Boston Beer Company Inc (SAM) 2009 Q2 法說會逐字稿

Good afternoon, my name is Kayla, and I will be your conference operator today. At this time, I would like to welcome everyone to the second quarter 2009 earnings 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.

I would now like to turn the call over to Mr. Jim Koch, Founder and Chairman. Please go ahead, sir.

Thank you and good afternoon and welcome. This is Jim Koch, Founder and Chairman, and I'm pleased to be here to kick off the 2009 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, 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 second quarter. Immediately following Bill's comments, we'll open the line up for questions.

We reported a second quarter depletions increase of 2% compared to the second quarter of 2008, adjusted for comparable selling days. Our depletions growth in the quarter was an improvement over the decrease in the first quarter. We believe that while underlying trends improved slightly, most of this improvement is due to the comparison to a period impacted by the voluntary recall that was announced in April of last year.

We continue to face increased competition from expanded distribution of regional craft brands and domestic specialty brands and adverse economic pressures that could be affecting our drinkers' willingness to trade up as often. We believe that the quality of our beers, our innovation capabilities and our sales execution, coupled with our strong financial position and the ability to invest in growing our brand, will position us well to maintain our brand health and for future growth.

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 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 and 10-Q. 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.

During the second quarter of 2009 we continued to experience declines in our underlying brand volumes, but these declines appear to be slower than those experienced in the first quarter. Looking forward, we feel we are in a good position to compete effectively through the strength of our brand and our sales force and are currently projecting that we should finish the year with flat depletions.

During the second quarter our investment in our media, advertising and sales force were increased relative to the first quarter spend and exceeded historic levels for the second quarter. For the third quarter, we have added radio advertising to this mix, as we believe this is a good time to be increasing investment in our brands. We are prepared to forsake some earnings in the short-term in order to make appropriate investments in brand building activities to position us well for future growth.

Our Pennsylvania brewery continues to brew great Samuel Adams beer. Now that the packaging services agreement with Diageo has concluded, the brewery is dedicated solely to brewing our beer and our gross margins are starting to look better as the Diageo volumes were very low margin. We have also started to see some efficiency gains as the brewery focuses on brewing. We do not believe we will know the full impact of brewery ownership on our costs until the end of the third quarter, which will be our first full quarter with no contract volume. The major investments necessary to upgrade the facility have been completed and we are now focused on a multiyear program to identify and execute projects that will drive efficiency and increase productivity to bring this brewery's economics closer to what we had planned and to maximize capacity.

Shipments and orders in-hand suggest that core shipments year-to-date through August 2009 will be down approximately 1% compared to the same period in 2008 and after adjusting the 2008 shipments for the total volume credited to wholesalers for the product recall during 2008. Actual shipments may differ and no inferences should be drawn with respect to shipments in future periods. We believe inventories at wholesalers at the end of the second quarter were at appropriate levels, given the current volumes and trends.

Now Bill will provide the financial details.

Thank you, Jim and Martin. Good afternoon everyone. We reported net income for the second quarter of 2009 of $11.9 million or $0.83 per diluted share, an increase of $3.4 million or $0.23 per diluted share from the second quarter of 2008. The increase in net income is primarily due to the product recall costs of $5.6 million that were incurred in the second quarter of 2008, and lower advertising, promotional and selling costs, offset by a decrease in underlying gross profit and an increase in the provision for income taxes.

Core shipment volumes for the three months ended June 27, 2009 was approximately 572,000 barrels, a 3% decrease versus the same period in 2008. Excluding the impact of the recalled product, core shipment volumes decreased 5%. The total company depletions in the second quarter increased 2%, adjusted for comparable selling days.

Our second quarter 2009 gross margin of 53% represents an increase of 2 percentage points over our second quarter 2008 gross margin that included the impact of the product recall. Excluding the impact of the recall, our gross margin has decreased by 1 percentage point. The decrease is primarily due to higher costs, driven by an increase in package material costs and the cost of operating the Pennsylvania Brewery, that were only partially offset by our realized price increases of 3%.

Advertising, promotion, and selling expenses decreased by $4.6 million as compared to the second quarter of 2008, primarily as a result of decreases in freight expenses for shipping beer to wholesalers, driven by reduced fuel costs, as well as the timing of marketing programs and more efficient purchasing of media.

We recorded a tax provision in the second quarter of 2009 of $9.5 million compared to $6.9 million in the second quarter of 2008. We currently expect our full year tax rate to be approximately 44%.

Consistent with our prior guidance and based on information of which we are currently aware, and our projection that the 2009 depletions will be flat to 2008, we continue to project 2009 earnings per diluted share of between $1.40 and $1.70, but actual results could vary significantly from this target. The current conditions make it especially difficult to predict what full year volume trends for shipments and depletions will be. We are committed to maintaining volume and healthy pricing and are prepared to invest to accomplish this, even if these investments cause short-term earning decreases.

