Boston Beer Company Inc (SAM) 2007 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth quarter 2007 Boston Beer Company earnings conference call. My name is Karen, and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Mr. Jim Koch, Founder and Chairman, please proceed.

Thank you. Good afternoon and welcome everyone. This is Jim Koch, Founder and Chairman, and I'm pleased to be here to kick off the 2007 fourth quarter earnings call for the Boston Beer Company. Joining the call from Boston Beer will be Martin Roper, our CEO, and Bill Urich, our CFO.

I'll begin my remarks this afternoon with a few comments on where we stand competitively, then pass the microphone on to Martin, who will provide an overview of our business. Martin will then turn the call over to Bill, who will provide financial details for the quarter as well as our outlook for 2008. Immediately following Bill's comments, we will open the line for questions.

We feel very positive about our fourth quarter depletions growth of 19%, which contributed to 17% growth for the full year 2007. We believe that we gained share in both the Better Beer and Craft Beer categories during 2007. This was our eighth consecutive quarter of double-digit depletion increases.

We believe these results are driven by drinkers trading up to our full flavored Craft Beers and the strength of the Samuel Adams brand and brand support, and increasing retailer and wholesaler support for the Craft category, as well as for Samuel Adams. While the Craft category continues to get more competitive, I believe that the quality and variety of distinct beers that Samuel Adams brews positions us well to compete in this challenging market, and the addition of the Pennsylvania brewery will provide us with a capacity and capabilities to meet this demand.

As previously reported, we entered into a contract of sale for the brewery in Lehigh Valley, Pennsylvania, which is just north of Philadelphia, and we completed our due diligence process. We intend to proceed with the purchase of this historic and award winning brewery where we brewed some of our beers from 1994 to 2001. We have already started making the necessary improvements to upgrade the brewery and hope to begin brewing and bottling our brands during the summer of 2008.

I will now pass the call over to Martin for a more detailed overview of our results.

Thank you, Jim. Good afternoon, everyone.

As Jim noted, we are encouraged by the depletions growth achieved in the fourth quarter. Our fourth quarter depletions growth reflected double-digit growth in the Samuel Adams brand family and the Twisted Tea brand family.

Our Samuel Adams brand continued to benefit from increased drinker interest, increased retailer support and the hard work of our wholesalers supporting our retail initiatives. We believe that our Samuel Adams brand health is being helped by our significant investment in media. Sales force point of sales materials and promotions. We intend to increase this investment level in order to maintain a leading position.

As noted, the Twisted Tea brand family achieved double-digit growth in the quarter. We expect the alcoholic tea category to remain very competitive, but we are encouraged by Twisted Tea's growth and we plan to continue to invest in the Twisted Tea brand to improve our position.

The Samuel Adams depletions growth achieved in the fourth quarter of 2007 reflected growth of all of our major beer styles. We believe that our brand health has been positively impacted by the strength of the Craft category which continues to experience growth from increased drinker interest in better beers, more flavorful beers and in variety.

The strengths of the Samuel Adams brand family trends during the quarter suggest that Samuel Adams continues to maintain strong brand equity with drinkers. We believe that maintaining strong brand equity in the Samuel Adams brand is vital to the continued health of our business and we remain committed to investing behind it as a number one priority to ensure long-term success. We continue to test and evaluate our initiatives to determine their effectiveness, and to identify the optimum investment required to generate sustainable volume growth.

As Jim mentioned earlier, the company entered into a contract of sale to purchase from Diageo North America a brewery located in Lehigh Valley Pennsylvania for $55 million. In the fourth quarter of 2007, we completed our due diligence process on this brewery and have now paid into escrow the 10 million deposit called for by the contract.

We expect to close on the purchase of this brewery as scheduled in June 2008, barring unforeseen circumstances. We have begun making certain capital improvements necessary to restock the brew house and to upgrade other portions of the brewery. We hope to have the brewery partially operational for our brands during the summer.

In addition to the purchase price of 55 million, we expect to have spent between $45 million and $55 million in due diligence and capital improvements by the end of 2008, with a further $10 million to $15 million in capital projects anticipated in 2009, to achieve our 1.4 million barrel capacity goal.

