Boston Beer Company - 10-Q quarterly report FY

The Boston Beer Company, Inc. and its subsidiaries (the “Company”) are engaged in the business of brewing and selling malt beverages and cider products throughout the United States and in selected international markets. The accompanying consolidated statement of financial position as of June 25, 2005 and the statement of consolidated operations and consolidated cash flows for the interim periods ending June 25, 2005 and June 26, 2004 have been prepared by the Company, without audit, in accordance with U.S. generally accepted accounting principles for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required for complete financial statements by generally accepted accounting principles and should be read in conjunction with the audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 25, 2004.

In the opinion of the Company’s management, the Company’s unaudited consolidated financial position as of June 25, 2005 and the results of its consolidated operations and consolidated cash flows for the interim periods ended June 25, 2005 and June 26, 2004, reflect all adjustments (consisting only of normal and recurring adjustments) necessary to present fairly the results of the interim periods presented. The operating results for the interim periods presented are not necessarily indicative of the results expected for the full year.

Short-term investments are classified as trading securities and primarily include municipal auction rate securities that totaled $24.1 million and $24.0 million as of June 25, 2005 and December 25, 2004, respectively.

The Company recorded a realized loss on the sale of short-term investments of $0 for the three and six month periods ended June 25, 2005 and $0.2 million for the three and six month periods ended June 26, 2004.

Inventories, which consist principally of hops, brewing materials and packaging, are stated at the lower of cost, determined on a first-in, first-out (FIFO) basis, or market.

Inventories consist of the following (in thousands):

The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share data):

Comprehensive income is as follows (in thousands):

The Company had outstanding purchase commitments related to advertising contracts of approximately $5.8 million and $12.4 million at June 25, 2005 and December 25, 2004, respectively. These purchase commitments reflect amounts that are non-cancelable.

The Company has entered into contracts for the supply of a portion of its hops requirements. These purchase contracts, which extend through crop year 2009, specify both the quantities and prices to which the Company is committed. The prices of these contracts are denominated in euros. Hops purchase commitments outstanding at June 25, 2005 totaled $10.3 million (based on the exchange rate at June 25, 2005), compared to $11.5 million at December 25, 2004.

In April 2005, the Securities and Exchange Commission (“the Commission”) amended the compliance dates for SFAS No. 123R. Under SFAS No. 123R, registrants would have been required to implement the standard as of the beginning of the first interim or annual period that begins after June 15, 2005, or after December 15, 2005 for small business issuers. The Commission’s new rule allows companies to implement SFAS No. 123R at the beginning of their next fiscal year, instead of the next reporting period, that begins after June 15, 2005, or December 15, 2005 for small business issuers. The Company intends to adopt SFAS No. 123R in fiscal year 2006. The Company is in the process of evaluating the impact of this pronouncement on its consolidated financial position, operations and cash flows.

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 three and six-month periods ended June 25, 2005 as compared to the three and six-month periods ended June 26, 2004. This discussion should be read in conjunction with the Management’s Discussion and Analysis of Financial Condition and Results of Operations, Consolidated Financial Statements of the Company and Notes thereto included in the Company’s Form 10-K for the fiscal year ended December 25, 2004.

Boston Beer’s flagship product is Samuel Adams Boston Lagerâ. For purposes of this discussion, Boston Beer’s “core brands” include all products sold under the Samuel Adamsâ, Sam Adamsâ, Twisted Teaâ and HardCoreâ trademarks. “Core brands” do not include the products brewed at the Cincinnati Brewery under contract arrangements for third parties.

Net revenue. Net revenue decreased by $0.4 million or 0.6% to $61.6 million for the three months ended June 25, 2005 as compared to the three months ended June 26, 2004. The decrease is primarily due to a decline in shipment volume of Boston Beer’s core brands, partially offset by net price increases and a shift in the product and package mix.

Volume. Total shipment volume decreased by 2.8% to 0.4 million barrels in the three months ended June 25, 2005 as compared to the same period 2004. The decrease in shipment volume was due to declines in Samuel Adams Boston Lagerâ, Sam Adams Lightâ, partially offset by growth in Twisted Teaâ, Seasonal Brands, and Brewmaster’s Collection.

Wholesaler inventory levels at the end of the second quarter 2005 were at normal levels, based on historical measures. Shipments and orders in-hand suggest that core shipments for July and August 2005 could be up approximately 11% as compared to the same period in 2004. Actual shipments for the current quarter may differ, however, and no inferences should be drawn with respect to shipments in future periods.

