Craft Brew Alliance's (BREW) CEO Andrew Thomas on Q1 2014 Results - Earnings Call Transcript

| About: Craft Brew (BREW)

Craft Brew Alliance (NASDAQ:BREW)

Q1 2014 Earnings Call

May 08, 2014 11:30 am ET

Executives

Andrew J. Thomas - Chief Executive Officer

Mark D. Moreland - Chief Financial Officer, Executive Vice President and Treasurer

Kenneth C. Kunze - Chief Marketing Officer and Vice President

J. Scott Mennen - Vice President of Brewery Operations

Analysts

Michael Halen - Sidoti & Company, LLC

Operator

Good morning, ladies and gentlemen, and welcome to the Craft Brew Alliance First Quarter 2014 Earnings Conference Call.

As a reminder, this call contains forward-looking statements. Forward-looking statements are not guarantees of future performance and are subject to risks and 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 Factors section in Craft Brew Alliance's most recent 10-K lists some of the factors that could differ materially from those forward-looking statements. Craft Brew Alliance undertakes no obligation to publicly update any forward-looking statements, except as required by law.

And now I will turn the call over to Andy Thomas, CEO. Mr. Thomas, please proceed.

Andrew J. Thomas

Thank you, Lacey, and good morning, everyone. It's my pleasure to present the Craft Brew Alliance investor conference call to discuss our results for the first quarter of 2014.

Consistent with our last call, I'm joined by members of our new executive leadership team, each with responsibility for areas of particular interest to our Q1 results.

By way of a roadmap for this call, I will again be addressing the general business and industry environment, as well as providing a high-level overview of our results. Mark Moreland, our Chief Financial Officer, will walk us through pertinent details of our financial performance. Ken Kunze, our Chief Marketing Officer, will provide commentary and perspective on our portfolio, brands and sales results. And Scott Mennen, our Vice President of Brewery Operations, will provide insight into our operations-related gross margin condition and progress in our operations and supply chain. Following the prepared remarks, we will then open up the call for questions. So let's get right into it.

While this, in most earnings calls, are appropriately enough about numbers, I'd like to start by highlighting some words: resolve, obligation, authenticity, legacy. Words with deep meanings that are often diminished in their overuse, but all words with deep significance for the first quarter of results under the active stewardship of CBA's new executive leadership team.

In our last call, I clearly stated that our new leadership team would "add the same level of resolve and the same track record of results to addressing our gross margin challenges that we brought to tackling our top line challenges 3 years ago."

Further, I said that looking forward, CBA was committed to and would have a laser focus in 2 areas: firstly, continued strength in development of our top line results; and secondly, meaningful improvement in our gross margins and bottom line.

So it's with deep satisfaction that on behalf of our new leadership team and on behalf of our outstanding family of employees at CBA, I can report a strong start to the year, with a Q1 2014 that begins to demonstrate our resolves in a manner true to who we are: authentic to the legacy of our founders and mindful of our obligation to our shareholders, our employees, our stakeholders and the environment.

Before getting into our numbers, let's first set some industry context. For the overall beer business, Q1 2014 was yet another quarter marked by challenges for the overall beer industry. The quarter saw a continued, if not accelerated, vibrancy in the craft segment, with further expansion in breweries and further recruitment of drinkers.

But tangibly, that vibrancy also brought more competition for relatively finite shelf space and tap handles. Harsh weather crippled much of the country for much of the quarter in ways unlike those ever seen before. And sadly, the industry saw new levels of infighting as small and large brewers and trade organizations publicly and in clear sight of consumers jockeyed for positioning favor from constituents, ranging from customers to retailers to politicians. But even against that somewhat somber backdrop, CBA firmly took consistent steps forward across the board.

In Q1 2014, CBA again saw continued strength in depletions and continued robust revenue growth. But importantly, both were finally highlighted by solid improvements in gross margin and a much improved bottom line.

For the first quarter of 2014, CBA grew net sales by just under plus 20%, grew beer shipments by just over plus 17% and posted continued growth in owned brand depletions of plus 8%. As Mark and Scott will detail, the disparity in sales and depletions is attributable mainly to continued progress towards synchronization of our supply chain, something that was a particular challenge in Q1 2013.

Further, while the plus 8% depletion growth is slightly lower than prior quarters, it is squarely in the range of our expectations and truly reflect strong and broad-based success in the face of our first full quarter post-SKU rationalization, a topic that Ken will address in his remarks.

Finally, as Ken will also detail, 3 of our 4 brand families, Kona, Redhook and Omission, again delivered depletion growth of double digits or better. And our final brand family, Widmer Brothers, began to yet again show clear signs of renewal as it prepares to kick off its 30th year.

