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The Boston Beer Company, Inc. (NYSE:SAM)

Barclays Back to School Conference Call

September 06, 2012, 03:45 pm ET

Executives

Jim Koch - Chairman

Analysts

Unidentified Analyst

Alright, good afternoon. Thank you for joining us. We are delighted to welcome back Jim Koch, the founder and brewer at the Boston Beer Company and he is joined by Bill Urich and [Matt Murphy]. Jim founded the company back in 1984 and brings many years of brewing and business experience. Quite honestly, we always look forward to hearing Jim’s perspective on the Beer category, particularly from his unique vantage point and of course we’ll have a chance to share some of Jim’s top quality product.

And with that, I'll hand things over to Jim.

Jim Koch

Thank you for coming and I am honored that anybody’s here with Craft in the next room, so if any of you think you are at the Craft presentation, this is Craft Beer; it’s a little different. So, let me, I guess, it wouldn’t be a presentation if I didn’t give you a word from our attorneys, I am about to make different statements; practically, everything I say won’t come true and if you want to know why, you can look at the 10-K and the 10-Q and see all the risk factors.

So, let me just start out with setting the stage for the part of the Beer world that we compete in which is United States and in the past few years, the primary dynamic has been driven by the new appearance of ABI and MillerCoors. Today’s those two global brewers produce 92% of the beer made in America, which is a striking transformation.

Now, the U.S. businesses are really just part of larger global and the role of the US businesses has become generating cash to invest in synergistic acquisitions and emerging markets and that cash generation has been quite extraordinary; I believe ABI tripled the free cash of Anheuser-Busch which was a reasonably well run company when they took it.

So these are just world-class managers running the US businesses. They've generated the cash by cutting costs and raising prices in a much more concentrated industry and not by driving volume or share growth. And some of that is I think coming bit to an end because synergies are largely gotten and my guess is they will turn attention in energy to trying to find pockets of growth through an innovation pipeline or small acquisitions like ABI buying Goose Island and then spreading those out through their national distribution footprint.

So we’ll be moving from cost cutting and price raising to maybe more innovation and search for pockets of growth, you see it with the successful launch of but Bud Light Platinum at significantly higher price points than Bud Light and about 1 million barrels in five months. So they are pretty impressive entrants with that.

On the other hand the growth in the US beer industry has been in the craft category; I call it craft and domestics’ specialty. Craft is small independent traditional brewers like Sam Adams and 2,100 other small traditional independent traditional brewers. Domestic specialty is one of the Craft look a like beers from the big brewers, things like Shock Top, Blue Moon, Goose Island, Leinenkugel, that the big brewers have sort of pushed into the craft category and started to be quite successful.

I think craft domestic specialty in the US this year will be about 8% of the volume, probably 11% of the revenue and the gross margin, of that 8% is about 6% is craft and 2% and change is domestic specialty. So a small piece of the US beer business, but a lot of opportunity to grow.

And this is, those of you who have been to the conference in previous years, there is a slide that I keep showing, actually first drew it in 1992. This is kind of my sort of simplified dump down to the level that you get after you have a beer understanding of what’s going on in the US beer industry and this is kind of, you could of think of these lines as 40 year moving average.

But if you go back to the US beer business in 1970, 99% of the beer sold in the United States was regular strength domestic beers from a much larger variety of producers than today that you had Pabst and Stroh and (inaudible) and Olympia and Lone Star and Old Style and Natty Boh etcetera.

But 99% of the beer was regular strength domestic beer. The import category was very small, less than 1% and there were no craft brewers. So that was little over 40 years ago. You fast forward today and that scene has changed dramatically. That 99% is down to 24%. The leading brand in the regular strength domestic beer is Budweiser, which may still be the largest brand in the world. In the U.S., they had their last year of growth for that brand, great brand run by a great company, great marketing, frogs, lizards, [wassup], all kind of cool stuff. Their last year growth despite all of that was 1987. Ronald Reagan was President.

