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Boston Beer Inc  (NYSE:SAM)
Q4 2018 Earnings Conference Call
Feb. 20, 2019, 5:00 p.m. ET

Contents:

Prepared Remarks:

Operator

Hello and welcome to the The Boston Beer Company Q4 2018 Earnings Conference Call.

At this time all participants are in a listen only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder this conference is being recorded.

And now I would now like to introduce your host for today's call, Jim Koch, Founder and Chairman. Sir, you may begin.

James Koch -- Founder & Chairman of the Board

Thank you. Good afternoon and welcome. This is Jim Koch Founder and chairman and I'm pleased to be here to kick off the 2018 fourth quarter earnings call for the Boston Beer Company.

Joining on the call from Boston Beer are Dave Burwick, 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 will provide an overview of our business. Dave will then turn the call over to Frank, who will focus on the financial details for the fourth quarter and 2018 fiscal year as well as our outlook for 2019. Immediately following Frank's comments, we'll open up the line for questions.

We're proud to report depletions growth of 11% for the quarter and 13% for the full year. We are thankful to our outstanding employees, our distributors, our retailers and our drinkers, all of whom helped return the company to double digit volume growth. We believe that our depletions growth is attributable to our key innovations, to the quality of our products and our strong brands, as well as sales execution and support from our distributors.

We're still seeing challenges across the industry including a general softening of the craft beer category and retail shelves that offer an increasing number of options to drinkers. We continue to work hard on our Samuel Adams brand messaging, focusing on communicating our artisanal care in the brewing of Sam Adams Boston Lager.

While it's still early, it appears that our new advertising campaign has noticeably improved Boston Lager's trends. We plan to continue to invest in this campaign in the coming months with a goal of further improving trends and returning Sam Adams to growth. We are confident in our ability to innovate and build strong brands and we are planning to launch three new brands in 2019 that we believe will complement our current portfolio and help support our mission of long term profitable growth.

I will now pass over to Dave for a more detailed overview of our business.

David Burwick -- President, Chief Executive Officer & Director

Thanks Jim. Good evening, everyone. Before I review our business results I'll start with the usual disclaimer. As we stated in our earnings release, some of the information we discuss in the release and that may come up on this call reflect the company's or management's expectations or predictions of the future. Such predictions and the like are forward-looking statements. It's important to note that the company's actual results could differ materially from those projected in 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 take a sheer deeper look at our business results for the quarter. Our depletions growth in the fourth quarter was a result of increases in our Truly Hard Seltzer, Twisted Tea and Angry Orchard brands that were only partially offset by decreases in our Sam Adams brand. Truly continues to grow beyond our expectations and we continue to work hard to grow distribution across all channels while building a strong brand.

We are committed to maintaining and improving our position as a leader in the emerging segment of hard seltzer as more competitors enter. Twisted Tea is growing both distribution and velocity while generating consistent double-digit volume growth. Angry Orchard's growth is led by Angry Orchard Rose, which was introduced in early 2008 (sic) [2018].

We are excited about our brand investment plans for Angry Orchard in 2019, which include expanding our packaging formats to reach more drinkers. Our overall plans for 2019 include significant investments in the second year of our successful 2018 innovations, which include Angry Orchard Rose, Truly Berry Variety Pack, Truly Wild Berry, Sam'76 and Samuel Adams New England IPA. These five new innovations in 2018 are within the top product introductions in their combined categories.

In 2019 we plan to build upon these successful innovations with three new brands that address important health and wellness opportunities in our categories. These brands include 26.2 Brew from our wholly owned affiliate, Marathon Brewing Company. 26.2 is a thirst-quenching gose beer made with sea salt to fit runners' active lifestyles.

Wild Leaf Tea, a craft hard tea with fewer calories of less sugar and Tura Alcoholic Kombucha, an organic, light and refreshing shelf-stable alcoholic Kombucha with live probiotics and real fruit. We are now in the very early stages of our national launch of both 26.2 and Wild Leaf and we will launch Tura later in the quarter on a more limited geographic basis. To date, the response from our wholesalers, retailers and drinkers on these new brands has been very positive, but it's too early to draw conclusions on the long-term impact. We're in a very competitive business and we remain optimistic for continued long-term growth of our current brand portfolio and our innovations.

We will continue to focus on cost savings and efficiency projects to fund the investments needed to both grow our brands and to build our organization's ability to deliver against our goals. In 2018, we increased the usage of third-party breweries in response to our accelerated depletions growth, especially in slim can packages and cans in general, and faced industrywide headwinds of higher packaging and transportation costs.

