Boston Beer Company, Inc.

Greetings. Welcome to the Boston Beer Company's second quarter 2020 earnings call. At this time, all participants will be in listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. At this time, I'll turn the conference over to Mr. Jim Cook. Mr. Cook, you may begin.

Thank you. Good afternoon and welcome. This is Jim Cook, founder and chairman, and I'm pleased to kick off the 2020 second quarter earnings call for the Boston Beer Company. Joining the call from Boston Beer are Dave Berwick, our CEO, and Frank Smola, our CFO. I'll begin my remarks this afternoon with a few introductory comments, including some discussion on the COVID-19 pandemic and the 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 results, as well as a review of our outlook for 2020. Immediately following Frank's comments, we'll open the line up for questions. As our world continues to grapple with this COVID-19 pandemic, our primary focus at Boston Beer Company continues to be on operating our breweries and our overall business safely and supporting our partners in the beer industry. Supporting the communities in which we work and live is one of our core values. And we're very happy that our Samuel Adams Restaurant Strong Fund has raised over $5.4 million so far to support bar and restaurant workers who are experiencing hardship in the wake of COVID-19. Working with the Greg Hill Foundation, this fund is committed to distributing 100% of its proceeds to grants to bar and restaurant workers across the country. While doing this, we also achieved depletions growth of 46% in the second quarter, of which 42% is from Boston Beer legacy brands, and 4% is from the addition of the Dogfish Head brands. I'm tremendously thankful for the effort of our coworkers in achieving our ninth consecutive quarter of double-digit growth while maintaining a focus on quality and innovation. We're also thankful to our outstanding distributors and retailers for their focus during COVID-19. Our business in the second quarter was strong, but uncertainties due to COVID-19 do remain. These uncertainties include our ability to continue to operate our breweries at a level of safety that meets our standards, the continued ability to distribute to off-premise retail locations and the timing of the reopening of on-premise retail locations. We will continue to work hard through the COVID-19 pandemic and prioritize safety above all else. I'm proud of the passion creativity, and commitment to community that our company and coworkers have demonstrated during this pandemic. We remain positive about the future growth of our brands and are happy that our diversified brand portfolio continues to fuel double-digit growth. I will now pass over to Dave for a more detailed overview of our business.

Okay, thanks, Jim. Hello, everyone. Before I review our business results, I'll start with the usual disclaimer. As we state in our earnings release, some of the information we discuss and that may come up on this call reflect the company's or management's expectations or predictions of the future. Such predictions are forward-looking statements. It's important to note that the company's actual results could differ materially from those projected in these forward-looking statements. Additional information concerning factors that could cause actual results to differ materially From those of the forward-looking statements, it's contained in the company's most recent 10Q and 10K. The company does not undertake to publicly update forward-looking statements, whether as a result of new information, future events, or otherwise. Okay, now let me share a deeper look at our business performance. Our depreciation growth in the second quarter was a result of increases in our truly hard seltzer and twisted tea brands and the addition of the dogfish head brands that were only partially offset by decreases in our San Diego Adams in Angry Orchard brands. The growth of the Truly brand, led by Truly Hard Lemonade, has accelerated and continues to grow beyond our expectations. Since early January, Truly has significantly grown its velocity and has sequentially grown its market share, while many other hard seltzer brands have entered the category. Truly is the only hard seltzer not introduced earlier this year to grow its share during 2020. We'll continue to invest heavily in the Chuli brand and further improve our position in the hard seltzer category as competition continues to increase. We're excited about our new Chuli advertising campaign that showcases colors, variety, and joy to hard seltzer drinkers through four different ads. Because we delayed the premiere of this campaign to June, given the consumer environment surrounding COVID-19, it's too early to know if it will resonate with drinkers. Twisted Tea continues to generate double-digit volume growth rates that are well above full-year 2019 trends. We expect to increase our brand investments in the second half compared to the first half and see significant distribution and volume growth opportunities for our Truly, Twisted Tea, and Dogfish Head brands. Samuel Adams and Angry Orchards volumes continue to decline as they are more deeply impacted by the effect of COVID-19 on on-premise retailers. We're encouraged, however, that Samuel Adams Boston Lager and Indy Orchard Crisp Apple both have experienced double-digit growth in the measure of off-premise channels during the quarter. We continue to work on returning these brands to growth, but don't expect them to grow during 2020 because of on-premise closures. I'm pleased that our overall business has shown great momentum in depletion improvements during the first half of the year. Given our trends for the first half and our current view of the remainder of the year, We've adjusted our expectations for higher 2020 four-year earnings, depletions, and shipment growth, which is primarily driven by the strong performance of our Truly and Twisted Tea brands. We've adjusted our business to the COVID-19 environment and continue to work to control what we can control, with our primary focus being the safety of our coworkers, distributors, retailers, and drinkers. We've deployed many safety protocols across our business and in our breweries, including entrance screening and temperature checks, face mask requirements, reorganized workspacing to increase physical distancing between and among shifts, and adding more cleaning and sanitation time to each shift. We're slowly reopening our hospitality locations, which were closed since March, with a focus on outdoor service and takeout. Our accelerated depreciation growth has been challenging operationally. We've been experiencing out-of-stocks, and we expect wholesaler inventories to remain very tight for the rest of the summer. We've been operating at capacity for many months and have further increased our uses of third-party breweries in response to the growth. In particular, the additional chewy volumes have come at a higher incremental cost due to an increased uses of third-party breweries, which is negatively impacting our gross margin expectation for the year. We're investing significantly in our supply chain, but do not expect these pressures to be relieved in the second half of the year. We'll continue to invest to increase capacity as appropriate to meet the needs of our business and take full advantage of the fast-growing hard seltzer category. We're a very competitive business, but we're optimistic for continued growth of our current grant portfolio. We remain prepared to forsake short-term earnings as we invest to sustain long-term possible growth in line with the opportunities that we see. Based on information in hand, year-to-date depreciation is reported to the company in through the 28 weeks into July 11, 2020, are estimated to have increased approximately 42% from the comparable weeks in 2019. Excluding the dogfish head impact, depletion has increased 37%. Now I'm going to hand over to Frank, who will provide the financial details.

