Boston Beer Company Inc (SAM) 2019 Q1 法說會逐字稿

Welcome to The Boston Beer Company First Quarter 2019 Earnings Call. (Operator Instructions) Please note this conference is being recorded. I will now turn the conference over to Jim Koch, Founder and Chairman of The Boston Beer Company. Thank you. You may begin.

Thank you. Good afternoon, and welcome. This is Jim Cook, Founder and Chairman. And I'm pleased to be here to kick off the 2019 first quarter earnings call for The Boston Beer Company. Joining the call from Boston Beer are Dave Barwick, our CEO; and Frank Smalla, our CFO.

I'll begin my remarks this afternoon with a few introductory comments, including some highlights of our results, and then hand over to Dave who'll provide an overview of our business. Dave will then turn the call over to Frank who'll focus on the financial details for the first quarter as well as our outlook for 2019. Immediately following Frank's comments, we'll open the line for questions.

Our total company depletions increased 11% in the first quarter, and we had our fourth consecutive quarter of double-digit depletions growth. We believe this is attributable to our key innovations, the quality of our products and our strong brands as well as successful 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 overwhelming number of options to drinkers.

We remain positive about the future of craft beer and are happy that our diversified brand portfolio continues to fuel double-digit growth. We're disappointed with our Sam Adams brand trends and continue to work hard on our brand messaging, focusing on the quality and care that goes into brewing our Sam Adams Boston Lager, along with a significant package redesign that is now hitting shelves and the recent release of our new lighter and brighter recipe for Sam Adams Summer Ale. We plan to continue to invest in the coming months to improve trends and remain focused on the long-term goal of returning Samuel Adams to growth.

While it's too early to draw long-term conclusions, we received very positive reactions from distributors, retailers and drinkers on our new Sam Adams packaging design and the new taste profile for Sam Summer Ale. We're confident in our ability to innovate and build strong brands 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 afternoon, everyone. Before we review our business results, I'll start with the usual disclaimer. As we state in our earnings release, some of the information discussed 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 such forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in the company's most recent 10-K.

You should also be advised that the company does not undertake to publicly update forward-looking statements whether as a result of new information, future events or otherwise. Okay.

Now let me share a deeper look at our business results for the first quarter. We had a good start to the year and are happy with our record first quarter shipment and depletion volumes. First quarter shipment's growth was significantly higher than depletions as we took active steps to ensure there are distributor inventory levels are adequate to support drinker demand during that peak summer months. Our depletions growth in the first quarter was a result of increases in our Truly Hard Seltzer and Twisted Tea brands that were only partially offset by decreases in our Samuel Adams and Angry Orchard brands.

Truly continues to grow beyond our expectations. We're expanding distribution across all channels and improving our position as a leader in hard seltzer as more competitors enter the category. Twisted Tea continues to generate double-digit volume growth, consistent with 2018 full year growth trends. Angry Orchard's volume declined against the first quarter 2018 national rollout of Angry Orchard Rose. We expect Angry Orchard to improve for the remainder of the year and are excited about our brand investment plans and the national rollout later in the year of Angry Orchard Crisp Unfiltered, an homage to traditional American cider with a less sweet fresh apple taste.

Our new brands in 2019 address important health and wellness and active lifestyle opportunities in our categories and include 26.2 Brew from our wholly-owned affiliate, Marathon Brewing Company, a refreshing Gose beer brewed with sea salt to fit runners' active lifestyle and flavor preferences. We recently sponsored the Boston Marathon and to date the response from our distributors, retailers and drinkers on 26.2 Brew has been very positive, but it's too early to draw conclusions on the longer-term impact.

Given our trends for the first 3 months and our current view of the remainder of the year, we've adjusted our expectations for higher 2019 full year depletions growth, which is primarily driven by the strong performance of our Truly brand. These volumes come at a higher incremental cost due to the increased usage of third-party breweries, which is negatively impacting our gross margin expectations for the year. We're in a very competitive business, but we're very optimistic for continued growth of our current brand portfolio, and 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 through the 15 weeks ended April 13, 2019, are estimated to have increased approximately 12.5% from the comparable weeks in 2018.

Now Frank will provide the financial details.

