Boston Beer Co Inc: Form 10-Q for the period ended Sep 25, 2021

The following is a discussion of the significant factors affecting the consolidated operating results, financial condition and liquidity and cash flows of the Company for the thirteen and thirty-nine week period ended September 25, 2021, as compared to the thirteen and thirty-nine week period ended September 26, 2020. This discussion should be read in conjunction with the Management’s Discussion and Analysis of Financial Condition and Results of Operations, and the Consolidated Financial Statements of the Company and Notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 26, 2020.

RESULTS OF OPERATIONS

Thirteen Weeks Ended September 25, 2021 compared to Thirteen Weeks Ended September 25, 2020

Slowdown of Hard Seltzer Category Impact. The thirteen weeks ended September 25, 2021 results include direct costs resulting from the slowdown of the hard seltzer category of $102.4 million, before the related tax benefit. These costs include inventory obsolescence, estimated destruction costs and other inventory related costs of $54.3 million, contract termination costs primarily for excess third-party contract production of $35.4 million and equipment impairments of $12.7 million. The total direct costs of $102.4 million have been recorded in the thirteen weeks ended September 25, 2021 financial statements as a $54.3 million increase in cost of goods sold, $35.4 million in contract termination fees and $12.7 million in impairments of long-lived assets.

In addition, the thirteen weeks ended September 25, 2021 results include indirect costs resulting from the slowdown of the hard seltzer category of $30.6 million, before the related tax benefit. These costs include increased raw materials sourcing and warehousing costs of $11.8 million, unfavorable absorption impacts at Company owned breweries and downtime charges at third party breweries of $11.4 million, customer return provisions for out of code or damaged products of $5.4 million and other costs of $2.0 million. These total indirect costs of $30.6 million have been recorded in the thirteen weeks ended September 25, 2021 financial statements as a $23.7 million increase in cost of goods sold and $6.9 million reduction in net revenue.

Net revenue. Net revenue increased by $68.9 million, or 14.0%, to $561.6 million for the thirteen weeks ended September 25, 2021, as compared to $492.8 million for the thirteen weeks ended September 26, 2020, primarily as a result of an increase in shipments.

Volume. Total shipment volume increased by 11.2% to 2,312,000 barrels for the thirteen weeks ended September 25, 2021, as compared to 2,080,000 barrels for the thirteen weeks ended September 26, 2020, reflecting increases in the Company’s Twisted Tea, Samuel Adams and Angry Orchard brands, partially offset by decreases in its Truly Hard Seltzer and Dogfish Head brands.

Depletions, or sales by distributors to retailers, of the Company’s products for the thirteen weeks ended September 25, 2021 increased by approximately 11% compared to the thirteen weeks ended September 26, 2020, reflecting increases in the Company’s Twisted Tea, Truly Hard Seltzer, Samuel Adams and Dogfish Head brands, partially offset by decreases in its Angry Orchard brand.

The Company believes distributor inventory as of September 25, 2021 averaged approximately 6 weeks on hand and was at an appropriate level for each of its brands, except for Truly, which has significantly higher than planned distributor inventory levels for certain styles and packages. As a result of slowing demand and continued uncertainty on future volume projections for Truly, the Company is working closely with its distributors to reduce Truly distributor inventory levels and have adjusted production and shipments during the third quarter and the remainder of the year. The Company expects total distributor inventory levels for its total business in terms of weeks on hand to be between 4 and 8 weeks for the remainder of the year.

Net revenue per barrel. Net revenue per barrel increased by 2.6% to $242.93 per barrel for the thirteen weeks ended September 25, 2021, as compared to $236.90 per barrel for the comparable period in 2020, primarily due to price increases.

Cost of goods sold. Cost of goods sold was $168.23 per barrel for the thirteen weeks ended September 25, 2021, as compared to $121.24 per barrel for the thirteen weeks ended September 26, 2020. The 2021 increase in cost of goods sold of $46.99 per barrel was primarily due to $84.3 million direct and indirect volume adjustment cost as a result of the hard seltzer slowdown described above and higher materials cost, partially offset by price increases.

Gross profit. Gross profit was $74.70 per barrel for the thirteen weeks ended September 25, 2021, as compared to $115.65 per barrel for the thirteen weeks ended September 26, 2020.

The Company includes freight charges related to the movement of finished goods from its manufacturing locations to distributor locations in its advertising, promotional and selling expense line item. As such, the Company’s gross margins may not be comparable to those of other entities that classify costs related to distribution differently.