They have had 25 consecutive years of decline and it's because of this dynamic, despite everything they’ve done, the consumer has gone away from what was 99% of the business and the consumers gone in two directions. They’ve gone in one direction to light beer and basically the consumer is pretty rational.

The consumer is saying, I can have a regular beer or I can have a light beer. They pretty much taste the same because I mean I’ve got pretty good powers, not that easy to tell the difference between Bud and Bud Light, Coors and Coors Light etcetera and they have less calories and the light version and you can drink more of it. So consumer made a rational decision. From a brewer’s point of view, it's a great deal. You know, light beer sells for the same price. It's cheaper to make and people drink in larger quantities; it’s a homerun. And so what was did not exist 40 years ago is now over 50% of the beer category from zero.

At the other end of the spectrum the consumer is doing the exact opposite and trading up. The consumer is basically saying, if I am going to have a regular domestic beer, why don't I have some better; why don't I get even more flavor, higher perceived quality, you know more cache, status image all those things and trade up and obviously this has happened in many, many, many categories.

And today, what I’ll call better beer which is imports and craft domestic specialty that category that didn't exist 40 years ago is now 22% of the beer volume. When I first drew this chart in 1992 it was 5% and I boldly predicted that it would double and get to 10%. It’s now at 22% and continues to grow. If you want to question of how high it’s up, it’s a very good one. The analogies that one could look at in wine and spirits, the high end of those categories depending on how you’re defining is about a third and growing.

So in those categories it’s already a third, could easily get to 40% and that's probably true with beer. No reason that beer should be different; it’s lagged wine and spirits principally because the big brewers with all the marketing cloud and distribution cloud and retailer muscle didn't want it to happen, because they didn't historically play in the high end and held the growth back. The dam has burst; there is no holding it back at this point.

So my guess is just based on wine and spirit will continue growing, and even in US when you look at sort of the leading edge markets, the coastal markets, the big city markets, craft domestic specialty import is already over 30% in places like New York or Miami or San Francisco or Los Angeles or Portland Maine or Portland Oregon; it’s already gotten to those levels.

So I am pretty confident that what has been going on for 40 years will continue to go on. And actually, you can see just the last four years, the trends have continued and at this point better beer is large enough and its growth is strong enough that going forward it may end up taking some share from light beer; light beer may have at this point topped out and in fact you see some of that.

So in the last four years about 11 million barrels or over 5% US beer volume has left the market in the form of the regular domestic beers and the light beers about half of that went to craft and domestic specialty and the rest of it just disappeared.

So when you look at what is going on in the US beer market, craft is driving the volume growth and doing more than just that, I mean not only you can see in the volume numbers that drives all the financial numbers that every body looks at, but there is something may be more important going on which is the United States is in the process of creating a beer culture which is unique in the world.

Today, all of the energy and excitement about beer is happening here in the US driven in typical US way by a lot of very innovative, very entrepreneurial, very creative, sort of rag-tag bunch of people, I mean I think about my peers in craft brewing and you look at, see here in Nevada where that come from Ken Grossman a bicycle mechanic.

Where did New Belgium come from? Kim Jordan, a social worker. Where did Dogfish had come from? Sam Calagione, an actor. So you have this very interesting diverse, somewhat bizarre group of people, who are doing something really extraordinary, changing the beer culture in the US and we’re seeing it.

Today, 20 some things are adopting craft beer the way their boomer parents adopted wine. Beer is exciting, fun, seeing a beer geek is a cool thing in the US and it's fascinating for me to go to other places in the world that have a venerable, amazing beer traditions like Germany and their culture, their beer cultures are dying.

We get a German brewer at least once a month coming here to Boston to our brewery wanting to know what is America doing to create such a great beer culture, to make beer interesting and exciting to 20 some things and it's threw a lot of innovation, passion, obsession about quality and willingness to do things that are different.

We did joint collaboration beer with the Weihenstephan, the oldest brewery in the world, the German Brewing University, the Research Institute for Germany and it was startling how good they were at doing the same thing only a little a better very year, but and they have kept doing and wondering why the consumer didn't care.

