The Boston Beer Company, Inc. (SAM) Q4 2018 Earnings Report, Transcript and Summary

Hello, and welcome to the Boston Beer Company Q4 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I now would like to introduce your host for today's call, Jim Koch, Founder and Chairman. Sir, you may begin.

Thank you and good afternoon and welcome. This is Jim Koch, Founder and Chairman, and I am pleased to be here to kick off the 2018 Fourth Quarter Earnings Call for the Boston Beer Company. Joining the call from Boston Beer are Dave Burwick, our CEO; and Frank Smalla, our CFO. I will begin my remarks this afternoon with a few introductory comments including some highlights of our results, then hand it over to Dave who will provide an overview of our business. Dave will then turn the call over to Frank, who will focus on the financial details for the fourth quarter and 2018 fiscal year, as well as a review of our outlook for 2019. Immediately following Frank's comments, we will open the line for questions. We're proud to report depletions growth of 11% for the quarter and 13% for the full year. We are thankful to our outstanding employees, our distributors, our retailers and our drinkers, all of whom help return the company to double-digit volume growth. We believe that our depletions growth is attributable to our key innovations, to the quality of our products and our strong brands, as well as sales execution and support from our distributors. We're still seeing challenges across the industry including a general softening of the craft beer category and retail shelves that offer an increasing number of options to drinkers. We continue to work hard on our Samuel Adams brand messaging, focusing on communicating our artisanal care in the brewing of Sam Adams Boston Lager. While it's still early, it appears that our new advertising campaign has noticeably improved Boston Lager's trends. We plan to continue to invest in this campaign in the coming months with the goal of further improving trends and returning Sam Adams to growth. We are confident in our ability to innovate and build strong brands and we are planning to launch three new brands in 2019 that we believe will complement our current portfolio and help support our mission of long term profitable growth. I will now pass over to Dave for a more detailed overview of our business.

Thanks, Jim. Good evening, everyone. Before we review our business results, I'll start with the usual disclaimer. As we stated in our earnings release, some of the information we discuss in the release and that may come up on this call reflect the Company's or Management's expectations or predictions of the future. Such predictions and the like are forward-looking statements. It's important to note that the company's actual results could differ materially from those projected in these 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. Okay, now let me share a deeper look at our business results for the quarter. Our depletions growth in the fourth quarter was a result of increases in our Truly, Hard Seltzer, Twisted Tea and Angry Orchard brands that were only partially offset by decreases in our Sam Adams brand. Truly continues to grow beyond our expectations and we continue to work hard to grow distribution across all channels while building a strong brand. We're committed to maintain and improve in our position as a leader in the emerging segment of Hard Seltzer as more competitors enter. Twisted Tea is growing both distribution and velocity while generating consistent double-digit volume growth. Angry Orchard's growth is led by Angry Orchard Rosé who was introduced in early 2008. We're excited about our brand investment plans for Angry Orchard in 2019 which include expanding our packaging formats to reach more drinkers. Our overall plans for 2019 include significant investments in the second year of our successful 2018 innovations which include Angry Orchard Rosé, Truly Berry Variety pack, Truly Wild Berry, Sam '76 and Samuel Adams New England IPA. These five new innovations of 2018 are within the top product introductions in their combined categories. The 2019, we plan to build upon these successful innovations with three new brands that address important health and wellness opportunities in our categories. These brands include 26.2 Brew from our wholly owned affiliate Marathon Brewing Company. 26.2 is a third quenching Gose beer made with sea salt to fit runners' active lifestyle. Wild Leaf Tea, a craft hard tea with fewer calories and less sugar, and Tura Alcohol Kombucha, an organic light and refreshing shelf stable alcohol kombucha with live probiotics and real fruit. We're now in the very early stage of our national launch of both 26.2 and Wild Leaf and we'll launch Tura later in the quarter on a more limited geographic basis. To date, the response from our wholesalers, retailers and drinkers on these new brands has been very positive, but it is too early to draw conclusions on the long term impact. We're in a very competitive business and remain optimistic for continued long term growth of our current brand portfolio and our innovations. We'll continue to focus on cost savings and efficiency projects to fund the investments needed to both grow our brands and to build our organization's ability to deliver against our goals. In 2018, we increase the usage of third party breweries in response to our accelerated depletions growth especially in slim can packages in cans in general and face industry-wide headwinds of higher packaging and transportation cost. We achieved our planned supply chain cost savings for the year, but the corresponding margin benefits were more than offset by the incremental cost we incur to meet the significant growth in our key innovations. Looking forward to 2019, we're targeting double-digit top line growth and importantly a significant increase in our operating income. We expect first quarter shipments growth to be significantly higher than depletions as we manage our supply chain and capacity to ensure distributor inventory levels are adequate to support drinker demand for our brands during the peak several months. We're targeting a 1 percentage point improvement in gross margins in 2019 as we work to adjust our supply chain to support our increasing volume projections. We're maintaining our previously stated multi-year goal of increasing our gross margins by about 1 percentage point per year, up the adjusted 2018 base before any mix or volume impacts. We're planning capacity and efficiency improvements in our breweries which are reflected in our capital spend expectations for 2019. We remain prepared to forsake short term earnings as we invest to sustain long term profitable growth in line with the opportunities that we see. Based on information in hand, year-to-date depletions reported to the company to the six weeks ended February 9, 2019 are estimated to have increased approximately 12% from the comparable weeks in 2018. Now, Frank will provide the financial details.