Advertising, promotional and selling. Advertising, promotional and selling expenses increased by $58.8 million, or 54.4%, to $166.8 million for the thirteen weeks ended September 25, 2021, as compared to $108.0 million for the thirteen weeks ended September 26, 2020. The increase was primarily due to increased brand investments of $37.6 million, mainly driven by higher media, production and local marketing costs, and increased freight to distributors of $21.1 million mostly attributable to higher rates and volumes.

Advertising, promotional and selling expenses were 29.7% of net revenue, or $72.15 per barrel, for the thirteen weeks ended September 25, 2021, as compared to 21.9% of net revenue, or $51.93 per barrel, for the thirteen weeks ended September 25, 2020. This increase per barrel is primarily due to advertising, promotional and selling expenses growing at a higher rate than shipments. The Company invests in advertising and promotional campaigns that it believes will be effective, but there is no guarantee that such investments will generate sales growth.

The Company conducts certain advertising and promotional activities in its distributors’ markets, and the distributors make contributions to the Company for such efforts. These amounts are included in the Company’s condensed consolidated statements of comprehensive operations as reductions to advertising, promotional and selling expenses. Historically, contributions from distributors for advertising and promotional activities have amounted to between 2% and 3% of net sales. The Company may adjust its promotional efforts in the distributors’ markets, if changes occur in these promotional contribution arrangements, depending on industry and market conditions.

General and administrative. General and administrative expenses increased by $1.7 million, or 5.7%, to $32.0 million for the thirteen weeks ended September 25, 2021, as compared to $30.3 million for the thirteen weeks ended September 26, 2020. The increase was primarily due to increases in external services partially offset by lower salaries and benefits costs.

Contract termination costs and other. Contract termination costs increased by $35.4 million from the comparable period of 2020, primarily due to cancellations of third-party production facilities agreements related to the slowdown of the hard seltzer category.

Impairment of assets. Impairment of long-lived assets increased by $13.7 million from the comparable period of 2020, primarily due to write-downs of equipment of $12.7 million related to the slowdown of the hard seltzer category.

Income tax (benefit) expense. During the thirteen weeks ended September 25, 2021, the Company’s effective tax rate was a tax benefit of 23.6% compared to a tax provision of 20.8% in the thirteen weeks ended September 26, 2020. This change in rate was primarily due to a higher tax benefit from stock option activity recorded in accordance with ASU 2016-09 in the thirteen weeks ended September 26, 2020.

Thirty-Nine Weeks Ended September 25, 2021 compared to Thirty-Nine Weeks Ended September 26, 2020

Slowdown of Hard Seltzer Category Impact. The thirty-nine weeks ended September 25, 2021 results include direct costs resulting from the slowdown of the hard seltzer category of $102.4 million, before the related tax benefit. These direct costs were all incurred in the thirteen weeks ended September 25, 2021 and are described in more detail in the thirteen weeks ended September 25, 2021 Results of Operations section above.

In addition, the thirty-nine weeks ended September 25, 2021 results include indirect costs resulting from the slowdown of the hard seltzer category of $41.5 million, before the related tax benefit. These costs, include increased raw materials sourcing and warehousing costs of $22.3 million, unfavorable absorption impacts at Company owned breweries and downtime charges at third party breweries of $11.8 million, customer return provisions for out of code or damaged products of $5.4 million and other costs of $2.0 million. The total costs of $41.5 million have been recorded in the thirty-nine weeks ended September 25, 2021 financial statements as a $34.6 million increase in cost of goods sold and $6.9 million reduction in net revenue.

Net revenue. Net revenue increased by $434.0 million, or 34.0%, to $1,709.5 million for the thirty-nine weeks ended September 25, 2021, as compared to $1,275 million for the thirty-nine weeks ended September 26, 2020, primarily as a result of an increase in shipments.

Volume. Total shipment volume increased by 29.7% to 7,037,000 barrels for the thirty-nine weeks ended September 25, 2021, as compared to 5,425,000 barrels for the thirty-nine weeks ended September 26, 2020, reflecting increases in the Company’s Truly Hard Seltzer, Twisted Tea, Samuel Adams, Angry Orchard and Dogfish Head brands.

Depletions, or sales by distributors to retailers, of the Company’s products for the thirty-nine weeks ended September 25, 2021 increased by approximately 24% compared to the thirty-nine weeks ended September 26, 2020, reflecting increases in the Company’s Truly Hard Seltzer, Twisted Tea, Samuel Adams and Dogfish Head brands, partially offset by decreases in its Angry Orchard brand.