Thank you, Jim and Dave. Good afternoon, everyone. For the second quarter, we reported net income of $60.1 million, an increase of $32.3 million, or 116% from the second quarter of 2019. Earnings per diluted share were $4.88, an increase of $2.52 per diluted share from the second quarter of 2019. This increase was primarily due to increased revenue driven by shipment growth of 39.8%, partially offset by lower gross margins and higher operating expenses. We began seeing the impact of the COVID-19 pandemic on our business in early March. Today, the direct financial impact of the pandemic has primarily shown in significantly reduced tech demand from the on-premise panel and higher labor and safety-related costs at our breweries. In the first half of 2020, we recorded COVID-19 pre-tax-related reductions in net revenue and increases in other costs totaling $14.1 million, of which $10 million was recorded in the first quarter and $4.1 million was recorded in the second quarter. The total amount consists of a $5.8 million reduction in net revenue for estimated CAC returns from distributors and retailers and $8.3 million of other COVID-19-related direct costs of which $5.6 million are recorded in cost of goods sold and $2.7 million are recorded in operating expenses. In addition to these direct financial impacts, COVID-19-related safety measures resulted in a reduction of brewery productivity. This has shifted more volume to third-party breweries, which increased production costs and negatively impacted gross margins. In April 2020, we withdrew full-year fiscal 2020 financial guidance due to uncertainties around COVID-19. Despite the continued uncertainties related to the COVID-19 pandemic, we feel our business outlook has stabilized and that it is now appropriate to give full-year fiscal 2020 financial guidance. We will continue to assess and manage this situation and will provide a full update in our third quarter earnings release to the extent that the effects of the COVID-19 pandemic are then known more clearly. Shipment volume was approximately 1.9 million barrels, a 39.8% increase in the second quarter of 2019. Excluding the addition of the darker shed brands beginning July 3, 2019, shipment increased 35.3%. We believe distributor inventory as of June 27, 2020 averaged approximately two and a half weeks on hand and was lower than prior year levels due to supply chain capacity constraints. We expect wholesale inventory levels in terms of weeks on hand to remain lower than prior year levels for the remainder of the year. Our second quarter 2020 gross margin of 46.4% decreased from the 49.9% margin realized in the second quarter of 2019. primarily as a result of higher processing costs due to increased production of third-party breweries, partially offset by price increases and cost-saving initiatives of company-owned breweries. Second quarter advertising, promotional, and selling expenses increased by $6.3 million from the second quarter of 2019, primarily due to increases in salaries and benefits costs, increased grant investments in media and production, The addition of darkfisher grant-related expenses beginning July 3, 2019, and increased freight to distributors due to higher volumes, partially offset by decreased investments in local marketing and national promotions due to timing of these costs compared to the prior year. General and administrative expenses increased by $2.9 million in the second quarter of 2019, primarily due to increases in salaries and benefits costs, and the addition of doctor share general and administrative expenses beginning July 3, 2019, partially offset by the non-recurrence of $1.5 million in doctor share transaction-related fees incurred in the second quarter of 2019. Based on information of which we are currently aware, we are now targeting full-year 2020 earnings per diluted share of between $11.70 and $12.70. However, actual results were very significant from this target. This projection excludes the impact of ASU 2016-09. Four-year 2020 depreciation growth, including darkfisher, is now estimated to be between 27% and 35%, of which between 1% and 2% is due to the addition of the darkfisher brand. We project increases in revenue per barrel of between 1% and 2%. Four-year 2020 gross margins are expected to be between 46% and 48%. We plan to increase investments in advertising, promotional, and selling expenses of between $70 million and $80 million for the full year 2020. This does not include any increases in freight costs for the shipment of products to our distributors. We estimate our full year 2020 non-gap effective tax rate to be approximately 26%, which excludes the impact of ASU 2016-0-9. We're continuing to evaluate 2020 capital expenditures and probably estimate investments of between $118 million and $200 million. The capital will be spent mostly on continued investments in our breweries and could be higher if deemed necessary to meet future growth. We expect that our cash balance of $86.7 million as of June 27, 2020, along with our future operating cash flow, an unused line of credit of $150 million, will be sufficient to fund future cash requirements. We will now open up the call for questions. Before we do that, though, I would like to remind everybody that we are still in different locations due to COVID-19, and Dave will act as an MC again when we address your questions, similar to how we did it in our last earnings call in April.