And in contrast with prior quarters, drumroll please, perhaps the most significant news for the quarter is that alongside this continued strength in the top line, for Q1 2014, total CBA gross margin grew 260 basis points, driven by strong accretion, both in our core beer business and in our restaurant and retail division.

And importantly, all of this gross margin expansion was accompanied by continued investment in the market, in our brands and in our organization.

Scott and Mark will provide more color on this expansion and provide a look forward into efforts to ingrain and sustain accretion, both in our existing breweries and facilities and through new partnerships, such as the one announced with Blues City Brewing.

Lastly, with respect to not only delivering results but doing so in a manner that is true to who we are and mindful of our obligations, Q1 also brought several cultural milestones for CBA, including the release of our first-ever sustainability report, the attainment of our goal to have 100% of our customer-facing employees certified in level 1 of Cicerone Beer Server training and a much-anticipated launch of a year-long celebration in honor of the 30th anniversary of Widmer Brothers.

I continue to believe that what makes CBA unique is that we combine the stole [ph] of a craft brewer with the body of a big brewer. Q1 2014's results begin to deliver on that advantage by driving solid business results on both the top and bottom lines and by doing it with a portfolio of pioneering brands in a way that no one other than CBA can.

So first, over to Mark for a flyover of financials. Then on to Ken and Scott to provide some more concrete details. Mark?

Mark D. Moreland

Thank you, Andy. As the numbers show, we're off to a good start for the year in absolute terms. On relative terms, are going up against soft financial performance in the first quarter of 2013. Overall for the quarter, we generated 20% growth in net sales, an EPS loss of $0.01 per share compared to $0.09 last year.

Starting with volumes. Our depletions were up 8% versus last year, [indiscernible] continued strength of our brands, as Ken will discuss, and reflects the impact of our SKU rationalization that we implemented last year. We also continued to see nice performance from our export business that is a small but growing segment, with shipments up 150% for the quarter.

Our total beer shipments were up 17% versus last year, reflecting both depletion growth and softness in shipments the company experienced in Q1 last year as a result of supply chain imbalances. While the difference in depletions and our shipment growth rate is significant, the spread can be understood in both percentage and absolute terms.

On a percent basis, the spread is 8 percentage points, which basically reflects the flip from last year Q1, where we were 9 points in the other direction driven by the inventory imbalance.

On an absolute basis, over the past several years, we've generally reported a depletion shipment spread per quarter of about 10,000 to 15,000 barrels, due to both slightly different reporting basis and also the growth of the business, which is also consistent with Q1 results.

Overall, we believe that the wholesaler inventories are at appropriate levels and expect that we'll experience quarterly fluctuations in depletion and shipment growth rates. Participate fairly tied alignment overall for the year.

Our total net sales increased 20% for the quarter as a result of the increase in shipment volume and increases in our revenue per barrel. Our gross margin reflects benefits from the fact our breweries both brewed more beer than last year, resulting in better capacity utilization, and operated very smoothly during the quarter, assisting us in generating a 260 basis point improvement in our gross margin rate to 27%. Scott Mennen will provide more color on our operations in a moment.

Our sales, general and administrative costs increased by 3%, on a rate basis, declined by 460 basis points to 27.5%, primarily driven by increases in sales.

We have affirmed our 2014 guidance, including depletion growth estimate at 7% to 11%, average price increases of 1% to 2%, growth in contract brewing revenue of 25% to 50% as a result of new partnerships, a gross margin rate of 28.5% to 30.5% for the full year. And as we continue to optimize our brewing locations and improve our capacity utilization and efficiency, we expect our gross margin rate to expand 500 to 700 basis points over the next 5 years.

SG&A expenses will range from $52 million to $54 million and capital expenditures of approximately $15 million to $20 million.

In closing, from a financial perspective, we are pleased with a strong start to the year and look forward to continuing to drive our top and bottom line performance.

And with that, I'll turn it over to Ken Kunze, our Chief Marketing Officer.

Kenneth C. Kunze

Thanks, Mark, and good morning, everyone. 2014 is a big year for Craft Brew Alliance as our breweries passed major milestones in the craft beer business, with Widmer Brothers celebrating 30 years, Kona 20 years and Redhook 33 years. There's not another craft brewer who has the legacy in craft that Craft Brew Alliance does.

As Andy mentioned, Q1 depletions grew plus 8% for the portfolio, within the targeted range and as planned, as we continue to execute our portfolio strategy of targeting more craft consumers across more occasions by uniquely positioning each brand with our diverse portfolio of craft beers.