Thank you, Jim and Dave. Good afternoon, everyone. For the first quarter, we reported net income of $23.7 million or $2.02 per diluted share, an increase of $1.24 per diluted share from the first quarter of last year. Net revenue increased significantly compared to the first quarter of 2018, driven by the planned acceleration and declining of shipments during the year to support current and anticipated growth and demand. The increase in net income reflects the higher net revenue, partially offset by increases in operating expenses and lower gross margins.

Shipment volume was approximately 1,076,000 barrels, a 32.5% increase compared to the first quarter of 2018. Shipments for the quarter increased at a significantly higher rate than depletions and resulted in significantly higher distributor inventory as of March 30, 2019, when compared to March 31, 2018. The company believes distributor inventory as of March 30, 2019, averaged approximately 6 weeks on hand and was at an appropriate level based on inventory requirements to support the forecasted growth of our Truly and Twisted Tea brands over the summer.

The company expects wholesaler inventory levels in terms of weeks on hand to return to more normal levels of approximately 3 to 4 weeks on hand later in the year. Our first quarter 2019 gross margin decreased to 49.5% compared to 50.5% in the first quarter of 2018, primarily as a result of higher processing costs due to increased production at third party breweries, higher temporary labor at company-owned and higher packaging costs, partially offset by price increases and cost- savings initiatives at company-owned breweries.

First quarter advertising, promotional and selling expenses increased $4.2 million compared to the first quarter of 2018, primarily due to increased investments in media and production, higher salaries and benefits costs and increased freight to distributors due to higher volumes. General and administrative expenses increased by $4 million from the first quarter of 2018, primarily due to increases in salaries and benefits and consulting costs.

During the first quarter, we recorded an income tax expense of $6.1 million, which consists of an income tax expense of $7.9 million, partially offset by a $1.8 million tax benefit related to the stock option exercises in accordance with ASU 2016-09. The effective tax rate for the first quarter excluding the impact of ASU 2016-09 decreased to 26.5% from 28% in the first quarter of 2018.

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. Excluding the impact of ASU 2016-09, our actual results could vary significantly from this target. We are currently planning increases in shipments and depletions of between 10% and 15%, an increase from the previously communicated range of between 8% and 13%. We're targeting national price increases per barrel of between 1% and 3%. Full year 2019 gross margins are currently expected to be between 50% and 52%, a decrease from the previously communicated range of 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 of 2019, not including any increases in freight costs 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're not able to provide forward guidance on the impact that ASU 2016-09 will have in our 2019 financial statement and full year effective tax rate, as this will mainly depend upon unpredictable future events, including the timing and value realized upon exercise of stock options versus the fair value when those options are granted.

We are continuing to evaluate 2019 capital expenditures and currently estimate investment of between $100 million and $120 million. The capital will be mostly spent on continued investments in our breweries and taprooms. We expect that our cash balance of $102.9 million as of March 30, 2019, along with future operating cash flows and our unused line of credit of $150 million, will be sufficient to fund future cash requirements.

During the first quarter and the period from March 31, 2019 through April 20, 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 Caroline Levy with Macquarie Group.

Just trying to understand, it would be super helpful if you could talk about how much of the shipments and the profitability in the first quarter will come out of the second quarter, in particular. Or how we should think about the spacing? Like do you still expect shipments to grow in the second quarter as you can -- would you continue to keep inventories high? You mentioned only pulling inventories down to the 3 to 4 weeks by the end of the year. And then also you didn't have pricing -- much price realization, I guess none, price mix in the quarter. Why do you expect a 2% to -- 1% to 3% range for the full year? That's my first question.

Okay. Caroline, this is Frank. So on the shipment piece, similar to what we had said last call, we're building it up essentially Q1, beginning of Q2 for the peak season that we see during the summer. So we will still be building a little bit and then the first half of Q2, then declining so that will be a net negative a little bit and then we'll be running down the pre-build or the extra inventory in Q3. That's broadly how we have phased it. We will, based on our full year depletions guidance, we will grow every single quarter overall our depletions. But it will, as I said before, it will come out a little bit in Q2 a little bit and then Q3. The other question that you have, I can't really give you a profit. We don't give profit guidance by quarter. I think the profit guidance really remains unchanged. In terms of how much was really pre-build, we typically have in Q1, as we prepare for the season, shipments that typically, if you go back the previous 2 years, typically outpace depletions as we build for the summer. Now this year was significantly higher because we knew our constraints and the expected demand of Truly. So that was the first question. The second question, I believe was related to pricing. So we see pricing coming through. What you see in the revenue line if you compare that to the shipments, that it's slightly lower. And that is literally a mix impact that you see on the revenue line that is not necessarily mixed impact on the margin line. But as we have increased the percentage of cans which have to -- which have a slightly lower revenue rate, you see that has mix impact on the revenue line, but again, not on the profit line.