Thank you. If you'd like to ask a question today, please press star 1 from your telephone keypad, and the confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For persons using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment while we assemble the queue. Thank you. Our first question is from the line of Bonnie Herzog with Goldman Sachs. Please receive your questions.

All right. Thank you. Good afternoon, everyone. I wanted to drill down on, you know, this impressive growth that we're seeing for this category, which it's been unbelievable. So I kind of would like to hear a little bit more from all of you about, you know, what gives you the confidence that this can really continue, especially as, you know, in the future, more bars and restaurants open. So kind of how do you think about that? And then maybe help all of us understand how you guys are thinking about the barriers to entry for the category since, you know, it seems like the category is obviously attracting a lot of new entrants. And, you know, just kind of want to hear your thoughts on how big of a risk you see this as more and more, you know, companies and or brands enter and especially maybe from non-beer companies. Thoughts on that. Thanks.

This is Dave. I think I'll start it, and then if anyone wants to jump in after that, that's great. So, I mean, I think we are very confident, and Bonnie, I presume you're talking primarily about the hard sell category. Yeah, I should have, yeah. Okay. And so, we're looking at growth this year. We think about 150%, and it might be like around 8% of total share of beer volume. Obviously, we've all seen it. We think there's a number of reasons why we're pretty confident in this. And this one is really starting with the consumer trends, which we talked about before. We look at three really important trends in the broader beer category, all of which really apply very directly to hard seltzers. The health and wellness trend, of course, the desire for variety-seeking and flavors of all different kinds and experimenting and discovering new flavors and brands, and also premiumization. So you have these very solid trends. You look at the sourcing. The sourcing is still, even now, it started out in more than half of the volume is coming from wine and spirits. Now, most recently, it's maybe about 50% or so still from wine and spirits. So you're sourcing from outside. of the category, and it's a very, it's a very sessionable occasion, more so, you know, more so than beer. We still see, there's a lot of upside from a shelf space perspective, so our seltzers are still significantly underspaced across channels, and then we even go further across channels, convenience and gas, on-premise, you know, still lots of opportunity to develop the brands in those channels. So there's a lot of different opportunities for growth here. We also think, we know that, I think this came from Nielsen, but I think 90% of people who drink hard seltzer see it as something separate and distinct from beer, right? So they don't see it as a beer, they see it as something that's unique. And we think this is a good thing if you have a brand that's not a about beer, but a brand that's made for the category. So I think, we talked about before, you look at the two, and the two leaders in this category are about 70 to 80% of the share. We used, and then we used the energy category sort of as a bit of an analog to show the consolidation that could happen when you have legacy brands that are working well and innovate aggressively and spend aggressively to maintain their turf, if you will, and we're seeing that play out. So, We're really confident. We think personally that we can play differently than other competitors through innovation. And, you know, and then the last thing I'll say, I know it's a long answer, the last thing I think we've been working on this now, this new approach, since the end of last year with the reformulation, spending more across all media forms, the lemonade launch, we've been able to gain 5%. IRI, NILO, plus convenience. We're about 28. We gained five share points. We closed the gap that began the year with our very formidable competitor. It was, I think it was a 41-point share gap. It's now a 15-point share gap. So, it doesn't mean, this is still early innings, right? But we do see progress. So, we think our view of the world is in the category, it's being validated by our actions. And, um, So that's where we're confident.