We have identified additional potential projects that could improve the brewery's efficiency and capabilities that may be completed over the next few years, depending on our final assessment of risk -- I'm sorry, on our final assessment of return on investment and need, which is currently estimated to total between $25 million and $35 million. Our focus is on transferring ownership and starting up the brewery at the 1.4 million barrels per annum capacity level and therefore the exact timing of any capital beyond 2008 is still being evaluated and may change.

As previously reported, we had previously been contemplating the construction of a brewery in Freetown, Massachusetts, but the probability of proceeding on this site has decreased due to entering into the contract to purchase the Pennsylvania brewery. As a result, in the second quarter of 2007 we determined that it was appropriate to write off $3.4 million, the amount that had been capitalized through June 30, 2007, on the Massachusetts brewery project.

In August 2007 we purchased the land in Freetown, Massachusetts for $6 million as protection against possibility that the results of the due diligence on the Pennsylvania brewery might prove unsatisfactory. As we have now concluded, we will proceed with the Pennsylvania brewery purchase. In February 2008 we placed the land in Freetown, Massachusetts, on the market.

As previously reported during the third quarter, the TTB performed a routine audit of our Cincinnati Brewery and other breweries, where some of our products are produced. In February 2008, the TTB formally disputed our regulatory and tax treatment for certain of our 2006 and 2007 Twisted Tea shipments and we have received a notice of demand for additional excise taxes plus interest and penalties of approximately $8.5 million. The TTB has asserted that these shipments were not classified consistent with TTB regulations that took effect January 1, 2006.

Based on our analysis to date, we believe that most of our Twisted Tea shipments were in compliance with applicable regulations. We are in discussions with the TTB regarding the differences in the methodologies used to ascertain regulatory compliance and expect these discussions to eventually include potential settlement terms.

While we believe settlements should be possible, we also believe that we have litigation options available to us to dispute the TTB's position. It is not possible to determine the ultimate outcome of these discussions or any future litigation, but based on information available on December 29, 2007, we concluded that the range of possible outcomes was between 3.9 million and $9.3 million.

First quarter of 2008, we have continued to gather additional information and refine our analysis, and now believe that if we do not pursue litigation, the potential expense could be as low as $1.8 million and would not be expected to materially exceed the $8.5 million which the TTB has assessed after considering amounts we have previously paid.

The ultimate outcome of this matter could materially differ from our estimates. Based on the information previously collected and our earlier assessment of likely outcomes, we recorded a provision of $3.9 million in the third quarter. We continue to maintain this provision in our December 29, 2007, financial statements related to this contingency.

Twisted Tea shipments were only minimally interrupted due to this matter during the year.

Net revenue per barrel for core products for the quarter increased by 5.2%, primarily due to price increases and a decrease in discounts.

During the fourth quarter of 2007, we saw a continuation of significant cost pressures, particularly unfavorable ingredients and packaging material costs, as well as unfavorable freight costs. Despite these cost pressures, we were able to increase our investment in advertising, selling and promotional support behind the brand, and continue to invest in our organizational infrastructure.

During the quarter, we continued to maintain a strong balance sheet with adequate cash positions to support our business strategy. Our shipments and orders in hand suggest that core shipments for the quarter ending March 29, 2008, appear to be up approximately 10% as compared to the same period in 2007.

Actual shipments may differ however, and no inferences should be drawn with respect to shipments in future periods. February year-to-date depletions are estimated to be up approximately 14% over 2007.

Now Bill will provide the financial details.

Thank you, Jim and Martin. Good afternoon, everyone.

The Boston Beer Company realized earnings of $0.46 per fully diluted share in the fourth quarter of 2007, an increase of $0.29 for fully diluted share over the fourth quarter of 2006, after taking into account a 2.2 million or $0.15 per diluted share provision for income taxes related to an income tax audit. This increase in earnings is primarily the result of increases in net revenue, and a decrease in general administrative expenses, only partially offset by increases in cost of goods sold, selling and administration expenses, and income taxes.

For the fourth quarter of 2007, Boston Beer recorded net revenue of 92.2 million, a 25.7% increase over the same period in 2006. This increase is primarily a result of the 19.5% increase in core brand shipment volume and the increase in net revenue per barrel of 5.2%.