And just as a follow-up, if I might, on the impact on the gross margin of third-party and the inventory build, is that something then that again, is going to be front-end loaded to more this quarter, second quarter, and then by the back-end, number one, I know you've got some capacity additions; but number two, you probably won't be building Truly and Twisted inventory to the same extent. So I assume that your back half will be better for gross margin?

So the back half will definitely improve. That's typically also how we look at our margins. If you look at the quarterly margins, the final margin will very much depend on how much Truly we will have to produce. And I think I'd said in the February earnings call, the way we project -- based on the volume that we had projected, we're projecting the gross margin and that was assuming a certain percentage go to external -- to co-packers. Now as we increase the volume, that portion that goes to co-packers will increase and will impact the gross margin. But it's really the higher -- the incremental volume that's driving the average margin. But overall throughout the year, the base margin will increase.

Just a strategic question for Dave, if I might. Just how do you think about the -- all the entries into Truly's space? I know White Claw is still growing very, very quickly. You're growing very quickly. But you've seen this game before. And how do you see it playing out as a sort of best estimate of what happens in the marketplace on spiked seltzers?

Yes. I mean I think you want to be #1 and #2. And I think if you look at what's transpired, actually since the category really emerged, really if you look at White Claw and us, we've been combined about 75% to 80% of the category up until the beginning of this year. And actually as we get into this year, with a lot more competition, both branches are still kind of holding that collective share, if you will. So but for us, it's -- obviously it's a top priority to continue to grow that business and to invest in that business, to drive distribution, to build the brand and to do everything we can, particularly in the early stages as a category is shaking out. And thus far that's -- we're sitting #2, we're not going to be happy until we're #1. But we feel like we're in a position that we can -- that we're building scale and will continue to grow this business.

Our next question comes from the line of Amit Sharma with BMO Capital markets.

This is Drew Levine on for Amit. I just wanted to circle back on that point you made about the increased competition. I mean it seems like beyond even spiked seltzer, there's increasing competition or increasing entrants into FMBs. So just curious on where you see that space coming from on the shelf, whether it be entrants into spiked seltzer? I mean is that going to impact any of the shelf space that you're planning on getting with retailers this year?

We think that retailers are going to continue to increase the space for hard seltzers. But as Dave said, us and White Claw have held nearly 80% share and continue to, even right now. So the new entries haven't gobbled up a lot of the market share at this point. We don't know what the future is. But some of them have been up, some of them have been down in terms of their market share below us and White Claw. But Truly and White Claw seem to be holding something like 80% market share in the IRI data. So it looks like those 2 leading brands continue to be the favorites of the retailers and the consumers. And there's a big gap between us and #3. So, so far nobody's really put a dent into the leadership positions of us and White Claw.

And then -- I'm sorry. And then just on Sam Adams brand on the last quarter you mentioned you were encouraged by some of the early trends you saw on the new marketing, planning to still stick behind it with new packaging and you recently hired a new CMO. So can you just tell us maybe how you're going to define success for that brand? And maybe any sort of difference in strategy under the new CMO?

