Greetings, and welcome to The Boston Beer Company Second Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn this conference over to your host, Mr. Jim Koch, Founder and Chairman. Thank you, sir. You may begin.

Thank you. Good afternoon and welcome to everyone. This is Jim Koch, Founder and Chairman, and I'm pleased to be here to kick off the 2021 second 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 will focus on the financial details of our second quarter.

Thank you, Jim. Good afternoon, everyone. As we look at the second quarter results, Truly has demonstrated its superior variety of flavors and the colorful and adventurous nature of Truly drinkers. Based on the brand's innovation leadership, strong brand building, and growing cultural relevance, we believe Truly is well-positioned to continue to grow share. However, we overestimated the growth of the hard seltzer category in the second quarter and the demand for Truly, which negatively impacted our volume and earnings for the quarter and our estimates for the remainder of the year. We increased our production of Truly to meet our summer peak, but we have had lower than anticipated demand for certain Truly brand styles, resulting in higher than planned inventory levels at our breweries and increased supply chain costs and complexity. At the same time, we've been experiencing out-of-stocks on certain of our core products, most significantly on our Twisted Tea brand family. We expect wholesaler inventories of Twisted Tea to remain tight for the rest of the summer. Our outlook for the hard seltzer category in the second half of 2021 is uncertain, and we planned our capacity and spending based on several volume scenarios. We'll continue to manage our capacity requirements through a combination of internal capacity increases and higher usage of third-party breweries. We continue to work hard on our comprehensive program to transform our supply chain with the goal of making it more efficient, reducing costs, increasing flexibility to better react to mix exchanges, and allowing us to scale up more efficiently. While we're in a very competitive business, we're confident in the continued growth of our current brand portfolio and innovations, and we remain prepared to forsake short-term earnings as we invest to sustain long-term profitable growth. Based on information in hand, year-to-date depletions reported to the company for the 20 weeks ended July 10, 2021, show our estimates increased approximately 32% from the comparable weeks in 2020. Now Frank will provide the financial details.

Thank you, Jim and Dave. Good afternoon, everyone. For the second quarter, we reported net income of $59.2 million, a decrease of $0.9 million or 1.6% from the second quarter of 2020. Earnings per diluted share were $4.75, a decrease of $0.13 from the second quarter of 2020. This decrease was primarily due to increases in operating expenses, lower gross margins, and a higher tax rate, partially offset by increased revenue growth driven by shipment growth. Shipment volume was approximately 2.45 million barrels, a 27.4% increase from the second quarter of 2020. Shipment volume for the first half was significantly higher than depletions volume and resulted in higher distributor inventory as of June 26, 2021, when compared to June 27, 2020. The company believes distributor inventory as of June 26, 2021, averaged approximately five weeks on hand and was an appropriate level for each of its brands, except for Twisted Tea, which has significantly lower than planned distributor inventory levels for certain packs. Our second quarter 2021 gross margin of 45.7% decreased from the 46.4% margin realized in the second quarter of 2020, primarily due to higher processing and other costs associated with increased production in third-party breweries, partially offset by price increases and cost-saving initiatives at company-owned breweries. Second-quarter advertising, promotional, and selling expenses increased by $61.3 million from the second quarter of 2020, primarily due to increased brand investments mainly driven by higher media, production, local marketing costs, and increased freight to distributors, which was primarily due to higher rates and volumes. General and administrative expenses increased by $3.3 million from the second quarter of 2020, primarily due to increases in external services and salaries and benefits costs. Based on information currently available, we're now expecting full-year 2021 earnings per diluted share between $18 and $22, a decrease from the previously communicated range of between $22 and $26. Excluding the impact of ASU 2016-09, financial results could vary significantly from this target. We're currently planning increases in shipments and depletions of between 25% and 40%, a decrease from the previously communicated range of between 40% and 50%. We're targeting national price increases per barrel of between 1% and 3%. Full-year 2021 gross margins are currently expected to be between 45% and 47%. We’ve also planned increased investments in advertising, promotional, and selling expenses of between $80 million and $100 million for the full year 2021, a decrease from the previously communicated range of between $130 million and $150 million. These amounts do not include any increases in freight costs for the shipment of products to our distributors. We estimate our full year 2021 non-GAAP effective tax rate to be approximately 26%. 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 financial statements. We're continuing to evaluate our 2021 capital expenditures and currently estimate investments of between $180 million and $230 million, a decrease from the previously communicated range of between $250 million and $350 million. The capital will primarily be spent on continued investments in our breweries and could be higher if deemed necessary to meet future growth. We expect our cash balance of $103 million as of June 26, 2021, along with our future operating cash flow and unused line of credit of $150 million to be sufficient to fund future cash requirements. We will now open up the call for questions.