Okay. And just to clarify something that you just mentioned in terms of innovation, because obviously a lot of that has been driving the growth through the category. So should we assume, you know, more to come from you this year in terms of your pipeline of innovation? Is that what's contributing to some of this conviction that you have for the category growth continuing or your business continuing?

I think if I look into the next two or three years, we see innovation coming in a continuous stream. We'll determine how we space it out. Because I think it's really important not to, when you innovate, sometimes there's an assumption that just innovating and putting a brand out there means you're building a brand. But innovation and strong brands are not necessarily the same thing. So we want to make sure we're building something that's strong, that can last. We think maybe lemonade. is, you know, it's been terrific for us, and, you know, the repeat rates are actually very high, 50% higher than all the other new products that were launched this year. The velocity is also very high, and we think it's providing a differentiated experience within the category, so we're also going to keep supporting that, and aggressively, but there will be a, we think, we have other ideas for innovation that will come behind that that we think also can kind of spark interest and excitement in the category.

Okay. If I can squeeze one more in, I really wanted to ask you guys about also the industry-wide can shortages that have been going on right now. I just want to get from you how big of an issue or concern it's been and really how material it's been And I guess it's my assumption that, you know, your main competitor, I think, has been more negatively impacted by the out-of-stock situation. So has that, you know, helped to contribute to some of the recent share gains that you've been experiencing? And how sustainable is that? Thanks.

Yeah, Bonnie, this is Frank. I mean, it's pretty clear, it's well-known in the industry that there is a real cash shortage in the industry across the U.S. which is spanning basically all the beverage suppliers and manufacturers. So far, we've been working well with our suppliers, and I think we've benefited also from the fact that we had pre-built canned inventory. We have pre-built, you know, product inventory for truly and for key, as you know, but we've also pre-built canned inventory. We've worked really well because we wanted to be prepared for the volume growth. We're running out of that, so, you know, going forward, we believe the impact will not be that dramatic, but it's hard to say because with all the COVID impacts that are coming on top of the explosive growth that you see across the different categories, it's really hard to predict. So far, you know, we might have some tightness, but we hope that with everything that we have pre-built that we kind of can manage through that.

Just to answer the last part of your question, Bonnie, about the share gains, I think there's a number of things that have led to that. One is the reformulation. If you look at our velocities from the time we reformulated, we went from growing 30% to 40% sales per point to over 100% for the last four months in a row. So that's part of it. lemonade certainly it's a nice year right now so lemonade absolutely is a part of it and to be fair to be honest I think over the last couple weeks I think we to Frank's point we've been maybe we're more fortunate to have fewer stocks I think that's part of what we've also seen happening as well okay very helpful thank you sure our next question is from the line of Vivian Ather with Cowan please receive your questions

Hi, thank you. Good evening. So, I was hoping to dive a little bit deeper into your thinking around A&P spend, please. You know, clearly it came down a lot in the quarter and not at the expense of your top line. And while you noted select incremental investment spending, your overall guidance seems to have come down a little bit relative to your pre-COVID guidance. And so, You've also called out some timing changes, delay in ad spend in June. Frank, I think you noted it as well in your prepared remarks. So I'm just trying to understand, if you think about the outlook for E&P, like how much of what we saw in the second quarter was just the timing that you've alluded to specifically versus some structural changes that just really reflect the benefit of some brand mix shift in your portfolio? Thank you.