It should be noted that Q1 performance was achieved while implementing a significant SKU rationalization of 25% to improve operational efficiencies and add a focused disciplined approach for how we go to market.

We continued to see rapid growth behind the Omission brand, with depletions up triple digit again as retailers and consumers alike gravitate to food items that offer great taste and the opportunity to avoid gluten.

Confirming Omission's great taste, Omission Lager, IPA and Pale Ale were awarded a gold, silver and bronze medal, respectively, for each of their styles at the New York International Beer Competition in February. To be clear, those wins were earned in traditional beer categories against the non-gluten-free beers. With only 35% ACV in grocery, we see a significant run room for Omission as the popularity of gluten-free continues to grow and as consumers continue to seek our great-tasting craft beers.

Redhook posted strong Q1 depletions, up 15%. Redhook's performance was boosted by the performance in Redhook's home market of Seattle, riding the wave of the Seahawk Super Bowl run and by improving levels of chain support in our Eastern region.

Specifically, Long Hammer IPA is gaining traction as a crossover IPA for domestic beer drinkers. In conjunction with our partnership with theCHIVE, we continue to see wholesaler and retailer enthusiasm for KCCO Black Lager as it expands footprint.

Craft Brew Alliance and Redhook received Buffalo Wild Wings' Vendor of Excellence for all beverage companies, alcoholic as well as nonalcoholic, for its partnership around Redhook's Game Changer, which contributed significantly to both Craft Brew Alliance and Buffalo Wild Wings results.

Audible Pale Ale, our beer developed last year in conjunction with Dan Patrick, took home the Gold Medal in Classic English-Style Pale Ale at the 2014 World Beer Cup. So while Dan Patrick is a funny guy, the beer is no joke.

Audible and Game Changer accounted for 45% of Redhook's gainers, while KCCO and Long Hammer accounted for the other 55% of gainers.

Kona depletions were up plus 11%. This was achieved while lapping a significant pipeline fill in Q1 of 2013 from expanded geography into the Midwest. Both Longboard Lager and Big Wave Golden Ale continue to track along at plus 13% and plus 36%, respectively.

With continued strong performance in its home market of Hawaii and with the current launch of Castaway IPA, we continue to see upside in mainland opportunities across the Kona portfolio in both the East and West. Look for a press release next week highlighting our new advertising campaign launching behind the Kona brand in San Diego and Orlando.

For Widmer Brothers, the Q1 of -- Q1 launch of Upheaval IPA is progressing strongly. Upheaval, our best damn IPA ever, is a Northwest-style IPA that has been receiving significant critical review from consumers, retailers, wholesalers and beer pundits alike.

To name a few, the Wall Street Journal, Imbibe, MarketWatch, MAXIM magazine have all recently reviewed Upheaval very positively. Celebrator called it one of the best IPAs of the Pacific Northwest. And MAXIM magazine said, "Simply put, it's delicious. If you're an IPA fan, you need to pick this stuff up...now." We couldn't agree more. Consumers have scored it very strong 92 out of 100 on the website RateBeer.

With Widmer Brothers' 30th anniversary, Rob and Kurt Widmer have been busy celebrating the momentous occasion with the start of a 30 small batch beers in the whole market of Portland, 1 beer for each year of the brewery's first 30 years. There are only a handful of craft brewers who have the staying power to pull this off, and Craft Brew Alliance owns 2 of them.

Hefe, the lead beer in Widmer Brothers brand, appropriately received the Gold Medal at the World Beer Cup and the category it created as the original American Hefeweizen. With Blue Moon and Shock Top doing the heavy lifting introducing more Americans to approachable, easy-drinking style of wheat beers, the wheat style is now the largest style in the craft style of beers, a fact that we believe bodes well for Hefe as consumers desire to trade up to a real craft Hefeweizen like Widmer Brothers Hefe.

We continue to make progress in our efforts to rebalance the Widmer Brothers portfolio on Hefe, Upheaval and Alchemy and moving closer to stability with the Widmer Brothers depletions down 1% in Q1.

With that, I'd like to turn it over to Scott Mennen who will highlight how he's leveraging SKU optimization and other efficiencies to improve our operating capabilities.

J. Scott Mennen

Thank you, Ken, and good morning. I will take a few minutes to review the progress of the operation the supply chain groups are making as we work to improve our cost structure and drive improvements in gross margin.

Q1 was a good start to the year, with 260 basis point expansion gross margin to 27% over the prior Q1, reflects that we are starting to see the results of improvements of our brewery operations. The breweries are operating more efficiently, due in part to the reduced complexity we realized from the SKU rationalization process.