And I was trying to explain, you got to do some, it’s not just about thinking of cost at it, it’s about putting value in, adding value to the beer and consumers will pay for that. There is a brewer that we sale just releasing in a few weeks a beer called Utopias.

Talking about premiumization, it sells for $170 a bottle. We sell every bottle we make and if you go on eBay, the pre-market prices is about $250. So you can't sale beer for $200 a bottle; the challenge is not how do you sale beer for $200 a bottle, its much simpler how do you create a beer that is worth $200 a bottle.

If you can do that it’s real easy to sell it for $170. So that what's going on in the US beer culture and to me that has the potential to lead to several decades of engagement with the consumer, continued trading up, continued growth and excitement just like we've seen with wine.

That took wine along time I came of legal drinking age in 1967. So I am dating myself. Anybody know with the number one selling wine in America was in 1967?

Yes, Michael he gets the brown bag price number one selling wine in America Thunderbird, what's the word Thunderbird. What's the price 20 twice $0.40 that was wine and we all know what happened there that is very possible in beer, and we have seen some of that. Craft has been growing double digits the last several years. It is up about 12% this year in volume growth, pricing is healthy and strong. So attracting a lot of attention in new entrants today.

There is about 2100 craft brewers, there are about the number is actually we wrote this several weeks ago. The number is now 1300 breweries in planning that’s the number of breweries in the entire Federal Republic of Germany.

And it took them about 2000 years to get those 1300 breweries. It’s going to happen in two. So we have this incredible explosion of breweries, styles of beer, the sort of Cambrian explosion in eco system that has a lot of nourishment for small scale brewing in the US.

The retailers are expanding their shelf space to make room but I believe we are within some period of time measured in years to before it hits the wall in terms of retailer space. Retailers have been expanding their coolers, pushing out mass domestic beers to make space for craft but they can’t keep doing it.

Craft space is growing faster than craft volume. So volume per skew is declining and at some point that has come to an end and brands are churning. The new brands from the top ten brewers, the ones with the staying power discontinuing after four years about 15% of the time but below those top 10, the churn rate is over 50%.

So this long tail of small volume brands is getting shelf spaced, but in many cases not holding it, but drinkers maintain their interest in craft for its taste, its authenticity, its variety. The attraction of small and local are all elements of craft. It's more competitive than it's ever been. We have 1300 little guys coming from one end, major brewers with their craft look alike the domestic specialties taking space and gaining share, actually growing faster than craft from a smaller base, local brewery going regional breweries going national.

Brew pubs starting to [shift]. So a lot is happening and the shelf space is grown but it can grow fast enough to accommodate what's coming down the pipe. We believe we're well positioned and this sort of tsunami of new brands and breweries were about 20% of the craft beer category which means we are three times the size of the next craft competitor.

Now, if that sounds impressive but it's like being the tallest pygmy. All of this means, we have about 1% of the US beer market but compared to any other craft I think we’re bigger than the next three or four put together.

We believe the trade up will continue and craft beer is affordable. Even in this recession, craft beer grew double-digits. That’s pretty amazing because it's an affordable luxury and the SAM brand position is we believe fairly enduring, it’s based on quality and substance rather than on being cute or having the right attitude at the moment and we remain the only craft beer who put significant media support behind our brand.

Our media support is on the order of $35 million and I think the next biggest one in craft is maybe $1 million. So we're basically the only voice out there.

And the retail environment probably is good for us, it continues to shift the national accounts as retailers consolidate and retailers have realized the potential of Better Beer.

The big guys were able to keep them focused on they are into the cooler for a number of years but today the growth in margin dollars volume, overall profitability is coming craft beer and the retailers who don't embraced that have lag behind their competitors.

Boston Beer has gained share both on and off Paramus and continues to add resources which is mainly people. So far this year, our depletions are about 9% with healthy pricing on Paramus is our key driver. We're much more heavily weighted than the rest of the beer industry to on Paramus because we believe that's where sampling occurs, that's were brand royalty is build, that's where you drink the beer that you are proud to be seen drinking and that's where people are more willing to trade up.

