Boston Beer Company Inc (SAM) 2008 Q4 法說會逐字稿

At this time, I would like to welcome everyone to The Boston Beer Company 2008 fourth quarter earnings release conference call. (Operator Instructions). Thank you. I would now like to turn the call over to Mr. Jim Koch, Founder and Chairman of The Boston Beer Company. Please go ahead sir.

Thank you. Good afternoon, and welcome. This is Jim Koch, Founder and Chairman and I'm pleased to be here to kick off the 2008 fourth-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 and then hand the microphone over 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 fourth quarter and 2008 fiscal year, as well as the outlook for 2009. Immediately following Bill's comments we will open the lines up for questions.

We reported 2% depletions growth in the fourth quarter, bringing the depletions growth for a second half of 2008 to 7%, as compared to 10% depletions growth in the first half of 2008. Our trends in the first two months of 2009 have slowed slightly from the fourth quarter. And while the better beer category appears reasonably healthy, we believe we may be losing share in recent months as the drinker is faced with more choices. We believe that craft beer will continue to grow and that we are well positioned to share in that growth through the quality of our beers, our innovation capability and our sales execution, coupled with our strong financial position and ability to invest in growing our brand. While we are disappointed with our recent depletion trends, we believe that the history, authenticity and quality of the Samuel Adams brands, our unique beers and our ability to invest will position us well for future growth. We are also proud of our acquisition and integration of our Pennsylvania Brewery during 2008, and especially pleased that we were able to meet the product demands of our wholesalers and drinkers without disruption during this important transition. I will now pass over to Martin for a more detailed overview of our results.

Thank you, Jim. Good afternoon everyone. During the fourth quarter of 2008 we experienced some slowing of trends in our brands, as did the imports in the overall craft category. As we enter 2009, this has continued and we have also seen signs of inventory reductions of both retail and wholesaler levels which could depress shipments and depletion levels. We believe these effects are generally reflective and consistent with recent economic developments, and while there is considerable uncertainty about short-term trends, we remain confident about the long-term prospect of our category and brands. We feel we are in a good position to compete effectively through the strength of our brand, our sales force and our ability to invest in long-term brand-building activities and that this positions us well for the future and should enable us to gain share.

Brewing and packaging volumes at the Pennsylvania Brewery increased compared to third quarter levels, but is yet to reach its expected full potential as we continue to co-pack for Diageo. Through the end of fiscal year 2008, we had spent $43.9 million on capital improvements at the Pennsylvania Brewery to upgrade portions of the facility and to restock the brew house with several additional projects committed to, and in progress, but not yet completed. Most of the major investments necessary to upgrade the facility have been completed, and we will now move to focus on projects that will drive efficiency and increase productivity.

We have been experiencing some higher operating expenditures than expected, mostly in material yields, repairs and maintenance, and compensation costs. However, as we look forward to 2009, we believe we will make progress on the efficiencies, capacity, and costs at our breweries as we start to benefit from the investments we are making.

We are pleased with our decision to purchase the Pennsylvania Brewery, with the tremendous effort made by our whole employee team during the acquisition and start-up and with our progress to date. We believe that owning our own breweries puts us in a good position to control our brewing future and to improve our efficiencies and costs long-term.

On April 7th, 2008, we announced a voluntary product recall of certain glass bottles of Samuel Adams products. The recall process was substantially completed during the fourth quarter. We made no material changes in our estimate of overall recall costs during the quarter. We continue to evaluate potential legal avenues we may pursue as a result of the recall, but cannot comment on any definitive plans at this time.

Now Bill will provide the financial details.

Thank you Jim and Martin. Good afternoon everyone. We reported net income for the fourth quarter of 2008 of $3.6 million or $0.25 per diluted share, a decrease of 46% or $0.21 per diluted share from the fourth quarter of 2007. The decrease was primarily driven by increased costs of raw and packaging materials, Pennsylvania Brewery costs, which included start-up expenses and an impaired asset charge relating to investments in the Latrobe Brewery. For the fourth quarter of 2008, net revenue increased $11.6 million or 13%, as compared to the fourth quarter of 2007. Net revenue increased due to volume and pricing of core products and noncore revenue associated with the production under the Diageo contract.

Our core shipment volume for the three months ended December 27th, 2008, was approximately 505,000 barrels, a 3% increase over the same period in 2007. We believe that wholesaler inventory levels at December 27th, 2008, were slightly higher than last year's levels as reflected in shipments exceeding depletions for the full year, and we currently expect that such inventory will unwind during 2009.

