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

Q3 2012 Earnings Call

November 1, 2012 5:00 p.m. ET

Executives

Jim Koch - Chairman

Martin Roper - President and Chief Executive Officer

Bill Urich - Chief Financial Officer and Treasurer

Analysts

Judy Hong - Goldman Sachs

James Watson - HSBC Securities

Andrew Kieley - Deutsche Bank

Operator

Good day. My name is Lisa and I will be your conference operator. At this time I would like to welcome everyone to the Third Quarter 2012 Earnings Call. (Operator instructions) At this time I would now like to turn the call over to your host, Mr. James Koch, Founder and Chairman. Please go ahead.

Jim Koch

Thank you. Good afternoon and welcome. This is Jim Koch, Founder and Chairman and I am pleased to be here to kick off the 2012 third quarter earnings call for The Boston Beer Company. Joining on the call from Boston Beer are Martin Roper, our CEO; and Bill Urich, our CFO.

I’ll begin my remarks this afternoon with a few introductory comments including some highlights of our results and then hand over the microphone to Martin, who will provide an overview of our business. Martin will then turn the call over to Bill who will focus on the financial details for the third quarter as well as review our outlook for the remainder of 2012 and our initial outlook for 2013. Immediately following Bill’s comments, we’ll open the lines for questions.

We achieved depletions growth of 15% for the quarter and 11% for the first nine months of the year, which is attributable to a strong sales execution and support from our wholesalers and retailers as well as our great quality beers, innovation capability and strong brands. We believe that craft beer will continue to grow and that we are well positioned to sharing that growth.

We released some excellent beers this fall, including Sam Adams Harvest Pumpkin and a new small batch brew, Sam Adams Fat Jack Double Pumpkin. And I believe that these styles have been well received. We remain confident about the long term outlook for the craft category and for Samuel Adams.

I will now pass over to Martin for a more detailed overview of our business.

Martin Roper

Thank you, Jim. Good afternoon everyone. As we stated in our earnings release, some of the information we discuss in the release and that may come up on this call reflect the company’s or management’s expectations or predictions of the future. I remind you that such predictions and the like are forward-looking statements and that company’s actual results could differ materially from those projected in such forward-looking statements.

Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in the company’s most recent 10-K. You should also be advised that the company does not undertake to publicly update forward-looking statements whether as a result of new information, future events, or otherwise.

In the third quarter our depletions growth benefitted from strength in our Samuel Adams Seasonal, Twisted Tea and Angry Orchard brands, offset by some slight decline in some of our other Samuel Adams brand styles. Based on the strength of the national rollouts of our Twisted Tea and Angry Orchard brands and the continuing growth of our Samuel Adams brand family, we have increased the investment levels in our sales force and our support behind our Samuel Adams brand.

We expect to continue to increase investments in advertising, promotional and selling expenses behind existing brands and also in innovation, commensurate with the opportunities and the increased competition that we see. During the quarter we updated our packaging for all Samuel Adams styles and continued the evolution of our brand communication for the love of beer that builds on our previous messaging.

Our higher than normal capital investment projects in 2012 support the increasing complexity of our portfolio and our Freshest Beer program, and have expanded the capacity and capabilities of our breweries to meet anticipated future growth. These projects have gone well. We expect a similar high level of investment will be needed in 2013 after which we should return to an annual capital investment level of between $30 million and $45 million including the capacity expansion initiatives to accommodate our expected growth.

We are making appropriate investments in brand building activities and capital improvements in our brewing and packaging capabilities to position us well for long term growth and continued efficiency gains. We are prepared to forsake the lost earnings that may result from these investments in the short term.

Alchemy & Science, our craft brew incubator continues to make progress and explore potential opportunity. Its House of Shandy brand added additional markets in a new style, the Nations Traveler, while Angel City Brewery launched to new styles in draft in the Los Angeles market and expects to have its brewery opened to the public by the end of the year.