So we focus a lot on that, and on national chains. That isn’t captured in the public data which tends to track supermarkets and convenience stores about a third of volume is draft. So it doesn’t appear in any of the IRI or Nielsen numbers and the majority of our sales force time is spend on Paramus.

Innovation is driving this category and it’s always been one of the core competencies of Boston Beer Company. For 28 years, we continue to push the envelope in a lot of different ways; obvious one is creating new styles of beer, we started with Samuel Adams® Boston Lager 28 years ago. This year we will brew and release commercially about 60 different and unique beers plus three new ciders and one new type of Twisted Tea.

But innovation is not just in the products, we recreated the beer glass this is the perfect pint. It was the first time that anybody applied the same principles of wine glassware to beer; I mean everybody knows that if you have a really good wine, you are going to drink it from the proper glass. You are not going to drink it from a Dixie cup.

But people then when they shift it to a really good beer, just drank it out of a shaker glass, I mean nobody really thought about it but the shape and structure of the glass affect the taste of beer in the same way that the glass affects wine.

So this is the first beer glass to try to optimize the flavor of a big complex beer. Obviously, we have a lot of advertising. I hope you guys have seen it, if not, I am wasting a lot of money, but I hope you have at least seen some of it and the innovation goes even to the supply chain. Beer has an archaic supply chain. Basically, the breweries essentially use the wholesaler’s warehouse to help them run their breweries more efficiently, which means that a lot more inventory is carried by the wholesale than truly necessary.

So two years ago we launched a Precious Beer Program to dramatically cut the inventory at wholesale and with the objective of making Sam Adams the precious beer in every market and that basically, dramatically reducing the wholesalers inventory and with that much smaller inventory, having them put back in their cooler at 36 degrees and the effect of that is eliminating the product degradation that happens at wholesale.

Typically, at wholesale for craft beer, there is about a month worth of product degradation and a good beer will last four, five months. So this takes a big hunk of the degradation out of the system. It's not cheap. Its lot investments in tankage and extra capacity for us to respond more quickly when you take that buffer inventory out, but it gives the consumer a noticeably better beer.

And I talked about Sam Adams. We also have two other products that we have created. One is Twisted Tea. It's a hard ice tea. We have been selling it for about 12 years. It's built slowly kind of on a grassroots basis and then last year we introduced Angry Orchard, a hard cider in New England. It surprised us with how well it did and so we introduced it nationally in April of this year.

And we look at these as complementary to our portfolio. They are higher priced premium products that sell to the US spirit drinker which is what we do and they contribute even financially to supporting Sam Adams, because the Sam Adams brand is really the engine that pulls the whole train.

And we continue to invest in the future; we believe we're in a great part of the US beer industry; its one of the most attractive parts of the global beer business. There is not that many places that are growing at 12% a year with very healthy pricing on a significant base.

So even though the US is a mature market, the part we're in is not in my belief mature at all, so this year we're going to spend some what between $55 million and $75 million on infrastructure mostly, capacity growth and capability growth. We are putting in a whole seller and building to barrel age high end beers and a packaging line to package them with the champagne cork; they sale for about $10 a bottle at retail and are in many ways a wine substitute and lots more tankage and debottlenecking of our breweries to accommodate continued growth.

We added sales people this year; higher than our overall volume growth, because we believe that a brand like ours is driven by education and retail execution more than marketing and advertising. So we have one of the largest sales forces in the beer business despite being 1% of the overall volume. Our sales force is well over 300 people I think somebody like ABI who is 50 times our size might have 600 people something like that. So I mean when you look at our organization, start sales were just way out of proportion to our size; we are like a little baby with a 40 pound head. It’s just this anomaly, but that’s how we have grown.

So, and we continue to invest in advertising and brand building activities and even new ventures. We are partnering with a man name Alan Newman, who is the founder of Magic Hat Brewery in Vermont before that. And he is a serial entrepreneur before Magic Hat he founded a company called Seventh Generation as green cleaning products and it’s about $300 million company now. So Alan is an interesting and creative individual and have basically and historically has proven himself to be largely unmanageable. For us he is just the kind of person that you know I enumerated earlier that it started as craft breweries and he is looking for opportunities on our behalf and it’s called Alchemy & Science; that’s the name of the collaboration with Alan Newman.