Cost of goods sold increased $16.3 million, primarily due to the increased cost of raw and packaging materials, increases in volume for core products, and the Pennsylvania Brewery start-up costs. General and administrative costs increased by $2.4 million during the quarter as compared to the prior year, driven primary by the addition of reoccurring planned administrative costs related to the Pennsylvania Brewery and a reimbursement in 2007 of prior period legal costs, due to a settlement reached in the fourth quarter of 2007 with insurers.

During the fourth quarter of 2008, we stopped brewing at the Latrobe Brewery. After reviewing the circumstances under which brewing at the Latrobe Brewery could restart, we determined that an impairment charge for related machinery and equipment of $1.9 million was appropriate.

The income tax provision for the three months ended December 27th, 2008, decreased to $2.7 million from $8.5 million for the same period in 2007, primarily as a result of lower pretax income in fiscal 2008. The provision for income taxes in the fourth quarter of 2007 included an adjustment for certain additional permanent items.

Core shipment volume for fiscal year ended December 27th, 2008, net of recall returns but including any recall related replenishment shipments, was slightly less than 2 million barrels, an 8% increase from the prior fiscal year.

Depletions increased by approximately 8% during the 2008 fiscal year compared to 2007 fiscal year. The increase in depletions is primarily attributable to the increases in [Sam] Adams Seasonals, the Samuel Adams [Brewmaster] Collection, and Twisted Tea. We are pleased with our 2008 growth in depletions that was accompanied by price increases of approximately 5%.

Net income of $8.1 million or $0.56 per diluted share for the fiscal year ended December 27th, 2008, decreased from $22.5 million and $1.53 per diluted share, for the fiscal year 2007, primarily as a result of the product recall and increases in cost of goods sold, advertising, promotional and selling expenses, and general and administrative expenses, partially offset by an increase in net revenue, a decrease in taxes, and impairment charges.

The estimated after-tax negative impact of the product recall on net income was $12 million or $0.84 per diluted share.

The net revenue increased by $56.8 million or 17%, as compared to the 2007 fiscal year due to the increase in core shipment volume, a 6% increase in net revenue per barrel for core products, and revenue from the packaging services agreement with Diageo.

Cost of goods sold increased by $62.2 million due primarily to volume increases, higher package material and ingredient cost, and recall costs.

Advertising, promotion and selling expenses increased by $8.4 million during the 2008 fiscal year, as compared to the prior year, primarily due to increases in freight expenses to wholesalers and salary and benefit costs.

General and administrative costs increased by $10.4 million during the 2008 fiscal year as compared to the prior year, driven by salary and benefit costs, start-up and reoccur planned administrative costs related to the Pennsylvania Brewery, and legal costs.

Our effective tax rate for the 2008 fiscal year increased to 48.9% from the 2007 rate of 46% as a result of lower than expected pretax income, primarily due to the recall, but with no corresponding reduction in nondeductible expenses.

The March 2009 year-to-date shipments and orders-in-hand indicate that gross core shipments will be down approximately 14% versus the same period in 2008. The March 2009 year-to-date shipments and orders reflect volume approximately 2% lower than the depletions from the same period in the prior year. Year-to-date depletions reported to us through February 2009 were down approximately 9% from the same period in 2008, with two fewer selling days in 2009. Year-to-date depletions adjusted for comparable selling days through February 2009 are estimated to be down approximately 4% from the same period in 2008.

We believe we are seeing inventory reductions at wholesalers and retailers, compared to prior years, that could be depressing the year-to-date shipments, orders-in-hand and depletions and that the shipments and orders-in-hand are generally consistent with the depletion trends. Considering those inventory adjustments for the full year, shipments could be expected to more closely mirror full-year depletion trends. Actual shipments may differ and no inferences should be drawn with respect to shipments in future periods.

Looking forward to 2009, based on information of which we are currently aware, we see cost increases of between 7% and 9%, primarily in packaging costs due to a new contract for glass bottles and due to the depreciation and operating cost of the Pennsylvania Brewery. While the costs of operating the new brewery are higher than rates under historic brewing arrangements, under contracts with others, we believe that such costs may be lower than future available contract brewing rates and that the advantages of controlling the brewing process and security of supply outweigh any potential additional cost.

These cost increases will be somewhat offset by price increases currently targeted at 3% and operational efficiency initiatives currently underway. But, we anticipate that our 2009 gross margin percentage could be lower than our full-year 2008 gross margin, excluding the impact of the recall on gross margin in 2008. While we continue to experience healthy pricing environment, there is no guarantee that we would be able to achieve the planned price increases. It is also difficult to predict what full-year volume trends for shipments and depletions will be based on current conditions.