Our first question comes from the line of Bonnie Herzog with Goldman Sachs.

I guess, I don't maybe even know where to begin. I understand that the category has been flowing, everyone is aware of this. That said, I'm truly struggling, pun intended, with how meaningfully your results have deteriorated? I guess I'm saying this because even as recently as May, your tone and comments suggested that even with a slowdown in the category you could still deliver relatively strong growth and hit your full year guidance. So I guess for me, this begs the question. How confident are you that you're going to be able to hit your new guidance, and really how much visibility do you have in your business?

Let me take a shot at that. I think first of all, when we spoke in our call in April, everything at that point we hurdled that first big COVID stock-up period of March and April, we did really well with the category. Even at the moment of our call, we felt really confident in where the category was going. What seemed to happen is that in May and June, we really kind of hit an inflection point in the S curve, where things transitioned from high double-digit growth rates to low double-digit growth rates. That was the first signal we got, and we had expected to hit that second bump better. If we look at the brand's performance just for perspective; Truly has outgrown the category for 11 months straight since last September; Truly has outgrown the category by 2x since January; and Truly has outgrown the category by 3x in the last 13 weeks. It's increased household penetration significantly, meaning we’ve grown our user base by almost 40% for Truly, which means the innovation is working. As we mentioned earlier, tea performance is very good and punch performed very well. So while we're growing the business, and bringing in younger and more multicultural consumers, we're also seeing that with tea and with punch. To recap on the category, we've seen it drop down by about 10% in the last 13 weeks while we were growing at between 20% and 30%. Therefore, it was a more severe drop. Yes, we hit that S curve, but it's kind of hard to see it coming looking forward. To add another thought on why that occurred, there’s been a proliferation of brands in this category. There’s a herd mentality in the business. Companies have tried to bring new brands into the marketplace, resulting in a lack of originality. I think what’s happened is a little luster has faded for the specialty segment for some consumers. Right now, we have around 220 brands and a thousand SKUs according to IRI in the category, which is about 50% larger than last year. Our retail customers are still trying to support all of them, but that’s going to change quickly, and the long tail will be pared off. Also, this move from off-premise to on-premise rebalance is part of the picture. Currently, only about 3% of the mix on the on-premise side is hard seltzers, while off-premise tends to be around 10-11%. We expect on-premise to grow. Our team feels confident as we’ve added 4,000 Truly draft lines, enhancing our distribution. While the pace of this transition is slower than we had thought, we believe it’s moving in the right direction. Regarding confidence in the guidance, while we’re aligning ourselves with the category, we differentiate by growing our brands and businesses. Third-party data providers show the full-year range around 20% to 50%. If it lands closer to the low end, we can continue to grow 2 or 3 times that rate, given our track record. If it reaches the high end of that range at 50%, we’ll need to grow at a similar clip. We believe we can capture market share this year. That’s how we view this situation.

Our next question comes from the line of Vivien Azer with Cowen.

Thanks very much for that very detailed answer. That's a great place to pick up. In terms of the on-premise penetration, can you just help dimensionalize that please? Like 4,000 draft lines that Truly compares to what for your portfolio, or is there an ACV measure we should be thinking about? Just to understand how incremental that could be.