So, short-term financially, the investment in infrastructure and brands means we're not getting the leverage that we might otherwise get if we weren’t doing all of that investment, but my belief is this is a -- we basically have a strong position in an attractive category and when you have that, you invest. We use to work at BCG and that was one of the quadrants. So that was what they taught me in 1978 and I think it's still true. I believe the investments are the right thing for the business, and frankly, we are more interested in long-term growth and health than we are in short-term earnings and as a largest shareholder, I think that's good for the shareholders.

And I would, in the future, I think pricing in the craft category which has been healthy for many years. At some point, it has to get tougher. Just with all those new entrants and with the big guys coming in, I believe that pricing will get tougher at some point in the future and we are very focused on making sure that we don’t have any unnecessary costs and we continue every year to be more and more efficient so that we can reinvest in the business and still maintain financial health.

So we think we have the right products, the right portfolio, the right infrastructure, the right investments, the right quality image and the right wholesaler and retailer relationships and probably the right attitude and approach to a business like this, which is to be innovative, to look for opportunities and capitalize on them, to remain flexible but also to be committed to continue to grow the Sam Adams brand, because as I said, for us that's the engine that pulls the train that leads to long-term success.

And highlights for the first six months; 9% depletion growth; we planned the price increase of 3%, we executed it. Gross margins about 55%. We grew our advertising promotion and selling expense by $6.5 million. Net income, decreased, reported income decreased $10 million, per diluted share, because we had a settlement with a glass company last year and if anybody remembers, I hope nobody, but we had a recall because we were sent bottles which had glass shards in the bottom of them in I think 2008 and hopefully at this point nobody even remembers it, but it was a defining moment in a lot of ways and we got of bunch of money from Owens-Illinois to compensate us for that. And full year EPS range, $3.80 to $4.20.

Thank you and I think what we do Michael; Q&A, okay. And I will this is to remind you, we have cold beer waiting for the end of this session. So I feel badly that the Q&A is the only thing standing you and your next beer, but that's the way its works. Yes.

Question-and-Answer Session

Unidentified Analyst

(Inaudible) obviously that hasn't hurt you at all, but where do you think the outlook for that, is that to improve effectively going forward?

Jim Koch

Okay, yeah. Bottomline is hops shortage as you view about are not an issue for us. There is a big blend of hops today and hops are in chronic long term oversupply due to a bunch of yield factors utilization and so forth, so there is more acreage come out of the world’s hops farms. But, what’s happening is as craft in US has developed it has become and explosion in need for specialty, esoteric smaller volume or interesting hops that bring different flavors to the beer. So the commodity into the hop market is in chronic oversupply.

But if we want, if the new hop becomes very attractive and even if its use Citra, Simcoe or Galaxy you can’t say there is not acorn, it can’t grow it the next years. It takes a couple of years for that for the plants we put in the ground and we get a good crop, so that’s what happening. The spot shortages of specialty, very desirable hops mainly in the part of small brewers who did not contract; we contract, so we are willing to make commitments so that we are sure, we are going to get the hops that we need.

And every once a while you are over gassed and we have to carry them a little longer, but we have not been able to make -- we never were in a situation when we couldn’t make a beer we wanted to because we couldn’t get the hop. Michael?

Unidentified Analyst

Jim three topics I would like you to touch on. The first one is the convenience to the channel which was always very difficult for Boston Beer to get into, but it seems like you are at an inflection point, I am curious about how much are you putting behind it and what’s going on in shelf? And second is just with the avalanche of new breweries. How does that influence your relationship with the wholesalers which is very strong and how do you manage that and then third, with respect to the retail shelf space, how do you see it evolving overtime as we know in wine, it's by origin, by varietal, do you risk to the shelf sets for craft beer as so many new brews come on the market and how do you going to think about managing that process?