Yeah, Vivian, hi. We're not really changing much of the spend that was indicated when we first gave you guidance in February. What has happened, the phasing is very different from last year. When we came out, we had an increase in the first quarter because we wanted to start the year strong. We knew there were new competitive entrants, and we wanted to make sure that we're out there at the beginning. So when you look at Q1, there was quite a bit of an increase. Q2 is a combination. We were flat, essentially, you know, slight increase, but largely flat. And that is a combination of it was partly planned, but also partly reduced due to the fact what happened with COVID, you know, the social discussion that was happening in the country. So we adjusted our expense a little bit on that. and we'll definitely spend more in the second half of the quarter. Within that, you should expect a higher increase in the fourth quarter because we also have to manage our product supply. So if you look at the growth rate in A&P spend in the second half of the year, the growth rate will be twice as high as the growth rate that we had in the first half of the year.

That's super helpful. Thank you. If I could just follow up. You're clearly referencing A&P dollars, and that makes a ton of sense to me in particular, you know, given the pre-commitments that you have to make around that kind of spend. But when I think about, Sam, historically, your A&P as a percentage of sales has been considerably higher than your peer group, and the 22% in change that you recorded this quarter is the lowest that I can recall in as many years I've been covering the company. Okay. Just to put the question back to you, if you'll indulge me, do you think that dollars is the right way to think about it now? Because it seems to have been tracking as a percentage of sales, but, again, because truly it's so much more important and maybe you get more halo, in particular because, like, lemonade and, like, the base business should complement each other on a spend basis. Has there been a philosophical change? Thanks for indulging the follow-up.

There hasn't been a philosophical change, and I think we look at percent of net revenue, at the end of the day, we spend what we feel is the right thing to spend, and when you go back, I think you see quite a variability in spend, in absolute terms, but also in percent of net revenue. Because the way we think about it, if we have something in our hands that we really want to push, we push it. And we say that every time, I think, that we look for the long term and we build the brand for the long term. And we're not trying to optimize the quarter. We're trying to optimize the year. We feel fairly comfortable with the significant increase in spend that we have this year. It has to be effective. That's important to us. We don't just want to spend to obtain a certain amount. we want to spend the money and get something back. And we feel fairly confident that we do that. That's also what we're increasing in the back half of the year. I mean, we had strong growth with not a significant increase this year. So far, there was slightly class differently as I explained before. But again, it's more guided by the need of the business than hitting a particular ratio.

Perfect. Thank you so much.

Thank you. As a reminder, you may press star 1 if you'd like to ask a question today. The next question comes from Kevin Grundy with Jefferies.

Hey, good evening, everyone, and congrats on the really strong results in this environment. Question perhaps for Dave and Frank, just on the guidance. So depletion is obviously outstanding in the first half of the year, north of 40%, including some contribution from Dogfish Head. So the guidance implies sort of rough math, a deceleration down to 15 to 30% in the back half a year. So understanding the comps get tougher, understanding there's some contribution from dogfish in the first half a year. Can you just kind of box in for us a little bit some of the assumptions around the high end and the low end of guidance? Dave, I think I heard you say, I could be mistaken. uh 150 sales for category growth is that kind of down the fairway is that what you're expecting where to to finish this year and it truly holds the line on from a market share perspective from here so just some commentary on the guidance and then i have a follow-up thanks sure thank you that's right um on the 150 that's our best guess for

for the category and truly will hold or grow, continue to grow share. I'll let Frank answer how we get to that range and what the assumptions were.

Yeah, so I think one thing is, if you look at the year-to-date and year-to-go clearly, it's obvious, like, you look at the depletions plus 40% and then we end, you know, the guidance is lower. A couple of factors. One is the high end of guidance We are not concerned about the demand. The demand is there. The constraint is around the capacity, and the capacity of the category has grown much stronger than what we had expected. Again, it's like it outpaced the capacity that we have put in, and we keep on running out of capacity. So if you don't have any capacity constraints, we will end up in the upper end of the range. It's really hard to say what's going to happen to the supply chain, and when I say supply chain, the broader supply chain that we depend on. We have a pretty good handle on our own supply chain, but there's also our partners. We don't know what's going to happen there. They're in different states. There's like supply, there's income strength potentially among our suppliers. We've talked about cans before, but that's pretty much true for all the materials that You might not have a structural tightness, but if COVID hits, the supply chain is just tight. So if we hit that, then we're going to get to the lower end of the range. I think the other thing that I want to say, I mean, you hit one thing is darkfish has clearly contributed in the first half of the year, whereas in the second half of the year, we are comparing to the six months that had darkfish that included last year. That's a certain impact. And the other one is that we, as you know, we have pre-built inventory for Trulia and for Crystal Tea in the first half to get us through the season. And normally that inventory peaks at the end of May, beginning of June, and then it carries us throughout the high season. What happened this year, you know, with COVID and the explosive growth, that we had in the category, especially off-premise, we used up this inventory, this Cleveland inventory, a little earlier. And that's what you see then partly also in the year-to-go number. So last year, we had a higher inventory level than what's carrying us a little bit longer into the third quarter. We don't have the same cushion anymore. We're pretty much end-to-model at the moment as we speak. And those are the key factors that contribute to the range that we have.