The breweries are also seeing the benefit of added structure and a more disciplined approach to operating. Q1 saw the rollout of our key performance indicators, KPIs, across the organization, which has helped sharpen the execution of our business.

One area that I would like to focus is our workaround sustainability. On April 22, we released the 2013 Annual Sustainability Report. In this report, CBA reported that we have achieved a recycle diversion rate of 99.4%, reduced natural gas usage by 6.3%, achieved significant savings in electricity and water through conservation efforts at all of our breweries. We will leverage this work to drive additional utility reductions of 5% in 2014. Some of those benefits were realized in Q1.

Another driver in gross margin improvement was the result of improved capacity utilization. In Q1, the capacity utilization was 68% compared to 58% in Q1 of 2013, a 1,000 basis point improvement. We attribute this improvement to 2 factors: first, volume increase to support depletions and shipment growth; and second, the improvement in the supply chain to better align production, shipments and depletions.

In addition, our work to better balance production across our breweries has led to improved capacity utilization in our larger Portland brewery, which in turn has enabled more efficient operation in our smaller breweries such as Woodinville.

Another area of continued focus is improving our supply chain operations. As Andy introduced in our Q4 conference call, John Glick, VP of Supply Chain, is focused on improving all facets of that area of the -- of our business. John and his team have started the critical work of fully assessing and properly aligning our production, inventory control and shipments.

While progress is being made, as can be seen by the better alignment of depletion and shipments, there is still much work to be done. This is not a simple task, and we anticipate continued improvement for the balance of the year.

I also want to give everybody update on our partnership with Blues City Brewing in Memphis. As announced on our Q4 call, CBA has partnered with Blues City to brew approximately 100,000 barrels of beer annually.

This partnership will expand our brewing footprint, bring increased flexibility to our brewery operation, allow us to leverage the specific expertise and strengths of our breweries, drive additional efficiencies, reduce costs as well as support our continued depletion growth in the Southeast and Midwest. I'm pleased to report that qualification and test brewing is on track in Memphis, and we plan to begin operation later in Q2, with full production online in early Q3.

The sharpened focus on efficient and disciplined execution of our brewery operations and supply chain, we have not lessened our emphasis on quality. As referenced in Ken's remark, our breweries have brought home multiple medals from the World Beer Cup Awards and New York International Beer Competitions, which serves as further testament to our unequivocal focus on brewing only the highest-quality, great-tasting beers.

In closing, I would like to emphasize that while we are pleased with the solid progress of the operation the supply groups are making, there is still much work to be done. We are optimistic that with a continued focus on 3 key efforts: disciplined execution of our brewery operations, improvements that are ongoing in our -- in the supply chain and the right balance of production across our balanced brewing footprint, we will be able to achieve our gross margin targets of 28.5% to 30.5% this year in 2014 and our longer-term target of 500 to 700 basis point expansion in the next 5 years.

Thanks. And now I'll turn it back to Andy.

Andrew J. Thomas

Thanks, Scott. Before moving to questions, I'd like to again say thank you to all of you. To our investors, to those analysts who cover us, to our interested parties and importantly, to our hard-working, passionate and engaged employees, be they in Portsmouth, New Hampshire; Portland, Oregon; Woodinville, Washington; Kona, Hawaii, or working remotely somewhere between.

Q1 was a good start to 2014. But it was just that, a start. We look forward to building on the solid foundation for the remainder of the year.

And with that, I will open it up for questions. Lacey?

Question-and-Answer Session

Operator

[Operator Instructions] And our first question will come from the line of Michael Halen with Sidoti.

Michael Halen - Sidoti & Company, LLC

Has Game Changer been able to keep its sales momentum in Buffalo Wild Wings? And where does it rank in sales or where did it rank in the -- in sales in the quarter?

Andrew J. Thomas

I can tell you that it has maintained its momentum in the Q1. And specifically, within Buffalo Wild Wings, it was up 25% in February and 35% in March. So it's near the top from a ranking perspective. BWW doesn't necessarily disclose any brand ratings, Michael, so we can't share kind of detail like that with you. Wouldn't be fair to our partners, but building on what Ken just said, we see continued, I'd say, traction for Game Changer, along with acceleration. And I think that's evidenced by Buffalo Wild Wings' acknowledgment in naming us Vendor of the Year on the beverage side. And there's a lot of good a lot of good things planned for the remainder of the year, including some stuff around the anniversary of Game Changer, which is coming up towards the end of second quarter into third.

Michael Halen - Sidoti & Company, LLC

All right, great. With that recognition, have you seen an uptick in maybe other chains that are looking to expand their craft beer selections?