We continue to evaluate 2009 capital expenditures and continue to expect them to be between $15 million and $25 million. This amount includes approximately $7 million of carryover projects committed to in 2008 at the Pennsylvania Brewery and completed during the first half of 2009.

We are focused on projects that will increase efficiency and productivity at our breweries. Decisions as to which projects will actually be undertaken will depend in part on their projected returns on investment. Accordingly, actual 2009 capital expenditures may be well different from these estimates.

We expect that our cash balances as of June 27, 2009 of $28.6 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 the covenants under our credit facility.

We will now open up the call for questions.

(Operator instructions) Our first question is from Lindsay Mann with Goldman Sachs.

Jim, I was hoping you could clarify; you mentioned that depletions in the quarter up 2% but you think that has to do with the comps. Do you have a sense of what you think the underlying run-rate is?

I'd just be guessing, because the recall moved a lot of numbers around and the reporting that we got back from our distributors on it, while good, was not always complete or uniform, so it would just be guessing. It's probably flat to slightly below that, if I had to make an estimate of what I would guess the underlying run-rate would be, so a few points or more below that.

Can you give us a sense of how your trends are running on on-trade versus off?

We are doing better on than off, especially in terms of gaining share. Obviously the off-premise business has been healthier this year than the on-premise. For us, the numbers are much, much closer, if not within the range of error. So we believe we are gaining share of on-premise business and not doing so well off.

And then just turning to the brewery project; could you actually remind us what you expect -- what your brewing capacity will be at Lehigh as we look to year-end and what percentage of your beer you anticipate to be brewing in-house say at year-end and maybe over the next year?

I think Martin is probably the best person to answer that one.

I think this year we're hoping to finish the year with only those packages that we do not have physical capability to package, brewed within our breweries in Cincinnati and Pennsylvania. So those would be smaller packages that we carry, a little bit of can business and some other sort of specialty packages that our fillers are not capable of dealing with. So, if I was to guess what the percentage of production that was under our own breweries, it would be order of magnitude 95% plus or minus a couple of percentage points.

In the first half of this year, we did contract brew some production at some other locations that could have been transferred into our breweries. And I think as we look at 2010, our hope is that we can continue to streamline operations and expand capacity with minimum capital investment just through operating efficiencies and just getting better at running a brewery to deal with our own growth. But there's always the possibility that we will need more contract capacity for brewing.

As it relates to specifically what that capacity is, I think when we purchased the brewery we said we hoped to do about 1.4 million barrels through the brewery and I think that's going to be probably roughly right for the next 12 months it's going to be roughly what we do and that, combined with Cincinnati, would get us up close to the 2 million barrel mark, which is probably just a little higher than our current running rate.

We do have options to expand the capacity of the Lehigh Brewery. We are really constrained by how efficiently we actually are running it. There's the capital equipment in place to do a little bit more capacity and our constraints are sort of bottling line efficiencies and speeds and we're working hard on those. I would not want to project to where we could take it, but we certainly believe that the Pennsylvania Brewery could support company growth for the next couple of years, provided we can finish our debottlenecking.

Okay, that's really helpful. And just wondering, am I correct in thinking that as you move everything in-house, the money that you're spending to co-pack with other brewers you'll no longer be spending and the D&A that you're booking in the current quarter maybe in the next quarter is kind of the run-rate until you start spending more, laying out more to expand the brewery if you choose to do that?

We intend to maintain some contract relationships so that we have flexibility should our growth accelerate or should we have the need to replace production capacity at our own breweries, so we expect to maintain those relationships. With regards to your question, which I think was sort of on depreciation expectations, we've tried to give you a sense of what our capital this year would be and my guess is that that would sort of be the rate that you might expect if we aren't experiencing volume growth.

Your next question is from James Watson with HSBC.

Starting out with volumes, I just have a question about a few of the factors that you guys talked about in the first quarter, though not today, that was destocking that you saw and some of the price gaps with the import beers and perhaps other craft beers now and I was wondering if you could comment on those?

We indicated at the end of last year that we felt that wholesaler inventories were a little higher due to basically shipments in 2008 exceeding depletions in 2008 by a slightly higher than expected margin. I think in the first six months we think that has corrected itself. The wholesaler inventories look to us, and this is not a science, but they look to us like they're in the range that they should be. So, the shipments that happened in the first six months were probably a little less than would otherwise have been if we'd started the year with wholesaler inventories at a more normal level.

With regards to pricing, we did execute pricing in select markets in the first quarter. Most of our pricing took, I think we were happy to find. There were a couple of markets where through competitive and retail pressure, we had to give some back, but we're generally happy with pricing. Based on our observations, most of the imports did not move and some craft chose not to move, but most craft did, so there were some price gaps opened up against, particularly the major imports and frankly I think we're happy with our volume trends relative to theirs.