The increase in shipment volume can be attributed primarily to increases in Samuel Adams Boston lager, Samuel Adams Seasonals, Samuel Adams Brew Masters Collection and Samuel Adams light. We believe that wholesaler inventory levels at December 29, 2007, were at appropriate levels.

Our gross margin for the fourth quarter of 2007 increased to 57.7%, from 56% in the fourth quarter last year, due primarily to-- due to a settlement with package material supplier over a 2007 pricing dispute, which had been provided during the year. Excluding the impact of this settlement, gross margin would have declined to 55.2%. This decline was due to increases in package material, ingredient cost and increased depreciation cost, which were partially offset by price increases.

Advertising, promotion and selling expenses increased by $3.4 million during the quarter, as compared to the prior year, primarily due to increases in advertising and promotional cost, and freight expenses to wholesalers. General and administrative costs decreased by 400,000 during the quarter, as compared to the prior year, driven by a $900,000 reimbursement of prior period legal costs, due to a settlement reached in the fourth quarter with insurers, partially offset by an increase in salary and benefit cost.

In responding to an income tax audit, we reviewed our judgments concerning certain income tax deductions and increased our tax provision by $2.2 million. This resulted in an effective income tax rate of 46% for the year. We estimate that our tax rate for 2008 will be approximately 42%.

Core shipment volume for fiscal year ended December 29, 2007, was 1.8 million barrels, a 16.9% increase from 2006 fiscal year. Depletions increased by approximately 17.3% during the 2007 fiscal year, compared to the 2006 fiscal year, primarily attributed to increases throughout the Samuel Adams brand family.

We are pleased with our growth in depletion that has been accompanied by price increases of approximately 3% in 2007. We increased our advertising and selling investment behind our brands by over 8%. And we achieved a 20% increase in earnings per share, while dealing with significant pressures on our supply chain costs, which reduced our gross margin by 2.2 points.

Net income of 22.5 million or $1.53 per diluted share for the fiscal year ended December 29, 2007, increased from $18.2 million and $1.27 per diluted share for the fiscal year 2006, primarily as a result of an increase in net revenue, offset by increases in cost of goods, selling and advertising expenses, general administrative expenses, the writeoff of brewery costs and income taxes.

Excluding the impact of the writeoff of $3.4 million or $0.13 per diluted share in capitalized costs related to the Massachusetts brewery project in the second quarter, and the provision for excise taxes of $3.9 million or $0.14 per diluted share in the third quarter related to the TTB audit, the company realized earnings of $1.80 per diluted share for the full year 2007, a 42% increase over 2006.

Net revenue increased by 56.2 million or 19.7%, as compared to 2006 fiscal year, due to the increase in core shipment volumes and a 2.5% increase in net revenue per barrel for core products. The increase in net revenue per barrel for core products is due to price increases, offset by the provision for excise taxes of $3.5 million, recorded in the third quarter related to a TTB audit and a shift in package mix from cases to kegs.

Cost of goods sold increased by 31.1 million, due primarily to volume increases, higher package material cost and ingredient cost, and the increase in other processing costs at our Cincinnati Brewery.

Advertising, promotional and selling expenses increased by $10.8 million during 2007 fiscal year, as compared to the prior year, primarily due to increases in advertising and promotional cost, freight expenses to wholesaler, salary and benefit costs.

General administrative costs increased by 1.9 million during 2007 fiscal year, as compared to the prior year, driven by salary, benefit and stock compensation costs, offset partially by the $900,000 reimbursement of prior period legal cost pursuant to the settlement with insurers reached in the fourth quarter.

The $3.4 million writeoff of capitalized costs in the second quarter relates to the Freetown, Massachusetts brewery project as entering into a contract in sale with Diageo North America for the Pennsylvania brewery, significantly reduced the likelihood of proceeding with the construction of the new brewery in Freetown.

The reported effective income tax rate for 2007 fiscal year increased to 46%, from the 2006 rate of 42.7%, due to an increase in provision for taxes related to an income tax audit.