Andrew J. Thomas

Yes. I'll let Ken kind of comment on this. But what I can tell you is there's 2 really great things that are happening on the heels of the partnership with Buffalo Wild Wings. Not only is Game Changer continuing to grow, but we're actually seeing a benefit back on the rest of the portfolio. So we track pretty closely, not only Game Changer sales at Buffalo Wild Wings but the rest of the Redhook portfolio, namely, some gains on Long Hammer IPA through Buffalo Wild Wings, but also as it haloes back on the rest of the portfolio, including Widmer Brothers, including Hefe, including Kona, despite the fact that it's not fully national yet and also on Omission. So net-net, on Buffalo Wild Wings, it's not just about Game Changer although it's mostly about Game Changer. There's definite evidence that says that a high tide raises all ships for our portfolio there. And then with respect to other partners, there's a lot going on with other national accounts. We announced, I think, in the last quarter Omission being expanded nationally into the Olive Garden chain. There's a couple of other great hits on Omission, but I'll hand over to Ken who's a lot closer to all that now. Ken?

Kenneth C. Kunze

I think we did a pretty good job of -- Andy, honestly. So I think in terms of the other national accounts, we're definitely seeing the other brand portfolios get nice pickup in terms of distribution and whatnot, but...

Andrew J. Thomas

Not much [indiscernible]

Michael Halen - Sidoti & Company, LLC

All right, great. That's helpful. Can you give us any color, or would you be willing to, on the Kona advertising, particularly the television segment of it?

Kenneth C. Kunze

Sorry. Just more detail in terms of what we're doing?

Michael Halen - Sidoti & Company, LLC

Yes. I guess where your -- what types of channels are you looking to advertise on? Is it just live sporting events?

Kenneth C. Kunze

So it's 2 markets, San Diego and Orlando. San Diego's a more developed market for Kona, and Orlando is a little bit less developed. So we consider this a test. The media will start in about a week, the middle of May, and it'll run through -- into August. And we're going to do pre- and post-test from consumer awareness and attribute standpoint. We're going to measure sales performance using IRI so that we can isolate other factors and really try to understand the impact that the media is having on sales performance. And you know what, we actually -- the media were across, TV, radio, digital out-of-home. And we will be on sports programming, so I know that we have, like, the -- some of the NBA finals. And the hockey playoffs are part of the mix, but it's also a broad network and cable mix as well.

Michael Halen - Sidoti & Company, LLC

All right, great. And I guess just one more. How should we look at inventory turns? How many do you expect this year, and what's a reasonable goal moving forward?

Mark D. Moreland

Yes. Mike, this is Mark Moreland. The inventory is certainly up from last year a bit and this way as our continued week and maybe to kind of optimize the supply chain in figuring out the right levels of inventory. There'll be a -- likely a tick-down. We're hoping a little more in the 4 walls, wanted to make sure we're able to have a hold-back strategy where we see demand, we can actually fulfill it out in a market. So it will be a little bit higher than last year and probably a small tick-down in overall turns but not even dramatic.

Andrew J. Thomas

Yes. Mike, I'll just take the opportunity. I mean, you've heard about inventory, be it from our call, inventory supply chain, either from this call, Boston's both MillerCoors or Miller and ABI have all talked about it. And for us, I think what's different -- because I think everybody has different challenges although they're all unique and sincere challenges. For us, as we move programming and as we start to look at what we're anticipating in Q2 and Q3, just one of the reasons we give a range on depletions of 7% to 11% is there are things that we're doing in this volatility in the market that will unfold. And the challenge for us is to make sure that we're adequately buffered. As Scott's improving the efficiency of the breweries and as John is worrying about making sure that we deploy that beer in the most efficient manner possible, we kind of flex our 4-wall inventory and try to -- with distributors' partnership, try to make sure that we're significantly buffered or sufficiently buffered, I should say, at the distributor level 2. So we expect inventory fluctuations at the end of Q1 going into Q2 and as we come out of the season. And I think proof of the pudding will unfortunately be in the eating. It's going to be one of those hindsight being 2020 issues where we look back and see how close we got to where we needed to be. But make no -- there's no question about it. We're actively in managing inventories, and there's nothing happening by accident. But it's more happening, an indication of volatility of demand and shifting of some programming.

Operator

[Operator Instructions] And at this time, I show that we have no questions in queue. I would like to turn the call back over to Mr. Thomas for his closing comments.

Andrew J. Thomas

Thanks, Lacey. I appreciate everyone's continuing support of CBA and being available for the call. We look forward to discussing the results for the second quarter of 2014 with you soon. Thank you very much, and have a great day, everyone.

Operator

Thank you for your participation in today's conference. This concludes your presentation. You may all disconnect. Good day, everyone.

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