Okay. You guys mentioned, it looks like core volumes were down 3%, if I read that correctly, through the end of the second quarter, but then you guys mentioned it was down 1% through August. So am I correct in thinking that August is pretty strong?

I think you're talking about orders and shipments, right? I think you can break out based on what we said, shipments were through the first six months of the year, what orders currently look like for July and August, and beyond that we would not want to comment on such isolated data. Frankly, we like to manage the business off of depletions and it's too early to tell what July looks like.

Okay. Last question is just on the advertising, promotional and selling expenses. They were a lot lower and I was just wondering how much of that, if you could break out, was the freight expenses, how much of it was related to volume or how much of it is related to lower media costs?

James, we have historically only broken it out annually in the 10-K, but I think it's safe to assume, given where oil is today versus where oil was this time last year, that our freight rates and fuel surcharges were significantly lower and that's the primary driver of the difference. And then as we indicated I think in the press release and in our opening comments, we actually raised our brand support spending in terms of people and advertising in the second quarter and indeed intend to raise it again in the third quarter. We are viewing this as a good opportunity to be active and to increase our share of voice.

(Operator instructions) Follow up question from Lindsay Mann with Goldman Sachs.

I wonder if you -- I know it's probably still pretty early days, but have a sense of how the Massachusetts sales tax increase is impacting your business?

Oh, we're sort of three days into it and I have to admit, I have not had reports from the field as to how the retailers in Massachusetts feel and how the retailers in New Hampshire feel. If I was to guess, the retailers in New Hampshire are very happy.

Okay thanks. And just sort of bigger demand picture, Sam Light's been under quite a bit of pressure recently in the scanner data and I was just wondering what your thoughts are on the longer term outlook for that brand?

We think long-term, you know, our vision for Better Beer is for Better Beer to continue to grow and ultimately to reach 30% to 33% of the beer industry, which would seem to sort of equate with where high-end categories and other drinks categories have reached. And in order for that to get there, we think that the light Better Beer category needs to play a role. And I know we're not alone in that, in that some of our major import competitors have the same view and have pushed hard on their offerings.

I think all of us are struggling a little bit with the economy, as the light brands seem to be a little bit more susceptible to trade down perhaps or trade out. But we're committed to the brand long-term and we think that it will be an important part of our brand portfolio and we continue to invest in it with media and other point of sale and promotional support.

And then lastly, just on hops prices; can you give us an update on what's going on in that market?

Sure. I'd have to admit that I am not completely up to speed on this, so I will give you my perspective and then if anyone else in the room or on the call has information, maybe they will chime in. About two years ago, we contracted out our hops needs for quite a while. We had been, we felt, squeezed by some other major suppliers coming in to buy the varieties that we like to buy and we protected ourselves. So from our perspective, we are pretty locked in.

Given some of the cost efforts that are going on and everyone's looking at their inventories and hops positions, there have been some offers for German Noble hops that are significantly below sort of future purchase price, and those have been offered basically because some people have some excess due to some of the sort of ordering that took place in the last two years. But that's not really going to affect us. We think long-term outlook for hops is prices will be softer than what we entered two years ago, but ultimately it's all going to be a function of weather in those key growing areas in Germany.

They obviously got hit by a hail storms in April-May that wiped out some hops fields that will address some of the glut of hops that exists that's forcing these slightly depressed prices. And so I think we're just going to see hops return to their normal steady state going forward, because if there is a slightly weak crop this year, it will be dealt with by people who have excess inventory and everything will stabilize. We have limited to zero visibility on the US hops situation, because our purchases of those hops are diminuous.

Your next question is from Andrew Kieley from Deutsche Bank.

Jim, I was wondering if you could talk a bit, I guess more at the broad consumer behavior level about what's going on in the off-premise, do you think consumer behavior has sort of bottomed here in terms of trade downs? Are you seeing any signs for optimism?

I think in terms of signs for optimism, I would look to the continuing health of the craft category, especially off-premise. And what I'm seeing is an increase in shelf space for craft beer, as the category maintains good volume growth and healthy pricing in an otherwise difficult economy. What is that? For us that has meant that as opposed to a couple of years ago when we were outgrowing the craft category, today the craft beer consumer has a lot more choices.

And I think many of our fellow craft brewers have in a sense followed our lead in what we did maybe four years ago, by focusing on a very healthy seasonal program and putting on the shelves attractive additional styles. And as a result, not only is there more space for craft, but it's being filled by some attractive brands. And that would be my take on the primary thing driving the situation where craft is growing faster than we are, and you sort of couple that with a consumer who is at this moment experimenting with these newly available brands.

