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

Contents:

Prepared Remarks:

Operator

Hello, and welcome to the Boston Beer Company Q4 2018 earnings conference call. [Operator instructions] As a reminder, this conference is being recorded. And now, I would like to introduce your host for today's call, Jim Koch, founder and chairman. Sir, you may begin.

Jim Koch -- Founder and Chairman

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 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'll 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 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 in 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 the 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.

Dave Burwick -- Chief Executive Officer

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.

OK. Now let me take -- share a 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're committed to maintaining and improving our position as a leader in the emerging segment of hard seltzer as more competitors enter. Twisted Tea has grown in 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. We're 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 includes 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. For 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 [Inaudible] beer made with sea salt to fit runners' active lifestyles. Wild Leaf Tea, a craft hard tea with fewer calories and less sugar. And Tura Alcoholic Kombucha, an organic, light and refreshing shelf-stable alcoholic Kombucha with live pro-biotics and real fruit. We're now in the very early stage of our national launch of both 26.2 and Wild Leaf, and 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 remain optimistic for continued long-term growth of our current brand portfolio and our innovations. We'll 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're 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're targeting a 1 percentage point improvement in gross margins in 2019 as we work to adjust our supply chain to support our increasing volume projections.

We're maintaining our previously stated multiyear goal of increasing our gross margins by about 1 percentage point per year off the adjusted 2018 base before any mix or volume impacts. We're planning capacity and efficiency improvements in 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 depletions reported to the company through the six weeks ended February 9, 2019 are estimated to have increased approximately 12% from the comparable weeks in 2018.

Now Frank will provide the financial details.

Frank Smalla -- 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 onetime 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 distributor inventory as of December 29, 2018 was at an appropriate level based on inventory requirements that support the forecasted growth of our brands and new innovations. Inventory as of December 29, 2018 at distributors participating in the precious beer program increased slightly in terms of days of inventory on hand when compared to December 30, 2017.

We have approximately 77% of our volumes on the precious 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 in 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 onetime 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 lower margins and higher advertising, promotional, and selling expenses that were partially offset by increased shipment volume.

Full-year 2018 shipment volume was 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 to increased planned investments in local marketing, media and point-of-sale, higher salary and benefits 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 onetime tax benefit of $1.72 per diluted share related to the 2017 Tax Cuts and Jobs Act, 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. Looking forward to 2019, based on information of 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 depletions of between 8% and 13%.

We are targeting national price increases per barrel of between 1% and 3%, and full-year 2019 gross margins are currently expected to be between 51% to 53%. We plan increased investments in advertising, promotional 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 on 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 [Inaudible] rooms. We expect that our cash balance of $108.4 million as of December 29, 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 will 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 Market. Your line is open.

Drew Levine -- BMO Capital Markets -- Analsyt

Hi, there. This is Drew Levine on for Amit. Thanks for taking the questions. So I just wanted to start out with the call for significant increase in shipments ahead of depletions in the first quarter.

Maybe if you could just give us any sort of help on magnitude that we should expect, any differential there. And then maybe as we think of shipments going through the year, if there's anything else we should think about from a cadence perspective.

Frank Smalla -- Chief Financial Officer

Yes, 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 -- 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 our [Inaudible] brand and also Twisted Tea.

This will be -- so the full-year guidance is really the guidance that's important. It's really difficult to give you 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 called for increased packaging, and obviously, with the Truly growth assuming that a lot of it's still going to be on a third party, but can you just maybe talk about capacity investments that the company has been making? And maybe if in 2019, we should start to see some shift in Truly manufacturing to any company-owned. Thank you.[Audio gap]

Operator

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

Laurent Grandet -- Guggenheim Securities -- Analyst

Hey. Good evening, everyone. I'd like to, I mean, to really speak about, I mean, the Samuel Adams franchise. I mean, I think last time we met there, you said -- I mean, you had aspirations for this business to come back to flat.

And when we look at these numbers, it's still in declining. So, two things here. You are revamping the packaging and having some new copies. I'd like understand a bit more how this is working.

Two is, I mean, some of the growth 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 -- you read. And then the last thing is how should we think about 26.2 in terms of volume opportunity for the franchise? Thank you.

Frank Smalla -- Chief Financial Officer

I'm sorry the line just dropped, so we didn't get the last question. We --

Dave Burwick -- Chief Executive Officer

From Drew.