So I think — well, there are about 262,000 accounts out there. We’re in almost half of them with at least one brand. We’d estimate we’re in around 125,000 accounts but not a full portfolio, just at least one of our brands. So having 4,000 additional draft lines is significant. We expect to see how this plays out. Certainly, cans remain the predominant packaging we deliver. However, we’ve observed significant interest among our customers for Truly on draft. Previously, we tested a flavorless version intended for mixology, which received less favorable feedback. Now we have a wildberry version that performs much better. As a data point, we’ve more than doubled our penetration for Truly, being in about 22% to 23% of our accounts now and continuing to grow.

On the margin side, given the reduction to your volume outlook for the full year on shipments and depletions, I was surprised that maybe there wasn't a little bit of improvement in your gross margin outlook. Is that a function of you guys being locked into contracts with third-party manufacturers? How do we think about that?

Yes, we definitely have a situation where, when you look at the prior year, it was clear that with volume growth, we would grow the Truly variety pack more externally than internally because we were at maximum capacity internally. This ends up being more expensive. So there was a margin decline because of that. With the volume slowdown we experienced in Q2, that relationship has improved. Depending on where the volume heads for the rest of the year, we’ll likely see improvement based on the revised guidance issued. In Q2, we don’t see the full benefit because of adjustments made. We do have flexible contracts with our partners, but the category slowdown came quite suddenly, leading to adjustment costs. What I can say is we see the cost reduction benefits at our internal breweries and expect those to come through.

I'll try to squeeze in one last one. You noted that you'll continue to focus on innovation, but also predicted that there will be a category shakeout. I think you guys have been good at predicting cluttered categories. Jim talked about it in the past with craft beer proliferation and that’s certainly something you guys have predicted. How are you thinking about innovation in the back half of this year and into 2022 given that the category does look very crowded right now?

First of all, we’ve gained about 60% more space year-over-year on the shelf. We think we can potentially pick up another 25% in the fall. There will be some change in fall resets. Given our performance, with the highest penetration of any brand in the category now, we believe our flavor innovation continues to bring new consumers into both the category and our brand. We need to continue innovating to differentiate and create incremental value to our brand and the category. We’ve had success in this regard and we will keep pursuing it. As we perform well as the number two player now, we feel we have a lot of latitude and support from our customers to continue growing our innovations.

Our next question comes from the line of Eric Serotta with Evercore.

First, a quick one for Frank. Your inventories were up pretty substantially, something in the order of $90 million sequentially. I know Dave called out increased inventory at the breweries. How much of that sequential increase in inventories on the balance sheet was related to finished goods at the breweries? And what's the risk of inventory obsolescence costs here? And then a follow-up for Dave and Jim afterwards.

So the inventory, to your point, has clearly increased, that's a function of the business. There are three reasons. One is a function of business growth that we've experienced in absolute terms, and we’re managing it well in terms of retail supply. Second, we have prebuilt inventory as we have done in the previous two years, which is what you see at wholesaler inventory. Now there’s a limit to how much wholesalers can take. Therefore, we had to build a little more internally rather than passing it to the wholesalers, and then came the slowdown. Typically, we build up until April, where we reach the peak in inventory and then begin decreasing it as demand picks up. That has happened as well. However, the pace slowed in May and June versus what we had predicted. From a forward-looking perspective, we don’t expect any write-offs, so everything is accurately reflected. Unless there’s another significant slowdown, which we don’t expect, our guidance accounts for that.

And then Jim and Dave, I was a little bit surprised that in your detailed explanation for the slowdown of the seltzer category that you didn't explicitly call out ready-to-drink (RTD) cocktails. Maybe that's what you’re referring to in terms of the consumer confusion, which I think was within the hard seltzer categories. So the question is, do you guys think that some of the hard seltzer slowdown is related to the explosion we've seen in RTDs? Drizly is obviously talking quite bullishly about what they're seeing on their platform for RTDs. What sort of interaction are you seeing, and what's the plan to participate in a bigger way?