Jim Koch

Okay, so there are three questions. Convenient stores, wholesalers and shelf presence. Convenient stores are the largest channel for beer in the US. They are depending on how you counted somewhere between 25% and 29% of the volume. They’ve been the last frontier for craft because I mean if you think about convenient store, they’ve only got a few doors for beer.

Two, for that kind of size and it's also a quick trip. Nobody goes into, you don’t go to the convenient store to like browse for new beers. You go in, you know where your favorite beer is, you go get it, you check out and you’re on your way.

So they have not been a favorable environment for craft that is changing. They’re now realizing that they’re missing out on a significant profit pool and so we’ve benefited from that because your convenient store, the first craft beer you’re going to put in is Sam Adams Boston Lager and the second is probably going to be Blue Moon or Sam Adams Seasonal.

So if they’re going to put in one shelf of craft, we’re going to be there probably with two SKUs and we have craft specialist in our sales force that we started hiring actually five years ago in preparation for this. So we see continued growth, [sea] stores are still under spaced for craft; craft can double or triple in [sea] stores.

With the wholesalers, they are kind of struggling with this tidal wave of new entrants and trying to figure out how to deal with it because beer wholesalers normally are meant to deal with big strong brands that turn and sell and not would getting in a 3% of their volume from 800 SKUs which is what it means, the long-tail of craft for a wholesaler will bring 800 SKUs and add or 2% or 3% more volume into a wholesaler that has 300 SKUs that to the other 97%, 98% of their volume.

So we're trying to help wholesalers manage through that we actually encourage our wholesalers to fully participate in the craft category to take in as many craft beers as they feel are good for their business and we will earn our predominant within that portfolio, we almost rather have a wholesaler that’s very good at craft and we'll earn the first place in their portfolio then one who doesn't take any craft in at all and therefore they shut out of a lot of the accounts that [won] a bigger portfolio.

And then third is this question of and bigger question with the (inaudible) of beer if you will. Do you think about alcoholic beverages, liquor is a branded category? People buy you know within (inaudible) gin or kind of thing it’s branded. Wine is relatively unbranded. People who don’t want to drink the same wine twice, you don't have the same kind of brand loyalties, the retailer can move you from one brand to another from a brand that you know and like to the one you never heard of, that the retailers this is way better and then they tell you about how the great it’s lovingly pressed by the whole family and the sunlight only comes on to the vineyards for three hours a day but there is no whatever wine has that.

The question is which way this craft beer go. My belief is that, and beers has always been a branded category and I believe craft beer will follow as beer as a branded category, because when you look at the shoppers for a decision tree, it’s kind of curious to know then I am going to have a beer I want, a regular priced beer I want, a better beer and then within better beer they start looking by brand and most talking to the beer manager at very good retailer in Texas [EGB].

And they tried setting their craft beer by style and it was apparently just a disaster, consumers couldn’t find what they wanted, they were frustrated, consumers want particularly, the consumers want retailers to organize and structure chaotic categories for them and craft beer runs the risk of being chaotic and consumers want some order and structure in that just like with imports. If not I mean they put all the Heineken together so you get this block of green and that helps the shopper know that’s the import category.

Unidentified Analyst

I am curious if you see an inflection point coming in the way the craft world is organized in terms of perhaps more alliances with the big brewers in the sense that all these little guys have this terrifying decision to make, or they restore capacity of taking a loan out on their home or something and then ramping up and also the challenge of locating strong distributors across the nation and such an eloquent solution of teaming up with the big boy who is so thirsty for any innovation and novelty in his portfolio, and also to the extent that beer, where the craft category is moving beyond just beer geeks to maybe drinkers that are sort of agnostic to the size of the brewery. And so I am curious if you think that there could be an inflection point there.

Jim Koch

One would think that there will be more of that. Surprisingly, there hasn’t been much. It's been 15 years since Anheuser-Busch became the largest shareholder in Redhook. That was 15 years ago. Since then, they bought Goose Island and they bought a couple of little things, I think like Dominion and Virginia Starr Hill. So far it really hasn’t happened. One would think it would, I mean, logically.