Selling Price. The net selling price per barrel increased by 2.2% to $174.60 per barrel for the quarter ended June 25, 2005 as compared to the same period last year. This increase is due to price increases and a shift in the product and package mix, which was partially offset by an increase in the provision for excise taxes payable. During the second quarter 2005, the Company recorded an adjustment in its provision for excise taxes payable in the amount of $0.5 million.

The product and package mix shift was driven by higher shipments of Samuel Adams Utopias™ in 2005 which has higher revenue per barrel than other core products and a shift in the package mix to bottles from kegs as the selling price per equivalent barrel is higher for bottles than for kegs. The package shift from kegs to bottles is primarily due to increases in Twisted Teaâ and Brewmaster’s Collection as these products are primarily available in bottles.

Gross profit. Gross profit was 59.9% as a percentage of net revenue or $104.62 per barrel for the quarter ended June 25, 2005, as compared to 60.5% and $103.34 for the quarter ended June 26, 2004. The decline in gross profit as a percentage of net sales is due to increases in cost of goods sold per barrel and the provision for excise taxes payable, partially offset by price increases that were taken during the first quarter 2005.

The Company expects its gross profit percentage for the full year 2005 to be approximately equal to the six month 2005 rate of 60.5%, provided product mix is stable.

Cost of goods sold increased by 3.7% or $2.47 per barrel to $69.97 per barrel for the quarter ended June 25, 2005, as compared to $67.50 per barrel for the same period last year. The increase is primarily due to shifts in the product and package mix and higher packaging material costs as compared to the same period last year.

The Company includes freight charges related to the movement of finished goods from 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 other entities that classify costs related to distribution differently.

Advertising, promotional and selling. Advertising, promotional and selling expenses increased by $0.1 million to $25.1 million for the three months ended June 25, 2005 as compared to the three months ended June 26, 2004 due to increases in freight costs and wages, partially offset by lower advertising expenditures.

For the full year 2005 we expect to increase our brand support in advertising, promotional and selling spend by between $3.0 and $5.0 million over full year 2004.

General and administrative. General and administrative expenses increased by 10.2% or $0.4 million to $4.0 million for the quarter ended June 25, 2005 as compared to the same period last year, primarily due to increases in wages, accounting, audit and legal fees.

Interest income. Interest income increased by $0.3 million to $0.5 million for the quarter ended June 25, 2005 as compared to the same period last year due to higher cash and investment balances coupled with higher interest rates earned on investments in 2005.

Other income (expense), net. Other income (expense) increased by $0.3 million to income of $0.1 million earned during the quarter ended June 25, 2005 as compared to expense of $0.2 million for the quarter ended June 26, 2004. This increase is primarily due to a $0.2 million loss incurred on the sale of available-for-sale securities in the quarter ended June 26, 2004 as compared to no losses incurred on investment sales during 2005.

Provision for income taxes. The Company’s effective tax rate increased to approximately 39% for the six months ended June 25, 2005 from approximately 38% for the same period last year. The Company currently estimates that its effective tax rate for fiscal year 2005 will be approximately 39%. The increase in the effective tax rate, as compared to the prior year, is due to apportionment of income amongst states.

Net revenue. Net revenue increased by $3.7 million or 3.4% to $110.3 million for the six months ended June 25, 2005 from $106.7 million for the six months ended June 26, 2004. The increase is primarily due to net price increases, an increase in shipment volume, and a shift in the package and product mix.

Volume. Total shipment volume increased by 1.1% to 0.6 million barrels for the six months ended June 25, 2005 as compared to the same period 2004, due to an increase in shipments of Twisted Teaâ, Brewmaster’s Collection, and Seasonal Brands, partially offset by declines in Samuel Adams Boston Lagerâ and Sam Adams Lightâ.

Selling Price. The net selling price per barrel increased by approximately 2.3% to $174.32 per barrel for the six months ended June 25, 2005 as compared to the prior year. This increase is due to net price increases that were taken during the first quarter 2005 and a shift in the product and package mix. These increases were partially offset by a $0.5 million adjustment in the provision for excise taxes payable during the six months ended June 25, 2005.

Gross profit. Gross profit was 60.5% as a percentage of net revenue or $105.47 per barrel for the six months ended June 25, 2005, as compared to 60.1% and $102.39 for the six months ended June 26, 2004. The increase per barrel is primarily due to net price increases that were partially offset by the adjustment in the provision for excise taxes payable and an increase in cost of goods sold per barrel.

Cost of goods sold increased by 1.2% or $0.83 per barrel during the six months ended June 25, 2005 as compared to the same period last year due to a shift in the product and package mix and an increase in packaging material costs.

