BOSTON BEER CO INC quarterly report, Q3 FY2017

Business context and reporting period

The Boston Beer Company, Inc. brews and sells alcoholic beverages in the U.S. and selected international markets, including Samuel Adams, Twisted Tea, Angry Orchard and Truly. This Form 10-Q covers the 13 and 39 weeks ended September 30, 2017; comparisons are with periods ended September 24, 2016. Amounts below are in U.S. dollars.

Financial performance and liquidity

Third-quarter net revenue declined 2.5% and volume fell 4.2%; year-to-date net revenue fell 4.4% and volume declined 5.8%. Net revenue per barrel rose 1.7% in the quarter and 1.4% year to date, primarily from pricing and package mix. Depletions (distributor sales to retailers) declined approximately 3.5% in the quarter and 6% year to date. Samuel Adams and Angry Orchard were the main sources of declines; Truly Spiked & Sparkling and Twisted Tea partly offset them.

Gross margin improved as higher revenue per barrel and, year to date, lower cost per barrel more than offset volume pressure. Third-quarter operating income increased despite lower sales, helped by lower general and administrative expense. For the 39 weeks, operating income decreased, while net income and diluted EPS increased, aided in part by a lower tax provision. The 2017 tax provision included $4.3 million of benefit from adopting ASU 2016-09; year-to-date effective tax rate was 32.5%, compared with 36.6%.

Operating cash flow for the 39 weeks was $108.2 million, broadly flat with $108.4 million a year earlier. Investing activities used $23.4 million, mainly for brewery capital investment, versus $37.0 million in 2016. Financing activities used $105.8 million, including $121.5 million for share repurchases. Cash declined to $70.0 million from $91.0 million at year-end 2016. Current assets were $179.1 million and current liabilities $109.4 million at September 30. The company reported no revolver borrowings and had its full $150 million credit facility available through March 31, 2019; a $0.34 million note payable was reported. Management said cash, expected operating cash flow and the unused facility should fund future requirements.

Material changes, outlook and risks

• For the first 39 weeks, advertising, promotional and selling expense was $185.2 million, down 0.6% in total but up to 28.2% of net revenue from 27.1%. General and administrative expense declined 12.9% to $54.3 million, primarily from lower stock compensation, consulting and legal costs. Asset impairment was $1.5 million, mainly for equipment at the Pennsylvania and Cincinnati breweries.
• In the first 39 weeks, the company repurchased approximately 833,000 Class A shares. Through October 20, it had repurchased approximately 884,000 shares in 2017 for about $130.5 million. On October 5, the board increased the cumulative repurchase authorization to $931 million; approximately $192.8 million remained at October 20.
• 2017 outlook: estimated depletion and shipment decline of 4% to 7% (revised and narrowed from the prior range of a 7% decline to a 1% increase); revenue per barrel growth of 1% to 2%; gross margin of 51% to 52%; and increased advertising, promotional and selling spending of $10 million to $20 million, excluding freight changes. Non-GAAP diluted EPS is projected at $5.60 to $6.20, excluding ASU 2016-09; the company estimated a 37% non-GAAP effective tax rate on the same basis. Management cautioned that actual results could differ significantly and increased brand investment may not produce volume growth.
• Preliminary 2018 targets: low-single-digit growth in depletions and shipments; revenue per barrel growth of 1% to 2%; gross margin of 52% to 53%; advertising, promotional and selling spending up $15 million to $25 million, excluding freight changes; and capital expenditures of $55 million to $65 million. Management said detailed guidance would follow with full-year 2017 results. Estimated 2017 capital expenditures were $35 million to $45 million.
• Unusual and contingent items: non-cancelable contract obligations totaled $171.6 million, including $59.5 million for hops, barley and wheat and $40.7 million for advertising. The IRS began examining the 2015 federal return in September 2017; two state audits were also ongoing. The company reported no pending or threatened litigation expected to have a material adverse effect. It had no off-balance-sheet arrangements and reported no material change in market-risk exposure.
• Accounting and management items: the company expected adoption of the new revenue standard in 2018 to require earlier recognition of variable promotional discounts, with an additional liability then estimated below $2 million and a one-time retained-earnings impact. The CEO’s planned 2018 retirement contributed to lower stock-compensation expense; the company estimated a 100% forfeiture rate for one CEO option grant.

Most important facts for investors to verify

• Whether shipment and depletion declines stabilize, especially for Samuel Adams and Angry Orchard, and whether growth in Truly and Twisted Tea continues.
• Whether the 2017 and preliminary 2018 outlook is achieved, including the basis and reconciliation limitations of non-GAAP EPS and tax-rate guidance.
• Whether planned brand spending supports sales without eroding margins, and whether brewery efficiency gains offset lower-volume fixed-cost absorption.
• How continued share repurchases affect cash, share count and financial flexibility, given the lower cash balance and remaining authorization.
• Progress and outcomes of federal and state tax examinations, the expected revenue-standard transition liability, and fulfillment of the company’s substantial purchase and advertising commitments.