These projects have had minimal sales to date. Our 2012 financial projections includes estimated expenses net of gross profit contribution attributable to Alchemy & Science projects of between $3 million and $5 million. But this estimate could change if new projects are added. We will continue to look for complementary opportunity to leverage our capabilities provided that they do not distract us from our primary focus on our Samuel Adams brand and on our wholesales.

We believe that as a result of our Freshest Beer program, we are delivering better freshest Samuel Adams beer to our drinkers while lowering wholesalers inventories, reducing cost and improving efficiency throughout the supply chain. We currently have over 70 wholesalers signed up and at various stages of inventory reduction. We have over 50% of our volume on our freshest beer program and believe this could reach between 65% and 75% by the end of 2012. We continue to evaluate whether we can reduce the inventory levels further.

Year-to-date depletions through the 43-weeks ended October 27, 2012, are estimated to be up approximately 12% from the comparable period in 2011. Now Bill will provide the financial details.

Bill Urich

Thank you, Jim and Martin. Good afternoon everyone. We reported net income of $20.8 million or $1.53 per diluted share for the third quarter, representing an increase of $4.5 million or $0.34 per diluted share from the same period last year. This increase was primarily due to an increase in core shipments which was partially offset by increased investments in advertising, promotional and selling expenses, which included freight cost to wholesalers.

Core shipment volume for the third quarter was approximately 772,000 barrels, a 17% increase over the third quarter of 2011. We estimate that inventory at wholesalers participating in the Freshest Beer program will lower by 296,000 cases as of the end of the third quarter as compared to the third quarter of the prior year. We also believe that inventory levels at the end of the third quarter for all wholesalers were at appropriate levels.

Our third quarter 2012 and 2011 gross margin was 56%. Cost increases in barley, hops and other ingredients were offset by pricing increases and lower operating cost per barrel due to increased volume and efficiencies. We continue to expect our full year gross margins to be between 54% and 56%. We intend to continue to focus on cost saving initiatives at our breweries and are pleased with the improvements we have made to date.

Third quarter advertising, promotional and selling expenses were $8.3 million higher than those incurred in the prior year, primarily as a result of increased investments in local marketing, advertising and point of sale, cost for additional sales personal and freight to wholesalers due to higher volumes. General and administrative expenses increased $2 million compared to the third quarter of 2011 due to increases in salary and benefit costs and Alchemy & Science startup cost.

Our effective tax rate for the third quarter of 2012 was approximately 38%. Based on information of which we are currently aware, we have left unchanged our projected 2012 earnings per diluted share of between $3.80 and $4.20 for the 52-week period ending December 29, 2012. Our actual 2012 earnings per diluted share could vary significantly from the current projection. We continue to expect that 2012 depletions growth will be between 8% and 12% for the 52-week period ended December 29, 2012 compared against the 52-week period ending December 31, 2011.

We expect 2012 shipment growth will be between 7% and 10% for the 52-week period ending December 29, 2012 compared against the 53-week fiscal period ending December 31, 2011. We estimate an aggregate inventory reduction at wholesalers participating in our Freshest Beer program of between 100,000 and 300,000 case equivalents at December 29, 2012, compared against December 31, 2011. We continue to target price increases per barrel of approximately 3%.

We now estimate that increases to advertising, promotional and selling expenses, not including any increase in freight cost for the shipment of products to our wholesalers, to be between $14 million and $18 million, up from the previous communicated estimate of $11 million to $15 million. Approximately $10.5 million of this projected increase has been incurred in the nine months ended September 29, 2012. We believe that our 2012 effective tax rate will be approximately 38%.

We continue to evaluate 2012 capital expenditures and have narrowed our estimated 2012 capital expenditures to between $65 million and $75 million, up from the previously communicated estimate of $55 million to $75 million most of which relates to continued investments in our breweries and additional keg purchases in support of growth.

