The Boston Beer Company, Inc. (SAM) Q2 2013 Earnings Report, Transcript and Summary

Good afternoon. My name is Hope, and I will be your conference operator today. At this time, I would like to welcome everyone to The Boston Beer's Second Quarter 2013 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). Thank you. Mr. Jim Koch, Founder and Chairman, you may begin your conference.

Thank you. Good afternoon and welcome. This is Jim Koch, Founder and Chairman. I'm pleased to be here to kick off the 2013 second quarter earnings call for The Boston Beer Company. Joining 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 second quarter as well as a review of our outlook for 2013. Immediately following Bill's comments, we'll open the line for questions. We achieved depletions growth of 24% and record total depletions in the second quarter. Depletions growth in the second quarter improved from our first quarter results of 16% primarily due to the improved growth of our Samuel Adams Seasonal program and our Samuel Adams Boston Lager. We believe that our depletions growth is attributable to strong sales execution and support from our wholesalers and retailers as well as our quality beers and strong brands. We were also delighted to learn that for the fifth year in a row our wholesalers ranked us the number one beer supplier in the industry in the annual poll of beer wholesalers conducted by Tamarron Consulting, a consulting firm specializing in the alcoholic beverage distribution industry. This is a testament to the efforts of all Boston Beer employees to service and support our wholesalers' business and to the relationships we have built with them. We continue to innovate and during the quarter we released Samuel Adams Boston Lager and Samuel Adams Summer Ale packaged in our new unique can which has been well received by wholesalers and drinkers and is generally in line with our expectations from a volume perspective. I will now pass over to Martin for a more detailed overview of our business.

Thank you, Jim. Good afternoon, everyone. As we state 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. Such predictions and the like are forward-looking statements. It is important to note that the 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 second quarter, our depletions growth accelerated from prior trends, due to the health of our Samuel Adams beers and the increased distribution of Angry Orchard, which was rolled out nationally during the second quarter of 2012. Our business is healthy and we believe that the strength we see in our main brands may well reflect a response to our increased investments in media, local marketing and point of sale and the efforts of our increased sales force. Accordingly, we have increased our expectations for full-year depletions growth to between 17% and 22% to reflect the current trends and to take – as we take advantage of the opportunities that we see, we are increasing our planned investments in our sales force and our support behind our brands for the remainder of the year. We also continue to invest at a high rate in capital improvements in our brewing and packaging capabilities to support our product innovation and brand growth. These improvements include our new can line that began production this quarter and a new bottling line…

Thank you, Jim and Martin. Good afternoon, everyone. We reported net income of $19.7 million or $1.45 per diluted share for the second quarter, representing an increase of $5.4 million or $0.39 per diluted share from the same period last year. This increase was primarily due to shipment increases partially offset by increased investments in advertising, promotion and selling expense. Core shipment volume for the second quarter was approximately 837,000 barrels, a 21% increase over the second quarter of 2012. The increase in shipments is due primarily to increases in Angry Orchard, Samuel Adams, and Twisted Tea. Inventory at wholesalers participating in the Freshest Beer Program was lower by an estimated 267,000 case equivalent compared to the end of the second quarter in 2012. Our second quarter 2013 gross margin decreased to 53.6% from 54.5% in the second quarter of 2012. This was primarily driven by increased brewery processing and ingredient costs, combined with $3 million of customer program and incentive costs that are now recorded as reductions in revenue. In the second quarter of 2012, customer programs and incentive costs were recorded as advertising, promotional and selling expenses. We are decreasing our full year gross margin target to between 52% and 54% from previously between 53% and 55%, primarily due to increases in ingredient costs and product mix. Second quarter advertising, promotional and selling expense, excluding 2013 customer programs and incentive costs of $3 million that were reported as reduction of revenues, were $6.1 million higher than costs incurred in the prior year. The combined increase of $9.1 million in advertising, promotional and selling, and customer programs and incentive costs was primarily a result of increased investments and local marketing and media advertising, costs for additional sales personnel and increased freight to wholesalers due to higher volumes. General and…

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

Hi everyone.

Hi, Judy.

Hi, Judy.

A few questions from my end. First, just looking at your Sam Adams performance in the quarter, clearly a sequential improvement from the first quarter. Can you just talk about how much the cans contributed in terms of your growth for Sam Adams trademark in the quarter? And then just broadly, just the improvement on the Lager and Seasonal. Can you just talk about what you think is really driving the sequential improvement just because when you look at the mainstream beer category, you've actually seen a lot of weather and consumer-related weaknesses and it seems like you've seen trends actually improve sequentially?

