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Craft Brew Alliance, Inc. (NASDAQ:BREW)

Q3 2012 Earnings Call

November 8, 2012 11:30 AM ET

Executives

Terry Michaelson – CEO

Mark Moreland – CFO and Treasurer

Andy Thomas – President, Commercial Operations

Analysts

Tony Brenner – ROTH Capital Partners

Joe Munda – Sidoti & Company

Jim Cole – Lombard Securities

Doug Thomas – JET Investment Research

Steve Olson – Private Investor

Operator

Welcome to the Third Quarter 2012 Craft Brew Alliance Incorporated Earnings Conference Call. My name is Ellen and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we’ll conduct a question-and-answer session. Please note that this conference is being recorded.

I will now turn the call over to Terry Michaelson, Chief Executive Officer. Mr. Michaelson, you may begin.

Terry Michaelson

Thank you and good morning, everybody. I’m pleased to present the Craft Brew Alliance investor conference call to discuss our results for the third quarter of 2012. I will be addressing the general business environment; Andy Thomas, our President of Commercial Operations, will provide detailed commentary and insight into the industry; and Mark Moreland, our Chief Financial Officer, will comment on the financial results. We will then open up the call for questions.

Before we begin, I will ask Mark to read our Safe Harbor statement.

Mark Moreland

Thanks 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 on our most recent Form 10-K lists some of the factors that can 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. Terry?

Terry Michaelson

Thanks Mark. We are very positive about our continuing progress in developing our brand portfolio strategy and delivering consistent sales growth. We’ve been very aggressive over the last few years investing in the short and long-term development of our brand and our sales organization in order to establish our national footprint.

This investment has been targeted towards what we consider is the foundational development of our new portfolio strategy. The initial results have been encouraging and we believe have substantially strengthened our market position and ability to complete – to compete successfully in the Craft segment long-term. We are extremely pleased with some of our recent trends, specifically highlighting the National IRI SIG data, which shows that over the last 16 weeks, both Redhook and Kona growth rates have been higher than other top national Craft competitors.

This is especially rewarding for Redhook, which continues a remarkable and robust turnaround to now be one of the top growth Craft brands in the U.S. However, as positive we are with our current portfolio sales trends and our long-term growth opportunities, we are disappointed that we have not been able to deliver the short-term earnings increases we had anticipated. We are operating in a very competitive market and although our increased investment in 2012 has had positive impact on sales trends, they have not increased as fast or substantially as we had planned, and the net result is our increased spend has had a negative impact on earnings.

At this juncture in our strategy development and our business development, we felt it was necessary to be very aggressive investing in initiatives that position us well for short and long-term growth. We believe our 2012 investments have strengthened our market position substantially and have established a very strong platform to deliver both in sales and profit growth in 2013.

Several of these investments are completely new initiatives that will add to our business strategy growth potential. We invested in the development and the initial rollout of Omission, our new gluten-free beer. Omission is the first U.S. gluten-free beer to be in national distribution that is brewed with traditional beer ingredient and to utilize a process to remove gluten that meets the international gluten-free standard.

We believe Omission is positioned very well in a strong emerging category. We also have made an investment in an export strategy that will allow us to leverage our existing portfolio in new countries and provide a strong sales and profit growth contribution over the next five years. These investments are indicative of our strategy to be aggressive in developing new initiatives that leverage our assets and strengthen our ability to increase value for our shareholders. I want to thank our CBA team for their commitment and tremendous work in continue to build our unique national portfolio strategy. I look forward to finishing 2012 with positive momentum and a very successful year of growth for CBA in 2013.

With that, I will now turn it over to Andy to provide further details on our performance.

Andy Thomas

Thanks, Terry, and good morning, everyone. While still not at the level of our expectations, Q3 was a solid and significant commercial step forward for CBA both relative to Q2 and in absolute terms. CBA enters Q4 with the strongest momentum we’ve had in years and for the first time ever, with three of the four brand families in our portfolio all posting significant growth and making sizable contributions to our commercial progress. A central reason for our being, our complementary portfolio of authentic Craft brands continues to strengthen and provide a strong foundation for future growth.

As with prior calls, I’d like to begin first with a walk through of the hard numbers and then provide a bit of context and highlight some nuances. Given the shift in number of selling days between Q3 2012 and Q3 2011, I’ll share rolling 13-week numbers ending September 30, 2012 to ensure that trends are not misleading, exaggerated or amplified. Also, as this continues to be a journey in activating the overall CBA portfolio strategy and in some cases turning around brands, where possible, I’ll be more explicit in helping bridge the progress made from prior calls and will overtly reference comments we’ve made in the past.

For Q3, the total CBA depletion growth trend increased sharply versus Q2 coming in at plus 6% for the quarter, up from plus 3% in Q2. Notably, Kona accelerated it’s already robust and sustained growth trends, posting growth of plus 22% in Q3 up from plus 20% in Q2. And Redhook showed sharply positive tangible signs of that continued recovery that we alluded to in the August call.

For Q3, Redhook depletions grew at over plus 8% as compared to a plus 2% trend in Q2. The Widmer Brothers story continued much as it did in Q2 with Q3 performance still negative at minus 9% compared to the minus 8% reported for Q2. Omission entered its national rollout in Q3, and though still in its infancy, made a double-digit contribution to the company’s growth.

For a quick look at each brand family, let’s start with Kona. Kona accelerated to plus 22% growth for the quarter on the heels of a three-pronged attack from flagship Longboard Lager, plus 18%; Aloha series, plus 21%; and the new mainland introduction of Big Wave Golden Ale.

Though available for less than half of the quarter, Big Wave is already showing expected strength, accounting for upwards of 25% of Kona’s quarterly growth with minimal signs of cannibalization at this juncture. And encouragingly, it’s important to note that the Big Wave launch activities to-date only reflect Phase I of the launch, with a targeted off-premise focus and limited distribution of draft. Phase II and the majority of the Big Wave impact will be realized in 2013.