Yes. I think -- well, it's going to take us doing a few things well. And I think success is changing the trajectory, we can get into positive. And we believe we can do it and there's a number of things we've been working on. I mean the brand communication was one thing we've talked about, the improved package design, bringing news to seasonal, innovation in general. And I think we started with change in the campaign and kind of going back to where we were. In terms of talk about product quality, the heritage, the authenticity of the brand. And when we looked at the numbers in Q4, we actually saw a pretty good bump for that. We saw maybe 4 or 5 points of trajectory change for Sam Adams. In Q1, we saw that kind of slip away from us a little bit. However, at the same time, these things have to work together. As you mentioned, we have new packaging in market now. It's only been in for maybe -- it's trickling in maybe, last 2 or 3 weeks. The early -- it's obviously very early. But the response has been very, very positive. When people see it in the market, particularly as we talk about crowded shelves and how do you stand out amidst a sea of colors and sensory experience, we think going back to blue and back to the equities that this brand stands for will make us much more highly visible. So we feel really good about where we're going with the packaging. On new Summer Ale, I mean that was a big thing. We developed -- Jim developed this product in 1996, I believe. And we hadn't changed the flavor profile, and going to this, what we're calling a brighter profile, similar recipe, but a lighter and brighter taste, we're seeing actually very encouraging signs, again only a few weeks out. We'll also continue to evolve the campaign. So we're believing very strongly that we can make movement on Sam Adams. Even IPA is growing this year pretty significantly in its sophomore year. '76, we have some work to do and we're working on some new communication. So Lesya is our new CMO. We're very excited to have her. She's a great leader. She's a super creative marketer. She was at Heineken, as you guys know, she was the CMO there. She did the Open Your World campaign at Heineken. Most recently, Tough As Grapes at Welch's and she's proven that she -- in tough category, she can find a way to grow brands. We also think she's a great cultural fit. So we're very excited to have her come in and relieve me of my duty. And she'll probably do a much better job than I've done. But we do feel like this is a lot of moving pieces and a lot of things. We feel like we're pushing things in the right direction. And really to get the big impact, over time we have to do a number of things concurrently that also reinforce the same idea. And we think those things are starting to come together now on Sam Adams. We'll see how the rest of the year plays out.

Our next question comes from the line of Judy Hong with Goldman Sachs.

So I guess first question from me is on Angry Orchard. So Dave, you talked about the brand being down in Q1 and you do expect improvement for the balance of the year. So can you just tell us a bit more color about the timing of the Crisp Unfiltered launch and some of the marketing plan that you have in place for this year? And is really the success of Unfiltered kind of the key reason that you see improvement? Or do you think that Rose and even the base cider could also improve as the year progresses?

Okay, Judy. So I think first of all, we're lapping -- with the Rose launch, we're lapping the most successful new product introduction in the category, I believe last year, for the most part into crafts. And so it's a big overlap. We expected it. It happened really in the first quarter. We're coming off of that now. We're continuing to invest a lot in Rose. So we expect Rose will grow this year, when the year is done. Right now it's not looking that way, but we believe it will. Unfiltered comes in different markets at different times. We'll be out there in June and some markets and in August in other markets. It's a great product. We feel very good about that. We also have done some things with packaging, with variety pack and slim cans, Rose in 12 pack cans, in 12 pack bottles. So there's a number of things going on that we think will bring the brand to positive before the year is over. The timing thing's a tough one, but again we expected it. We're still a 59, 60 share in the category. And we still -- our consumer measures are still very strong. So I think the big overlap is behind us and now we're looking toward a different trajectory as the year progresses.

Okay. And then I guess my other question was just if I look at your year-to-date depletion trend, it looks like April actually accelerated, which seems to diverge from some of the recent scanner data. And I know it's never really a perfect measure. But I guess I'm wondering if you can offer any insight into why there's been kind of a divergence? And if there's anything in terms of the retail inventory build or anything that is causing April, the depletion trends to actually accelerate even as some of the scan data has been softer?

Yes, I think, I mean there's 2 different things. One is depletions and one is scan data. I think we use IRI. And based on what IRI tells us and what we know our depletions growth is across our portfolio, it lines up pretty well. I think Nielsen there seems -- Nielsen doesn't seem to capture, particularly tea growth for whatever reason across different channels, I mean the nature of the brand and where it's sold. And I think that seems to be something that might be a miscue compared to where IRI is. So we've accelerated, but the trends have been pretty -- I'd say they've been pretty consistent over the first quarter and into April.

Yes, there just seems to be, Judy, some kind of weird and significant disconnect between IRI and Nielsen. And as you can see from our results, our real depletions are closer to Nielsen, you have a correct...

IRI.