Advertising, promotional and selling. Advertising, promotional and selling expenses decreased by $1.9 million to $44.9 million for the six months ended June 25, 2005, as compared to $46.7 million for the six months ended June 26, 2004. The decrease is primarily driven by reduced advertising spending, partially offset by higher freight costs for the six months ended June 25, 2005 as compared to the prior year. The increase in freight costs is due to higher shipment volume and higher freight rates in 2005 as compared to last year.

General and administrative. General and administrative expenses increased by 17.3% or $1.2 million to $8.0 million for the six months ended June 25, 2005 as compared to the same period last year. The increase in general and administrative expenses is primarily due to an increase in wages, accounting, audit and legal fees during the first half of 2005 as compared to last year.

Interest income. Interest income increased by $0.4 million to $0.8 million for the six months ended June 25, 2005 as compared to the same period last year due to higher cash and investment balances coupled with higher interest rates earned on investments in 2005.

Other income (expense), net. Other income (expense), net increased by $0.5 million to $0.2 million for the six months ended June 25, 2005 as compared to the same period ended June 26, 2004. This increase is primarily due to a $0.2 million loss incurred during the six months ended June 26, 2004 on the sale of available-for-sale securities as compared to no losses incurred on investment sales during 2005.

Provision for income taxes. The Company’s effective tax rate increased to approximately 39% for the six months ended June 25, 2005 from approximately 38% for the same period last year. The Company currently estimates that its effective tax rate for fiscal year 2005 will be approximately 39%. The increase in the effective tax rate, as compared to the prior year, is due to apportionment of income amongst states.

Cash and short-term investments increased by $4.9 million to $64.7 million as of June 25, 2005 from $59.8 million as of December 25, 2004. The increase is primarily due to $14.0 million of cash provided by operating activities, partially offset by $7.0 million used for purchases of property, plant and equipment and $2.2 million used in financing activities.

Cash from operating activities increased by $1.4 million in the six months ended June 25, 2005 as compared to the same period last year, primarily due to a $2.5 million increase in net income.

The Company used $7.0 million for the purchase of capital equipment during the six months ended June 25, 2005 as compared to $2.1 million during the same period last year. Purchases during the first half of 2005 primarily consisted of machinery and equipment purchases related to the brewery expansion project in Cincinnati and, to a lesser extent, purchases of kegs.

During 2005, the Company plans to spend in the range of $12.0 million to $15.0 million on capital expenditures for investment in production efficiencies, kegs and information systems. This estimate includes approximately $6.5 million that the Company anticipates spending on the expansion project at its Cincinnati Brewery in 2005. The expansion project at the Cincinnati Brewery is expected to be completed in the third quarter 2005 and is expected to increase future production volume at that brewery to approximately two-thirds of total production volume.

Cash used in financing activities of $2.2 million during the six months ended June 25, 2005 increased by $4.1 million as compared to the $1.9 million of cash provided by financing activities during the same period last year. The increase of cash used in financing activities is due to $3.6 million used to repurchase the Company’s Class A Common Stock under its Stock Repurchase Program during the six months ended June 25, 2005 coupled with a $0.5 million decline in proceeds from the exercise of stock options as compared to the same period last year.

The Company repurchased $3.6 million and $0 during six month periods ended June 25, 2005 and June 26, 2004, respectively, of its Class A Common Stock under the Company’s Stock Repurchase Program. Effective July 26, 2005 the Company’s Board of Directors increased the aggregate expenditure limitation on the Company’s Stock Repurchase Program from $80.0 million to $100.0 million. As of August 2, 2005, the Company has repurchased a total of approximately 7.3 million shares of its Class A Common Stock for an aggregate purchase price of $80.0 million and had $20.0 million remaining on the $100.0 million share buyback expenditure limit.

As of June 25, 2005, the Company’s cash was primarily invested in taxable and tax-exempt money market funds and short-term tax-exempt interest-bearing securities. The Company’s investment objectives are to preserve principal, maintain liquidity and achieve favorable tax advantaged yields.

With working capital of $63.9 million and $20.0 million in unused credit facilities as of June 25, 2005, the Company believes that its cash flows from operations and existing resources should be sufficient to meet the Company’s short-term and long-term operating and capital requirements. The Company’s $20.0 million credit facility expires on March 31, 2007. As of the date of this filing, the Company is not in violation of any of its covenants to the lender under the credit facility and there are no amounts outstanding under the credit facility.