The couple of things that mitigate against it is craft brewers are kind of a narrowly grouped, just sort of individual (inaudible) and everybody likes running their own business. They really have been very few of them that have been even sold over the last 10 years. So, I mean we like what we're doing and most of us are otherwise unemployable by a big company and we started these craft breweries because we don’t want that. So that’s one thing.

The second is distributor footprint issues which are big deal because once a brand gets to be attractive and has proved itself, across a large part of the US and therefore reaches the attention of the big brewer by that time they have a largely complete wholesaler footprint which is at odds with the footprint of the acquiring brewery and state laws make it extremely difficult to move your brand into your wholesaler, Anheuser-Busch is still struggling with lot of [Stella] wholesalers that are not a beer wholesalers and with their [cloud] and muscle you would have think they could gotten it done.

So with craft beers that’s have a major impediment for the brewer to actually realize the value of their brand if there is negative synergies to the acquirer because of the conflicting distributor footprint.

Unidentified Analyst

I have got two questions. The first is I think since the convention in November last year, AB itself stands on distributors about carrying third-party brands and that's asking for more alignment and I just wonder if that had any impacts on the craft brewers and for Boston Beer specifically if you rely on the AB network.

And the second question is Boston Beer have largest craft brand makes a good EBIT margins. I know that right above which is it mix zero around zero or something and I don't know about Sierra Nevada, [Yung Wing] and Dogfish and the others ones, but I just wonder if and at some point comes the decision of when you grow, when you have to put more money to invest the second brewer and then that's point when many decided to sell. So, putting all those things together why wouldn’t the consolidation between craft brewers make sense? And why it hadn’t happen yet? Because I understand many people there are for fun.

Jim Koch

Okay. First question AB is trying to re-exert control over their distributors after and they had a 100% share mind program put in by Anheuser-Busch in the mid 90s, AB deserves the loyalty of their wholesalers, AB made them wealthy and AB represents 90% of the profits for most of the wholesalers. So you would think they could exercise a lot more control, the issue is they are wholesaling you as an independent business person. His rights are protected by franchise laws. He can do whatever he damn well pleases and the brewery has limited options to force them back in the line Anheuser-Busch both had loyalty, he made them rich, they would follow.

It’s not quite that way anymore and so this jailbreak happened where the AB Networks started looking for craft brands. I don’t think they are going to go back. The answer to your question I don’t think it affected craft that much but little tiny bit at the margin but not that much and your second question was why not consolidation among craft brewers.

Again you would think of what happened, it hasn’t partly because of the things I said. Number one, you can consolidate a conflicting distributor footprint which is a big problem and Alan Newman described to me the problems he had when Magic Hat they brought Pyramid and all of a sudden, they had in a lot of markets they were sending salespeople into that market to do business with two competing wholesalers. And the wholesalers wouldn’t see their salespeople because they say today you are working for me to sale Magic Hat but tomorrow you can be with the Pyramid wholesaler ruining my business, get the hell out of here.

So these distributor footprint issues are surprising to people running the beer business because you think of regular consumer package goods. You move your wholesalers when brands consolidate. In the beer business with some exceptions, you basically can’t do that and you’re stuck with the negative synergies of conflicting wholesaler networks and not able to move it without extraordinarily high payments.

I mean, this is probably stunning to a lot of you, but you can calculate the brand value of Sam Adams, you know, the market cap, minus whatever. So you get a brand value number, divided by the number of cases; I don’t know what it comes out to, $30 a case or something like that. That is less than the brand value to the wholesaler. So I as the brand owner have a minority position in the value of my brand in the marketplace. The wholesalers have the majority position.

Unidentified Analyst

I have just two questions. The first is, what is your reaction when people say, you know, the Boston Beer, the Sam brand has largely grown over the last several years from expanding the seasonal portfolio while the core original Boston Lager has become a smaller part of the portfolio and does that show that the overall brand is weakening or strengthening or how do you think about that?

And then the second question unrelated is, when you think about the shelf space issue that you highlighted and you put that in the context, you been doing it for a long time; it happened in the late 90s. How do you think this was going to play out when the wine and beer retailers you know end up taking back shelf space and shrinking the available category?