We also continue to generate positive cash flow for the full year 2007, our operating cash flow was $53.8 million. After taking into account capital expenditures of $37.1 million, and our repurchase of stock during the year of 6.1 million, our cash and short-term investments as of the end of the year totaled $95.5 million.

During the year ended December 29, 2007, the company repurchased 182,500 shares of its Class A common stock for a total cost of $6.1 million. From December 30, 2007, to March 7, 2008, the company repurchased an additional 428,779 shares of its Class A common stock for a total cost of $15.3 million.

Through March 7, 2008, the company has repurchased accumulated total of approximately 8.5 million shares of its Class A common stock for an aggregate purchase price of $114 million and had $6 million remaining on the $120 million share buyback expenditure limit, set by the Board of Directors. As of March 7, 2008, the company had 9.7 million shares of Class A common stock and 4.1 million shares of Class B common stock outstanding.

Moving on to our outlook for 2008, we are facing overall production cost increases in 2008, currently estimated to be between 12% and 16% over the full year 2007. Approximately 7% of these estimated increases are expected to be driven by malt and hop cost increases, approximately 1% by package material cost increases, and approximately 3% from the cost of starting up the Pennsylvania brewery.

In addition, potential incremental costs associated with contract brewers, account for 2% of the estimated increase.

Increased depreciation costs due to significant keg purchases to support our on-premise growth could contribute another 2%. These cost increases may be somewhat offset by price increases of 5% that we plan to implement. But we anticipate that 2008 gross margin could still be down three points below full year 2007.

Based on these assumptions, 2008 earnings per share are expected to be between $1.70 to $2.00, absent any significant changes in current plan levels of brand support or any unexpected costs related to the Pennsylvania brewery acquisition and start-up.

Current plans for 2008 are to increase brand support by 10 to $13 million, including freight expense to wholesalers. We continue to pursue cost saving initiatives and pricing opportunities, and hope to preserve our economics to allow for continued support of our brands with appropriate investment in order to grow volume and earnings.

We currently estimate total capital expenditures in 2008 to be between 110 and 125 million, of which 45 million is the balance of the Pennsylvania brewery purchase, and 45 to 55 million relates to capital expenditures necessary to restart and upgrade the Pennsylvania brewery.

In addition, approximately 15 million will be utilized to purchase kegs to support continuing growth. 3 to 5 million may be used to upgrade the brewery in Cincinnati, Ohio, and 2 to 3 million for investments and technology and other miscellaneous capital investments.

These amounts are current estimates based on our current plans and information. As of March 10, 2008, we have increased our existing line of credit from $20 million to $50 million, and have no borrowings outstanding. We expect that our cash and investment balances as of December 29, 2007, of $95.5 million, along with the future operating cash flow and the line of credit will be sufficient to fund future cash requirements.

We will now open up the call for questions.

(OPERATOR INSTRUCTIONS). Your first question comes from the line of Andrew Kieley from Deutsche Bank. Please proceed.

Hi. Good afternoon, everyone.

Hi Andrew.

Couple questions. First I wanted to ask about entree trends. Obviously, given the numbers that you reported today, looks pretty strong but are you seeing any tail-off in those channels. Because we've seen so many of the restaurant companies talking about the comps getting hit there.

Let me take that. I think we have seen a little bit but it's mixed in with a bunch of other trends going on. One is at the consumer level, there continues to be a strong trading up trend across a lot of food and beverage, but Sam Adams is certainly included in that.

And a second is increasing retailer support. The operators want to encourage that trade-up and they also want to encourage their beverage alcohol business because it's just more profitable for them.

So it's, at this point, hard to tease out each of those three positive things from the overall softness, especially in casual dining, where we sell a lot of beer. So our trends remain reasonably good but I think we're sort of holding our breath to see what happens to the economy in the next three months.

Could you remind us what -- maybe what percent of volume goes through the entree, against at-home consumption?

For us, it's -- we can't get an exact handle on it because we sell to distributors who then sell to on-and-off premise customers. Roughly on the order of magnitude, it's roughly 30 some percent, maybe in the high 30s right now. It's been probably, I don't know, as high as 40 I think. But if I had to guess, and I'm just guessing, because we don't have the exact numbers, I'd say it's in the high 30s.