We achieved our planned supply chain cost savings for the year, but the corresponding margin benefits were more than offset by the incremental costs we incurred to meet the significant growth in our key innovations. Looking forward to 2019, we are targeting double-digit top-line growth and, importantly, a significant increase in our operating income. We expect first quarter shipments growth to be significantly higher than depletions as we manage our supply chain and capacity to ensure our distributor inventory levels are adequate to support drinker demand for our brands during the peak summer months.

We are targeting a one percentage point improvement in gross margins in 2019 as we work to adjust our supply chain to support our increasing volume projections. We are maintaining our previously stated multi-year goal of increasing our gross margins by about one percentage point per year of the adjusted 2018 base, before any mix or volume impacts. We are planning capacity and efficiency improvements at our breweries, which is reflected in our capital spend expectations for 2019. We remain prepared to forsake short-term earnings as we invest to sustain long-term profitable growth, in line with the opportunities that we see.

Based on information in hand, year-to-date depletion is reported to the company through the six weeks ended February 9th, 2019, are estimated to have increased approximately 12% from the comparable weeks in 2018.

Now Frank will provide the financial details.

Frank Smalla -- Treasurer and Chief Financial Officer

Thank you, Jim and Dave. Good afternoon, everyone. For the 13-week fiscal fourth quarter, we reported net income of $21.8 million or $1.86 per diluted share, a decrease of $0.71 per diluted share from the fourth quarter of last year. This decrease was primarily due to a fourth quarter 2017 favorable one-time tax benefit of $1.72 per diluted share related to the Tax Cuts and Jobs Act of 2017.

Operating income for the fourth quarter was $28.8 million, an increase of $14 million or 94%, primarily due to increases in net revenue as well as decreased advertising, promotional and selling expenses, partially offset by lower gross margins.

Shipment volume was approximately 958,000 barrels, a 6.3% increase compared to the fourth quarter of 2018. We believe distributed inventory as of December 29, 2018 was in an appropriate level based on inventory requirements to support the forecasted growth of our brands and new innovations. Inventory as of December 29, 2018 at distributors participating in the Freshest Beer program increased slightly in terms of days of inventory on hand when compared to December 30, 2017.

We have approximately 77% of our volume of the freshest beer program. Our fourth quarter 2018 gross margin decreased to 51.9% compared to 52.4% in the fourth quarter of 2017, primarily as a result of higher processing costs due to increased production at third party breweries, higher temporary labor at company-owned breweries and higher packaging costs, partially offset by price increases, cost saving initiatives at company-owned breweries and lower excise taxes.

Fourth quarter advertising, promotional and selling expenses decreased $10.4 million compared to the fourth quarter of 2017, primarily due to lower expenditures on media advertising and point of sale marketing, partially offset by increased local marketing, higher salaries and benefits costs and increased freight to distributors due to higher rates and volumes and less efficient truck utilization. General and administrative expenses increased by $6.1 million from the fourth quarter of 2017, primarily due to increases in salaries and benefits and stock compensation costs.

The company's effective tax rate for the quarter increased to a provision of 24.7% from a benefit of 107.7% in the comparable period in 2017. This increase was primarily due to the fourth quarter 2017 favorable one-time tax benefit of $1.72 per diluted share related to the Tax Cuts and Jobs Act of 2017. Our full year net income decreased $6.4 million or $0.27 per diluted share to $92.6 million or $7.82 per diluted share compared to the prior year. This decrease is primarily due to lower taxes in 2017 related to the onetime tax benefit from the 2017 Tax Cuts and Jobs Act, as well as in our margins and higher advertising, promotional and selling expenses that were partially offset by increased shipment volume.

Full year 2018 shipment volume of approximately 4.3 million barrels a 13.7% increase from the prior year. Full year 2018 gross margin decreased to 51.4% compared to 52.1% in the prior year. The margin decrease was primarily the result of higher processing cost due to increased production at third party breweries, higher temporary labor at company-owned breweries and higher packaging costs, partially offset by price increases, cost saving initiatives at company-owned breweries and lower excise taxes.

Full year advertising, promotional and selling expenses increased $46.2 million compared to the prior year, primarily due to increased planned investments in local marketing, media and point-of-sale, higher salary and benefit costs and increased freight to distributors due to higher rates and volumes and less efficient truck utilization.