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make significant estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. These items are monitored and analyzed by management for changes in facts and circumstances, and material changes in these estimates could occur in the future. Changes in estimates are recorded in the period in which they become known. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from our estimates if past experience or other assumptions do not turn out to be substantially accurate.

Inventories are stated at the lower of cost, determined on a first-in, first-out basis, or market. Our provisions for excess or expired inventory are based on management’s estimates of forecasted usage of inventories. 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 recorded as cost of goods sold.

The excess hops inventory reserve accounts for a portion of the inventory obsolescence reserve. The Company uses certain Noble hops grown in Germany, for which it enters forward contracts to ensure adequate numbers of farmers in its preferred growing regions are planting and maintaining the proper quality hop vines. The Company manages hop inventory and contract levels as necessary to attempt to ensure that it has access to the best hops each year. The current inventory and contract levels are deemed adequate, based upon foreseeable future brewing requirements. Actual hops usage and needs may differ materially from management’s estimates.

Throughout the year, the Company’s sales force engages in numerous promotional activities. In connection with its preparation of financial statements and other financial reporting, management is required to make certain estimates and assumptions regarding the amount and timing of expenditures resulting from these activities. Actual expenditures incurred could differ from management’s estimates and assumptions.

The Company enters into promotional discount agreements with its various wholesalers for certain periods of time. The agreed-upon discount rates are applied to the wholesalers’ sales to retailers in order to determine the total discounted amount. The computation of the discount accrual requires that management make certain estimates and assumptions that affect the reported amounts of related assets at the date of the financial statements and the reported amounts of revenue during the reporting period. Actual promotional discounts owed and paid could differ from the estimated accrual.

In certain circumstances and with the Company’s approval, the Company accepts and destroys stale beer that is returned by distributors. For several years, the Company has credited approximately fifty percent of the distributor’s cost of the beer that has passed its expiration date for freshness when it is returned to the Company or destroyed. The Company establishes an accrual based upon two factors. The first factor considers actual prior months’ return expense, which is applied to an estimated lag time for receipt of product and the processing of the credit to the distributor by the Company. The second factor is the Company’s knowledge of specific return transactions. The actual stale beer expense incurred by the Company could differ from the estimated accrual.

The Company purchases kegs from vendors and records these assets in property, plant and equipment. When the kegs are shipped to the distributors, a keg deposit is collected. This deposit is refunded to the distributors upon return of the kegs to the Company. The first fill allowance for deposits, a current liability, is estimated based on historical information and this computation requires that management make certain estimates and assumptions that affect the reported amounts of keg deposit liabilities at the date of the financial statements and the reported amounts of revenue during the reporting period. Actual keg deposit liability could differ from the estimates.

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123R, Share-Based Payment (“SFAS No. 123R”). This Statement is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS No. 123R focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. The Statement requires entities to recognize stock compensation expense for awards of equity instruments to employees based on the grant-date fair value of those awards (with limited exceptions).

In April 2005, the Securities and Exchange Commission (“the Commission”) amended the compliance dates for SFAS No. 123R. Under SFAS No. 123R, registrants would have been required to implement the standard as of the beginning of the first interim or annual period that begins after June 15, 2005, or after December 15, 2005 for small business issuers. The Commission’s new rule allows companies to implement SFAS No. 123R at the beginning of their next fiscal year, instead of the next reporting period, that begins after June 15, 2005, or December 15, 2005 for small business issuers. The Company intends to adopt SFAS No. 123R in fiscal year 2006. The Company is in the process of evaluating the impact of this pronouncement on its consolidated financial position, operations and cash flows.

In November 2004, the FASB issued Statement No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. Statement 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material. Statement 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company does not believe adoption of Statement 151 will have a material effect on its consolidated financial position, results of operations or cash flows.

In December 2004, the FASB issued Statement No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29. Statement No. 153 addresses the measurement of exchanges of nonmonetary assets and redefines the scope of transactions that should be measured based on the fair value of the assets exchanged. Statement No. 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The Company does not believe adoption of Statement No. 153 will have a material effect on its consolidated financial position, results of operations or cash flows.

In this 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 unanticipated. Such risks and uncertainties include the factors set forth below in addition to the other information set forth in this Form 10-Q.

Since December 25, 2004, 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 June 25, 2005, 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 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 are effective to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to them by others within those entities.

There was no change in the Company’s internal control over financial reporting that occurred during the quarter ended June 25, 2005 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

As of August 2, 2005, the Company had 10.0 million shares of Class A Common Stock outstanding and 4.1 million shares of Class B Common Stock outstanding.