Okay, thanks. Secondly, I've asked before, but I wondered if you could give us any sense of how much distribution runs through Miller and Coors houses, and if you see that as a risk as we get later into 2008, as those companies potentially consolidate.

It's a big piece of our volume. Again, I don't think we've added it all up, but it's -- I'd just be guessing. It's well over half, anyway, and well over that number and we're, again, it hasn't happened. I think there's going to be some time that's just going to be transition and from our point of view, it's pretty murky at this point. We certainly have a lot of Miller Coors houses now and they perform at least as well as the unconsolidated houses.

Okay. And finally, just wanted to ask, as far as the 2008 outlook or the guidance goes, are you building in any cost benefit there from the new brewery? I know you're trying to get up a good part of the capacity up by the end of the year but I wasn't sure if you were building any actual production cost savings by the end of '08?

I'll let Martin handle that.

Thanks, Jim. Hey, Andrew. I think one of the reasons for our range is that it's a little unclear exactly how much production we will be able to produce in the Pennsylvania brewery this year. We have contractual commitments to Diageo to produce their needs for a period of time first, and we certainly want to position ourselves to be able to put our beer into the brewery if Diageo should not need the production that we have agreed to provide them. And-- but depending on that mix will depend exactly what we will see from the facility. So this point in time it's difficult to plan and I'd say we're probably not seeing benefit this year.

Okay. Thank you.

Your next question comes from the line of James Watson with HSBC. Please proceed.

Good afternoon, everyone.

Good afternoon.

Good afternoon.

I had a question about the pricing environment in '08. You mentioned in the -- in your remarks that you were planning to take a 5% increase. I was wondering if that has been implemented so far?

Hey, James.

Yes. Go ahead.

Well, I think Jim just answered yes.

Most -- we haven't implemented all of it but most of it has been implemented, though it's been fairly recently, so I don't think we have any clarity about its impact on our depletions, it obviously doesn't all get implemented at once but the majority of it has been implemented.

Okay. So it happened midway through the quarter, so perhaps for all of '08 we're not looking at a full 5% increase once we take into account the early part of the quarter?

James, I'll let Jim -- Jim, let me handle. James, I think what we said is we're intending to take or plan to take 5% during the quarter. I think if you look at what we did last year, you'll see that we were successful in taking some pricing, so it's not inconceivable that in total we may get 5% for the full year.

Okay. Yes, so you've had very good mix effect for the second half of 2007, because I think you took pricing of 3% but you've gotten 5%, and I'm wondering, one, what is really driving that mix effect? Is that a switch to on-premise. And two, could we continue to see that into '08?

Jim, it's Bill. It's primarily driven by the fact that we had significantly lower discounting in the fourth quarter of this year.

Okay.

I should say of last year.

And will we be able to see that lack of discounting going forward or is that something that's just going to be in the fourth quarter of '07?

I can't predict that at this point in time.

Let me add to that. I think when we say that we intend to execute price increases of 5%, we look at that on a net basis, so it includes front line price increases and discount increases or decreases. So you should be thinking, when we say pricing, that we're talking about net revenue per case equivalent.

Okay. Great. And just one last question on the pricing, what are you seeing in the market? We've read that some of your competitors in the Craft segment are taking up pricing, maybe $1 per six pack. Have you guys seen that in the marketplace and does that have any effect on your strategy?

We compete with a lot of different people, all the way from the large domestics to the imports through to Craft, and there's certainly been a range of responses to these costs. I think we have seen some of the smaller Craft brewers having those kinds of increases and then on the other hand you've got big importers like Corona and Heineken with much smaller increases, so it's all a big mix and I don't think that you could look at any individual slice of it. It's sort of a mixture of a bunch of different competitors with a range of price increases.

Great. Thank you very much, guys.

Your next question comes from the line of Andrew Sawyer with Goldman Sachs. Please proceed.

Follow-up question on the brewery investment. I guess I was just looking at it, it looks like your rough investment is going to be on the order of $120 million and I was wondering if you could kind of scope out for us how you think about getting returns on that investment. I think if you think about as a bogey, a 10% after tax return would require about 20 million of pretax cost savings. Is that the right way to think about it heading into '09? If not, how should we be thinking about getting the returns on that investment?