Looking forward to 2013, we are in the process of completing our 2013 planning process and will provide further detailed guidance when we present our full year 2012 results. Currently we are using certain targets and assumptions based on information of which we are currently aware. We are targeting high single digit depletion trends and price increases per barrel of between 1% and 2% to partially offset anticipated barley, hops and other ingredients, packaging freight and processing cost pressures.

Full year 2013 gross margins are currently expected to be between 53% and 55% due to anticipated price increases not full covering anticipated cost pressures and some other product mix changes. We intend to increase advertising, promotion and selling expenses by between $6 million and $12 million for the full year 2013, which does include any increases in freight cost for shipment of our products to our wholesalers.

We estimate increased expenditures of between $2 million and $3 million for continued investment in existing brands developed by Alchemy & Science, which are included in our full year estimated increases in advertising, promotion and selling expenses. Additional projects yet to be developed or acquired may significantly increase investments in Alchemy & Science and advertising promotion and selling expenses. We estimate our full year 2013 effective tax rate will be approximately 38%.

We are currently evaluating 2013 capital expenditures and our initial estimates are between $55 million and $65 million, most of which relate to continued investments in our breweries as well as additional keg purchases. Based on information currently available, we believe that our capacity requirements for 2013 can be covered by our breweries and existing contract capacity at third party breweries. We continue to maintain a strong cash position with $62.8 million in cash as of September 29, 2012.

During the first nine months of 2012, we repurchased approximately 120,000 shares of or Class A common stock for a total cost of $12.6 million. And repurchased approximately an additional 25,000 shares during the period of September 30, 2012 through October 26, 2012 at an approximate cost of $2.7 million. On October 1, 2012, the board of directors approved an increase of $25 million to the previously approved $275 million share buyback expenditure limit for a new limit of $300 million.

Through October 26, 2012, we have repurchased a cumulative total of approximately $10.7 million shares of Class A common stock for an aggregate purchase price of $267.1 million and had approximately $32.9 million remaining on the $300 million share buyback expenditure limit set by our board of directors.

We will now open up the call for questions.

Question-and-Answer Session

Operator

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

Judy Hong - Goldman Sachs

So few questions. First just in terms of your spending going up for the full year. Can you just give us some perspective on what brands or kind of what the nature of the investments that are going up for the year? Is that more towards the Angry Orchard, Twisted Tea, or is it going towards the Sam Adams brand family?

And then just broadly speaking, if you can talk about the payoff that you are getting from these investments. Clearly the overall sales growth has been pretty impressive but the Sam Adams, the core beer family is still down, it sounds like based on your comments. So how are you thinking about the investments that you are making on the core bear portfolio and whether you are starting to see some traction on those investments.

Martin Roper

Sure, Judy. Let me first of all start up, obviously we were very pleased with the quarter and I think as is available from the sort of publically scanning data, we had a strong quarter on Sam Adams as a total brand family versus sort of year-to-date trends. So we were very pleased.

As we think about what might be driving that, we certainly introduced new packaging in late June, early July. I think we talked about that in the last call. We also rolled out an evolution of our communications messaging under the, for the love of beer, moniker which we are following up with the point of sale. And that rolled out also at the end of June. Also in parallel to that, and I think we had mentioned this on previous calls, we have added to our sales force that are driving at a high level and we are approximately 60 people more than this time last year.

And all of those things seem to have helped this in the quarter basically executing in the Sam Adams brand family, increasing distribution and availability and display. And I think we are also helped by having a leading position in the seasonal category in that quarter. Beyond Sam Adams we are also pleased with Twisted Tea’s progress and its continued growth, solid growth across the country. And then also the progress of Angry Orchard after its national launch in April.

So as we look forward, one of the biggest expense numbers is the people number which is sort of not directly targeted behind any specific brand. But we have increased our spending on the Sam Adams brand communication to drinkers through the medias we buy, particularly the online space. And we are, commensurate with the growth that we are experiencing, increased plan spend behind Twisted Tea and Angry Orchard, just to take advantage of the momentum we have.