Jim Koch

Okay. So I think your first question was, I am thinking about the second one. First question again was the seasonal?

Unidentified Analyst

Yeah.

Jim Koch

Okay. I mean we think about Sam Adams as a brand and in our category its not a – the consumer looks at Sam Adams as a portfolio and not as a single SKU and that’s largely true in craft beer; it’s not just us; that's everybody. There are virtually no significant brands in craft beer that have only a single SKU and right now the consumer is interested in drawing and experimentation and we want to keep our Sam Adams drinkers in the Sam Adams portfolio by adding other styles, other flavors, different price points; when we started doing seasonal 1988, so that's been, something that's been part of our portfolio now for 24 years and who knows what the next growth category will be or whether it will collapse back, but our feelings is the consumer looks at Sam Adams as a brand with a portfolio of beers.

The second I think the question of the retailer shelf space, I mean its interesting beer is starting to take a little bit shelf space from wine which hasn't happened for decades. My guess is, retailers will probably continue to expand the shelf space for craft beers for several years, but it will hit a wall. I don't think it’s going to contract because they think volume will grow. When it stops growing, I don’t see it shrinking because I think the volume will grow, the retailer will just come to the conclusion that I had a 20% more shelf space for craft and I didn’t sell more beer and may be that wasn’t a good idea.

I mean I am seeing it even with on premise retailers have added draft [handles], they have gone from 10 to 20 to 30 and somewhere about 20, their volume stops growing. And they realize okay it was good to go from 10 to 20, I created people up, I got revenue increases but it went from 20 to 30. I just added confusion at the cost and I didn’t sell any more beer at a higher price, it’s just a demonstration of that sort of the jelly experiment when you have 36 jellies people buy less than when you have six, and they are less satisfied with their purchase because they wish they bought one of the other 36. But if you only got six, it’s organized, they pick favorite quickly and they are happy.

Unidentified Analyst

There is a question how will be the attractiveness of craft beer you wholesalers change when craft beer doesn’t have pricing power anymore?

Jim Koch

I think it will continue to be attractive because it’s probably the highest margin beer that they sell and if craft beer looses pricing power it’s probably going be reflected through the other categories. To me distributors will still be delighted with craft beer because not only is it the most, they make the most dollars per case on it and if you think about wholesaler I don’t know there are some rough numbers, let’s say across the wholesaler, I don't know, $2 to just physically move a case of beer through the system into the retailer. It cost them $2 and there is a mass domestic beer that lets say they make a $4 a margin on. So they net $2. The craft beer, they might make $6 in margin on. They net $4 because it doesn’t cost anymore to move a case of Sam Adams than it does to move a case of Busch Light.

So from the wholesaler’s point of view, the profitability is even greater than the margin, the gross margin indicates. The other is craft brewers do a lot of the wholesaler’s work for them. You know, we have 300 plus salespeople out there. Their whole job is to make, is to sell more Sam Adams, i.e., make more money for the wholesaler. You know, AB is not doing that, MillerCoors is not doing that. Even the imports don’t have that, have not lifted such a large proportion of the sales cost and burden from the wholesaler. So wholesalers are very happy with the growth of craft beer. If it doesn’t have the pricing power, it will take a decade for that to become an issue.

Unidentified Analyst

Without identifying other of your smaller craft brewer, I am just curious what's your view into their profit margins, in terms of how fragile, do you guys dealing with like nice juicy 15%, 20% EBIT margins, or like, are they like (inaudible) by their fingernails, low single-digits or something. What's your sense of that?

Jim Koch

I have no idea. It's just hard to ask, there are 2,100 of them ranging from guys who are making three barrels a week to you know guys who are making 20,000 barrels a weak. They appeared to be able to get the capital expand in most cases. I mean banks will lend to successful businesses and capital is really, really cheap right now. There is beer in the back.

Unidentified Analyst

There is beer in the back and we're ready. Please join me in thanking Jim, appreciate your time.

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