat linked to gas prices or at the pump, but beyond that… And those have been sort of marginal, right, as to what we saw two years ago. And from availability point of view, I think we’re lucky in our operating locations – we to date haven’t seen that. Could we see it? Of course, but to date we haven’t.

James Watson – HSBC

Great. And last, just we’ve seen wheat costs really shoot up. Have you guys seen anything in terms of your outlook for barley change in the last quarter?

Martin Roper

We primarily purchase Canadian turro (sp) and so that’s the market we look at. And I think, you know, to date there’s been a little reaction to the wheat situation but not a huge amount. We’re not yet fully covered for next year and so I really can’t say exactly what our barley costs are going to be next year.

James Watson – HSBC

Okay, that’s great. Thank you guys.

Operator

Our next question comes from the line of Andrew Kieley with Deutsche Bank.

Andrew Kieley – Deutsche Bank

Hi, good afternoon. I was just wondering, this quarter it looks like the core shipments were lagging the depletions a little bit. I was just wondering do you expect that to catch up a bit in the Q3?

Martin Roper

I think typically we would expect, you know, that on a full year basis all of that stuff corrects itself, and there’s certainly some month-to-month variation; there’s even some seasonal build going into the summer and then that somewhat unwinds a little bit, and certainly unwinds significantly in December. So for full year planning basis I think that’s a good assumption.

Andrew Kieley – Deutsche Bank

Okay. And then just in terms of the pricing environment, I mean is most of that… Are you seeing more pressure just on the high end in terms of imports or other craft competitors? Is that mostly where it’s more competitive?

C. James Koch

Well, there’s some divergent trends. The imports have been less able over the last couple of years to raise their prices and in many markets they’re drifting below craft beer, whereas five years ago they tended to be above craft beer. So there, yet craft beer pricing is strong so there seems to be a little bit of a decoupling within better beer.

Andrew Kieley – Deutsche Bank

Right, okay. And then Jim, I just wanted to go back to the you know, the competitive and the shelf space question. As you see some of the big domestic brewers putting more activity into craft, and we’ve seen some of these very small craft brands grow at you know, very high rates, but you’re seeing shelf space expand. Does that leave room for everyone in the craft category to grow, especially more established brands, craft brands like yours? Is there enough space for everyone to grow at good rates?

C. James Koch

Well, there’s always more people wanting to get on the shelf than there is shelf to get onto, so that’s going to be a permanent situation. I think it does open up opportunities in the short term for us to get distribution of other styles beyond you know, lager and light and seasonals, 6s and 12s; and it’ll depend on the market how many additional styles and SKUs we can you know, we can gain. I think longer term it does give us an opportunity as our volumes continue to grow to get second facings, because there are starting to be you know, out of stock situations of some of the stronger-selling craft beers like Sam Adams because you’ve got, you know, a shelf, one slot for Boston Lager six-packs. And that maybe holds four six-packs and somebody comes in and buys two of them on Friday at 5:00 and somebody else comes in and buys the other two on Friday at 7:00, and you’ve got an out of stock maybe even for the whole weekend.

So as our volume grows it does give us opportunities to prevent out of stocks by double facings of some of the faster-moving packages, and you’ve seen that for years in the other strong better beer brands like Heineken and Corona.

Andrew Kieley – Deutsche Bank

Okay. And then last question. If you could just update us on capacity utilization at the Pennsylvania plant, where that stands. And then in the past you’ve given sort of a long-term gross margin target, I think high 50s. Is that still sort of the long-term goal of the company?

Martin Roper

Andrew, on the capacity side I think you know, we have now had full ownership and full control of that facility with only beer now for 12 months, and I think I’m pleased to say that we’re going to get through this summer with all of our Sam Adams beer brewed in those facilities. And we’re still identifying you know, areas to increase capacity and de-bottleneck. And I think our expectation is you know, based on the growth rates we see for the next 12 months we’ll be able to get through our pinch points next summer in our own facilities, too.

But frankly the growth rates are difficult to assess. The beer styles that we may introduce may require different processing so we have and continue to maintain relationships with third-party contract brewers, which affords us some flexibility to move big volume.

Andrew Kieley – Deutsche Bank

Okay, thank you.

Operator

Thank you. There are no further questions at this time. Mr. Koch, are there any closing remarks?

C. James Koch

No. Thank you all for joining us and we’ll speak again in about three months.

Martin Roper

Cheers!

C. James Koch

Thanks.

Operator

Thank you for joining today’s conference call. You may now disconnect.

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