Judy Hong - Goldman Sachs

Okay. And then just in terms of guidance. So first on depletions. Just given the strength that you have seen on your depletion trends year-to-date, I am just wondering if there is any reason why you didn’t take up the 8% to 12% depletion guidance and whether you do expect some slowdown in the fourth quarter. And then just in terms of the gross margin guidance for 2013, I guess I am just curious to hear from your perspective on the pricing side is there any reason why you wouldn’t take up pricing more just to kind of manage through gross margin pressure more aggressively.

Martin Roper

As we look at the fourth quarter, we don’t see some of the mix sort of growth issues that we experienced in the third quarter being quite beneficial to us. But obviously we could be wrong and we certainly have been happy. From the year-to-date number you will conclude that we have started off that quarter strong. So we are certainly happy with where we are and that’s our current best guesstimate but of course we could be wrong. It sort of related to mix issues.

As we think about next year, we certainly would try to optimize our revenue per barrel as we have in previous years. I just think as we look forward, we don’t think the competitive landscape at least in the price points that we are playing in are quite as favorable as they have been historically. And that is based on signals that we are reading as to retailers happiness and drinkers happiness with crop pricing going up year after year at rates to cover our costs. But we are starting to feel some push back on that and therefore we are probably not as optimistic that we will be able to.

But that being said, we have very real cost increases next year. A lot of them driven by what's going on in the corn markets this summer and therefore barley up price pressure but there are other pressures too. So we will certainly try but in doing our financial planning and also in providing guidance we didn’t think we could be as optimistic as in previous years.

Judy Hong - Goldman Sachs

Okay. And then just finally, Bill, I know you have a strong cash position but CapEx has been going up and you are going to have another year in 2013 where your CapEx steps up as well. So just in terms of your willingness to take on debt and pay for some of those CapEx increases or fund share buyback, can you just talk about what your role in this is, on that front?

Bill Urich

Well, historically, we have elected not to take on any debt and to fund any capital projects through our cash, our cash flow. And that’s what we have done year-to-date and had current plans right now, but that could change.

Operator

And your next question comes from the line of James Watson with HSBC.

James Watson - HSBC Securities

Just wanted to follow up first on that pricing statement. You talked about getting more push back from -- and from consumers. I guess I am more concerned with the retailers. I am just wondering, if you give a little more color on what you are seeing there, which is year-to-date your pricing per barrel is up above your guidance this quarter. It looks like it was up 5%. So it is very strong. So I am wondering what you are seeing there and just how that relates to increased competition, kind of for shelf space at retailers.

Martin Roper

Yeah, I think, James, we are looking forward and we are reacting to some of the conversations with retailers that we have either had or we have read about, that other people have had or where retailers have gone public with some concern about where beer pricing is going. I think just like in anything, we have gone up and not everyone else followed and I think that somewhat shows up in some of the IRI, Nielsen data by market and we are also reacting to that. And obviously we wish to be competitive and we wish to maintain or position in the marketplace.

So based on both of those sort of factors, we are just not convinced that our ability to take pricing to cover our cost which is what we are trying to do, then we are going to be able to do that next year. And you know there have been years in the past that’s been the case and then we have been able to recover or indeed the cost elements have recovered. But just as we looked at next year we are just not as confident as we were this year.

James Watson - HSBC Securities

Okay. And is it that you guys are seeing more competition from long tail or is the pressure kind of from that domestic specialty brands that are at a price point just below you. Is that a plan, more pressure next year?

Martin Roper

No, I think it’s a combination of things. One, there is more craft beers on the shelf with a great variance of prices on the shelf which inevitably provides a different competitive dynamic than let's say six-seven years ago when maybe there were only three or four craft beers on the shelf.