Net revenue per barrel. Net revenue per barrel increased by 3.32% to $242.93 per barrel for the thirty-nine weeks ended September 25, 2021, as compared to $235.12 per barrel for the comparable period in 2020, primarily due to price increases.

Cost of goods sold. Cost of goods sold was $143.74 per barrel for the thirty-nine weeks ended September 25, 2021, as compared to $124.86 per barrel for the thirty-nine weeks ended September 26, 2020. The 2021 increase in cost of goods sold of $18.88 per barrel was primarily due to $95.2 million direct and indirect volume adjustment cost as a result of the hard seltzer slowdown described above and higher materials cost, partially offset by price increases.

Gross profit. Gross profit was $99.19 per barrel for the thirty-nine weeks ended September 25, 2021, as compared to $110.27 per barrel for the thirty-nine weeks ended September 26, 2020.

Advertising, promotional and selling. Advertising, promotional and selling expenses increased by $163.1 million, or 53.2%, to $469.3 million for the thirty-nine weeks ended September 25, 2021, as compared to $306.3 million for the thirty-nine weeks ended September 26, 2020. The increase was primarily due to increased brand investments of $99.7 million, mainly driven by higher media, production and local marketing costs, and increased freight to distributors of $63.2 million mostly attributable to higher rates and volumes.

Advertising, promotional and selling expenses were 27.5% of net revenue, or $66.69 per barrel, for the thirty-nine weeks ended September 25, 2021, as compared to 24.0% of net revenue, or $56.45 per barrel, for the thirty-nine weeks ended September 26, 2020. This increase per barrel is primarily due to advertising, promotional and selling expenses growing at a higher rate than shipments.

General and administrative. General and administrative expenses increased by $9.9 million, or 11.4%, to $96.9 million for the thirty-nine weeks ended September 25, 2021, as compared to $87.1 million for the thirty-nine weeks ended September 26, 2020. The increase was primarily due to increases in external services and salaries and benefits costs.

Contract termination costs and other. Contract termination costs increased by $35.4 million from the comparable period of 2020, primarily due to cancellations of third-party production facilities agreements related to the slowdown of the hard seltzer category.

Impairment of assets. Impairment of long-lived assets increased $12.6 million from the first half of 2020, primarily due to write-downs of equipment of $12.7 million related to the slowdown of the hard seltzer category, partially offset by lower write-offs of equipment at Company owned breweries.

Income tax expense. During the thirty-nine weeks ended September 25, 2021, the Company’s effective tax rate was 17.3% compared to an effective tax rate of 21.1% in the thirty-nine weeks ended September 26, 2020. This lower rate in year-to-date 2021 was primarily due to the higher impact of deductions for option activity on lower net income compared to the thirty-nine weeks ended September 26, 2020.

LIQUIDITY AND CAPITAL RESOURCES

Cash decreased to $86.5 million as of September 25, 2021 from $163.3 million as of December 26, 2020, reflecting purchases of property, plant and equipment and payments of tax withholdings on stock-based payment awards and investment shares, partially offset by cash provided by operating activities.

Cash provided by operating activities consists of net income, adjusted for certain non-cash items, such as depreciation and amortization, stock-based compensation expense, other non-cash items included in operating results, and changes in operating assets and liabilities, such as accounts receivable, inventory, accounts payable and accrued expenses.

Cash provided by operating activities for the thirty-nine weeks ended September 25, 2021 was $51.0 million and primarily consisted of net income of $66.3 million and non-cash items of $78.6 million, partially offset by a net increase in operating assets and liabilities of $94.0 million. Cash provided by operating activities for the thirty-nine weeks ended September 26, 2020 was $208.9 million and primarily consisted of net income of $159.1 million and non-cash items of $82.7 million, partially offset by a net increase in operating assets and liabilities of $32.9 million. The decrease in cash provided by operating activities for the thirty-nine weeks ended September 25, 2021 compared to the prior period is primarily due to lower net income compared to the prior year and increases in Truly brand finished goods inventory, partially offset by a $42.6 million obsolescence reserve related to the hard seltzer slowdown. This inventory, net of obsolescence reserve, is expected to be sold through the first quarter of 2022.

The Company used $119.6 million in investing activities during the thirty-nine weeks ended September 25, 2021, as compared to $100.0 million during the thirty-nine weeks ended September 26, 2020. Investing activities primarily consisted of capital investments made mostly in the Company’s breweries to drive efficiencies and cost reductions and support product innovation and future growth.