Sure. Well, let me take some of that and then if Jim would like to comment, he can. I think we did see pretty good turnaround in trends on Sam Adams from the first quarter sort of starting late in the first quarter. The cans launch occurred around May 1st and I think the can volume, as Jim indicated, has met our expectation. I think a good proxy for that is the publicly available sort of IRI data, which sort of suggests that cans are roughly 4% of our off-premise bottle business. And that's sort of what we have talked about sort of mid-single digits as a target for cans as incentive bottles and I think that's what we've seen. Obviously some of that will be cannibalization. How much? Don't know. And it's hard to interpret how much of the growth of our brands is coming from cans, but it's obviously just part of it given there is some cannibalization and the brand trends at least in IRI, which is a publicly available information, I'll just way it faster than that. So with regards to your second question which is what might be causing that, I think again we saw a pickup in trends in the off-premise starting late March. I think it's visible in the IRI data and it doesn't seem to us to be pricing driven and sort of feature ad driven based on the data that we see. Of course, it could be. I think it's reflective of the brand being healthy. And just what we're doing across all of our efforts both our sales force, our marketing and media efforts, our wholesalers' efforts and good execution. And it just seems that we're currently back in a rising tide and floating with it. The Craft Brew has reported their numbers and I think we're pleased to have Sam Adams trending closer to those numbers than they have in the past.

Yeah, I guess I'd just comment, many years of watching numbers go bounce around, this is only a quarter. We're very happy that the trends have improved on Boston Lager and are Seasonal both of which are crucial, but it is just a quarter so we'll see.

Okay. And then just, if we look at your depletion guidance for the full year, at this point it still seems to be pretty wide range. In the back half, I know the comparisons get a little bit more challenging. So maybe talk about sort of puts and takes in terms of the risk to the upside or downside as you think about the back half of the year either the continued performance on the Sam Adams brand or Angry Orchard, just trying to understand the wide range that you still have on the depletion guidance?

Sure. Well, the second half of the year is bigger for us than the first half of the year and there are still a number of things here that I wouldn't pretend to say that we fully understand. The starting point would be the Sam Adams trends which we're obviously very pleased with. We are finishing Summer Ale pretty clean. In fact Oktoberfest conversions have already started earlier than perhaps we would like, but that appears to be clean. The next two, three months are pretty critical for us from a volume as a percentage of the year perspective. So, frankly until we have those behind us, we're not that excited about predicting Sam Adams ranges. I think on a tea perspective, tea was slower than we would have liked earlier in the year, but it seems to have picked up some velocity again. And so to Jim's point, we've got two data points a week first – a growth first quarter and a stronger growth second quarter and choosing which number to project out for the rest of the year can lead in a pretty significant range. And then Angry Orchard obviously the comparisons are much, much harder in the second half of the year, but we're obviously pleased with how the brand has performed. I think if you look at the – again publicly available off-premise data, we now have the number one cider in the country in the off-premise, pure apple juice cider. So that's exciting although it's still a small category and these are still relatively small numbers. We just don't know how that category is going to continue to grow. I think it's fair to say that a lot of the category growth seems to have accrued to our offerings and obviously we would like the category to keep growing, but just don't know how far that can be pushed. And so we watch that and at this point in time again, there is a very wide range of potential outcomes as to what that growth should be. So, at this point in time with so much of the year still ahead of us, we'd like to give us a range that we feel we can fall within.

Okay. And then my last question is, is just looking at the broader competitive landscape, you've had a lot of new products that were launched by the major companies whether it's the value craft segments or some of the FMB products. And I'm just curious in terms of your observation and how those brands are interacting if any with either your brands or the broader craft segments? And to what extent it's cannibalizing more the main stream domestic beer segments? And just given how challenging the broader industry volume has been so far, do you think that there is risk of more price competition or anything that you see as a risk in terms of the broader industry competitive dynamic?