Thank you, Jim and Dave. Good afternoon, everyone. For the 13 week fiscal fourth quarter, we reported net income of $21.8 million or $1.86 per diluted share, a decrease of $0.71 per diluted share from the fourth quarter of last year. This decrease was primarily due to a fourth quarter 2017 favorable one-time tax benefit of $1.72 per diluted share, related to the Tax Cuts and Jobs Act of 2017. Operating income for the fourth quarter was $28.8 million, an increase of $14 million, grown 94%, primarily due to increases in net revenue as well as decreased advertising, promotional and selling expenses partially offset by lower gross margins. Shipment volume was approximately 958,000 barrels, a 6.3% increase compared to the fourth quarter of 2018. We believe distributor inventory as of December 29, 2018 was an appropriate level based on inventory requirements to support the forecasted growth of our brands and new innovations. Inventory as of December 29, 2018 at distributors participating in the Freshest Beer program increased slightly in terms of base of inventory on hand of when compared to December 30, 2017. We have approximately 77% of our volume in the Freshest Beer program. Our fourth quarter 2018 gross margin decreased to 51.9% compared to 52.4% in the fourth quarter of 2017, primarily as a result of higher processing cost due to increased production at third party breweries, higher temporary labor to company owned breweries and higher packaging cost partially offset by price increases, cost saving initiatives at company-owned breweries and lower excise taxes. Fourth quarter advertising, promotional and selling expenses decrease $10.4 million, compared to the fourth quarter of 2017, primarily due to lower expenditures on media advertising and point of sale marketing, partially offset by increased local marketing, higher salaries and benefits cost and increased freight to distributors due to higher rates in volumes and less efficient truck utilization. General and administrative expenses increased by $6.1 million from the fourth quarter of 2017, primarily due to increases in salaries, benefits and stock compensation costs. The company's effective tax rate for the quarter increased to a provision of 24.7% from the benefit of 107.7% in the comparable period in 2017. This increase was primarily due to the fourth quarter 2017 favorable one-time tax benefit of $1.72 per diluted share related to the Tax Cuts and Jobs Act of 2017. Our full year net income decrease $6.4 million or $0.27 per diluted share to $92.6 million or $7.82 per diluted share compared to the prior year. This decrease is primarily due to lower taxes in 2017, related to the one-time tax benefit from the 2017 Tax Cuts and Jobs Act as well as lower margins, higher advertising, promotional and selling expenses that were partially offset by increased shipment volume. Full year 2018 shipment volume was approximately 4.3 million barrels, a 13.7% increase from the prior year. Full year 2018 gross margin decrease to 51.4% compared to 52.1% in the prior year. The margin decrease was primarily the result of higher processing cost due to increased production at third party breweries, higher temporary labor at company-owned breweries and higher packaging costs, partially offset by price increases, cost saving initiatives at company-owned breweries and no excise taxes. Full year advertising, promotional and selling expenses increased $46.2 million compared to the prior year, primarily due to increased plant investments in local marketing, media and point of sale, higher salary and benefits cost and increased freight to distributors due to higher rates and volumes and less efficient truck utilization. Full year general and administrative expenses increase by $17.7 million versus 2017, primarily due to increases in salaries and benefits cost, stock compensation costs and legal and consulting costs. The full year effective tax rate increased to 20.3% from the 14.7% rate in the prior year primarily due to the fourth quarter 2017 sales from one-time tax benefit of $1.72 per diluted share, related to the 2017 Tax Cuts and Jobs Act, partially offset by a decrease in the 2018 Federal Statutory Tax rate from 35% to 21% and the third quarter 2018 favorable impact of $0.38 per diluted share due to tax accounting method changes. Looking forward to 2019, based on information of which we're currently aware, we're targeting 2019 earnings per diluted share of between $8 and $9, of actual results could vary significantly from this target. We are currently planning increases in shipments and depletions of between 8% and 13%. We're targeting national price increases per barrel between 1% and 3% and full year 2019 gross margins are currently expected to be between 51% and 53%. We plan increased investments in advertising, promotional and selling expenses of between $20 million and $30 million for the full year 2019. Not including any increases in freight cost for the shipment of products to our distributors. We estimate our full year 2019 effective tax rate to be approximately 27%. Excluding the impact of ASU 2016-09. We are not able to provide forward guidance of the impact that ASU 2016-09 will have on our 2019 financial statements and full year effective tax rate as this was mainly dependent on unpredictable future events including the timing and value realized upon exercise of stock options versus the fair value when those options were granted. We are continuing to evaluate 2019 capital expenditures and currently estimate investments of between $100 million and $120 million. The capital will be mostly spent on continued investment on our breweries and capitals. We expect that our cash balance of $108.4 million as of December 29, 2018 along with future operating cash flow and our unused line of credit of $150 million will be sufficient to fund future cash requirements. During the fourth quarter and the period from December 29, 2018 to February 15, 2019, the company did not repurchase any additional shares of its Class A common stock. We have approximately $90.3 million remaining on the $931 million share buyback expenditure limit set by the Board of Directors. We will now open up the call for questions.