Okay. That's helpful. Thanks, Greg. I'll ask one more and then hop back into the queue. I wanted to maybe for Jim and Dave on the on-premise channel, maybe talk a little bit about what you've seen and then from a demand perspective, maybe how that progressed as you moved through the quarter and maybe even currently what you're seeing in July. And then just to follow up on-premise related question Bonnie mentioned earlier, Unique dynamic, of course, with Seltzer, where it really doesn't have any presence to speak of in the on-premise channel. Is there any rethink to that? Do you see that changing? This is true for both you and for Mark Anthony Brands as well, when it really hasn't been a push. Is there any rethink to that? Is that channel recovers? And relatedly, do you think you'll see some demand impact on seltzers as consumers return to that channel, just given sort of the lack of availability or presence, if you will, of hard seltzers at this point. Thanks for all that.

Okay. And Jim, I'll let you take this one.

Sure. You know, we've seen an evolution of the on-premise. You know, in March and through April, it basically just disappeared. We were probably, during that period, took back as much beer as we sold. So it was kind of a zero. And it has recovered somewhat. But, you know, not even half of what it used to be. And it's faltering. You know, you've seen the new shutdowns. And people... even when bars are open, restaurants are open, people aren't going to them. So the on-premise still is very weak for us. And we anticipate, you know, that not changing in the next few months. After that, we'll just have to see. In terms of the second part of your question, we actually see a much bigger opportunity for hard seltzer on premise than has been realized yet. We were expecting this summer to be a time when there would be a lot of penetration that we didn't have last summer into the on premise because it's a natural thing for people to consume, you know, on decks, outside. on patios and so forth. But even with the places that have opened their outdoor seating, it's still distanced and it's a fraction of what it used to be. And putting new products in is not high on their list. So I think it's going to be summer of 2021 when we see a big penetration of hard seltzers, and I expect it'll get to the point where you walk into a bar or a restaurant and you expect them to have some hard seltzer, either, probably either Truly or White Claw. So I do think there's a decent upside for seltzer on premise, but not, probably not in the next six to nine months. Got it.

Thanks, Jim. I'll hop back into queue.

Good luck, guys.

Thank you.

The next question is from the line of Eric Serota with Evercore. Please proceed with your questions.

Good evening, everyone. Hoping you could delve in a little bit more into the shelf space opportunity. Our understanding is that the spring shelf resets didn't occur as would be expected due to COVID. Just wondering how you see the shelf resets playing out in the fall or whether you think it's more of a 2021 event. And then a quick follow-up for you. Sure.

Eric, this is Dave. I think you're right. I mean, a lot of innovation didn't get out there this spring for obvious reasons. And, you know, we're starting to talk to our customers about 2021. And what we're hearing back is, for the most part, that's when the shell sets are going to occur is in 2021. So a whole generation of innovation may have been put on hold. Within the category itself, I mean, there's still a lot of opportunity for hard cells. As you know, it's under space across channels. And we expect to see with the growth rates we're having now and, you know, out of stocks pretty much across the board, we're definitely expecting to see more, you know, more space being allocated to this hard seltzer in 2021.

Great. And then, Jim and Dave, a follow-up for you. Last year, you know, in the fourth quarter towards the end of the year, you started to communicate, you know, what was a very deliberate plan, which played out very well for you guys to manage through and, you know, come out on top of the hard seltzer, you know, competitive onslaught that happened earlier this year. I'm wondering, you know, if there is a similar type of plan that As you look to first half of 21 or even second half of this year as White Claw ramps up its capacity, just wondering sort of how you're thinking about the next 12 months and if there's anything you could share with us today or if we should stay tuned for the fall or if this is more of a we'll be talking about this this time next year.