Hey Andrew, it's Martin. I think what we tried to do in our communication is lay out the many facets that go into the decision to buy or to build a brewery, and certainly in comparing the alternatives on the contract brewing front, we have a declining availability of contract capacity. We have that capacity concentrating in fewer hands. We actually have our own growth causing problems in getting access to contract capacity because we're such a significant piece of it.

And then the prices that people are willing to provide contract capacity also increasing. So you know, against that backdrop, our decision to proceed with the purchase and operation of a brewery was based on our projections of all of those trends.

So I think, you know, given that it is actually quite difficult for you to model and we are at this point unable and unwilling to provide some clarity as to what we think the cost of goods is going to be next year, because frankly we haven't brewed there yet. And once we've brewed there and we have a good sense of yields and labor costs and efficiencies and other things, we'll be in a much better position to do that and I think we'll probably be there sometime third quarter.

So at this point in time I'm not sure I can directly answer your question, other than to say that we compared it to what we anticipated the alternatives to be and we decided it was a really good business decision.

All right. Well, thank you very much for that, Martin.

Your next question comes from the line of Philip Cane with [Trustan] Investment. Please proceed.

Yes, I was just wondering if you valued your inventory on a LIFO basis, would that make a big difference in the profit figures, your value on FIFO?

I don't have that information in front of me so I just can't comment.

Okay. At the closing, are you -- do you plan on drawing down your cash balances or using your line of credit to come up with that money?

Could you expand on the question? I don't think I fully understand.

Okay. I mean you have a 50 million line of credit, you have close to 100 million in cash and equivalents, are you going to draw down your cash balances at the closing or are you going to draw on your line of credit instead.

I don't think I can actually answer what our intent is. I would just refer you to our historical practice which is to have the line of credit available. But I think historically, I'm trying to think whether we've ever actually drawn it down. I don't think we have. I would just refer you to that history.

I see. And in terms of Diageo's output from the Lehigh Valley plant, do they plan on keeping the output at pretty much the same levels of the past couple years? They make Smirnoff Ice there, right? And then taper it off? Or have they indicated a big decrease in their plans for the output there.

I don't think it would be appropriate for me to indicate, one, what products they produce there or indeed what their volume plans are. What I can indicate is that we have some contractual commitments that we are required to meet to produce their needs, if they should request. And as such, it makes it very difficult for us to estimate the effect of the brewery on our operating cost this year and even in the first half of next year.

I see. Okay, thank you.

Your next question comes from the line of Lyron Bentovim from Skiritai Capital. Please proceed.

Good afternoon, guys. I want to focus on the buyback. How much money have you guys used in the buyback over the last couple years?

I think we've disclosed that in our filings.

You talked about it earlier, a couple minutes ago.

Yes.

What was the number you stated, since you started the buyback program or whatever?

Is your question how much we repurchased of stock since the beginning of our start of the buyback program?

In your initial kind of comment you mentioned the number, like a hundred and something million, kind of reconciling, trying to figure out how much shares you bought, what average price and so forth.

Yes, we repurchased $114 million of stock. It's right in the -- it's in the release so I'm sure you can do the math of -- and we have repurchased approximately 8.5 million shares.

8.5 million shares since when?

I believe it started either early 2000 or late '90s.

Late '90s.

Yes, I wasn't here then.

Yes, it was in the late '90s.

Thank you, ladies and gentlemen. There are no additional questions. At this time I would like to now turn the call over to your host for today for closing remarks.

Well, thank you very much. We look forward to --

Jim, if I could just add, I think in future our intention is to issue our release after the market close and we would then propose a 4:30 conference call. For those of you who have been on our regular conference calls, we've always tried to do the release in the afternoon and then do a 4:00 call.

But given market conditions and some advice we received, we're going to move to releasing our announcements after the market closes and then having a call immediately afterwards. Hopefully that will still meet everyone's schedules and work needs, and I think that's currently all we have to say.

Thank you, we appreciate the participation and we'll see you next quarter.

Thanks, all.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.