[Operator Instructions] Our first question comes from the line of Amit Sharma with BMO Capital Markets. Your line is open.

Hi there, this is Dru Veen [ph], on for Amit. Thanks for taking the questions. I just wanted to start out with the call for significant increase in shipments you have with depletions in the first quarter. Maybe if you could just give us any sort of help on magnitude that we should expect any differential there? And maybe as we think of shipments going through the year, if there's anything else we should think about from a cadence perspective?

This is Frank. Let me just comment on discrepancy. The Q1 typically is a quarter where we have higher shipments versus depletions because we're building up our [indiscernible] for the season, which is typically Q2 and Q3. Now this year, we are also building higher inventories that we have agreed with our whole sellers mainly to support the growth of our Truly brand and also Twisted Tea. The full year guidance is really the guidance that's important. It's really difficult to give you the quarterly guidance, but we expect Q1 to build up the inventory and then give it back to Q2 and Q3. So there's no full year impact on that, but I would say if you look at our full year guidance for the growth, I'd say like about 30% to 40% of that growth will be shipped in addition in Q1 to the normal Q1 business.

Great. Thanks. And then if I could just touch on cash and gross margins; you called for increased packaging and obviously with the Truly growth, assuming that a lot of it is still going to be on third party, but can you just maybe talk about capacity investments that the company has been making and maybe if in 2019, we should start to see some shift in Truly manufacturing to any company-owned? Thank you.

Thank you. Our next question comes from the line of Laurent Grandet with Guggenheim. Your line is open.

Hey. Good evening, everyone. I'd like to really speak about either sum it [ph], last time we met there you said that you have aspiration for this business to come back to flat on when we do get the leased numbers is still declining. So two things here; you are resenting the packaging and having some new copies, I'd like to understand a bit more how this is working; two is some of the growth is supposed to come from the time you were saying Sam '76, but also New England IPA getting more distribution. There is no mention about those two in the release you read. And then the last thing is how should we think about 26.2 in terms of volume opportunity for the franchise? Thank you.

I'm sorry. The line just dropped so we didn't get the last question.

From Drew.