We are committed to trying to grow market share and to maintain volume and healthy pricing and we are prepared to invest to accomplish this even if this causes short-terms earning decreases. Based on our estimates at this time, we are targeting 2009 earnings per diluted share to be between $1.40 and $1.70, but actual results could vary significantly from this target.

We continue to evaluate 2009 capital expenditures, but currently expect them to be between $20 million and $30 million, which includes approximately $7 million of carryover projects committed to in 2008 and in progress at the Pennsylvania Brewery. We anticipate focusing on projects that will increase efficiency and productivity at the breweries, and decisions as to which projects will be undertaken will depend in part on their projected returns on investment. Accordingly, the actual 2009 capital expenditures may be well different from these estimates.

We expect that our cash and investment balances as of December 27th, 2008, of $9.1 million, along with future operating cash flow and our unused line of credit of $50 million will be sufficient to fund future cash requirements. We continue to be in compliance with all of our debt covenants and have affirmed the availability of our line of credit. We have not yet borrowed any funds under the line of credit, and the timing of the future borrowings will depend on the timing of inventory purchases and capital expenditures. We anticipate using the line of credit at some point in time in the next 12 months as we continue our capital investments and have seasonal inventory changes related to hot purchases and other timing issues on certain payments. We expect to end 2009 with no borrowings under our line of credit or incur any other debt.

We will now open up the call for questions.

(Operator Instructions). Your first question comes from the line of James Watson with HSBC.

Good afternoon everyone.

Hi James.

Couple of questions, I will start on volume, just a clarification, you said that the core shipments through March year-to-date were down 14% and that was -- but the underlying volume was down 2%. So, I just wanted to make sure, so we're looking at so far this year, 12% difference between depletions and shipments, and how would that compare to how overstocked you thought inventories were at the end of the fourth quarter?

Hi James, this is Martin, let me take a haggle at this. Let's see, one way to think about how much inventory might have been overstocked is to look at last year's shipments versus depletions, which will be available to you in the 10-K that we will filing, hopefully just a little bit later today, and from that you get a good perspective that there was some inventory build last year, and probably not that significant on a full-year basis, but if that was to unwind on a quarter basis that might show up. What we've seen in our shipments and orders to date through the end of March is obviously a negative trend, significantly greater than the depletion -- the decline in depletions that we are seeing, certainly on a selling day adjusted basis. And so what we tried to do was provide a reference point for you as to how that compared to our depletions over this same time period last year, and obviously that's just off by a couple of percentage points.

Typically, in the first quarter, or -- and indeed in the first half of the year, we would expect to see some wholesaler inventory build, up to the peak selling months of July, and frankly those would continue perhaps through to November and unwind through Thanksgiving and Christmas. We're not sure we're seeing that this year, based on anecdotal evidence and also what our shipments are relative to depletions, and we think that's probably just indicative of how people are behaving in the current economic climate.

Okay, so we are seeing that destocking might be a little more weighted in the first half of the year, especially if that was traditionally when the buildup was?

Yes, and when we say destocking, I think what we're looking at is what we might have expected inventory build to have been over that period of time. We are just not seeing it.

Okay, and as for the slow-down we've seen in the volume, I was wondering just if you can comment on whether that's focused on-premise or off-premise, and if there are any specific brands or geographies that this is weighted in? Just where we are seeing this coming from?

James, what we are seeing is -- may be a little counterintuitive, but we are significantly stronger in the on-premise, where we appear to be continuing to grow. That has been more than offset by what looks like weakness in the off-premise.

And our best guesses as to what is going on give us a number of factors. I think, first, there is just some category catch-up going on. We've significantly outgrown both the craft category and the overall better beer category for three years now as we've expanded distribution, pushed our seasonals, added variety, probably earlier, faster, maybe better than the rest of the category, and there is some catch-up now as other brands are pushing their distribution out adding seasonals and variety.

I think, second, our pricing has been above better beer, and even a little bit above the rest of the craft category. I think there has been some retailer destocking, which shows up in the depletions.

And then finally, there is something doing on with the economy, that while beer is pretty recession resistant, it's probably not unaffected.

That's great. Just a follow-up on the one point, you said your pricing was above the general craft category. Would that make it tougher for you to take any additional pricing to make up for anything in this year?

Well, we've implemented most of our price increases. We started putting them through at the beginning of the fourth quarter last year, and we do it selectively, strategically, but most of them are done now. So, we wouldn't expect further price increases. We've projected about a 3% for this year, and the vast majority of that has already been implemented and has shown up in the market.