Secondly, on the domestic specialty front, you have one of the lead domestic specialty brands pretty aggressively competing on price and that threatens basically the category of price stability and they seem to be driving volume very successfully based on that. And so we have to watch that and think about price gaps and monitor those.

And then also, at least as we understand, it has some indication that there is going to be some introductions of new in the domestic specialty brands, potentially at lower price point, still it’s a combat, that activity. And so the whole pricing structure of the high end American craft beer and domestic specialty beer is sort of evolving a little bit and it’s not quite as clean as it was 5-6 years ago, and it’s done on a market by market by specific basis obviously.

So we are reacting to what we see and what we believe is going to happen and obviously we would be happy to be wrong.

James Watson - HSBC Securities

That’s pretty interesting about the changing nature of the pricing. How much of a gap do you feel that these new competitors can come into compared to I guess the core of craft beer and still be drawn from the same consumer and still be relevant competitors. Or at what point would the price be too low to almost not be seen as a craft competitor? Is that a problem?

Jim Koch

James, I would say, there are not absolutely clear lines of demarcation in this part of -- what I will think of as the better beer category. I mean in some ways we compete for customers and for ads, and for shop space, with a wide range of other beers. And that you would have to throw imports into the mix as well where we competes with ads and shelf space and customers. And if you look at the IRI or Nielsen data for this year, you will see that our price increase has been higher than -- particularly on 12 packs which is the big promotable package. We have taken price higher than the 12 packs of the major imports and the major crafts.

So you have got that dynamic across imports in the other crafts. The same thing is true with domestic specialties. Martin mentioned some of the interaction there and there are new ‘value crafts’ coming from the big mass domestic producers, and you have even got things like Yuengling that effect our volume. So we compete in a pretty comprehensive space and this year our price increase have been higher than the comparable brands. So there is a little bit of that as well. You know we went up pretty aggressively this year.

James Watson - HSBC Securities

Just one quick last one on this topic. Do you guys consider yourself as having an entry in any of this value craft or is that a place that you would be kind of interested if the industry moves there, you would feel that you would have to kind of have an entrant there?

Jim Koch

Well, it’s hard to have a crystal ball but right now -- to answer your first question, we really don’t consider ourselves as having an entry in that. We have always competed as a craft brewer and have often price leadership. So we don’t have a lot of incentive or desire to take the category price down. And our economics and the cost of our ingredients put us at a disadvantage if that’s part of the game

Operator

(Operator Instructions) Your next question comes from the line of Andrew Kieley with Deutsche Bank.

Andrew Kieley - Deutsche Bank

I just want to understand the, I guess, the accelerations and depletions this quarter. Could you just talk a little bit about the mix of that? How much maybe cider was part of that, how much it might have been? I think you launched Oktoberfest a little bit earlier than usual, so maybe just some of the moving pieces in that.

Martin Roper

Yeah, I am not sure what one of total Sam Adams grew nicely and that was reasonable numbers. And some of that perhaps was due to a clean cut over from [summer ale] to Oktoberfest compared to last year. Because I don’t think we launched it earlier this year than we did last year. I just think the cut over was managed much tighter and obviously we spend a lot of time trying to get those things right to minimize obsolescence or beer in the market at the wrong time.

And I think that’s one of the hidden benefits of Freshet Beer, frankly, is a greater ability to manage that on a significant piece of our volume. So that certainly helped. But across our (inaudible) portfolio, we saw strength in seasonals and some of the Brewmaster styles and some of the eclectic beers that we have at the high end. Twisted Tea continued to grow and obviously we continue to benefit from the new markets we have entered in the last 24 months.

And so that showed solid growth. And then our cider brand, Angry Orchard, that rolled out was obviously rolling out against no comparable volume in that time period last year, all these [diminuous] volume. We did have it in New England in September a little bit but obviously that was all incremental. And so they all contributor I think we are very happy with the Sam Adams brand family growth. I should mention our variety pack business also did very well. And that we are going to try and to do everything we can to maintain that momentum until the fourth quarter.