Or I mean closer to IRI. You do have a correct read that they have accelerated in April. We don't see any unusual retailer build or anything like that. It just looks like consumer takeaway is accelerating. And a lot of what's driving our total depletions is we're getting bigger in tea and in hard seltzer, which have the strongest growth rates. So Sam Adams will always be at the heart and soul of the company. But we have evolved our portfolio and our mix to a point where we can deliver nice double-digit growth without Sam Adams contributing to it. It's just a fact of life at this point that our portfolio is able to grow double digits, despite some of the softer trends in craft beer.

Right, right. Yes, no, that makes sense. My last question, just going back to, I guess Truly and relating to kind of your taking up the full year depletion guidance. So I guess I just want to confirm that the increase your depletion guidance for the full year is entirely driven by the Truly expectation going up? And then more broadly speaking, if you look at some of the other FMB categories, you look at Mike's dominating the hard lemonade category, Twisted Tea dominating the tea-based category. In spiked seltzer, it seems like both White Claw and Truly have really become 2 dominant brands. So what is it about kind of both of those brands that are resonating? Is there sort of a different brand proposition? And do you think that, that kind of duopoly evens the nature of this category between the 2 brands? Can that be sustained as both brands are actually getting bigger?

We think so. And certainly, the -- you track the data over the last 2 years and there have been new competitors coming and going, but the combined share of those 2 companies has been very consistent. I don't know that I want to use the word duopoly. But let's just say there's 2 very strong, very competitive entrants in there that are -- we're both competing tooth and nail with each other. And that's paid off. And the ability to fend off smaller competitors, I just -- why is that? I mean I think we -- the 2 of us pioneered the category. So there was a big first mover advantage. We are both very, very good at making a really good, clean base that doesn't have off flavors or off notes in it. So the product quality of both is very high and we're both very aggressive in that category. And we're -- neither one of us wants to give up any share and we haven't. So we do see that as potentially a stable, long-term situation of having 2 very strong competitors in there. Frankly, there's not a ton of differentiation in the category. So it's still somewhat fluid. And as you see from the growth rates, there's a ton of new drinkers coming into this category. It's phenomenal. If you go look at the data, the category is expanding distribution at an enormous rate and at the same time, getting really big pull per point increases. So it seems very healthy category.

And just to add to Jim's comment, we're also seeing actually more than half of the volume coming from outside of beer, quite honestly, like coming from spirits and primarily wine, which is a big win. And we also see it coming out of white beer as well within the category.

(Operator Instructions) Our next question comes from the line of Laurent Grandet with Guggenheim.

My question is really about the Sam Adam -- Samuel Adams (inaudible) and seems to be, I mean a bit challenging. So first you said consumers are reacting well to the new pack and the campaign. Are you talking about the current consumer or new consumers that you are targeting?

Yes, I think, so if I go back -- I'll go back to the advertising campaign that we started this whole thing with like end of last September. And I think what we found is that, that campaign really reinforced the equities of the brand. It kind of told people, reinforced what they already believed about the brand and it worked very well with our existing consumers. I think where the opportunity for this campaign is, I'm just talking about the campaign, is to more probably engage younger, say 21- to 35-year-old consumers with a brand that they don't know as well and to give them something really exciting to try the brand. I think -- so it worked on a level with our current consumers who are very important to us, our current drinkers, probably not so much bringing new drinkers in. When you -- it's hard to say with the packaging, and we tested the packaging in almost all consumers, we think the packaging is going to work with everybody because reality is you've got to be able to find our product to buy it. And so we feel -- I personally feel really good about this. I've been through this like 1,000 times probably. And when you look at -- if you go into a store and see us on display, you see this on the shelf and you immediately find Sam Adams and that's so important for all consumers. So we feel really good about that. I think on the news around Summer Ale, we think also that's going to be broadly appealing and bring a lot of people in. And every year, we -- probably about 70% or so consumers who come to Summer Ale are new consumers. So in terms -- over every year, a large part of the consumer base. And we think we can attract a lot of new consumers with the call out of now lighter and brighter. We also think that existing consumers -- we tested this very extensively with our existing consumers because it's -- we have a big franchise, particularly New England and the Atlantic area. And they preferred it significantly better than the old Summer Ale. So we feel like, okay, so with the advertising, I think is working not as broadly as we need it to. We're going to -- we're working on that and we're going to change that. But everything else in terms of packaging, innovation, it seems to be working pretty broadly. Last thing I'll say is Sam '76, it's a more drinkable, like kind of refreshing lager and that seems to be drawing younger consumers into the franchise as well.