Okay. Then at the distributor level, I was wondering if you're feeling any impact or if there's any disruption at all, as you see consolidation at the distributor level and are you happy with distribution the way it is for you currently or do you see any shifts in the future there?

I wouldn't say that we've seen any real major discontinuity in our distributor base, despite the move of the big brewers to consolidate their networks into fewer wholesalers. It really hasn't been that much different than it's always been. The consolidation of wholesalers has been a fact of life for 25 years. So, from our point of view, there's really no major disruptions from what's going on at the Miller Coors and the A-B InBev level.

Okay. Then I just wanted to get more perspective on gross margins, I guess. We had three or four quarters where we were down in the mid 40s and obviously it's a big jump up this quarter. Do you think that sort of low 50s level is sustainable now that you're doing more in-house brewing or are there other factors for the rest of the year that we should think about in terms of commodity cost inflation or anything else?

Jim, why don't you let me try and handle it and you can chime in. We're obviously happy with our gross margin in the quarter. If you look back a couple of years, it's not as good as it was a couple of years ago. The key changes from a couple of years ago are significantly increased glass costs as a result of a new glass contract, which is probably not reversible. It's unlikely to go down significantly. We're getting some alleviation due to natural gas prices, but fundamentally our cost position on glass was changed. And then we've also got higher barley costs that are a significant contributor to gross margin decline in the last two years.

And then just the acquisition of the brewery and the startup and sort of basically not running it as efficiently as we would see us running it long-term. We're still in efficiency ramp-up mode, plus carrying Diageo volume which was contract to act at significantly worse gross margins than our regular shipments. I think all of those things depress gross margins relative to two years ago. I think this is the first quarter that you see the Diageo impact was only a month worth and we're starting to see some signs of efficiency gains at the breweries that we're excited about, but it's still very early stages yet.

Our long-term sort of bonus for Management goal is to try and return gross margins to the levels they were several years ago. I think we all recognize that's a stretch, but that's what we've bonused ourselves on and that's going to take a while. But that's the challenge and if we're able to generate some extra volume and the return on the capital projects that we would like, plus the day to day line operating efficiencies, we think that's possible, particularly coupled with price increases.

Okay. Then just one more on the cost side. In terms of the freight savings, how much of that savings was a function of spot prices in fuel versus changes in your shipping contracts?

I'm not totally sure I understand the question as it relates to spot buying versus freight contracts. But fundamentally, two years ago we had a supply network that consisted of Cincinnati Brewery brewing at High Falls in Rochester, brewing with Miller in Eden, that was shipping to the West Coast for us and paying West Coast freight, and a couple of other sort of more minor locations. And we are now in a situation where most of our brewing is in Cincinnati and Lehigh. And so that's the big shift and we're now shipping to the West Coast under our own dime.

So from that perspective we've seen some upward pressure on our cost per cases, because we're shipping from East to West on our own dime. That being said, I think we've been very pleased with the freight weights that are available from our breweries to the West Coast, based on empty return trailers that are going past their door. So it isn't as bad as we thought it was going to be.

As it relates to what's gone on over the last six to nine months on freight, obviously we've seen the fuel surcharges collapse. They're still there because of how our freight contracts read, but they've sort of collapsed and there have been opportunities to renegotiate the contracts, because there is more traffic, so some of it's due to that. But frankly, the traffic contracts renegotiation has only happened in the last couple of months, so I'm not sure the effect of that has been seen yet.

Okay. Then just a final question on the shipments and depletions timing. It sounds like for the rest of the year those should be sort of more in line timing wise; we shouldn't have the mismatches that we've had the past couple of quarters?

Obviously really hard to predict. The mismatches tend to happen when wholesaler expectations for what they're going to deplete get out of whack with what they actually deplete. My sense is everyone's looking at it right now and looking for maybe planning for flat and if they're ordering for flat, then inventories are going to be at the right level at the end of the year. But if they order for flat and were down 3, then we're going to have some inventory build that we'll be talking about that will need to work its way through. And frankly, if they order for flat and we're up 2 or 3, we might have some shortfall and we'll have to catch that up. So, it's really hard to tell.

As we've said before, we try to focus on what they're shipping into retail is the best indication of business trends. We were happy we're up in the quarter but we do think that was due to the recall and the trends are probably negative, but slightly better than the first quarter, as Jim alluded to. And as we look out, our target for the year is to try and finish flat. There's a lot of hard work and heavy lifting that's going to be needed to do that, but that's our current goal.

Thanks and congratulations too on participation in the Presidential Beer Bash. That's quite a marketing coup there you pulled off.

We were lucky.

(Operator instructions) There are no further audio questions at this time. You may continue with any closing remarks.

Thank you everyone for joining. We'll see you on the third quarter earnings call. Thank you.

Thank you. Bye-bye.

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