Andrew Kieley - Deutsche Bank

Okay. And then second question was just on the cider and the tea. You mentioned getting to the full national footprint. Are both those products fully national now or when do you anticipate that would happen?

Martin Roper

Well, I think it’s fair to say that we have launched then nationally in all the states. But that doesn’t really mean they are national because there are different levels of penetration on the distribution side and certainly we are not good enough to quick our fingers and get national distribution of a brand just like that. So if I still, to go back to tea, yeah, we have national distribution but it ranges from very strong penetration in a couple of markets like in the north east and then the central to -- you know we are still sort of building distribution and have lots of distribution opportunities in the South, in the Midwest and the West Coast, all the southern West Coast.

So, yeah, we are national but we still have very significant distribution opportunities. And I think if you look at the Nielsen or IRI numbers, just see that. Angry Orchard in we launched in New England in September of last year and then sort of rolled national in to the March, April, May timeframe. I think we are happy with the distribution penetration that we have gotten. But we are still at a fraction of where we are with Sam Adams.

So to us, yeah, we are national but until we can close the distribution gaps a little bit, we haven’t reached sort of national potential. So we still see upside from growing the distribution numbers. And again I think that’s very apparent in the IRI Nielsen numbers.

Andrew Kieley - Deutsche Bank

Okay, thanks. The other question just on the product pipeline. I guess how are feeling about the innovation pipeline. Anything, I mean it sounds it will -- for the next 12 months be mostly blocking and tackling on the newer brands that you already have or are there any big new projects we should be thinking about?

Martin Roper

Well, I think we always have Sam Adams beer development ongoing. So that’s ongoing and you should expect us to continue to innovate and lead in that fashion with new beers for our Brewmaster’s collection, for our Barrel Room, for our single batch series and also for our variety packs to be introduced next year. And that’s all sort of the brand building elements of our brewing and innovation and also some efforts to increase shelf space.

I think from a major brand volume perspective, you are right, we are going to be focusing on optimizing the potential of a sort of three larger brands of which Sam Adams is easily the largest and then Twisted Tea and Angry Orchard. And that’s going to be our primary focus in planning for next year. But we do have with our relationship with Alchemy and Science, a couple of projects that are in market right now but if they prove to have attractive opportunities for maybe more significant national pushes, we could chose to roll next yea. And there are also things under consideration of our discussion that could emerge into such opportunities.

But certainly, as we think about our financial planning we are planning on blocking and tackling and optimizing the opportunities that we see on the brands we have rolling right now. And anything else obviously would be icing on that cake.

Andrew Kieley - Deutsche Bank

Okay. Maybe just one last for Jim. Just given some of the comments about the pricing environment and you know all the headlines we have seen, it seems like there is more activity not just in the beer but in the cider side. Does it change at all? How you think about the competitive environment or is it more, just sort of more of the same of a very active competitive environment that has been for the past few years?

Jim Koch

Yeah, I think it certainly have been very active competitive environment, as you say for the last few years in it. Probably becoming even more so. I think everybody is looking for smaller and smaller pockets of growth. And there are now thousands of craft brewers so if there is a hot style, you are going to have hundreds of new entries very very quickly. So innovation is important but you know you are not going to have the field to yourself for more than a few weeks.

So that does drive us to make sure that we focus on the blocking and tackling of the brands that we have today and the big volume packages and products within those brands.

Andrew Kieley - Deutsche Bank

Okay, thanks very much. I hope the storm didn’t reach you bad up there.

Jim Koch

We just had wind. You guys had Noah’s Ark.

Operator

And there are no further questions at this time.

Martin Roper

Well, thank you everybody. We know for many of you it has been very difficult the last couple of days. We do appreciate you joining the call and we look forward to talking to you in the New Year. Cheers.

Jim Koch

Cheers.

Operator

And this concludes today's conference. You may now disconnect.

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