Yeah, this is Dave. I think the way I look at it is we're still, for your last question, Erica, we still haven't fully realized the potential, for example, of truly lemonade, which didn't get cut in to a lot of sales because of COVID. And we're seeing a lot of progress there in terms of If you basically look at Q2 versus Q1, we're seeing penetration growth, and actually it's more than doubled. Repeat has increased by about a third, but there's still a long way to go there. Also, because we just reformulated our flavors for the base truly brand, there's still lots of opportunity there. So we think... The place we're running right now is a good place to run. But as I mentioned before, I think, Yvonne, to your question, we believe innovation will continue to play an important role in the category. And so we're looking far ahead on that. We have nothing to share today, but maybe in our next call we will be able to share more information on that.

Great. I'll pass it on. Thank you. Thanks.

The next question is from the line of Nick Mody with RBC Capital Markets.

Great. Good afternoon, everyone. Dave, I have a question. Hey, how is everyone? Two questions from my end. One is just on innovation. I know the retail landscape has been changing and what they take onto the shelf has been changing. I just wanted to get your state of the union on what you're seeing from retailer behavior in terms of accepting new products. That's the first point. The second one is I guess the million-dollar question, or I don't know, maybe it's more than a million dollars, I'm sure it's more than a million dollars, is when gross margins are going to start growing again or expanding again. I mean, it's clear this category has surprised everyone, but I think maybe now it's not so much a surprise on what the potential could be. So maybe you could just give us your longer-term vision on how you think about the category growth rate, how you think about capital spending, and when maybe we can expect gross margins to start expanding again. Sure.

I'll take the first part of that, and I'll hand the gross margin part over to Frank. I think we know that for the fall, very little innovation is going to get into the marketplace across the board very well. So I think retailers are definitely focusing on just very few new things. I think they like what they've got right now, which is basically fewer SKUs being more productive. And so, if anything, we'll see what happens as we get to next year, but I think there's a lot more productivity and a lot more profitability in the system when there's fewer SKUs delivering the growth. And I think it's really important. It's going to be an important time to continue to strengthen core brands. And one of the interesting things we've seen, and I know we're not the only ones, of course, and a lot of brands have seen it, a lot of legacy brands, but particularly with, for example, Boston Lager, and also Angry Orchard Crisp, Apple, when we've seen those brands in Q2 grow their penetration, grow their repeat, grow, you know, and obviously on-premise, double-digit growth, and people coming back to some of the brands that they tried before that maybe have been distracted from. And so it'll be interesting to see how it plays out and how much core brands participate in growth as we tend into next year versus innovation. um so it's to be it's to be determined we're you know we're obviously preparing for any any alternative there we have lots of innovation to go into next year but we haven't you know we haven't determined what we're going to launch and what we're not going to launch because we don't want to go we want to get the right balance i think i think customers again based on early conversations with our customers we're hearing sort of the same thing from that um and plus i think everybody's just kind of shell shots what's happened So they're being more thoughtful about the steps they take going forward. So that's the first part of the question, and I'll let Frank address your first margin, your laid-out question. Yeah.

So clearly, if you look at the growth margin, it's not what we want it to be, very fairly. We want it to have it much higher. I'm not particularly happy about it, but I'm not concerned because, you know, we know what the reason is. And if you look at this year, I mean, they're quite a bit more than three points below last year. If you look at this year, what the key reasons are, number one is we have significantly higher growth than what we had expected, okay? So, and all, as we've said before, we are servicing the demand as much as we can at any cost because we want to build the brand, we want to build the category. So the incremental cases that we produce, they are external production. They come at a higher cost. But we're happy to do that because once it stabilizes, we'll get to a better cost structure. The second point is that we're impacted by COVID too. So the cost, a big chunk of the cost that we have due to COVID is in the gross margin line. And you see some slight improvement already this year. If you look at what we had in Q1 as a margin, there was an improvement in Q2. And if you look at the guidance, we'll see us coming in a little above where we are right now. And the reasons are that COVID was a little more front loaded, the students that No major thing is happening in the second half of the year and we're adding internal capacity. When it will substantially improve really depends on when we get a better handle on the growth and we can plan it a little bit better. Plans run that way. We are making progress in the efficiencies in our own breweries. We're rethinking the supply chain and we're not thinking really about like an internal production and external production. of the whole construct as an integrated supply chain. And once you do that, you get to different ways of working and to different cost savings. So at this point, we're driving the growth, and we don't mind that much of that comes at a lower gross margin because if you look at the gross profit and you look at the leverage that we're getting from all of the rest of the P&L, you look at the operating income, the operating income margin, that is the right strategy, and we're building the brand. One set of slides, we have quite a bit of runway to improve the gross margin by improving the way we're sourcing with relatively clean plans on that. And then we also, as you mentioned last time, have separate projects, supply chain transformation, which helps us operate that way more efficiently than we're doing at the moment.