We did get cut off when Drew asks his second question regarding the cost and the margin and capital investments. So let me answer that question. As you have seen, all margin decrease which we have highlighted already in the last guidance, but it's lower than the long-term prices that we have given, we have said that it will get to savings in our gross margin and improved gross margin on average, about 1 point every single year, we're getting to those savings. They're just masked but the incremental cost that we're experiencing because the volume growth especially of Truly is far out pacing our expectations. To meet the volume growth, we had to use increasingly co-packers which is adding a fee and that's weighing on the cost and the addition we also had incremental labor, a temporary labor that we had to employ in our breweries. This will reduce. We bring in incremental capacity in-house in 2019 and see a significant improvement in our cost. The guidance that we're giving is a fairly good guidance for the overall gross margin. The actual gross margin was naturally dependent on the actual volume for Truly. We have planned for a certain volume. If we get to that volume, we have a fairly good improvement on our cost base. If the volume grows, it's going to go above what we are projecting, we might have to use higher co-pack volume and that will increase our cost and will impact our margin negatively. I will tell you though, we're fully aware of what we're doing and we have plans in place to bring the capacity in-house once we're convinced this is a long term volume. We're getting to the underlying savings from cutting waste out of the system, but again they are massed by those complexity cost due to the relatively strong growth that we are seeing with our innovations. For the current caller, if you could repeat -- we came in just when you talked about New England IPA and 26.2. These are more -- I had one more query and we'll answer your question. Sorry about that.

No, that's okay. So good evening, everyone. I think Dave, last time we met, you mentioned that your aspiration was to have the summit and it's franchise to go back to flat. We thought what we are seeing right now in the Nielsen numbers. Just wanted to understand I mean the three [ph] you got there: one is about preventing the packaging and having a new marketing copy, so I wanted to know how all these is working; the second thing is about New England IPA and Sam '76. I think I understood at the time that you wanted to push things further in terms of distribution, but you didn't mention anything about those two in your press release. And then I wanted to understand the 26.2, how should we think about this one in terms of -- for you more, I would say potential.

Okay. This is Dave. I'll take a shot at that. The first question was around Sam Adams and we're going there. We're on a journey. I think Jim mentioned in his part of the script, we have a new campaign that we put out there last September and it's actually with the needle for us. There's really 180 from where we've been before and I think where we're finding our voice again with Jim on camera as well as how we talk about the product and how we make the product that makes us unique. That's one element right there that we'd like where we're going, ready to for, not 100% of the way where we want to be on the branded communication but we took a big step forward with that campaign, we're going to continue to press harder on that this year. In addition, we do have a new package design for all of our take-home packages in our premise. That will begin in the market starting in April and again, we had it back to the core equities of the brand and we believe we're going to appear much better on shelf for the blue block that looks super premium and reinforces some of the very important things in people's minds about in particular Boston Lager, but certainly Sam Adams. So we're hopeful that that's going to have an immediate impact. When it gets in the market, we think it's an important element. Also last year, we had a very good Octoberfest season where we grew Octoberfest. Some real [ph] didn't grow last year, we went back and looked at the product and we think it's been round a long time, it was the first one out there. We decided it was time to maybe reformulate that product, make it little easier drinking for the summer, and so we'll have the new summer come in as well by April timeframe. So we've got around Sam that sort of energy and the effort around Sam right now at a high level. As it relates to New England IPA and Sam '76, it's a sophomore year for both of these brands and we're best seen considerable dollars behind both of them to grow in the second year. New England IPA last year was sort of in the back seat because there were so much innovation, it probably didn't get the support that it deserve. By the way, that was the highest repeat rate of any new product launched in the category last year was New England IPA. Sam '76 was a very close number, too, as the year finished. So, they are two great products, two great beers that people really like and they're coming back to and we're most certainly putting a big effort on them in the marketplace this year through all different types of marketing means that we have at our disposal. 26.2 is really going after a holding space for us which is really around the area of Health and Wellness. And there has been a lot of talk about health and wellness and Beer & Beyond lately. We watch a different ways to play in that space. 26.2 is going active. People have lived an active lifestyle and care about their health and looking for something that's a little bit more aspirational and maybe a craftier version, if you will, of a brand that's been very successful [indiscernible]. So we feel like it's a brand by the way that we have in Boston only and long time as only during the time of the Boston Marathon since 2012. It's sat very well in Boston, now taking it nationally, but this is a new space for us and we're going to build it carefully and in a smart way. We think there's a whole platform around this type of beers -- so I believe first non-Sam Adams identified beer is going to come from Marathon Brewing Company which we own, which will be a broader platform for beers within the health and wellness space. This is our first entry. We feel really excited about it. It's already been proven in Boston from a quality perspective and we at some point be sharing some exciting news about a launch in the not too distant future.

[Operator Instructions] Ladies and gentlemen, thank you for participating in today's call. That concludes the call. You may now disconnect. Everyone, have a wonderful day.

Thank you, everybody. We'll talk to you again in a few months.