Full year general and administrative expenses increased by $17.7 million versus 2017, primarily due to increases in salaries and benefits costs, stock compensation costs and legal and consulting costs. The full year effective tax rate increased to 20.3% from the 14.7% rate in the prior year primarily due to the fourth quarter 2017 favorable one-time tax benefit of $1.72 per diluted share related to the 2017 Tax Cuts and Jobs Act of 2017, partially offset by a decrease in the 2018 federal statutory tax rate from 35% to 21% and a third quarter 2018 favorable impact of $0.38 per diluted share due to tax accounting method changes.

Based on information on which we are currently aware, we are targeting 2019 earnings per diluted share of between $8 and $9, but actual results could vary significantly from this target. We are currently planning increases in shipments and depletion of between 8% and 13%. We're targeting national price increases per barrel of between 1% and 3% and full year 2019 gross margins are currently expected to be between 51% and 53%. We plan increased investments in advertising, promotion and selling expenses of between $20 million and $30 million for the full year 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 of the impact that ASU 2016-09 will have on our 2019 financial statements 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 were granted.

We are continuing to evaluate 2019 capital expenditures and currently estimate investments of between $100 million and $120 million. The capital will be mostly spent on continued investments in our breweries and tap rooms. We expect that our cash balance of $108.4 million as of December 29th, 2018 along with future operating cash flow and our unused line of credit of $150 million will be sufficient to fund future cash requirements.

During the fourth quarter and the period from December 29, 2018 through February 15, 2019, the company did not repurchase any additional shares of its Class A common stock. We have approximately $90.3 million remaining on the $931 million share buyback expenditure limit set by the Board of Directors.

We'll now open up the call for questions.

Questions and Answers:

Operator

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

Drew Levine -- BMO Capital Markets -- Analyst

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

Frank Smalla -- Treasurer and Chief Financial Officer

Yeah this is Frank. Let me just comment on that discrepancy. The Q1 typically is a quarter where we have higher shipments versus depletions because we're building up our year for the season, which is typically Q2 and Q3. Now this year we are also -- we're building higher inventories that we have agreed with our wholesalers mainly to support the growth of Truly brands and also Twisted Tea.

This will be for the full year guidance is we do the guidance that's important, it's really difficult to give you a quarterly guidance, but we expect Q1 to build up the inventory and then give it back in Q2 and Q3. So there's no full year impact on that. But, I would say if you look at our full year guidance for the growth, I'd say like about 30% to 40% of that growth will be shipped in addition in Q1 to the normal Q1 business.

Drew Levine -- BMO Capital Markets -- Analyst

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

Operator

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

Laurent Grandet -- Guggenheim -- Analyst

Hey good evening, everyone. I like to I mean to really speak about I mean either Sam Adams franchise and last time we met Dave, you said I mean you have such situation for for this business to come back to flat when we look at the least numbers. Its still declining. So two things here.

You are revamping the packaging and having some new copies make to understand a bit more how this is working. Two is, I mean some of the growith is supposed to come from at the time you were saying Sam '76, but also New England IPA getting more distribution. There is no mention about those two in the release you just read. And then the last thing is how should we think about 26.2 Brew in terms of volume of opportunity for the franchise? Thank you.

David Burwick -- President, Chief Executive Officer & Director

I'm sorry the line just dropped. So we didn't get the last question. We didn't, that cut off when you asked this second question regarding the cost and the margin and capital investment. So let me answer that question, as you've seen, our margin decreased, which we had highlighted already in the last guidance. But it's, along this long term guidance that we have given that we will get to savings in our gross margin and improve gross margin on average by one point every single year.

We're getting to those savings. They're just masked by the incremental cost that we're experiencing because the volume growth especially of Truly is far outpacing our expectations. So to meet the volume growth, we had to use increasingly co-packers which is adding a fee and that's weighing on the cost and in addition we also had incremental labor, temporary labor that we have to employ in our breweries.

Now this this will reduce, we bring in incremental capacity in the house in 2019 and see significant improvement in our cost. The guidance that we're giving is a fairly good guidance for the overall gross margin. The actual gross margin was naturally dependent on the actual volume for Truly. We have planned for certain volume. If we get to that volume, we have a fairly good improvement in our cost base if the volume growth is going to go above what we are projecting, we might have to use higher co-pack volume and therefore it will increase our cost and will impact our margin negatively.