Dave, and really just to follow up on this, I mean seems like Sam '76, I mean 26.2 or you just mentioned New England IPA or other, I mean the seasonals, I mean are bringing a younger consumer. Am I right on this? I mean what's the age group that -- for those drinkers? And how much of those which -- who are trying, who are entering into the Sam Adams franchise through those, sub brands, are they are migrating to the -- I mean the Boston Lager? Because at the end of the day, I mean you don't want to alienate the existing consumers, but I mean you want to bring more consumers in. And those sub brands could be a way to get it. But I'd like to understand, is that -- if that's real, that I mean those brands are attracting younger consumers first? And then how many of those are migrating them to the Boston Lager franchise?

And that's the hope. That's the hope. We don't have the data yet. I mean, 26.2, obviously is very early. New England IPA is still relatively small business, but growing rapidly. So we don't really dive in deep, by the idea is it would be -- it's great if they are an on-ramp to Boston Lager, because those people experience our brands and they want to try different and something more flavorful is there. It's something that we should be measuring over time. And maybe in subsequent calls, we can share more insights about that.

Yes. And my last question is really about, I mean the more the -- your wholesalers and retailers. They’ve been seeing kind of the Boston Lager beer, I mean declining for quite some time now. I know you do have a very strong relation with them, you've got -- you do have lots of feet in the ground -- on the ground I mean trying to push the product. But are they getting kind of nervous about keeping your SKU on shelf? Is there a risk here? Or I mean with all what you are doing, you see, the [SEB] stabilizing or even starting to pick up again?

Yes. I mean I think, I mean our wholesalers certainly have stuck with us and the brand and they know the brand has a special place for us. But as Jim mentioned earlier, it's like it's one piece of the portfolio now. The business looks different. And we're driving a lot of growth through a more broad-based, balanced portfolio, if you will. But it is a challenge, when you get to customers, it is a challenge. And we need to -- that's why we keep bringing news to the brand. And we're trying to do that through things we talked about, whether it be the new package design, the new -- the evolved communications on lager, the news behind seasonals (inaudible) like '76 and New England IPA. And we're trying to bring enough energy back to the brand to ensure that we get the support from our customers. I think wholesalers are all in. Customers, it varies based on where you are and what channel you're looking at.

Yes, and with the wholesalers, Sam Adams continues to be the lead craft beer. And we're not really losing to somebody who is going to replace Sam Adams. We're losing share to the other 7,000 craft brewers. I mean we're in a category that grew 4% last year, but the number of brewers grew something like 13% or 14%. So it's a category that is losing to fragmentation, which continues to make Sam Adams as the category leader with the largest volume, an important brand to them. Because they want to put stuff on the shelf that is going to be known, that consumers are familiar with, that they're pretty sure is going to sell at a diminished rate versus last year. But the vast majority of craft SKUs is selling less than they did last year because of that fragmentation.

And are retailers starting to clean up their shelf from, I mean those lower selling in SKUs is the trend you're seeing?

We think that, that is where trends are going. Wholesalers are pruning their portfolios and retailers are looking at doing the same thing. I think the growth of hard seltzers means they've got to get space from somewhere, and some of that space may be coming from the lower selling craft SKUs. But I would say it's very -- this is a trend happening in slow motion. It's -- the consolidation in craft that we're going to is going to be a slow process. But we do believe that eventually, like in virtually all categories, strong, well-supported brands, high-quality, will eventually emerge from any kind of consolidation and/or shakeout. And Sam Adams is the -- we believe the long-term beneficiary of that.

Our next question comes from the line of Kevin Grundy with Jefferies.

I wanted to come back to hard seltzer, this is a question for Jim and Dave. So Jim, you mentioned the company is able to do double-digit growth, which to your credit is outstanding. But with respect to seltzer, in the absence of improvement of Sam Adams brand, we can agree that growth rates for hard seltzer at some point will come out of the stratosphere. And in the absence of being able to turnaround some of the challenges in the beer part of your portfolio, the growth rates are going to come down and they may come down materially depending on what this landing looks like in seltzer. So with that as the background, how are you guys internally thinking about the potential size of the category, like what's the sort of the right analog for us to think of where it can go either as a percentage of overall beer or total alcoholic beverages? And then what would you say, what gives you confidence about the long-term staying power of this category given some of the episodic boom-bust that we've seen with innovations, like hard soda comes to mind?