Cash used by financing activities was $8.1 million during the thirty-nine weeks ended September 25, 2021, as compared to $11.4 million provided by financing activities during the thirty-nine weeks ended September 25, 2020. The $19.6 million decrease in cash provided by financing activities in 2021 from 2020 is primarily due to $15.5 million in payments of tax withholding on stock-based payment awards and investment shares in the thirty-nine weeks ended September 25, 2021, an increase of $13.8 million from such amounts in the thirty-nine weeks ended September 26, 2020.

During the thirty-nine weeks ended September 25, 2021 and the period from September 26, 2021 through October 21, 2021, the Company did not repurchase any shares of its Class A Common Stock. As of October 21, 2021, the Company had repurchased a cumulative total of approximately 13.8 million shares of its Class A Common Stock for an aggregate purchase price of $840.7 million and had approximately $90.3 million remaining on the $931.0 million stock repurchase expenditure limit set by the Board of Directors.

The Company expects that its cash balance as of September 25, 2021 of $86.5 million, along with future operating cash flow and the unused balance of the Company’s line of credit of $150.0 million, will be sufficient to fund future cash requirements. The Company’s $150.0 million credit facility has a term not scheduled to expire until March 31, 2023. As of the date of this filing, the Company was not in violation of any of its covenants to the lender under the credit facility.

2021 and 2022 Outlook

Year-to-date depletions through the forty-one weeks ended October 16, 2021 are estimated to have increased approximately 23% from the comparable period in 2020.

The Company currently projects Non-GAAP earnings per diluted share, which excludes the impact of ASU 2016-09, for 2021 of between $2.00 and $6.00, primarily as a result of the slowdown of the hard seltzer category and the related inventory write-offs, contract termination fees, equipment impairments, absorption impacts, downtime charges, and increased sourcing and warehousing costs. This estimate is highly sensitive to changes in volume projections, particularly related to the hard seltzer category. The Company’s actual 2021 earnings per share could vary significantly from the current projection. The Company is currently estimating 2021 depletions and shipments growth of between 18% and 22%. The Company is targeting national price increases of between 2% and 3%. Full-year 2021 gross margins are currently expected to be between 40% and 42%, which includes combined full year direct and indirect costs of the hard seltzer slowdown estimated at $132.0 million, of which $95.2 million has been incurred in the first nine months and the remainder of $36.8 million are estimated to be incurred in the fourth quarter. The Company intends to increase advertising, promotional and selling expenses by between $80 million and $100 million for the full year 2021, not including any changes in freight costs for the shipment of products to Distributors. The Company intends to increase its investment in its brands in 2021, commensurate with the opportunities for growth that it sees, but there is no guarantee that such increased investments will result in increased volumes. The Company estimates a full-year 2021 Non-GAAP effective tax rate of approximately 28.0%, which excludes the impact of ASU 2016-09.

The Company is completing its 2022 planning process and will provide further detailed guidance when the Company presents its full-year 2021 results. Based on information of which it is currently aware, the Company is using the following preliminary assumptions and targets for its 2022 fiscal year, which are highly sensitive to changes in volume projections, particularly related to the hard seltzer category. The Company is forecasting depletion and shipment percentage growth of between mid-single digits and low-double digits. The Company is targeting national price increases of between 3% and 6%. Full-year 2022 gross margins are currently expected to be between 45% and 48%. The Company intends to increase advertising, promotional and selling expenses by between $10 million and $30 million for the full year 2022, not including any changes in freight costs for the shipment of products to distributors. The Company intends to increase its investment in its brands in 2022 commensurate with the opportunities for growth that it sees, but there is no guarantee that such increased investments will result in increased volumes. The Company estimates a full-year 2022 Non-GAAP effective tax rate of approximately 26%, excluding the impact of ASU 2016-09.

Non-GAAP earnings per diluted share and Non-GAAP effective tax rate are not defined terms under U.S. generally accepted accounting principles (“GAAP”). These Non-GAAP measures should not be considered in isolation or as a substitute for diluted earnings per share and effective tax rate data prepared in accordance with GAAP, and may not be comparable to calculations of similarly titled measures by other companies. Management believes these Non-GAAP measures provide meaningful and useful information to investors and analysts regarding our outlook and facilitate period to period comparisons of our forecasted financial performance. Non-GAAP earnings per diluted share and Non-GAAP effective tax rate exclude the potential impact of ASU 2016-09, which could be significant and will depend largely upon unpredictable future events outside the Company’s control, including the timing and value realized upon exercise of stock options versus the fair value of those options when granted. Therefore, because of the uncertainty and variability of the impact of ASU 2016-09, the Company is unable to provide, without unreasonable effort, a reconciliation of these Non-GAAP measures on a forward-looking basis.