I will tell you though this is, you know we're fully aware of what we're doing and we have plans in place to bring the capacity in house once we're convinced that this is a long term volume. So we're getting to the savings, the underlying savings from cutting waste out of the system. But again there are masked by both those complexity costs due to the relatively strong growth that we're seeing with our innovations.

Again for the current caller, if you could repeat -- we came in just when you talked about New England IPA in 2016 which are more -- and we're more clear, what's your question? Sorry about that.

Laurent Grandet -- Guggenheim -- Analyst

Okay. No, that's OK. So good evening, everyone. So I think Dave last time we met, you mentioned that your aspiration was to have the Sam Adams franchise to go back to flat and it looks like we are seeing right now in the Nielsen numbers? So just wanted to understand I mean the three initiatives you've got there.

I mean one is about revamping the packaging and having a new marketing company. So I wanted to know how all this is working. The second thing is about New England IPA and Sam '76. I think I understood at the time that you wanted to push this further in terms of distribution. But you didn't mention anything about those two in your press release. And then wanted to understand, I mean the twenty 26.2 Brew, how should we think about this one in terms of volume or I will say potential?

David Burwick -- President, Chief Executive Officer & Director

This is Dave. I'll take a shot at that and let the guys jump in. The first question was around Sam Adams and we're going there. I think we're on a journey I think Jim mentioned in his call, in his part of the script. We have a new campaign we put out there last September and it's actually (inaudible) for us. We believe there is really 180 from where we had been before and I think we were finding our voice again with Jim on camera as well as how we talk about the product, how we make the product that makes us unique.

So that's one element right there that we like where we're going. Where had you before, not 100% of the way where we want to be on the brand communication. But we took a big step forward with that campaign, we're going to continue to press hard on that this year. In addition we do have a new package design for all of our -- all of our take home packages and our premise that will be hitting the market starting in April and again we went kind of back to the core equities of the brand and we're going -- we believe we are going to appear much better on shelf with a blue block that looks very super premium and reinforces some of the very important things in people's minds about the particular Boston Lager, but certainly Sam Adams.

So we're hopeful that that's going to have an immediate impact when it gets in the market. We think it's an important element. Also you know last year we had a very good October Fest season where we grew October Fest somewhere it didn't grow last year. We went back and looked at the product and we think it's been around a long time and this is the first one out there. We decided it was time to maybe reformualte that product, make it a little easier drinking for the summer. And so we'll have a new Summer Ale coming in as well about April timeframe.

So we've got around Sam that's sort of the energy and the effort around Sam right now at a higher level. As it relates to New England IPA and Sam '76, it's just sophomore year for both of these brands and we're investing considerable dollars behind both of them to grow in the second year. New England IPA last year was sort of in the back seat because there was so much innovation. It probably didn't get the support that it deserved. By the way that was the highest repeat rate of any new product launch in the category last year was New England IPA. Sam '76 was a very close number too as the year finished. So there are two great products -- two great beers that people really like and they're coming back to and we are most certainly putting a big effort on them in the marketplace this year through all different types of marketing means that we have at our disposal.

26.2 Brew is playing -- it's really going after a whole new space for us which is really about the area of health and wellness and there's been a lot of talk about health and wellness and beer and beyond lately. And we're watching it for ways to play in that space. 26.2 is going active people of living active lifestyle and care about their health and looking for something that's a little bit more aspirational and maybe a craftier version if you will of a brand that's been very successful in the culture. And so we feel like it's a brand by the way that we've had in Boston only and on premise only during the time of the Boston Marathon since 2012.

It's done very well in Boston, now taken internationally, but this is a new space for us and we're going to build it carefully and smartly and we think there's a whole platform around this type of beer. So first -- I believe first on Sam Adams identified beer is going to come from Marathon Brewing Company, which we own, which will be a broader platform for beers within the health and wellness space. This is our first entry. We feel really excited about its sort of improvement in Boston from a quality perspective and we have some -- at some point, we'll be sharing some exciting news about our launch in the not too distant future.

Laurent Grandet -- Guggenheim -- Analyst

Thank you. I'll pass it on for others. That's special. Thank you.

Operator

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

James Koch -- Founder & Chairman of the Board

Thank you everybody. We will talk to you again in a few months.

Duration: 27 minutes

Call participants:

James Koch -- Founder & Chairman of the Board

David Burwick -- President, Chief Executive Officer & Director

Frank Smalla -- Treasurer and Chief Financial Officer

Drew Levine -- BMO Capital Markets -- Analyst

Laurent Grandet -- Guggenheim -- Analyst

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