Yeah, let me sort of split it into two parts and I'll give my perspective and then again if Jim would like to weigh in, he can. On the first part, there's a tremendous amount of competitive activity. And it's not just the big brewers with their introduction of higher priced items to try and build out there higher end portfolio. Obviously, there has been several launches and a fair amount of muscle flex to get retail space and distribution, but it's also in the other imports and craft where the number of new brewers again based on the brewer's association numbers, it's still growing and all of them are introducing new products. So I think the biggest impact for us is just the sheer variety of what's available to a retailer to put on the shelf or put on tap. And that's very challenging whereas 10 years ago, we may be had, I don't know, maybe a 10% share of SKUs in the craft space. I'm going to guess we're down under 1% or 2% share of SKUs in the craft space now given all this new activity. And then you've obviously got the big brewers who appear to be making big pushes to expand their high end. So the biggest impact for us, I think, is the fight for shelf space and tap handles. And that sort of mirrors our belief in our sales force and the quality of that team and also the number of people we have, and we're committed to that – sort of addressing that by having people in the street and supporting accounts, and supporting wholesalers as best as we can and hopefully the best in the industry. With regards to the pricing, you are seeing some of those introductions get introduced to…

Yeah, I would build on that. I mean it's essentially what you're seeing, Judy, everybody is seeing, is some weakness in kind of the mass domestic part of the beer category and the excitement in growth coming out of the high end not just better beers like crafts and imports and domestic specialties but FMBs now cider. And with that, lots of opportunity brings lots of competition. And my point of view on it is that's a better place to be than not much opportunity and not much competition. So it comes with the territory and our solution to that has always been overinvestment in long-term brand health year-after-year for Sam Adams and now tea and cider. And I think maybe we're seeing some of the payoff from that long-term, year-after-year investment in brand health for Sam Adams as there are retailers who are being inundated with so many brands and consumers being inundated with so many brands and a few retailers realizing that the strong stable brands that consumers know are what they need to sell. And so we are seeing some of the leading edge retailers pulling back a little bit on the kind of the beer of the day mentality and making sure that they have the staples of the craft category like Sam Adams available all the time, because the drinkers do have brand loyalties that we've built for many years.

Okay. Thank you very much.

Thanks, Judy.

Your next question comes from the line of Vivien Azer from Citi.

I wanted to circle back on the pricing discussion and just ask for a little bit more color on your revised guidance for net revenue per barrel growth which has come down from plus one to two to plus one, and whether that's more a function of mix shift within your own portfolio or your outlook for category pricing or the competitive landscape?

That's a good question, and I think it's obviously a little bit of both. But I would say more of it is mix shift within our product portfolio. It's pretty subtle and some of it is also the downward pressure on pricing from some of these lower priced beers that are trying to hit a price point below craft. So, it's a little bit of both.

Okay. And just to follow-up on that then. As we look at the outlook for category pricing, I mean AVI reported earlier today their net price realization continues to – on a price leader basis continues to be pretty good, but certainly it seems to be weighing on volumes across the board. To the extent they end up taking less pricing to drive volume growth, how much does that limit your ability to price?

I think as we said before, it's always helpful if the big players are moving on price but ultimately our price gets determined by what the craft beer drinker will pay for craft beer which is obviously a slightly different drinker decision point than perhaps they're dealing with for the vast majority of their volume. So, certainly it's sort of useful from a timing perspective that they're going. We can go and everyone gets to works on pricing at the same time period. But we'll be looking at what's our view on the craft drinker, what's our view on that demand for our beer, what's their support of our beer to Jim's point, is our brand investment building stronger, brand loyalty and will that support better pricing. We'll also be looking at all of our cost impactors and it's a little early to know what those will be because the agricultural components of those aren't yet finalized and won't be until harvest. So this is something we'll have a much better feel for when we talk to in October.

Okay, that's fair, absolutely. Thank you very much.

Thank you.

(Operator Instruction). Your next question comes from the line of Caroline Levy, CLSA.

Hi, everybody.

Hi, Caroline.

Hi, Caroline.

Hi, Caroline.

Hi. A couple of questions on the cider and I was just a few minutes late hopping on the call, so I don't know if you addressed this. But what percent of your volume is cider? And then separately, what percent is tea at this point nationally?

Yeah, hi, Caroline. We, I think, as you know, historically, have chosen not to disclose that. And we would just direct you to sort of the publicly available IRI or Nielsen data for a good proxy.

Okay. And so is cider equally popular on-premise, would you say, versus off-premise or more so on-premise?

I'd say that cider looks like – from a development perspective, it's sort of following similar trends to craft beer which obviously are distinct from mass domestic beer.

Yeah.

So there is an on-premise component to it. I think it's fair to say that the category is still new, so we don't yet know how that mix will work out. And there's still some distribution opportunities. And again, it's a small category. So we're still trying to work out and find out what those stable ratios on and off-premise are.