The Company is continuing to evaluate 2021 capital expenditures. Its current estimates are between $160 million and $200 million, consisting mostly of investments in capacity and supply chain efficiency improvements. The Company estimates full-year 2022 capital spending of between $140 million and $190 million. The actual total amount spent on 2021 and 2022 capital expenditures may well be different from these estimates. Based on information currently available, the Company believes that its capacity requirements for 2021 and 2022 can be covered by its Company-owned breweries and existing contracted capacity at third-party brewers.

Off-balance Sheet Arrangements

At September 25, 2021, the Company did not have off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K.

Contractual Obligations

There were no material changes outside of the ordinary course of the Company’s business to contractual obligations during the three-month period ended September 25, 2021.

Critical Accounting Policies

The Company’s critical accounting policies are discussed in Part II, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations of the Form 10-K for the year ended December 26, 2020. The Company believes that the consistent application of these policies enables the Company to provide readers of the interim consolidated financial statements with useful and reliable information about the Company’s results of operations and financial condition. No material changes to the Company’s critical accounting policies, as previously disclosed, have occurred during the first nine months of 2021, except for the expansion of the Company’s Provision for Excess or Expired Inventory policy due to the large provision reported in the third quarter of 2021 as discussed in Note B of these condensed consolidated financial statements.

Provision for Excess or Expired Inventory

The provisions for excess or expired inventory are based on management’s estimates of forecasted usage of inventories on hand and under contract. Forecasting usage involves significant judgments regarding future demand for the Company’s various existing products and products under development as well as the potency and shelf-life of various ingredients. The Company experienced a significant decline in demand for its Truly branded products during the third quarter of 2021 and is forecasting lower demand for Truly branded products for the remainder of the 2021 fiscal year and for the 2022 fiscal year. The lower forecasted demand for the Truly branded products resulted in a $42.6 million provision for excess or expired inventory during the third quarter of 2021. A significant change in the timing or level of demand for certain products as compared to forecasted amounts may result in recording additional provisions for excess or expired inventory in the future. Provisions for excess inventory are included in cost of goods sold and have historically been adequate to provide for losses on its inventory. Provisions for excess or expired inventory included in cost of goods sold was $11.3 million, $8.1 million and $4.2 million in fiscal years 2020, 2019 and 2018, respectively.

FORWARD-LOOKING STATEMENTS

In this Quarterly Report on Form 10-Q and in other documents incorporated herein, as well as in oral statements made by the Company, statements that are prefaced with the words “may,” “will,” “expect,” “anticipate,” “continue,” “estimate,” “project,” “intend,” “designed” and similar expressions, are intended to identify forward-looking statements regarding events, conditions, and financial trends that may affect the Company’s future plans of operations, business strategy, results of operations and financial position. These statements are based on the Company’s current expectations and estimates as to prospective events and circumstances about which the Company can give no firm assurance. Further, any forward-looking statement speaks only as of the date on which such statement is made, and the Company undertakes no obligation to update any forward-looking statement to reflect subsequent events or circumstances. Forward-looking statements should not be relied upon as a prediction of actual future financial condition or results. These forward-looking statements, like any forward-looking statements, involve risks and uncertainties that could cause actual results to differ materially from those projected or anticipated. Such risks and uncertainties include the factors set forth below in addition to the other information set forth in this Quarterly Report on Form 10-Q and in the section titled “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 26, 2020.

Since December 26, 2020, there have been no significant changes in the Company’s exposures to interest rate or foreign currency rate fluctuations. The Company currently does not enter into derivatives or other market risk sensitive instruments for the purpose of hedging or for trading purposes.

As of September 25, 2021, the Company conducted an evaluation under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer (its principal executive officer and principal financial officer, respectively) regarding the effectiveness of the design and operation of the Company’s disclosure controls and procedures as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) were effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the requisite time periods and that such disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to its management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

As a result of the COVID-19 pandemic, certain employees of the Company began working remotely in March 2020 but these changes to the working environment did not have a material effect on the Company’s internal control over financial reporting. There was no other change in the Company’s internal control over financial reporting that occurred during the thirty-nine weeks ended September 25, 2021 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

In addition to the other information set forth in this report, careful consideration should be given to the factors discussed in Part I, "Item 1A. Risk Factors" in the Company’s Annual Report on Form 10-K for the year ended December 26, 2020, which could materially affect the Company’s business, financial condition or future results. The risks described in the Company’s Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not currently known to the Company or that it currently deems to be immaterial also may materially adversely affect its business, financial condition and/or operating results.