To be honest, we're primarily focused on the hard seltzer proliferation instead of RTDs or canned cocktails, and at this point, we don’t see it affecting the hard seltzer category or Truly. If you were to consider High Noon as part of the hard seltzer category, it holds about a two share. It's also about a quarter of the entire RTD business, so you can see a comparison. We believe the canned cocktail business occupies about 8% of the hard seltzer category, with High Noon contributing to that. At present, we’re still learning about the interactions between both markets. We’re confident there is a segment for hard seltzers, but we also recognize the uniqueness of the canned cocktails. We will participate because it’s important for us, including our partnership with Beam Suntory and leveraging our Dogfish Head brand.

Our next question comes from the line of Laurent Grandet of Guggenheim.

Two questions from me, and one is a follow-up from Vivien’s questions earlier on on-premise. So I would need you to help me reconcile the numbers here. It looks like based on depletion in the quarter of about 24%, that’s pretty much what we see in the Nielsen retail business, which would mean that actually on-premise didn't deliver any upside if you look at those numbers. Maybe you could share the performance in on-premise by brand for the entire company, and more specifically on Truly. It would also help me reconcile the growth of on-premise during the quarter with what we've seen in retail.

So the question is about our on-premise performance and whether it’s keeping pace with retail. To clarify, we’re approaching sales in on-premise that align with 2019 levels. We're growing in on-premise, and one of the primary reasons why both Sam and Dogfish are returning to growth is due to our stronger handles. While I’m not sure how else to explain it without sharing proprietary data, we believe we are indeed growing in the on-premise space. We want to ensure our data aligns with retail, which could differ with the Nielsen data you referenced. While it shows 24%, we’ve seen growth on-premise outpace off-premise for every brand during the quarter.

It’s difficult to understand this in the numbers. Specifically for Truly, last year it was about 2% to 3%, and you’re saying it’s about 3%. That’s a small upside versus last year. Where do you think a brand like Truly, or hard seltzer in general, could position itself size-wise versus retail? Should we think of this being around 8% to 10% of the retail sales of Truly or hard seltzer? I’m not expecting it to go up to 15% like beer, but should we consider Truly ultimately to be around 8% to 10% of its retail?

I think that's reasonable. I would start with the likelihood that hard seltzers, including Truly, will under-index on-premise for the foreseeable future unless the draft category takes off as a big volume driver. If you don’t play on draft, you miss out on sizable on-premise low ABV volume historically associated with beer. Hence, I'd predict it could land around the 10-ish mark or maybe slightly less for the next year or two. Over the longer term, there is potential upside from yet-to-be-seen innovations.

I understand. Could you please clarify the nature of the deal with Beam Suntory and what we should expect in terms of upside? I’m not specifically asking about Truly but your overall plans.

We’ve intentionally kept details sparse because we don’t want to share with competitors. Essentially, it's a partnership, not a licensing deal. We aim to introduce some of their brands into the FMB space. We know that certain consumers favor spirit brands in the FMB space. Through our collaborative R&D and marketing efforts utilizing their distribution network, we aim to craft a version of Truly that could enter the spirit market successfully. With Beam Suntory's expertise, this should also support our growth in the spirits world.

I’d add that both we and Beam Suntory believe a spirits-based product will find its best route to market through the spirits distribution system. There’s potential for a Truly vodka but it should go through a spirits producer. We’re fortunate to partner with Beam Suntory in this endeavor. Meanwhile, malt-based products with any spirits branding will find more success through a beer supplier like us in our beer wholesaler network.

Our next question comes from the line of Filippo Falorni with Morgan Stanley.

First question, could you explain and give a bit more detail on your expectations for Truly in the second half? I know you said for the full year you expect at least to grow at the low end, 2 to 3 times the low end of the 20% to 50%. Any thoughts on the second half as you cycle more normalized comparisons would be very helpful for us.