Taking a look at Redhook, I’d like to start where I left off in August. At that time, I discussed the importance of pricing and promotional calendar alignment and said “we believe that Q3 will see the completion of the major pricing and promotional work in Washington along with improved performance in that geography.” Indeed that’s exactly what we saw in Q3. Specifically for the Pacific Northwest, Redhook growth shot up to plus 9% for the quarter, propelling national growth on Redhook to plus 8% up from plus 2% in Q2, and importantly due to the targeted nature of the pricing and promotional alignment, net revenue per barrel continued to grow for Redhook in Q3.

Volumetrically, national flagship Long Hammer IPA led the Redhook charge up plus 15%, flanked by plus 34% growth on Redhook variety packs and strong support from Redhook’s local Backyard Series in both New Hampshire and Washington. As similarly stated on in August “on Widmer Brothers, the story is eerily familiar, strengthen in new initiatives, strengthen in variety packs, strengthen in the high end, and stubborn weakness in legacy markets particularly on Hefeweizen draft.” In fact, not a lot has changed in the last three months offering the proverbial double-edged sword.

On one side, the Widmer Brothers’ issues have been clearly identified and are clearly stabilizing, but on the other side, the fact is reflective of the reality that our new initiatives in the high end have yet to reach sufficient scale to offset legacy volume declines. The overall minus 9% decline in volume was entirely concentrated in CBA’s western region. And again, over a half of that decline came entirely from losses in California, predominantly on Widmer Hefeweizen.

On the bright side, key strategic initiatives including the Rotator IPA Series and our renewed focus on seasonals continued to advance, building scale and approaching a volume contribution of nearly 25%. Perhaps more importantly, as the Widmer Brothers family moves to a more profitable brand position, worthy of the legacy of Kurt & Rob Widmer, the volume contribution from the high end is growing, and although, still a very small base, it’s helping to propel total Widmer Brothers revenue per barrel appreciably, up in the middle single digits nationally on a year-to-date basis.

Lastly, among the brand updates is our newest brand family, Omission. Again, focusing on Oregon, where we have the most experience in different restrictions and our ability to message gluten-free. Since launch in April, Omission has grown to over 66% of the gluten-free beer market in Oregon as tracked by SymphonyIRI Group becoming the clear number one brand family in the segment with Omission Pale Ale and Omission Lager, the number one and number three SKUs in the segment respectively.

The national roll continues as do our efforts to creatively communicate the message of Omission’s point of difference for gluten-intolerant beer lovers, that is brewed with malted barley and crafted to remove gluten. For reference, looking at national growth and trends, the gluten-free beer category as a whole is up 55% year-to-date through October 21, and despite limited, but growing national availability for Omission and restricted messaging, the combined Omission brand family now represents a 6.6% dollar share within the category, and Omission Pale Ale and Lager are already the number three and number five gluten-free beer SKUs nationally.

As Terry mentioned upfront, investments behind Omission were another target of our strategic SG&A spend increases and we remain unabashedly optimistic about the potential of Omission. Bringing this all together as in our prior calls, I’d like to summarize gainers and decliners, and offer a few geographic and off-premise insights before closing. Starting with gainers and decliners, Q3 saw a similar pattern as Q2 with gainers outpacing decliners by better than two to one, again, with all four brand families contributing to the gainers column. And keeping with the same level of analysis as shared in prior calls, the decliners became even more concentrated in Q3 as nearly 90% of decliners came from just three of the 33 possible brand family geographic division combinations that we use to examine our business.

Geographically, both CBA’s East and West regions showed total portfolio growth, with the East trend versus last year accelerating to plus 23% and the sizeable West region still posting growth of better than plus 2% despite absorbing literally 100% of the Widmer Brothers brand declines. The strong East performance is directly attributable to many of the targeted SG&A investments made to build out our East footprint and activate our brand portfolio in key Eastern geographies.

Also contributing to the East performance is the continued and gradual resourcing of the Midwest, the real benefits of which will become more evident in the medium term.

Finally, taking a look at publicly available off-premise data as reported by SymphonyIRI Group also shows strong evidence of the portfolio strength headed into Q4. As Terry alluded to upfront for the 13 weeks ending September 30, 2012, and beyond, both Kona and Redhook are posting strong double-digit growth versus last year, and in both cases are growing faster than our composite of benchmark national Craft competitors. Again, it is a first for CBA to have two brand families growing at such robust rates for that sustained period of time.

In closing, as we bring home 2012, we believe that we’re entering Q4 in the strongest overall position we’ve had in well ever. The portfolio strategy continues to show tangible signs of working and is now being activated in the most explicit consumer-facing way ever. Through the CBA Winter Variety Pack, a mixed pack celebrating our three world class winter seasonals, Kona Pipeline Porter, Redhook Winterhook, and Widmer Brothers Brrr.

Kona continues to post robust growth and is being energized with the Big Wave launch. Redhook is showing its strongly sustained growth in better than a decade. Widmer Brothers is showing stubbornly slow, but steady signs of stabilization in the core while new initiatives in the high-end begin to grow scale, and our targeted SG&A investments continue to show immediate term – returns while exceeding significant medium and longer term growth.

While I’ll refrain from previewing 2013, until we share 2013 guidance, we’re excited about the pipeline of initiatives across the portfolio, which will build upon the learning’s and momentum of 2012. Until then, on to Mark.

Mark Moreland

Thank you, Andy. Our year-to-date financials and our updated guidance reflect the investments and business dynamics Terry and Andy have discussed. As we discussed on our last conference call, we chose to increase our investments in certain sales, marketing and brand initiatives to further build out our portfolio and sale capabilities.

These investments included items such as launch of our Omission brand and increases in our East Coast sales force. We’re confident that these initiatives will generate significant return on investments for the company and are positioning the company well for continued future growth. Our updated guidance reflects the fact that we have increased our spending in the strategies areas, and expected both faster growth of our existing product base and somewhat lower operating costs.

I’ll briefly highlight the quarter performance before discussing year-to-date results and full year guidance. For the quarter, our sales were up 10% versus last year. Gross profit was down 86 basis points. SG&A increased 13% and our EBITDA came in at $3.7 million, an 8% decline from last year. Our EPS for the quarter was $0.05 compared to $0.07 last year. On the balance sheet, we ended the quarter with $3.5 million in cash, no borrowings under our $22 million revolver and EBITDA leverage ratio of 1.2 times.

