SAM

Business Context and Reporting Period

Company: The Boston Beer Company, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2007
Business Overview: The Company sells low alcohol beverages, primarily under the Samuel Adams, Twisted Tea, and HardCore Cider trademarks. Operations include brewing, packaging, and distribution in the U.S. and select international markets.

Key Financial Metrics

All figures in thousands, except per share data.

Material Changes vs. Prior Period

• Revenue Growth: Net revenue increased 17.1% ($13.5M) for the quarter and 21.4% ($29.1M) for the six months compared to the prior year. Growth was driven by a 15.2% increase in shipment volume and a 1.6% increase in net revenue per barrel.
• Margin Compression: Gross margin for core brands decreased to 57.0% (Q2) and 56.4% (YTD) from 59.4% and 58.7% respectively in the prior year. This was primarily due to higher costs for package materials and ingredients, partially offset by price increases.
• Unusual Item: The Company recorded a $3.4 million write-off of capitalized costs related to a proposed brewery project in Freetown, Massachusetts. This was necessitated by the decision to pursue the acquisition of a Diageo brewery in Lehigh Valley, Pennsylvania instead.
• Operating Expenses: Advertising, promotional, and selling expenses increased 11.1% for the quarter, driven by higher freight costs and sales force expenses. General and administrative expenses rose 13.9% due to salary increases and depreciation on new corporate headquarters.

Guidance, Outlook, and Risks

• 2007 Outlook: Management expects diluted earnings per share to be between $1.42 and $1.70 for the full year 2007. This guidance accounts for the $3.4M write-off but excludes potential significant expenses related to the Lehigh Valley brewery acquisition or other brewing options.
• Capital Expenditures: Estimated at $17M to $21M for 2007 absent major brewery investments. If the Lehigh Valley acquisition proceeds, total capital investment could range from $31M to $48M. This includes $3M to $7M for upgrades to the Latrobe, Pennsylvania brewery.
• Brewery Strategy: The Company entered a Contract of Sale on August 1, 2007, to purchase a Diageo brewery in Lehigh Valley for $55 million. Renovation costs are estimated between $30M and $75M. The Company is also expanding production at a contract brewery in Latrobe, PA, to alleviate capacity constraints at its Cincinnati facility.
• Risks and Contingencies:
  • Legal Proceedings: The Company is defending class action lawsuits regarding advertising to underage drinkers. While district courts have dismissed cases, plaintiffs have appealed. Insurance coverage disputes with Royal Insurance and Massachusetts Bay Insurance are ongoing, though courts have thus far ruled in favor of the Company's right to defense.
  • Supply Chain: The Company has committed to $30.2 million in hops purchases through 2013 to secure supply, exposing it to currency fluctuations (denominated in euros) and crop availability.
  • Production Issues: Extended operating hours at the Cincinnati brewery have stretched capacity, leading to service level challenges and potential product destruction.

Investor Verification Checklist

• Lehigh Valley Acquisition: Verify the status of the due diligence period and the finality of the $55M purchase price and estimated $30M-$75M renovation costs.
• Cost Pressures: Monitor the trajectory of raw material (hops) and packaging costs to assess if the projected 2 percentage point gross margin decline for 2007 holds.
• Cincinnati Brewery Capacity: Track the resolution of production issues at the Cincinnati facility and the ramp-up of the Latrobe, PA contract brewing arrangement.
• Legal Outcomes: Review the status of the appeals regarding the underage drinking class action lawsuits and the final resolution of insurance coverage disputes.
• Capital Allocation: Confirm if the Company will utilize its remaining $7.4M stock repurchase authorization or prioritize capital for the new brewery renovations.