The best way to assess it is based on the relationship to category movements, and we have good historical data on how we perform in relation to the category. I'd prefer not to predict the category's trajectory. However, we’ve been growing at about a 3:1 ratio relative to the category over the past 13 weeks. With the easing of comps from last year, we expect improvements, especially with the on-premise sector starting to regain momentum. We anticipate that confusion among consumers and support from retailers will diminish in the latter half of the year. Given our brand building and innovation strength, we believe we’re well positioned to capitalize on these changes. While we don’t know how this translates into precise growth numbers, we’re prepared to adapt to potential shifts in market demand.

To add on that, we expected a slowdown in May and June, which made it very difficult to predict outcomes. 2020 was volatile, with a dramatic demand peak in May and June from the consumer and retailers preparing. We saw the impact reflected in depletions and our shipment volumes, thus a moderation was anticipated. However, the actual slowdown was a bit sharper than expected. We foresee this moderating in the back half of the year, yet the composition between natural category slowdown and the events of May and June remains unknown.

You’ve made significant progress in the U.S. market with Truly as a mega brand. Why not pursue more aggressive international expansion, starting with Canada and potentially other markets? Is there room for investments to make it happen in-house or alongside another beverage company globally?

We do have a rapidly-growing business in Canada where we’ve made significant progress, and we are launching in the UK right now with our partner, Shepherd Neame, the oldest brewer in the UK. We also have a great marketing platform with Dua Lipa, a popular UK citizen. Our focus remains winning in North America while also exploring growth in international markets as we refine our approach. The upcoming years will be telling regarding the hard seltzer market’s performance outside of North America.

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

I understand you’re focusing on the seltzer category. Could you unpack the factors driving the slowdown? As you assess your key performance indicators, how would you departmentalize the order of magnitude driving this slowdown? When you consider the transition from the euphoria phase to normalized growth, what do you think is reasonable to expect? Is the initial ambition for hard seltzers around 15% of the beer market still a valid goal?

I can start that, and then Jim or Frank may want to share insights. In terms of the category, yes, it’s a shift in the S curve. The unusual overlaps during COVID have made it difficult to gauge. Currently, household penetration in the category is still rising, and those within the category are consistently buying more. Customer retention appears solid as the year progresses, but we did see a distinct fall in growth rates from triple digits to double digits. Expectations for future growth suggest a pattern of continuous growth, although we advise caution as various brands inundate the market and challenge original offerings. Retailers are increasingly pressured by product similarity, and the prolonged expansion of brands and SKUs encourages us to brace for market adjustments. Our estimates suggest a CAGR of 15% to 25% in the coming years, but we await further data as we progress through the summer.

We’re experiencing a turbulent phase, as the change in trajectory was steeper and more sudden than we expected. It arose while we were comparing against unprecedented COVID conditions from the prior year. Therefore, interpreting the May and June numbers is complicated. We’re surprised at this impact, especially since we've introduced Truly Punch, which has seen success but not quite the volume addition we initially anticipated. The landscape is uncertain currently.

To follow up on the impact of potential major brands exiting the market, would there be interest in absorbing their inventory influences through the distribution channel, despite the current commodity cost environment? How do you view these counteracting market conditions?

Typically, when brands exit the market, there’s minimal volume to contend with, often reflecting about 0.7% share. The category is attractive across the board for retailers, wholesalers, and suppliers. Hence, I don’t anticipate price wars breaking out in the seltzer category. While we may have larger inventories than desired at the moment, overall demand remains robust. With the long shelf life of our products, we can manage production cuts and adjust inventory over time.

To add to the inventory perspective, last year’s surplus would have been welcome amid the current seasonality. Pricing remains focused on quality and brand strength rather than drives associated with price competition.

We have reached the end of today's question-and-answer session and I'd like to turn the call back over to Mr. Jim Koch for closing remarks.

Thanks, everyone, for joining us for this call, and we look forward to speaking to you in another three months when we think we'll have a little more clarity. Maybe the outlook will be clearer. Thank you, everyone.

Thank you for joining us today. This concludes today's conference. You may disconnect your lines at this time.