Yes, we don't see this as following the hard soda path for several reasons. One, that was driven by trial and not much repeat. And we had Coney Island Hard Root Beer, so we went through that. It was a lot of trial, there wasn't much repeat. And it also kind of ran against consumer trends because it was loaded with sugar and loaded with calories. So and when that information started to become more prominent, the category went away. Hard seltzer is very much riding a very strong, powerful trend in alcoholic beverages, also in non-alcs, health and wellness, less sugar, fewer calories, more drinkable. So we see it as very much an expression of powerful consumer trends that have come to alcoholic beverages. We're also encouraged by the fact that despite this almost crazy growth, I mean we're looking at a category that's almost tripling. So yes, the growth rates will come down. We're absolutely certain of that. But as they come down, they're coming down on a bigger volume base. So the incremental volume from the category will not drop as fast as the growth rates, which makes it, again to your first part of your question, that's why it may well continue to more than offset whatever is going on with craft beer. Because if it triples in volume and the growth rate goes down to 50%, that's still a lot of new cases. So we see this category as having legs. We don't know how high up is. But we were frankly a little surprised at how strong it has continued through January, February and March, when we thought it's winter, it's going to slow down. It didn't. So we have been surprised by the continued strength of the category and by the continued brand dominance of the 2 category leaders who pretty much started the whole category.

Okay. That's helpful. Two quick follow-ups from me. Jim, question for you also on U.S. beer pricing in general. We picked up some rumblings from distributors that the industry may not be taking the right tack here with respect to pricing and potentially pricing itself at a disadvantage relative to some of the other alcoholic categories like spirits, particularly given the volume losses that continue in the category. Do you see it that way? Do you see any risk to pricing, which has been rational in the beer category for some time?

Well, I can't predict or determine what competitors are doing. I can say that we're very comfortable with our pricing. We -- as a rule, it's been slightly below inflation over the last 20 years. So in real dollars, our pricing comes down. So we think that's healthy. And we do see continued trade-up. So on any individual item, it can come down in real terms, but real pricing overall for the business can go up due to the mix shift. And we believe that there is continuing premiumization and continuing consumer trade up as brewers like Boston Beer and others continue to come out with interesting and appealing innovation, so new beers and new categories that consumers haven't seen before. So that prevents the commoditization.

Okay. That's helpful, Jim. One last one, just to come back to the Sam Adams brand. Can you speak broadly to advertising and marketing levels behind that brand over time, just given the volume issues? Has that come in? I guess just to kind of maybe push a little bit on it, is it -- could one make the case you're potentially sort of throwing good money after bad given the volume issues with it sort of in the absence of having some hard-hitting marketing or sort of innovation behind it? So any comments there on advertising and marketing behind the Sam Adams brand. That's it for me.

Yes. Just very, very broadly, we very roughly over the last 4, 5 years kind of maintained the -- roughly the same level of support. So it has -- so on a per case basis -- hang on, my wife is calling. Sorry, all right. So on a per case basis, I guess our spending has probably gone up. And our overall feeling is Sam Adams is a unique, iconic brand with very high awareness, very high respect, very high quality scores. And so iconic brands like that, that are -- have high level of esteem and are pretty much pure, untouched brands, those are rare. And you support those through ups and downs because they're -- you don't just replace something like that. And as I said earlier, we're very fortunate now within the craft beer category to be one of the few players that continues to have the resources to do that. Our overall business is healthy, strong and growing. And that's a big advantage over the rest of the craft category where they've only got 1 bet. Their stool is on 1 leg and ours is on 4.

Our next question comes from the line of Caroline Levy with Macquarie Group.

I wanted to look out a little further into the next few years and just kind of understand the gross margin outlook. As you build your own capacity, at this time a year from now, how much of your Truly might you be able to be making in in-house and how much upside could there be to margins? Because I guess the question is, do you keep having to pay co-packers? Or what are the levers to gross margin that you see going forward?