Great, thank you very much guys.

Your next question comes from the line of Lindsay Drucker Mann with Goldman Sachs.

Hi Lindsay.

Lindsay, your line is open?

Hey everyone, sorry about that, I was on mute.

No wonder we couldn't hear you.

So, I just wanted to follow up on James' question about the shipments and depletions year-to-date because I was still confused. So, your core shipments year-to-date, down 14%. And, are your depletions down 2% year-to-date or down 12% year-to-date?

Neither. They are down 9% raw numbers. Again, the moves -- months have moved around in a funny way this year and it's not a leap year, there are two fewer selling days in the first two months, and that equates to, as best we can guess about 5%, so if you adjust it for our estimate of this effect of the two fewer selling days, on an apples-to-apples basis we are talking about depletions for the first two months being down 4%. 9% raw, 4% selling day adjusted.

Okay. So, could you clarify on the sentence, the orders from March 2009 year-to-date shipments, orders reflect volume approximately 2% lower than the depletions from the same period in the prior year?

Yes, Lindsay, what that says is if we were reporting in our Q what our orders were for the first quarter, it would be -- it would represent a volume 2% less than we completed last year in that same period of time. And we provided that information to help you understand this destocking issue that's currently going on.

Okay. (Multiple speakers) Sorry.

Does that make sense?

Yes. Yes, I think so.

So on the cost side, Martin you mentioned that as of now you're operating at brewery costs that are higher than what your historic contract arrangements had been. Do you envision those operational costs getting to be lower than what your historic contract arrangements have been as you extract efficiencies down the road?

We certainly see them declining from what we experienced in the fourth quarter. Whether they will reach historic contract levels is probably -- that's probably an extremely stretched target. I think the way we look at it is, is we expect them to match existing contract levels which, frankly, are much higher than the historic contract levels. That again, makes sense?

Does that cost -- does that cost of producing include things like the longer shipping distances? Is that all in or is that just production?

That's just production, the Pennsylvania Brewery actually helps us on the freight side in its closeness to New England, and then there are also some benefits to the west coast due to its closeness to the major New York, New Jersey markets and the [back haul] situation there.

Okay.

But again, one of the things we lost at the end of October was we had a Miller subsidy for our west coast freight. So, that disappeared with the end of our old Miller contract, where they had basically subsidized our west coast freight as if it came from the Tumwater area of Washington. So, that is a change as it relates to the freight going into '09.

Okay. And then is there a way for you to help us better understand what the one-off costs of -- you mentioned some start-up costs and things related to the new brewery that happened in 2008 that won't be repeated in 2009?

We haven't quantified that and put that out for public disclosure. There is obviously the write-off of the brewery asset in Latrobe, the impairment charge. We certainly hope to be brewing in Latrobe again. But, based on the -- our probabilities of potential outcomes we decided that the appropriate thing was to do -- was to take an impairment charge.

We are still producing for Diageo in the brewery in Pennsylvania, and that frankly complicates exactly what our cost fixture is because we have a lot of activities for them around their production that aren't on-going costs. So, I just don't think at this point in time we are in a position to quantify what those might be, but hopefully we will have a better picture later in the year.

Okay, and lastly, when do you think you may have better visibility to some of these operating efficiencies that you talked to?

Well, again I think the situation is complicated by our continuation of the Diageo production relationship, much [as] (technical difficulty) we love them and respect them and have had a great relationship, that relationship ends towards the end of April, beginning of May, and then the brewery will be a brewery with production of our products, and we'll probably have to have six months of operation of that for us to have a good understanding of what our baseline is and also what the potential is. So, I'm thinking -- end third quarter.

Okay. Great, that's it for me for now, thanks very much.

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

Bill, I was just wondering, when you're talking -- for the guidance, that 2009 gross margin might be down, what's the comparable margin you are using for 2008?

Excluding the recall cost, so we have disclosed the recall cost in terms of what the impact has been on both the revenue and on the cost of goods line. The K has been filed. There is a pretty good explanation in the K, Andrew, that should help walk you through that. So, if you exclude that, that would be the base.

Okay. And then I just want to clarify the comment you just made about the long-term margins in the new brewery. When you are saying you don't think it can reach historic contract margins, are we talking about like a 55%, 56% level, or that we would be closer to recent contract margins? What kind of margins does that imply? Is that closer to 50% gross margin? I just want to clarify that comment that you made.