Do you think there's a big opportunity from flavor innovation within cider, so you can do apple plus? I mean is that an opportunity you're looking at?

Well, I think there are some real challenges in sort of cider and how it's made and what you can do to it within the existing sort of tax structure that make it quite challenging to do those sorts of things at the brewery as opposed to in the on-premise or at the home. There is some mixology going on of mixed drinks being made of cider and things added in the on-premise, which is sort of interesting. I'm not sure whether it's a fad or more permanent, and I would imagine that people are doing similar things at home. But as it relates to sort of cider flavor innovation, it's a little harder than in beer where effectively as long as we're using barley and hops that we have a lot of things we can do from a flavor perspective. Cider is a little tougher.

Okay. And then just moving on to your distribution, did I hear you say that you think you only have 1% of SKUs displayed? And is that an on-premise or off-premise comment?

No, this is more a comment of those 2,000 craft breweries out there. Each of them have five or six beers. And if you multiply that up, we only have 50.

But if you think about shelf space, are you getting your fair share do you think, I mean, or more than your fair share, because you talked about your excellent sales force which is definitely conformed in talking to industry players? But do you feel that you have your fair share of shelf space or you're doing a good enough job on that?

No.

We never feel like we have our fair share.

Yeah, that was a stupid question. I knew that. Sorry.

But I would sort of add to it. I think if you go back 10 years and looked at it, you would have said, you know, Sam Adams has a share that's roughly proportional to our share of the category. I think if you went out today, you'd say, Sam Adams doesn't have a share in proportion to the category. And I think that's one of the dynamics that has changed over the last seven years that as retailers have added more space to the category, it's been very hard for us to maintain our share of that space.

Right. And it just begs the question though because you do have a reputation for great sales force, but what do you think can be done to get back to fair share?

Well, I think we're going through a time period where retailers are trying to figure out the balance between the strong brands that they're going to sell and then this tsunami of variety that is hitting their stores. And the category is still growing. There's a lot of stuff in flux. So it hasn't really sorted itself out yet. And it's not surprising imports went through this in the '80s where there was just a whole bunch piled into the market, some of them survived because they had great quality and great brands and lots of support and others washed away while those strong brands continued to grow. And I think retailers are just trying to figure out how much variety is just right and some of them have too much, some may have too little.

Thank you.

I would add to that. I'd say, there certainly has been a pendulum swing to more variety and whether that's the right amount or not, I would leave to each individual retailer who knows the customers better. But as they've added variety, they've reduced pack out. And so what you do see is either demands on the wholesaler for much higher levels of service and delivery and greater frequency or you see out of stocks of sort of the key brands. And I would hazard a memory that imports went through the same thing in the '90s that the import category was hot, lots of new imports came in, the import category was divided up into smaller imports, the big imports had lots of out of stocks. Ultimately, the retailers went through that process and made the right decisions for each retailer based on the market what the correct allocation of space was to the bigger core brands that needed the pack out versus the smaller brands, which were there for choice and diversity. And I think at this point in time we're still in a stage with craft where basically the pendulum is swinging to variety.

Great. My last question is just quickly on margins, if I might just ask. At what point do you think you'll really be able to get operating leverage, because I know you're investing heavily in sales, marketing, even in G&A. Do you see a point in the near future where you can actually leverage the top-line growth?

Well, I think it's fair to say we would like to. I think the growth obviously has surprised us a little bit and we've got some catch up going on and we got some inefficiencies in our breweries and just dealing with that acceleration that are happening. And I can't give you a great answer as to when that will finish. I think our number one priority is trying to support our wholesalers and keep them in inventory and keep the breweries running safely, and – but we're still pursuing the growth opportunity. We have this opportunity that seems to have arrived where we're getting returns on the brand investments and we're going to continue to try and charge through that opportunity and take advantage of it as well. So certainly long term, we'd like to see leverage. It's something that we talk about a lot. In the short term, we seem to be struggling to actually produce leverage and I think it's down to all those factors.

Thanks so much.

(Operator Instruction). Your next question comes from the line of Marc Riddick, Williams Capital.

Hi, Marc.

Good afternoon, guys. How are you?

Hi, Marc.