The year-to-date period, revenue is up 11%. Our current guidance for the year – full year is for sales growth of between 11% and 13%, which is slightly lower than our last guidance of 13% to 15% driven by weaker than expected existing product growth. Gross profit year-to-date is up 9% with an approximate 60 basis point reduction in rate. While this performance compares favorably to our initial guidance of negative 100 basis points for the full year, it is lower than our last guidance.

This change is primarily driven by reduction of leverage driven by the lower sales guidance and higher than anticipated distribution costs in the back half. SG&A year-to-date is up $4 million or 13% versus last year. We continue to expect full year spend of between $43 million and $45 million. Resulting SG&A full year growth rate of 8% to 13% is roughly in line with projected volume growth. In total, we are adjusting our EPS guidance to $0.12 to $0.17 versus the prior range of $0.20 to $0.25.

In summary, we’re investing to drive the long-term health of our portfolio and are beginning to see significant positive sales trends develop albeit a little slower than we had originally anticipated. We look forward to providing you with full year 2013 guidance, which will show meaningful sales and earnings growth once we complete our planning process over the next few months.

And with that, I’d like to open the call for questions. Ellen?

Question-and-Answer Session

Operator

Thank you. We will now being the question-and-answer session. (Operator Instructions) Our first question comes from Tony Brenner from ROTH Capital Partners. Please go ahead.

Tony Brenner – ROTH Capital Partners

Thank you. Couple of questions, first of all, what happened to the Fulton Street Brewery contract brewing agreement?

Terry Michaelson

This is Terry, I’ll take that. We’ve been talking to Anheuser-Busch for some time that contract had a life that ended at the end of next year and we’ve been talking to them about the fact that they are moving production to the Anheuser-Busch breweries and would prefer to do that, and quite frankly from our standpoint based on what our growth expectations are in the East, we believe that are producing our own products would deliver better gross margin, so we negotiated a deal that was beneficial for both of us and quite frankly we believe we came out in a positive position versus keeping that through the end of next year.

Tony Brenner – ROTH Capital Partners

How so? What is the recompense for losing five quarters of production?

Terry Michaelson

Well, the – there was a payment for that – for that entire period and the way the contract was structured, the payment for ending that was somewhat positive to what the actual gross margin flow would have been for actually producing it. So we got a higher payment for that and freed up capacity to give us flexibility. So it was a double win.

Tony Brenner – ROTH Capital Partners

But that is not taken on the income statement, I take it.

Mark Moreland

It is Mark, Tony. It is not in Q3, the deal was signed early October, so will be in Q4.

Tony Brenner – ROTH Capital Partners

Okay. Secondly, can you talk a little about Redhook on the West Coast and particularly on Washington in terms of what’s happened with retail prices for the brand and what the shipments are and depletions in that particular market as a result?

Andy Thomas

Yeah, sure. Tony, this is Andy. So thanks for the question and thanks for calling out Redhook, it’s one the areas we’re really confident of as it started to move in, as I said in the script, it’s partly due to its targeted changes, specifically in the Pacific Northwest and Washington State. What we did was rather than try to roll the price back because we’re not in a game here where we’re trying to discount the brand and just grow volume and not grow profitability.

We took a really targeted approach, sitting down with wholesalers and predominantly in Washington State, and taking a look at what key retail factors, be that the chains or be that some of the off-premise factors that we needed to target and what were key promotional windows, where we wanted to hit competitive price points.

So overall, what you will see if you look at some SIG data is that the average price per case of Redhook is ticking down or not growing as fast as it was and that’s driven by two things. It’s driven by slightly more promoted volume and it’s driven secondly by the fact that we’re actually getting signs of trade up of more people buying 12 packs and less people buying just six packs, which will have a mix effect on the brand, which is divorced from price.

So without getting into a lot of the – the too much of the detail that I can generalize from, we’re not seeing wholesale price reductions in the brand. We are seeing slightly more promotional activity which is targeted. We’re seeing more targeted promotional periods and more focus on getting the volume driven during those periods and we’re seeing a mix shift towards 12 packs away from six packs in the geography. And that’s not different from what we see nationally.

Again, this is kind of national data, but if you take a look at the SIG data for Redhook in the recent four weeks or in the recent 12s, the numbers on a brand like Long Hammer are seriously – they put a big smile on my face, let’s say it that way. We’re seeing growth on Long Hammer IPA nationally in SIG that is in excess of 20%, 30%, 40% for four week rolling periods. And again, it’s all attributable not to blanket price reductions, but to more focused promotional spend and more awareness to hitting promotional periods at key retailers.

Tony Brenner – ROTH Capital Partners

And the volume effect as a result of all of that in that market is what?

Mark Moreland

Well, as I said in the Pacific Northwest for the quarter, we’re up 9% off of a negative trend for the quarter.

Tony Brenner – ROTH Capital Partners

In depletions? Is it depletions or shipments?

Mark Moreland

That’s depletions. And the STRs – that’s STR depletions and if you look at the off-premise data it’s growing a little bit more robustly than that still.

Tony Brenner – ROTH Capital Partners

Okay. Last question. Just perusing retail beer cases recently, one thing I’ve noticed is that there are endless varieties at Shock Top and Blue Moon on display, which I’m sure in addition to draft is affecting Hefeweizen. I’m just wondering what portion of your marketing effort on Widmer is still devoted to Hefeweizen versus rest of the portfolio. Thank you.

Andy Thomas

Hey. It’s a great question, Tony. This is Andy again and I’ll jump on that one. I’ll be able to share more when I talk about 2013, but I can share with you some of the generalities and some of the learnings we have. The wheat category in general continues to attract a lot of attention not just from Blue Moon and Shock Top as you’ve alluded to, but you see new entries in kind of Craftier aspects of the segment from people like Deschutes, who are doing a wide IPA and people who are playing with wheat beer more.