That's a good question. And there's a couple of them. Frankly, we didn't anticipate the continued growth rate being as strong as it is. So we're doing more co-packing than we thought. We will -- that will go down in the last 4 months of the year. It's a seasonal product. It peaks in June, July and August. As you can guess, even with our co-packers, between us we don't have enough capacity to meet the projected demands for those months as it happens, so that's why we've got all this inventory out there that will get -- we believe will get us comfortably through the peak. And we have a couple of things that are going to help the margin. The vast majority of hard seltzer for us is in variety pack. We are semi-hand packing that now. But in May, we are bringing on a large automated variety pack line that will take a significant piece of the direct labor out of that operation. We literally have hundreds of temps at our brewery in Pennsylvania, literally hundreds of temps every day who do, among other things, the packing of these variety packs. So it's ugly. And we are automating that. And we have purchased the -- a big piece of the equipment for a new can line, including the filler, the seamers, et cetera. So that will go in. But it will be too late to get this peak, but we'll have that for the peak of next year. And that will bring in -- or that'll give us the capability of bringing in house a lot of good production that's not in-house. Now my hope is we've still -- that we're doing just as much contract production next year because we've underestimated the volume again. But if the growth rate slows down, we will have another new can line. So we anticipate bringing much more in-house next year.

That's super helpful. And then just do you think about the value of your beer brand or brands as being higher than your -- the value of, say a Twisted Tea or a Truly because over time -- the history used to be that beer brands were more valuable than FMBs. But do you think that still holds true? Or do you think we should be looking at things differently today?

Boy, Caroline, that's almost philosophical, certainly very speculative question. I mean if you just -- all I can do is look back and it turns out that some FMB brands have been quite enduring. You could think of Twisted Tea, Mike's Hard Lemonade, Smirnoff, even the Lime-A-Ritas and so forth have ups and downs. But I don't know. My gut tells me the beer brands are more stable. But it's really good question. So I'm looking forward to your next research note on this.

I'll have it all figured out by then.

Our next question comes from the line of Sean King with UBS.

I know we're kind of in uncharted territory here on seltzer. But I guess given the large number of sort of well-heeled players entering the space, what gives you confidence that pricing in the category remains rational?

Well, it's a good question. And there will potentially be some downward pressure. But I think everybody's putting a lot of money behind it. So there may not be that much room for downward pricing. And I'm not sure that the consumer is that price-sensitive because they're paying up for higher quality. So at the end of the day, they're -- if something doesn't taste as good because they didn't use the same quality of ingredients or their base was not as clean because they don't have the expensive equipment to do that, the consumer is not going to make the trade-off of I'll pay $2 a case less, but it doesn't taste as good. At the end of the day, flavor trumps price, I believe.

And I would just build on that, say flavor plus a brand that people recognize would trump price. I think the 2 brands -- because as Jim mentioned before, because Truly and White Club have been out there from the beginning and they're certainly the most visible getting tremendous execution in the market. I think for a new consumer who doesn't quite know the category, and so the category awareness is pretty low. If you're going in for the first time, you're -- I think you're more likely as a consumer to try something that you've seen before, you recognize or your friends have -- you've seen your friends drinking. So I think that also plays to the 2 brands at the top of the pyramid.

Our next question comes from the line of Judy Hong with Goldman Sachs.

I had 2 kind of housekeeping questions, actually. One is just going back to the inventory impact. So I think if you're planning to take inventory levels down from 6 weeks to, say 3 weeks, it equates to roughly 275,000 barrels that will need to come down. So, Frank, I just want to clarify your earlier comment. So is some portion of the 275,000 roughly coming out a little bit in the second quarter but more in the third quarter, and so by the end of third quarter, you're pretty much at kind of that normalized 3 or 3.5 weeks of inventory level?

That's directionally correct. So the majority would come out in Q3, but it will start in Q2.

Okay. And then, Frank, just on the advertising promo and selling expenses going up $4.2 million, how much was that freight versus the advertising?

So 2/3 of that is freight, 1/3 is advertising. And the freight is really related to the higher volume. There was a slight rate benefit, but it's essentially all volume.

Ladies and gentlemen, we have reached the end of our question-and-answer session and I would like to turn the call back over to Mr. Jim Koch for closing remarks.

Thank you, everybody, for joining us this afternoon, and we'll speak in another 3 months. Cheers. Thank you.

This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation.