Craft Brew Alliance's (BREW) CEO Andrew Thomas on Q2 2014 Results - Earnings Call Transcript

Aug. 7.14 | About: Craft Brew (BREW)

Craft Brew Alliance (NASDAQ:BREW)

Q2 2014 Earnings Call

August 07, 2014 11:30 am ET


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


Anton Brenner - Roth Capital Partners, LLC, Research Division

Robert Sanders


Good day, ladies and gentlemen, and welcome to the Quarter 2 2014 Craft Brew Alliance, Inc. Earnings Conference Call. My name is Caroline, and I will be your operator for today. [Operator Instructions] As a reminder, the call is being recorded for replay purposes. And now, I'd like to turn the call over to Andy Thomas. Please go ahead, Andy.

Andrew J. Thomas

Thank you, Caroline, and good morning, everyone. It's my pleasure to present the Craft Brew Alliance investor conference call to discuss our results for the second quarter of 2014. Before we begin, I'll ask Mark to read our Safe Harbor statement.

Mark D. Moreland

Thanks, Andy, and good morning, everybody.

As a reminder, this call may contain forward-looking statements. Forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from those described in any such forward-looking statements.

The Risk Factors section in our most recent Form 10-K lists some of the factors that could cause Craft Brew's actual results to differ materially from the forward-looking statements made on this call. Craft Brew undertakes no obligation to update publicly any forward-looking statements, except as required by law.

And with that, on to Andy.

Andrew J. Thomas

Thank you, Mark. This morning, I'll provide a general overview of the quarter's 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. In summary, Q2 2014 was a very good quarter for CBA. The quarter not only delivered the sales performance as expected on the top line but importantly, Q2 2014 also delivered the promised improvements in gross margin, as evidenced in the bottom line and our EPS. In fact, in many regards, Q2 2014 will go down as a record quarter for CBA.

Let's take a look at the hard numbers, starting with the top line. The top line was not only healthy, but as expected, it was far more synchronized across the areas of depletions, shipments and sales, with depletions up plus 9% for the quarter, beer shipments up plus 13% for the quarter and net sales up plus 16%. Notably, the gains were widespread across the portfolio, with all major brand families, Kona, Redhook and Widmer Brothers, contributing to a robust performance in the quarter, including the strongest quarter for Widmer Brothers in the last 5 years. As the team will explain, depletions, shipments and sales moved much more in concert with each other than they did in Q1, with the Q2 differences directly attributable to conscious and deliberate management of our brands, our business system, our breweries and supply chain.

Specifically, the depletion-to-shipment gap is related to healthy management of our supply chain in the face of a volatile and uncertain environment, as Scott will detail. And the difference in shipments to sales is the direct result of pricing actions and more depth management of our portfolio and absorption of our SKU rationalization, as Ken will discuss.

Looking at the all important metric of gross margin, as I stated earlier, Q2 was a record quarter for CBA, with gross margin advancing by a remarkable 230 basis points to 32.8%. As the team will detail, the gains in gross margin came from not only more active management of our brand and product mix but more so from tighter management of our brewery operations and more forward-looking and less reactive management of our supply chain. These improvements in gross margin came while managing a record level of capacity utilization in our breweries, in record levels of weekly shipment and transfer activity, as Scott will detail. Further, we still successfully brought online our partnership with Blues City Brewing in Memphis, an initiative well executed and deliberately timed to scalably expand our brewery footprint at this juncture in our capacity development.

Lastly, the record quarterly performance in earnings per share came after continuing to invest in the long-term health of our business, with SG&A spend up slightly as a percentage of net sales.

Before handing off to Mark, 2 general remarks on the quarter. Firstly, at CBA, we now proudly declare that we aspire to be the leader in brewing, branding and bringing to market world-class American craft beers. I firmly believe that the performance in Q2 is not only a further validation of our business strategy and our view of the market but importantly, another quarter that demonstrates the ability of these leadership team and the great family of employees at CBA to deliver on that strategy and realize that vision.

Secondly, as strong as Q2's performance was, it's important to be mindful that it wasn't always easy. Headwinds from an increasingly competitive market, heightened retailer demands in both the on and off premise, increasing complexity in the supply chain, heightened operational costs and share volatility in the market were ever present throughout the period. And they're all likely to intensify in the back half of 2014. While we will endeavor to manage these headwinds in the back half of the year as effectively as we did in Q2, the fact remains that the year is progressing materially as we anticipated. And as such, we are still reaffirming the ranges of our full year guidance, as Mark will detail.

So first, on to Mark.

Mark D. Moreland

Thanks, Andy. The financials have continued on a strong trajectory for the year, consistent with our expectations and our full year guidance.

Overall, we've generated 16% sales growth in the quarter and 17% on a year-to-date basis, which has generated EPS of $0.10 for the quarter and $0.09 year-to-date. Our depletion volume was up 9% both on a quarter and year-to-date basis, reflecting continued strong consumer demand, the impact of our SKU rationalization that we implemented last year and continued health of our international sales, which were a small segment of our overall business but which were up 130% in the quarter. Ken will also provide insight to the brand and market drivers underlying these numbers in a moment.

Our total beer shipments were up 13% for the quarter and 15% on a year-to-date basis, reflecting both the depletion growth and improvement to our supply chain management in response to challenges we experienced last year. Overall, we believe that wholesaler inventories are at appropriate levels and expect that we'll experience quarterly fluctuations in depletion and shipment growth rates but anticipate fairly tight alignment overall for the year.

Moving to gross margin. Our gross margin improvement of 230 basis points for the quarter to 32.8% and 240 basis points improvement year-to-date to 30.3% reflects continued benefit from the improvements in both brewery and supply-chain operating efficiency and increased capacity utilization, which Scott Mennen will discuss. Our brewery utilization of 87% was the primary driver of the highest quarterly margin we've ever generated.

Another contributing factor to our gross margin improvement was a 260 basis point margin growth of our restaurant operations for the quarter, primarily as a result of soft comps due to last year's closure of Woodinville Pub. Looking forward, we confirm our full year margin guidance of 28.5% to 30.5% and at risk of being somewhat redundant, expect our back half margin generation to lead to results consistent with our historical seasonality and guidance.

Our selling, general, administrative costs increased by 17% for the quarter and 10% on a year-to-date basis, with the rate to net sales up 40 basis points to 26.8% for the quarter and down 180 basis points year-to-date. The total increase reflects planned additions to our SG&A structure, and our quarterly basis reflects changes in timing of our advertising and media spending.

Regarding cash flows. Our cash flows from operations were about flat for the quarter versus last year and were up about 85% on a year-to-date basis. On the capital expenditure front, we've continued to evaluate and execute our capital plan consistent with our guidance of $15 million to $20 million, which given our first half spend of $5.1 million, means that we'll accelerate spending in the back half.

We have reaffirmed our 2014 guidance to include depletion growth of 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 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.

Lastly, we expect SG&A expense to range from $52 million to $54 million for the full year. In closing, we are pleased the company has generated expected results during the front half of the year in spite of market dynamics and look forward to continuing to drive our top and bottom line performance throughout the back half.

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

Kenneth C. Kunze

Thanks, Mark. Good morning. Through the second quarter, CBA continued to execute our portfolio strategy of targeting more Craft consumers across more occasions by uniquely positioning each brand within our diverse portfolio. Our focus on core brands delivered as expected. As Andy highlighted, for the portfolio, depletions grew plus 9% for both Q2 and year-to-date, squarely within the targeted range and as planned. On a national level, our Q2 gain-to-loss ratio was a plus 2.5 and we continue to demonstrate balance, with gains equally split between the East and the West. We continue to see mix shifts with off-premise package volume increasing faster than on-premise draft volume, driven by our strategy and our growing market penetration of the broader beer category. We expect this trend to continue and it will add pressure to our efforts to improve margin.

For Q2, pricing increased plus 1.2% and is up 1% year-to-date. Even with the significant SKU rationalization implemented in Q1, which eliminated 25% of our SKUs, the portfolio continues to generate healthy depletions. Redhook, is one of the brand families that had a significant number of SKUs rationalized. Redhook depletions were up plus 5% for the quarter and plus 10% year-to-date reflecting efforts to refocus the brand. And our focus brands Long Hammer IPA, Audible Ale, Game Changer Ale and KCCO Black Lager continue to drive growth as we rebalance the portfolio. Each of our brand's home markets are important and are a key part of our strategy. This is true for Redhook and Seattle. Some of you may have seen the CNBC story titled "Goal! Brewers Score with soccer partnerships," which highlighted Redhook's efforts to build brand affinity with the MLS's Seattle Sounders rabid fans by partnering with the largest fan club, the Emerald City Supporters, in creating the official brew, ECS Blonde, that was launched in the quarter. Fan engagement of professional soccer in the Northwest is at a different level than the rest of the U.S., more European, and is an example of how we engage and leverage our local sponsorships in our home markets.

Widmer Brothers has a similar relationship in Portland with the Timbers in a brew called Green & Gold Kölsch, which was enjoyed by all the fans at the MLS all-star game in Portland last night. Speaking of Widmer Brothers, the Brothers are celebrating the brewery's 30th anniversary and kicked off the festivities April 2 in our newly remodeled pub in Portland and with the launch of a beer series aptly named, 30 Beers for 30 Years. As the beer press noted, Widmer Brothers is one of a handful of craft brewers who could even attempt such an ambitious project. Each beer represents a different year in the brewery's history and each graphic design was created by a different local artist, giving each label a unique and special interpretation and a fresh take on the Widmer Brothers brand. Q2 saw 6 of the 30 launched in Portland. Separately, Q2 also saw the launch of 2 out of a series of 6 collaborations with small up-and-coming Oregon craft breweries. On Memorial Day, Widmer Brothers kicked off a summer-long program behind our flagship brand, Hefe, called 100 Days of Hefe, executing over 160 events over the 100 days of summer. Kurt and Rob Widmer had been busy blitzing the local and national media getting the brands and their American success story in front of consumers. Hefe remains Portland's #1 craft brand, and the 30th anniversary is proving to be a viable platform to reengage wholesalers, retailers and consumers alike. Have you had your Hefe today?

Q2 saw Hefe's rate of loss cut in half, nearing stabilization or flat growth for packaged volume. Overall, Widmer Brothers depletions were plus 4% for Q2 and improved plus 2% year-to-date. The second quarter is the best recorded performance for the Widmer Brothers brand family in the past 5 years.

Omission continues to ride the gluten-free trend, growing triple digits for both Q2 and year-to-date. It is the great-tasting, gluten-free alternative brewed with malt. Omission received a focused push in May's Celiac Awareness Month, building trial and distribution. In the most recent IRI reporting period for the 13 weeks ending July 20, Omission sprints closer to market leadership with a 44 share of the gluten-free segment, driving almost 98% of the dollar growth with only 40% ACV distribution.

Kona depletions were up plus 16% for Q2 and are up plus 14% year-to-date. Performance was driven by strong growth of Big Wave Golden Ale, the launch of Castaway IPA, strong home market performance in Hawaii and the growth of Longboard Lager. Kona was named the best local beverage company by Honolulu Magazine, a further testament to our home market leadership. Kona's media tests in Orlando and San Diego continued through the quarter with positive initial results. The TV spots entitled, Dear Mainland, can be viewed on YouTube. The test will end in Q3, and we will evaluate the impact on revenues and profits. And as the new campaign intones, "One life. Don't blow it."

With that, I'd like to turn it over to Scott Mennen, our Head of Brewery Operations.

J. Scott Mennen

All right. Thank you, Ken, and good morning, everyone. As in the past conference calls, I would like to take a few minutes and update you on the progress the brewery operations and the supply chain teams are making as we work to reduce our cost structure and drive improvement in CBA's gross margin.

In Q2, we built on our efforts started late last year to improve the operating efficiencies of the breweries and supply chain. This was accomplished through simplification of our process, with the reduction of SKUs as well as improved operating focus on our breweries and supply chains, as we employed a more disciplined approach with the rollout of key performance indicators and a more balanced approach to capacity utilization. These efforts helped improve CBA's gross margin performance in the face of freight mix challenges to 32.8% for Q2, a 230-point basis point improvement over Q2 in 2013 and 30.3% for the first half of 2014, a 240 basis point improvement over the same period in 2013. Capacity utilization for Q2 was 87%, a 1,000 basis points greater in Q2 2013 and for the first half of 2014, the capacity utilization was 78%, again 1,000 basis points greater than the same period last year.

The capacity utilization improvements are related to 2 primary drivers: increased shipments to support the 9% improvement in depletion and the 47.8% increase year-to-date in contract brewing and international shipments. We also adjusted our finished good inventory position, as seen by the 44% increase in finished good valuation in the first 6 months. This was done to ensure adequate supply to meet the growing demand for our beers while ensuring a seamless transition as we bring on our new brewing capacity in Memphis.

In addition, we implemented a revised inventory policy to ensure we avoid the out of stock issue that plagued us in 2013. While we expect our inventory value to reduce over time with the successful startup of Memphis, we did not have adequate inventory in the past to meet the dynamic changes in our business.

Next, I'd like to update everyone on the progress the team has made on the startup of our partnership with Blue City in Memphis, Tennessee. I'm happy to report that the project continues on track and that the first test shipments out of Memphis began in May, with full shipments coming online in July. As a reminder, we have partnered with Blues City to brew up 100,000 barrels of beer each year. This partnership will expand our brewing footprint and bring increased flexibility to our brand operation, allowing us to leverage the specific expertise and strengths of our brewery, drive additional efficiencies to reduce costs as well as support our continued growth in the Southeast and Midwest. While we have been driving significant improvement in gross margin in the past quarter, we did not lose sight of our primary mission, to brew great-tasting high-quality beers. This is best evidenced by the 9 awards our brewers took home, including 4 gold medals at the North American Brewers Association Award that took place in Idaho Falls in June. Kona Brewing brought home 2 golds: Longboard Lager and Big Wave Golden Ale. Widmer Brothers brought home 5 awards. 2 of which were gold, Drop Top Ale and Saison A' Fleurs; silvers for Citra Blonde and Old Embalmer; and Altbier brought home the bronze. Square Mile also brought home 2 awards, with Original bringing home a bronze and Spur and Vine, our hopped version, also taking home a bronze. These awards are great testaments to the talent of our brewing team and CBA's ability to consistently brew great-tasting award-winning beers at all locations, from Woodinville to Memphis to Kona.

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

Now 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; Memphis, Tennessee; or working remotely somewhere in between.

I'll end this Q2 call with some words that I used to start the Q1 call. Those words are resolve, obligation, authenticity and legacy. As I said in Q1, I can again report a continued strong 2014 that begins to demonstrate our resolve 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.

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

Question-and-Answer Session


[Operator Instructions] The first question, which comes from the line of Tony Brenner from Roth Partners.

Anton Brenner - Roth Capital Partners, LLC, Research Division

So a couple of questions. Ken mentioned that the Hefeweizen decline was half the rate that had been in the previous quarter. Where exactly does that put it, at that 3% or something different than that?

Andrew J. Thomas

Tony, this is Andy. So we don't disclose exact numbers for obvious reasons but it is -- I would place it in the single digits is all I would say. And by the way, Tony, I think you kind of raised an eyebrow for all of us because you nailed the quarter in your latest report. So that didn't go unnoticed by the way.

Anton Brenner - Roth Capital Partners, LLC, Research Division

Yes, you lived up to my expectation.

Andrew J. Thomas

It's what we like to hear, Mr. Brenner.

Anton Brenner - Roth Capital Partners, LLC, Research Division

Okay. And then, Omission, I presume, did Ken mentioned the inclusion of Omission sales or depletions or -- I think I missed that.

Andrew J. Thomas

Did you mention it?

Kenneth C. Kunze

Still triple digits.

Anton Brenner - Roth Capital Partners, LLC, Research Division

Okay. I presume that's what's driving the Widmer growth so dramatically.

Andrew J. Thomas

Yes, I mean, I think if you take a look at the Widmer Brothers numbers, so as we are very open with, we include Omission in there and we include the Square Mile. So I would say there's kind of 3 primary drivers right now, which are buoying the Widmer Brothers numbers. So one is obviously, Omission. We haven't disclosed those numbers separately, but you can kind of extrapolate them from what's available through IRI to get an idea of magnitude there, Tony. Secondly, Square Mile is doing well. It's in very limited number of states, so it's not a major contributor but it's buoying the performance. And then thirdly, the core Widmer Brothers portfolio. I think it's not only the stabilization of Hefe, as Ken alluded to, it's something Ken teased back in Q1, too. I think it's also Upheaval IPA is doing remarkably well for us as that brand starts to grow some distribution and penetration.

Anton Brenner - Roth Capital Partners, LLC, Research Division

Okay. Quick question regarding Blues City. It's a multi-year arrangement with production up to 100,000 barrels a year. Is there the potential to increase that amount of volume as you -- go ahead.

J. Scott Mennen

Yes, we've locked-in capacity around that 100,000. Obviously, as our capacity needs increase over time, we have the flexibility to go back and continue to expand that arrangement with them.

Anton Brenner - Roth Capital Partners, LLC, Research Division

Okay. Last question. You're right in the middle of your extremely large range of depletions for the year at 9%. What would it take, what would have to change to, at least in the second half, be closer to the higher end of that range?

Andrew J. Thomas

So I'll take issue with the fact that 7% to 11% is a wide range, but that's beside the point, we'll debate that over a beer. So we're squarely in the middle of it. I think, Tony, as I said, the market isn't easy right now. Our guys are out there fighting tooth and nail, and we're trying to make sure that we not only sell well but we sell wisely. And so we're not just chasing volume, which we may have been more likely to do in the past, without understanding the implications for margin and complexity. And as a result, we're trying to be prudent, I would say, and maintain the range of 7% to 11%. What I would say is what would change is competition continues to intensify, you can see kind of the continued efforts we've had to try to get draft stabilized but draft continues to be a drag on us in terms of the increased competition on the on-premise. We are cycling very candidly, we're cycling what we kind of call a monsoon of the load and volume for Game Changer for last year with Buffalo Wild Wings. Just on that topic, we continue to have a really healthy relationship with B-Dubs and are really happy with the way that's developing and Game Changer continues to do well. But those are all headwinds that we've got as we get into Q3 and into the balance of the year. So as I said in the script, the year is pretty much progressing the way we thought it would. So 7% to 11% might sound wide, but we think it's prudent for us to reaffirm that right now.


[Operator Instructions] We have another question, and it comes from the line of Robert Sanders from JET Equity Partners.

Robert Sanders

I just wanted to follow up on the last question and you were talking about the partnership at BW3 and how well that's gone. Are there any opportunities with other national food establishments to kind of take what you've done at BW3 and roll it out into other markets with other chains? What is the opportunity in the pipeline looking like there?

Kenneth C. Kunze

I think we view our national account team has a strategic advantage relative to other craft brewers in the marketplace. And it's funny, I was thinking about this on the way into work this morning, and we talked a lot about B-Dubs because it was pretty newsworthy in terms of what we did, but at the same time, Safeway's our biggest account, and we have really strong relationships with retailers all across America. So we're actually in kind of constant communication in terms of programming and developing innovation and ideas that work across the portfolio. At the same time, kind of building on some of the points that Andy mentioned earlier, that becomes clear with Scott's presentation, we're trying to also balance that with being efficient in terms of how we do it and bring it to market.

Robert Sanders

That's helpful. And maybe just if I can have a follow-up. Mark noted that the CapEx budget is going to increase a little bit here in the back half of the year, and any guidance where that additional CapEx is going?

Mark D. Moreland

Sure. There's some timing differences, front half-back half. There's projects we'd initiated and some kind of slipped into the back half. We obviously don't give quarterly guidance, but it's all going according to plan. Effectively, one of the bigger chunks is a slug of cooperage of kegs we're bringing in, which was a fairly sizable chunk of capital you'll see in Q2 coming through. And then other key projects in the breweries to increase our efficiency in the breweries.


There's no further questions. So now I'd like to turn the call back over to Andy for closing remarks.

Andrew J. Thomas

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


Thank you, Andy. Ladies and gentlemen, that concludes your presentation for today. You may now disconnect. Have a good day.

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