Frank Smalla -- Chief Financial Officer

We didn't -- we got cut off when Drew asked his 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 a -- it's lower than the long-term guidance that we have given [Inaudible] that we will get to savings in our gross margin and improve gross margin on average by 1 point every single year. We're getting to those savings.

They're just masked by the incremental costs that we are 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 the incremental labor -- temporary labor that we had to employ in our breweries. Now this will reduce as we bring in incremental capacity in-house in 2019 and see a significant improvement in our cost.

The guidance that we are giving is a fairly good guidance for the overall gross margin. The actual gross margin would naturally dependent on the actual volume for Truly. We have planned for a certain volume. If we get to that volume, we'll 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 a higher co-pack volume, and therefore, it will increase our cost and will impact our margin negatively. I will tell you, though, this is -- we're fully aware of what we're doing, and we have plans in place to bring the capacity in-house once we are convinced 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, they are masked by those complexity costs due to the relatively strong growth that we are seeing with our innovations.

Jim Koch -- Founder and Chairman

And for the current caller, if you could repeat. We came in just when you talked about New England IPA and 26. Was there more? [Inaudible] We'll answer your question. Sorry about that.

Laurent Grandet -- Guggenheim Securities -- Analyst

OK. 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 Samuel Adams franchise to go back to flat.

And is that what we are seeing right now in the recent numbers? So just wanted to understand, I mean, the three initiatives you got there. I mean, one is about revamping the packaging and having a new marketing copy, so I wanted to know how all this is working. The two -- the second thing is about New England IPA and Sam '76. I think I understood at the time that you wanted to push these 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 26.2, how should we think about this one in terms of volume or, I would say, potential?

Dave Burwick -- Chief Executive Officer

OK. This is Dave. I'll take a shot at that and let the other guys jump in. The first question was around Sam Adams and where we're going there.

We're on a journey. I think, as Jim mentioned in his part of the script, we have a new campaign that we put out there last September. And it's actually moved the needle for us. We've really -- it's really a 180 from what we had done before, and I think we were finding our voice again with Jim on camera as well as how we talk about the product and how we make the product, what makes us unique.

So that's one element right there that we like where we're going [Inaudible], not 100% of the way where we want to be on the brand communication, but we took a big step forward with that campaign and 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 take-home packages and off-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 to -- we believe we're going to appear much better on shelf with the blue black that looks very -- super premium and reinforces some of the very important things in people's minds about, in particular Boston Lager, but certainly Sam Adams. So we're hopeful that, that's going to have an immediate impact when it gets into market.

We think it's an important element. Also, last year, we had a very good OctoberFest season, where we grew OctoberFest. Somewhere didn't grow last year. We went back and looked at the product, and we think it's been around a long time.

It was the first one out there. We decided it was time to maybe reformulate that product, make it a little easier drinking for the summer. And so we'll have a new summer ale coming as well about April time frame. So we've got around Sam -- that's sort of the energy and the effort around Sam right now at a high 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 backseat because there was so much innovation. It probably didn't get the support that it deserved.

By the way, it 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 they are two great products, two great beers that people really like and they're coming back to, and we're 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 is playing -- it's really going after a whole new space for us, which is really about -- around the area of health and wellness.

And there's been a lot of talk about health and wellness in beer and beyond lately. And we're -- there's lots of different ways to play in that space. 26.2 is going to active. People that live an active lifestyle and care about their health, but -- 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 [Inaudible].

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 taking it nationally, but this is a new space for us. We're going to build it carefully and smartly.

And we think there's a whole platform around this type of beer. It's our first -- I believe, first non-Sam Adams identified beer that's 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 starting to prove it 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 Securities -- Analyst

Thank you very much. I mean, I'll pass it on further to next question.

Dave Burwick -- Chief Executive Officer

Sure.

Operator

[Operator instructions] [Operator signoff]

Jim Koch -- Founder and Chairman

Thank you, everybody. We'll talk to you again in a few months.

Duration: 31 minutes

Call Participants:

Jim Koch -- Founder and Chairman

Dave Burwick -- Chief Executive Officer

Frank Smalla -- Chief Financial Officer

Drew Levine -- BMO Capital Markets -- Analsyt

Laurent Grandet -- Guggenheim Securities -- Analyst

More SAM analysis

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