Congratulations on a great quarter. I wanted to get into one of the things you had mentioned about Oktoberfest. And if I recall correctly last year and this might have just been my observation as far as the timing of it, it felt as a consumer at least like Oktoberfest seemed to hit the shelves quicker than normal, maybe a little bit earlier in the calendar than normal last year and I think maybe the benefit really was a function of the benefit of the Freshest Beer Program. And I was wondering that there seemed to be a little bit of a commentary that was made earlier about the timing of Oktoberfest, I was wondering if that might be something that we see happen again this year? And then I have a couple of follow-ups.

Yeah, our typical target to run out of wholesale for Summer Ale, and this is like most of the wholesalers is end of July. And I think it's fair to say, and I'll apologize to those wholesalers now if they happen to be listening or following these remarks, that we ran out of Summer Ale earlier than that and that's partly due to the acceleration that we're talking about. And so I think in my earlier remarks, I said that we were anticipating a slightly earlier conversion to Oktoberfest. Now what you see at retail is typically delayed a week or so from when the wholesaler runs out and some of the wholesalers like the retail to run out before they put two Seasonals on the shelf. But I do think we'll be earlier this year because of that, because of that acceleration that we saw that basically we obviously hadn't planned for and didn't have the liquid to support through to the end of July. So we have been shipping Oktoberfest. I know some is in retail already. I don't know where you shop, but I'm sure we could let you know if you – where to find it if you'd like to.

Well, it's always an issue when you run out of beer. So that's a sad statement for all occasions. But one of the other things I wanted to get into from that standpoint then is with the rollout of some of – with Angry Orchard, for instance. It's actually interesting, is there a seasonal approach that you're looking at taking with that as well because it seems as though maybe it's just some of the things I came across in trades that there seem to be perhaps the opportunity to have a little bit of a seasonal approach similar to what you do with the flagship?

Well, with Angry Orchard we did introduce a variant, Elderflower variant, which was quite delightful. It sort of reminded me of growing up in the UK drinking Elderflower juice which we used to make from a tree in our neighbor's yard. And that did well for us and we're in the process of replacing that with our full cider, which is Sinful Cider Angry Orchard and so yeah, we're already doing that. It's not big volume. Could it be? Again, the category is so small and it's still very early stages of whatever it development is that we just don't know, but certainly there seems to be some interest in like variety pack of cider and so we've got some ciders in there and one of them has a seasonal element to it.

Okay. And one other thing. As far as the hiring that you talked about and you do historically, of course, reinvest in your brands throughout the year which is great to see. I was wondering if there was any particular focus this year as opposed to last year as to the hiring trends that you're trying to target. I mean is there any – is it a similar mix of folks you're bringing on as far as function or is there any particular area that you'd really like to be aggressive on there?

Well, I think obviously with the accelerated capital planning we've been in the last 12 months reasonably aggressive trying to add engineering capabilities and project management capabilities and also sort of start-up commissioning capabilities. And given the projects that we expect to do in the next 18 months, I would expect that area of focus to remain high. Obviously with this sort of growth, there are all areas of the company are stressed and so I'm sure we'll look at all areas. But fundamentally, we've always believed that feed on the street is what sort of can really impact the business. And so I would expect that to remain a primary focus too. Having said that, we haven't yet developed sort of our target plans for next year. So I really can't talk any specifics.

Okay. And one last thing and I wanted to sort of go off topic a little bit. As far as the investment in advertising and promotional spending, what's really interesting is that it's been started for a long time, you've been very big advertisers especially within the sporting area. And I was wondering if there was any opportunity to maybe get – maybe best bang for the buck is the best way to put it, when you're dealing with some of those given that the current environment there, I mean we currently know some of the things that have taken place with ESPN. We know that they have a competitor coming up. As a buyer of advertising in sport areas, is there an opportunity for you to maybe, to get a better return on your investment there?

Well, there may be. We've had long relationships with a number of the networks and properties that we've been very pleased with. Our approach to buying media has always been pretty analytical and sort of value based. Certainly, we participate in the upfront of media process and that process isn't yet closed this year. So it's still a little early to understand how some of the things that you mentioned may affect those commitments. But certainly we welcome new networks and talk to that fit our demographic and can meet our economic needs. With all that said, we obviously spend a lot of money for a brewer our size, but we're still spending very significantly less money than the big guys. So we're in the fringe of some of these discussions.

Okay, great. Thank you very much, gentlemen.

Thanks.

And there are no further questions at this time.

Well, great. We very much appreciate everyone joining us and for your support of our products and we encourage you to have a beer tonight. Cheers and look forward to talking to you soon.

Cheers!

Cheers!

Thank you. This does conclude today's conference call. You may now disconnect.