And I think it’s safe to say you’ll see our 2013 plans when they come out that we are going to be a lot bolder and a lot more aggressive in starting to kind of proudly evolve the Hefeweizen brand and proudly evolve the legacy we have in wheat. So again without sharing too much, the generality I can tell you is the wheat category continues to attract more attention, it continues to attract more consumers and it’s an area you’ll see us play in more. The percentage of which we deliver as a percentage of the Widmer Brothers budget, I’ll refrain from talking too much about until I talk about 2013, but suffice it to say, you’ll see increased programming not only around Hefeweizen in 2013 but also around wheat in general.

Terry Michaelson

I can’t say – this is Terry. I’ll add on to that. I can’t say that our overall strategy is that wheat will become a smaller portion as a percentage of that portfolio going forward and as Andy said that’s not because we believe – don’t believe that the wheat category still has some upside potential for this segment or for us because we do, but we also believe that that Widmer portfolio has a lot of strength in our potential and other areas and that’s showing in the high end, it’s showing in the Rotator IPA and you’ll see further initiatives from us that aren’t related to the wheat and we think that’s going to strengthen the portfolio and the performance – the balanced performance of that long-term.

Tony Brenner – ROTH Capital Partners

Okay. Thank you.

Mark Moreland

Thank you, Tony.

Operator

The next question comes from Joe Munda from Sidoti & Co. Please go ahead.

Joe Munda – Sidoti & Company

Good morning, guys. Thanks for taking my questions.

Mark Moreland

Good morning, Joe.

Joe Munda – Sidoti & Company

Real quick Andy, you talked about the gluten-free beer market and Omission – the gluten-free beer category is up 55% this year. What is that total addressable market?

Andy Thomas

It’s a great question, Joe, and we’ve tumbled numbers on it and if you go through an exercise and I’ll give you some methodology here that you can kind of explore and we can follow-up on it if anybody is interested. But what we do is we take a look at the number of celiacs in the U.S., which is around 1%, and then we take a look at per capita consumption amongst the legal drinking aged consumers out there and we make some assumptions on what with the per caps be for a gluten intolerant consumer or for a celiac. And then we try to level on top of that how many people are leading gluten-free lifestyles as a lifestyle choice not as a medical imperative.

And when you do that, you end up with numbers that range as dramatically as 3 million cases upwards of 12 million to 40 million cases depending on what assumptions you make on, how many are celiacs are actually going to consume beer, what their per capita spend would be, what their per capita consumption would be, and then how many on top of that can you level from lifestyle? So, as a really low, low, low bar estimate conservatively, we think at the low end of the range is probably a 3 million case to a 5 million case market, and on the high – right now growing as I said 66% or 55%. And on the upper range, it really depends on how much you want to flex those metrics to how big you can get.

But suffice it to say the number can get pretty large. An interesting thing and Joe, you and I have talked about Omission a lot, and I’m sure with everybody as – we’ve said before, what we – what we’re learning on Omission is, there is a really interesting multiplier in that gluten-free beer market and that’s in the fact that when you have a gluten-intolerant beer drinker who has stopped drinking beer, you tend to find that the people in that household or the friends of that individual have also stopped their consumption of beer. So when you bring back one person who is gluten-intolerant into the beer market, what we’re finding is that we are bringing back a multiple of that because all of his cohort, all of his kind of support group comes back into the beer market as well. And that’s why it’s really difficult to kind of size the market because of all of these factors that we’re learning.

Joe Munda – Sidoti & Company

Okay. Well, Andy that brings to my next question, can you talk about, a little bit about the product placement when it comes to Omission?

Andy Thomas

Yeah, sure. So what we do is, and as I’ve alluded to in the script, we have a kind of a two-pronged approach, which is candidly more complex than we would like. So when we go back and connect dots for everybody and as hopefully you guys have come to expect, we try to be as forthright as we can with sharing with you learnings and challenges we have.

We made some targeted investments on Omission, because we saw a window for it. And what we knew was that it’ll be a little bit of a longer burn and what we’re learning is we also – it’s a little bit more expensive than we might have wanted it to be, because we can actually program differently in Oregon than we can outside of Oregon, because of our ability to stay gluten-free in Oregon and our ability to not stay gluten-free outside of Oregon.

So what we do is we dial up gluten-free as much as we can in Oregon where it’s legal for us to do so, and outside of Oregon, we really rely very heavily on social media, on public relations and on the buzz generated from Oregon consumers for people to know that Omission is gluten-free. Additionally, we’re placing the Omission brand, we call it kind of gluten-free by association.

So to Joe’s direct question, we’re placing the Omission brand in more and more gluten-free occasions and associating it with more and more gluten-free organizations, things like celiac awareness days, doing cross promotions with other gluten-free brands, even in parts of the country where we can’t stay gluten-free because of TTB and FDA restrictions. So that’s another way that we try to get the message out there.

And for social media, now, what we do, what we have discovered with Omission is what we call – the consumers have what we call an “O” moment which is when they actually drink the beer and realize that it tastes like real Craft beer and they have this wonderful experience. And we have a website now of www.o-moments.com where consumers can go on and share their “O” moment and they can tell their story and we direct people to there when they ask is it really safe for a celiac to drink, because consumers are being incredible effusive in their praise for the brand and in the fact that it’s fitting into their lifestyle in a very good way. So we drive people there from social media.

And then lastly, Joe, what I would talk about is, we’re taking advantage of when other people are using gluten-free and we can say it when other people do, so for example last weekend, Omission Lager and Omission Pale Ale took the gold and silver in the gluten-free category in the Great International Beer & Cider Festival.

So we can say that Omission was awarded the gold and the silver respectively in the gluten-free category because they’re – we’re just reporting what somebody else did. So we’re a lot more active in getting that done. But to my connect the dots point, all of those things are pretty slow burn, but when you understand what the upside is for, it was a decision we felt we took that we had to do now, because the FDA and TTB will figure this out, and when they do, it’ll be easier for competitors to come in and we’re real big believers in order of entry effects and now the fact that we’re out there, first will pay dividends for us when that happens.

Joe Munda – Sidoti & Company

Okay. Andy, also I mean I know a lot of sporting venues, for instance, here in New York, I know the Mets, they run like a Celiac Awareness Night and they serve gluten-free food, is that a possibility for you guys...

Andy Thomas

Yes, it’s....

Joe Munda – Sidoti & Company

To create awareness? And also I don’t mean to cut you off, but is it possible to get the product into the stores where like a gluten-free shopper would shop like, for instance, Andy, personally my wife, obviously, she has celiac disease, so this hits home personally. So I spend a lot of time at Whole Foods, and would it be possible to get the product into a type of Whole Foods or a mass big box retailer that is focused on healthy living and also supplies gluten-free products?

Andy Thomas

Yeah, so, great questions, and at the end I’ll actually ask Terry to pile on because as all of you know this is a project near and dear to Terry’s heart, because Terry himself is a celiac. And so I’ll offer a little bit of perspective. And then Terry I think it’ll be great, if you could jump in and add some color. With respect to stadiums, Joe we’re actually targeting them now. What we’ve learned again that work keeps coming back, is that most stadiums not only have some gluten-free nice, but they actually have gluten-free concession areas.

Joe Munda – Sidoti & Company

Yeah.

Andy Thomas

And that’s become almost a universal in stadiums around the country. So you’ll see us very unapologetically going after the gluten-free sections in stadiums starting immediately. So you’ll actually start to see that happening. And with respect to gluten-free stores and this where I think Terry can add some color. One thing we’ve done and you’ll start to see rollout is we’re evolving our packaging again, outside of Oregon, where even though we can’t say gluten-free, what we’re going to be saying explicitly on the packaging is crafted to remove gluten.

And for a lot of stores the fact that we weren’t saying anything in terms of the gluten levels overtly on the packaging, with a deterrent for them, because they were still reticent to put us in the gluten-free sections or stock us as a gluten-free product. What we know from our sales calls in the last several weeks when the packaging has been readily be presented to retailers is just that one move of us saying on the packaging crafted to remove gluten is making many national retailers, well likes of Whole Foods or Safeway or some other retailers, a lot more comfortable with putting us in the gluten-free section. And Terry, do you want to elaborate on that?

Terry Michaelson

Yeah, I can. Just a minute. I think you’ve covered most of it. As we talked about, this really is evolving science. There have been some international studies that have been just done recently that validates the testing of the process that we use and we think that’s going to make a lot of difference. So, I think the general environment is getting much more comfortable with what’s happening in this country. We’re starting to sell some Omission internationally and again that’s a part of our export strategy and that’s starting very slow in Europe. We’re also selling in Canada. So we’re going to be selling all around the United States as well and in both of those markets, we can stay gluten-free.

In Canada, they just sanctioned the labeling for our process for beer. So we’re very optimistic that the regulatory agencies in this country are going to evolve fairly soon and that, that will kind of open the gates so to speak as Andy talked about for us. And that that credibility we built from that gluten-free consumer, we believe is going to mean a lot because we’ve spent a lot of time paving the way and creating those personal connections, but we are very optimistic that the regulatory environment is going to change very soon based on the fact that the rest of the world has moved in that direction and there is now international research that validates what we are doing.

Joe Munda – Sidoti & Company

I have just one more and I’ll hop back in queue. Andy, can you talk about – give us a little bit more color on the European distribution and are there any plans to open a brew pub in Europe to help drive the product and create awareness?

Andy Thomas

It’s great questions and we’ll share more on our export strategy probably in the Q4 call, when we are – when we have more to talk about and plans, but I’ll talk about that right now. So we’re working as we’ve released with a company called Craft Can Travel! And it is a small company that is our exclusive exporter and is staffed with a lot of former Heineken executives who know export well.

And as all of you know, I’ve kind of come from that same – cut from the same cloth, so there is connection there. We feel really strong about the export partner that we’ve chosen in Craft Can Travel! and one of the reasons we feel so strongly about them is we’re taking a really deliberate approach, again, connecting the dots for you guys and not just looking for the short-term gain of sending a container over to Europe and saying, hey, that’s great, we sent over a container, but actually sending over containers in places where we think we can actually build brands for the long term.

So as a result, we’ve targeted upwards of eight countries in Europe and in Asia Pacific specifically, countries like the U.K., Sweden, Ireland, the Netherlands, Denmark, a lot of the Scandinavian nations as well as Hong Kong, China and increased activity in Japan, where we already an export business in the short term.

In each of those countries, our agent – the gentleman’s name is Martin – has been over there and has actually interviewed a number of importers, and we went through into an importer selection process, again, not just sending containers to the shores and saying that’s great, but in each of those countries, we’ve worked to select an importer, which was a long process as you guys kind of imagine doing due diligence.

We’ve actually worked on them with what portfolio will we import for them or export from our perspective across all three brand families and it’s another area that has some tangible proof for everybody and why the portfolio strategy makes a difference, because what we’re finding is our ability to go to those countries and not just sell one brand but actually have offerings across the Redhook, Kona, and Widmer Brothers portfolio allows us to actually be a lot more important to them, and from logistics efficiency perspective, allows us to actually send full containers of our own product overseas.

So that process has been a long process for us, it was probably better than six months of pretty intensive work and pretty intensive investment in visiting countries and visiting importers to make sure we made the right selection to get the containers rolling.

So to your explicit question after that, Joe, do we think we’ll open a brew pub in Europe, it’s not in the cards now, but what I’ll tell you is our approach is to not just send containers over there, but to start to develop brands. So I wouldn’t say that it’s something that would be unheard of in the future even though it’s not planned now, because what we are finding is, there is in a number of European countries and a number of Asian Pacific countries, there’s kind of a rebirth of beer and American Craft Beer is playing pretty well. And with the exception of few of our competitors, nobody has really tackled the market as strategically as we feel we are, and we’re really excited about what long-term dividends that that can pay for us.

Joe Munda – Sidoti & Company

Thank you, Andy.

Operator

(Operator Instructions) Our next question is from Jim Cole from Lombard Securities. Please go ahead.

Jim Cole – Lombard Securities

Good morning, Terry, and Mark, and Andy. I had a question in – a couple of questions, but one was in reference to the costs of goods sold? And I’m wondering if the marketing and promotion expenses are going to be going up as the same percentage of cost of goods sold going forward?

Mark Moreland

Sure. Jim, this is Mark Moreland. We talked previously that we have been in an investment mode in SG&A, and sales and marketing certainly through 2011. This year, we’re sailing at or a little north of our volume growth. We would expect going forward that SG&A would be growing at a normalized rate close to volume, so we could be – we could be in some financial leverage off of that. So what I can say is going forward we would expect that ratio, the percentage of SG&A to revenue to go down over time.

Jim Cole – Lombard Securities

You don’t breakdown the marketing promotion expenses as a percentage of costs of goods sold, do you?

Mark Moreland

No, we don’t and actually it’s just for clarity, sales and marketing are in our SG&A and so the cost of goods sold and gross margin are exclusive of that amount.

Jim Cole – Lombard Securities

Okay. And can you comment on depreciation and amortization going forward? I would assume it would just pretty much stay the same?

Mark Moreland

Sure. With our current CapEx, we’re targeting this year $8.5 million to $9.5 million, our D&A runs a little lighter than that, so right now we’ll be adding at a faster rate to our capital base than what it is depleting. So you’d expect some increase in that overtime.

Jim Cole – Lombard Securities

Right.

Mark Moreland

It won’t be dramatic at this point, but it would stabilize or be higher at this point, but not in a material way.

Jim Cole – Lombard Securities

Okay. And the last question, I know this is probably difficult because it’s so new right after the announcement, but what are the volume expectations for the Craft Can Travel! say on the low side and then on the high side, or can you comment?

Andy Thomas

Hi. This is Andy, I’ll jump in. We’ll provide more guidance on that, Jim, when we do 2013. As I said, I think you actually answered your own question, we’re so early on into it that we’re just kind of getting our sea legs under us, no pun intended and we’ll be able to offer more perspective on what we think the long-term potential there is when we offer guidance.

Jim Cole – Lombard Securities

Right. Thanks guys.

Andy Thomas

Thank you.

Mark Moreland

Thank you.

Operator

The next question is from Doug Thomas from JET Investment Research. Please go ahead.

Doug Thomas – JET Investment Research

Hey, good morning, guys.

Mark Moreland

Good morning.

Andy Thomas

Good morning, Doug.

Doug Thomas – JET Investment Research

I – the last quarter and again I’m not so much interested in near-term earnings visibility because I recognize that you’re building something that’s going to take a while to, I’m not even really sure what the value of guidance is quite frankly, when you’re undertaking to build a franchise like you are, but having said that you seemed last quarter to be pretty confident that some of the trends which have been hampering your bottom line performance were either turning or on the verge of turning and that appears not to have been the case and I’m just wondering are the trends that Andy talked about that continue – is that really – is that what accounted for the slight disappointment this quarter and the change in tone or is there something else that I’m not considering?

Terry Michaelson

No, this is Terry, and I’ll kind of answer the first part of that and then I’ll let Mark and Andy chime in on that. And I appreciate your perspective that we’ve been pretty honest with our shareholders as we’ve been developing this company. It is still a young company, although Redhook has been around and Widmer have been around for a long time, and Redhook was public company for well over 10 years. This company is really a brand new company built for the new Craft segment and we’ve been in phases of growth on that since 2008. The first phase really was getting the business structure in place, doing a lot of the modifications we need to do in terms of fee structures and acquisition, those kinds of things and getting some financial stability and help.

The second part of that as you alluded to has really been strengthening our market position making certain that we have a brand strategy and national strategy that really makes sense and that we believe can deliver long term, and we’ve been very focused and dedicated to invest against that believing that that’s the best way to create long-term value.

This year, we believed based on the following of our shareholders that we were at a place where we’ve grown enough that we could start sharing some guidance and some insights into what we’re thinking. And the fact is – is that we don’t have a lot of history on how fast these kinds of investments will react on the upside. So the facts are – is that our portfolio and our sales are moving forward in a very positive way, and as Andy said, we’re in the best position, we ever have been.

The other fact is, is that it did move quite as fast as we would have hoped. We are probably over optimistic, and when you’re spending against those and investing, you end up disappointing the shareholder in terms of where guidance is. And I don’t want in any way say that that’s okay or that that’s something that we think that we don’t need to take responsibility, we do.

And we now believe coming out of this year and going into 2013, we’ve been in the development phase of this strategy enough that we understand much more what to expect from our portfolio. We have a much better sense what that means on a national basis, what’s happening with our cost of sales. So we like the position we’re in. We’re disappointed that the earnings didn’t come in where we expected. But honestly, it really is a dichotomy here in that we’re very disappointed about missing guidance.

We’re the most positive we’ve ever been about the position our portfolio is in, what that means for the future. So we got ahead of ourselves a little bit, came out, because of the trends we were seeing. We got overly optimistic on sales and we got overly optimistic on how much upside there was on cost of sales and the margin, and that ended up costing in terms of being short on the earnings.

I just want to make certain people understands that we take that seriously and that is an indicative of what we believe will happen going forward and again as we said once you get the market position and the portfolio healthy, which we believe we are in that stage, we believe that the growth in the process will follow even at a more meaningful way than it has in the last few years. Mark, you want to add?

Mark Moreland

I think it sounds like pretty much a top line question would probably offload to Andy.

Andy Thomas

Thanks, Mark. How are you doing Doug? So I think as I think about it and I look at the quarter, the quarter I feel good about from the top line perspective, I don’t feel as great about as I would like to, and that’s why I say I feels good. The Redhook numbers are great. I think if you look at a brand like Redhook and saying that we grew 8% for the quarter, we were growing at 2% given how much work we had to do to me is a check mark for that.

On Kona, the acceleration there on the launch of Big Wave I feel good about. So let me talk about Widmer Brothers a little bit because as everybody knows when you understand our volume dynamics, Widmer Brothers is still the biggest brand we have and we are not bringing actually steps backwards by a percentage point from the prior quarter it’s tough because it eats up a lot of that positive momentum. So let me talk about what we’ve experienced at Widmer Brothers.

We’ve thought Widmer Brothers might be a little bit more sensitive to some of the promotional activity we are going to do and it wasn’t as promotionally sensitive as we thought. Again double-edged sword, so it means that there is still some profitability there for us to cultivate and to grow and shows us that it is a competitive issue. And I want to talk about that a little bit, if you take a look at what’s happening in the segment, you see a lot of investment and you see a lot of clutters you guys know. I think folks have said that there is brewery and half opening every day.

Samuel Adams announced I think on their call that they have more than 60 people on the street additionally this year, so 60 more people on the street. And as a result, you see that kind of core Craft part of the market, where Widmer Brothers is playing become increasingly competitive. And I think that’s something that we probably were overly bullish about, that didn’t turn in the quarter.

So to be clear on that, Doug, I think Redhook behaved the way we wanted to in the quarter, you can argue a percent here or there, but going from 2% to 8%, given everything that went on I think is great. Kona accelerated in the quarter great, Widmer Brothers didn’t get worse, but we hoped it would get better and it didn’t. And I think as we talk more about 2013, you’ll hear a lot more about our learnings on Widmer Brothers, because I end up talking about it in every call, it’s a pretty complicit, it’s a pretty complicated story. And I would say that’s the majority of area that we basically got a little bit surprised on the downside in the quarter.

That said, the other thing that happened in the quarter and I want to make sure everybody understands this, we’re actively taking a look at how much we spend and where we spend on a regular basis. And this goes to a little bit of the question that I think Jim asked in terms of where does our SG&A spend go, there are areas where we could probably diverse more of our SG&A spend to make the short-term trends better and we probably could have played some cards on Widmer Brothers, that would have made the quarter a little bit more explosive, and made this call maybe a little bit easier and less stressful for a lot of us, but we really are in it for the long haul.

So it might sound like an easy answer, but we decided to take those dollars and not divert them to some short-term gains, but to make sure that we were doing things that we thought continued to stabilize the Widmer Brothers brand and seated us well for the long-term.

So in a long way around, Doug, I feel really good that we had the exciting quarter we would on Kona and Redhook, we didn’t know Widmer Brothers, and I think it’s a testimonial to some discipline that we’re trying to exhibit to make sure that we don’t just excite you today and disappoint you tomorrow. I’d rather excite you for the long-term than kind of make you happy today and kind of what the hell happened to these guys tomorrow.

Doug Thomas – JET Investment Research

And Andy while I’ve got you, could you spend a minute talking about how the Big Wave launch has – how you’re using the launch? I mean, I know in certain geographic areas it’s an opportunity for you to introduce Kona and others. It’s an – on the West Coast, for example, as you’ve said it’s an opportunity to refresh and reinvigorate that brand in certain – with certain customers, how are you – how are you seeing the positioning of that introduction here take place over the next couple of quarters?

Andy Thomas

Great question, you summarized a lot of what we’re trying to do, which I appreciate, because it shows that you’re paying attention and it shows that we’re getting the message across. So when I said this as Phase I, let me elaborate on that a little bit. What we did was, we only introduced Big Wave draft effectively in Northern and Southern California and in Florida, because we wanted to start to seed it.

And we started to seed the brand off-premise in the whole U.S. with the exception of the Midwest states we’re not out in yet, in anticipation of building a little bit more demand so that for spring sets, as you guys know the times of the year important for the off premise and the beer business, when the major resets are done by off premise retailers, that we would have a selling story to go against in all the geographies. So that was a little bit of thinking behind the Phase I of the Big Wave launch.

To that effect, we focused most of the activity in California and Florida, although, we’ve got distribution in pretty much everywhere we would want to right now in terms of Phase I, heavy emphasis on public relations to kind of get the brand rejuvenated a little bit more not that it need a lift, but as you’ll hear when you understand our 2013 plans, we are not resting on our laurels with Kona at all and we really believe that we’re just seeing the beginning of a very long growth trajectory for that brand, more of what you’ve seen and more good things to come. So with Big Wave, it’s been a lot of what you said, it’s focusing on key markets to basically add some new news, it’s been a way for us to enter new markets.

I think in New York, it’s a great example. We had a fantastic quarter in Manhattan, the metropolitan New York area, specifically on Long Island with Kona and one of the things that drove that was Big Wave and we did things like have our surf ambassadors like Reef McIntosh go to a PR Blitz in Manhattan, and he was walking through Time Square with a surfboard and riding the subways with the surfboard and taking cases of Big Wave to people out on Long Island and just using as a way to really introduce people to what Kona meant. So Phase I focused draft-only in those geographies, package on a very targeted basis outside of those geographies and looking for a really Big Wave II, no pun intended in the spring with sets.

Doug Thomas – JET Investment Research

And I appreciate that, and Terry, just to extend the thought about the – all of the noise in the category right now with all these new breweries opening and a lot of confusion and a lot of people trying new products, I’m sure it’s very – I’m sure the supply chain is very crowded right now, although, I got to say I’m very impressed with.

And I’ve said this to certain people about the presence in places like Whole Foods which I think is phenomenal with their new refrigerator section at the front and also cost plus World Market and other places I’ve been, I’ve been very impressed to see a full line of products out there and god knows I am doing all I can to support in terms of drinking and giving away product to friends, but what is – what do you see happening over the next year in terms of all of the new breweries out there and is this – given what we also face in terms of potentially higher taxes on capital gains and – all of this noise that’s coming, it’s not necessarily related to the brew – the Craft Brew category, what do you think is your best view of what happens in term of consolidation within this space, if any?

Terry Michaelson

I’d appreciate the question. This is a very competitive segment and we expect that over the next and whether that’s 18 months or three years that you’re going to see some consolidation or you’re going to see some brewers leaving the market, because it’s simply getting too crowded, especially when you look at it on a regional basis, you can pick a small town in Oregon, Bend, Oregon, it had five breweries opened in the last year and a half and it’s under – a 100,000 people.

So it’s just – it is getting very crowded. I think the good news that we have for both the segment and for us, is this really is being driven – the growth is being driven by a fundamental change in the way the consumer looks at beer and quite frankly their alcohol consumption in that they’re looking for quality, they’re looking for variety and they’re looking for brands that not only they can discover, that they can trust over time. So all those, there certainly is a lot of competition by the regional brand those are forming good new relationships. There’s also a lot of awareness and interest in brands like Redhook and Widmer and Kona and Omission as they go out, and our ability to get those into the market are going to help a lot.

So we think that overall strength in the fact that the way that we’re build with the breweries and with our sales organization, our distribution continues to put ourselves in a place to be a part of the consolidation to be able to partner with some of those great brands on a regional basis that have great brands that quite frankly the business dynamics as they want to expand are just too daunting for them both financially and operationally. So we think that there are going to be opportunities as most of you seen in this segment recently, there – with NAD and with Woodchuck, the cider company, Vermont, cider selling – the prices are pretty frothy at this point and what we’re interested in as we look at these things as making sure we do a deal that is good for everybody in it and we make sure that we can provide a really solid and meaningful return for our shareholder.

So we still think that’s an opportunity where we’re going to continue to evaluate that and when we find an opportunity to take one of those brands much like what we did with Kona, I think I’ve said this before, when we took over Kona and really started growing that as Widmer in 2005, it was under 15,000 barrels and it’s now over 200,000 barrels. So I think you can see when you have a great brand and you put it into our system what the upside opportunity is.

Doug Thomas – JET Investment Research

Thank you, very much. I appreciate it, and I know what I’m getting everybody, I know for the holiday. So good luck and like I said, I think you really might want to – I don’t know what you want to do, but I think the whole idea of building a great franchise with terrific brands to me sort of supersedes the need to give near term guidance, I think it just puts a lot of unnecessary stress and pressure on people. There is only two companies – public companies in the Craft Brew space, so I’m not sure you need to necessarily try to forecast EPS on a quarterly basis, that’s all I’m saying.

Terry Michaelson

I really appreciate that input and obviously we’ve been weighing the pluses and minuses in us wanting to make certain that we provide the most information we can for our shareholders and our excitement about the company. We may have got ahead of ourselves in terms of some of the ways we approach guidance, but we’ll certainly evaluate that. What I can tell you is we’re not going to change our strategy that we believe is working and building this company in the right way and building a really dynamic portfolio and the business model that really is advantage. We are going to stay focused on that. I can tell you we will be very careful as we approach things with the guidance going forward in terms of how we do that to make certain that we’re not putting ourselves in a corner or providing information that maybe confusing to analysts or shareholders.

Doug Thomas – JET Investment Research

Appreciate that. Thanks guys.

Operator

Our next question is from Steve Olson, private investor. Please go ahead.

Steve Olson – Private Investor

Good morning. Thanks for taking the question. Regarding the contract brewing, do you still have other contract brewing relationships?

Terry Michaelson

We do have another contract brewing relationship that’s in place and I can tell you there are people coming to us all the time that are asking us about contract brewing. We’ve been fairly candid all the way along that we don’t see that as a big piece of our ongoing business. We like and appreciate to have a good partnership with the existing contract brewer that we have and we believe that, that’s a valuable piece of our business at this point, but going forward, I’m not sure how much we’ll evolve ourselves in that. If there’s an opportunity and we think that’s life for a certain period of time, we certainly will look at it again but we like the position we’re in now for growth in where breweries are.

Steve Olson – Private Investor

And regarding the capacity of the existing breweries, I think you recall there were plans to expand from the 1.1 million barrels to 1.2 million barrels by the end of next year. If my recollection is correct, has that – will that change because of the contract brewing discontinuing with Goose Island?

Mark Moreland

This is Mark. The actual capacity of our footprint won’t change and so we are continuing to build out our footprint both this year and next year to the 1.2 million barrels you talked about. And so we still anticipate that our – the first phase of the three phased process, we will complete the build out. Second phase we will continue to grow and grow into that phase and then as we max our capacity internally, at some phase we will go out and look for contract brewing ourselves to supplement our own production, so any need for future, significant capital investments in the new brewery or purchasing a new brewery is very far in the future.

Steve Olson – Private Investor

Okay. And just looking at the leverage and capitalization of the company and then, Terry, along your comments about some of the prices being pretty high, could you share your thoughts as far as allocating capital possibly to repurchasing some shares. Where does that fit into a priority as far as the capital allocation?

Terry Michaelson

I think from this standpoint, we believe that the strongest subside for the shareholder is in the growth of the business at this point. So our priority for capital at this point is to invest in initiatives we believe are going to continue to position us well for the marketplace. As we grow, as we look at the competitive environment, we certainly will evaluate things like stock repurchase. But on the front end here, we believe that the real value for our shareholder really is going to come on the upside of the growth that we have and we’re very optimistic about not only the existing brands we have, but new initiatives that we have to put into place. So that’s going to remain the priority for at least the near-term.

Steve Olson – Private Investor

The current valuations and current leverage of the company would seem to me to be able to have less shares outstanding when the growth – when and if the growth is realized would provide shareholders with a nice return also?

Mark Moreland

Yes, most certainly. We do realize we have a number of shares out and that’s why the EPS relatively looks so low or at least was one of the drivers of that. Well, if you take a look at the capital structure options we have in front of us, but as Terry said right now the ability for us to invest and get a significant excess return off of our business is high. And we’re going to continuing to focusing our cash investments there and we’d anticipate that given where the market is going to be the case for quite some time.

Steve Olson – Private Investor

Okay. Thank you.

Mark Moreland

Thank you.

Operator

We have no further time for questions today. I’ll now turn the call back to Mr. Michaelson for closing remarks.

Terry Michaelson

I appreciate everybody’s interest in our company and I look forward to the year-end call for 2012. Thank you very much.

Operator

Thank you ladies and gentlemen, this concludes today’s conference. Thank you for participating. You may now disconnect.

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