Well, our intention is to manage the business to return to historic gross margin levels. The question that I think Lindsay asked was whether our costs would be the same, and that's certainly a very, very stretched target and may be a very good long-term target which may be helped by some growth. But, I wouldn't put it as a realistic target in the next couple of years to return to historic contract.

Our medium-term goal to make sure the breweries operate as efficiently as our current contract alternatives. Our gross margins goals are certainly to get back to historic gross margin levels. Whether we can do that or not will obviously be a function of our ability to maintain healthy pricing and what goes on on the commodity side of our business as it relates to hops and barley, as well as what's going on with oil and energy type prices. The rest of it, we somewhat have a good line of sight as to how we can improve. Certainly, I think -- like other breweries -- we forward-contract on some of those items for about a year. There's certainly some softness there, and as we look forward, we hope that when we are in a position to contract again we will be able to take the benefit of that softness that we currently see.

Right. Okay. Is the -- then just a little bit more on the guidance. I was wondering first, if on the EPS guidance, if that's a clean number or if there's any one-time items we should be aware of in that EPS guidance? And then second, just looking at the EPS guidance, you're assuming pricing is up a bit, margins flattish. Is there an assumption there about what you think shipment volume does full-year and do you think you can grow core volume in this environment and with pricing moving higher? I guess is the question I would have.

Let me answer the first part of that question. In our guidance, I don't believe that we have forecasted any extraordinary items. We certainly wouldn't plan on doing that, so nothing that we're aware of today. And I'll let Martin answer the second part of that question.

Sure. We put a plan together at the end of the third quarter and we've been massaging it ever since, as there has been obviously significantly greater murkiness as to what volume trends might be and pricing trends and while, frankly being some upside on the cost side. What we wanted to do was communicate an EPS range based on current information and current best guess of volume and costs and all other activities.

I think like any company in currently dealing with the economies -- economic situation that we're dealing with, we've initiated a number of projects to try and find efficiencies and resources that we can move to brand-building activities or to support additional volume, and what we tried to communicate was if we have those opportunities, our preference is to maintain share, maintain healthy pricing and grow volume, as opposed to maintaining earnings, because we certainly believe that the things that we want to grow are more valuable long-term than just the short-term earnings picture. That being said, based on what we currently know, this is our earnings guidance and we will be updating it on a quarterly basis.

Okay, sorry, just one last detail. Could you just remind us of what the full capacity of the new brewery is now and maybe by year-end, and do you think it will be fully utilized capacity by the end of the year?

I think we anticipate brewing about two-thirds of our beer there on an annualized basis once the Diageo contract is over. The brewery actually, we believe has the potential to produce more than that with the addition of some capital expenditures in the bottleneck areas and also some enhancement to some efficiencies in some areas, and certainly the basic backbone infrastructure is there to go up to 2 million barrels.

Okay, thank you.

(Operator Instructions). Your next question is a follow-up from the line of Lindsay Drucker Mann with Goldman Sachs.

Everyone, thanks for the follow-up. I was curious if you could talk to why we've seen in the Nielsen data, so for the grocery store data, your volume trends have been so weak in the past few months?

Yes. They have been much weaker than other categories for us. I think some of it is what I talked about earlier that there's just more shelf space to craft beer now as the category catches up to our leadership in expanding distribution and seasonals, and pricing shows up a little more there than on-premise. There is so much other noise in on-premise costs that if your keg prices go up a bit, they may or may not be adjusted at that point. And third, we had a little -- in January and February, we believe we had a little less display and ad activity in January and February, some of which we think we are getting back in March. So, yes, the Nielsen numbers look worse than the rest of our business.

Okay. And is -- we've seen a couple of years now where you've had more shelf space and distribution points allocated to craft categories. Is 2009 a year where you anticipate that to continue?

We think so. The category still has a lot of strength and vitality to it. A lot of consumer interest in it. So -- and retailers need higher profit items that have decent volume, and craft category is taking space as a result.

Okay. Thanks. And then lastly on the advertising side, are you guys shifting any of your ad spend or advertising strategy to meet the consumer in this different economic climate?

Yes. A little bit. We are not going to make a major change that we foresee. But, there is some sort of tonality differences because the climate has changed. Obviously, the consumer is in a different place than they were six months ago when we put our plan together.

Okay. Thanks very much.

Thank you.

There are no further questions at this time, I would now like to turn the call back over to Mr. Bill Urich.

Yes, thank you everyone, and we will talk to you at the first quarter earnings release.

Thanks too.

Thank you.

This concludes today's conference. You may now disconnect.