Very helpful, Frank and Dave. Thank you.

The next question is from the line of Lauren Grada with Guggenheim. Pleasure to hear your questions.

Hey, good evening, everyone, and congrats on another great quarter, Jim. Even in your best dreams three or four years ago, you couldn't think of a quarter where the patient number could approach 40%. Okay, more into the innovation, so one of the reasons of the success this year can be attributed to the lemonade line extension. What have you learned, Dave, from this line extension that can help you further develop the Trulia franchise going forward, specifically around differentiation? And what about the tests you are doing in New York? I think Trulia is a higher ABV.

And so, so, so I think as it relates to, I mean, I think with lemonade, I think what we learned, I think what everybody learned, I guess, from the outside looking in is that there's a certain expectation of what a hard seltzer is. I think, we think it's, you know, 100 calories or fewer, you know, one gram of sugar thereabouts, two grams of carbs. Nothing artificial, right? And obviously, it has to taste really good and refreshing. And I think that's sort of the, those are the parameters to play in space. I also think a parameter is that, I strongly believe, and particularly when you see the consumers see it as a separate segment, they don't see this beer, that I think a pure white brand also can resonate more deeply. But I think what we also learned is that people are really craving variety and different ways to experience those base characteristics, if you will. And sometimes you just want more flavor. I mean, right? I mean, it's like how many sparkling waters can you drink without craving the Pepsi? That's me. Or something like that. People want more flavor. They want a sweeter profile at times. And so we were able, that's something, That's how that was helpful for us to understand. That's probably the most important thing, the most important thing that we've learned thus far.

I would add that basically flavor dominates. And so, you know, we just happened with the lemonade to hit a flavor profile that people, really enjoyed. I mean, to be totally honest, the volume surprised us as well. And the only thing I can attribute it to is we just hit the bullseye of flavor for the space between seltzer and lemonade.

And I believe, I mean, a bit of this is coming from the fact that you are unique in the lemonade in that space. So along that line, is The test you are doing in New York is higher ABV, another way to differentiate yourself from in the States, or what's the goal here?

Yeah, that's, so yeah, one thing I did mention is that the, it's like sort of 5% ABV is sort of the given number, but yeah, you know, we are testing, White Claw is also testing the product surge, ours is called EDGE, And we're looking at that, but that's a possibility. If I go back to what Jim said, I think the flavor experience might be more, we'll find out, might be more powerful than necessarily than ABV, if you will. But I think everybody, everyone's looking at ways to create a differentiated experience. One thing I should point out, actually, is that a couple things about lemonade. One, it's actually bigger than Mike's now. Number two, they're not our competitor. Mike's just done quite well. In fact, Truly's not really sourcing much wine, and Truly Lemonade's not sourcing much wine from that brand, but because it's addressing the needs of a hard seltzer drinker in that moment. And so I think, again, anything else we would share, we don't want to share much more than that, but I think Jim's point is my point. I think we have a good sense of what, or an improving sense, of what hard seltzer drinkers are looking for, and the extent that we aim to continue to provide those experiences, and because we're working with a brand that hasn't been extended yet, it's not an extension of another brand, I should say, we have the ability to build out a bigger platform, if you will, onto that brand.

Thank you. One more for me, if I may. One of your objectives at the beginning of the year was to have a more balanced male-female consumer base, and therefore attract the human consumer into the franchise. Could you please update us on that progress and where should be the right balance for the brand?

Yeah, we are making progress. I think if you look at it, we might be still maybe a smidge more female skewed than, say, my clients, but not as much as we were before. There were chances of the pack design to be more veil-oriented. We actually have another one that's hitting the market pretty much right now that's even more sort of male skewed, if you will. And so if you look at the volume, though, the volume is, more than 50% of the volume is consumed by men, because men just happen to drink more than women. But we have been able to close that gap that when we came out of the gate, as you know, we were very much focused, and that was the opportunity at the time, was really targeting women very directly. We continue to evolve that, and we see the numbers and the gender break being pretty much gender neutral.

Thank you. Good luck, guys, for the future. Thank you.

Next question is from the line of Wendy Nicholson with Citigroup.

Hi. Good evening. My two questions are, number one, have you developed any more plans about a potential UK launch or expanding further into Europe? It just doesn't seem to me why that wouldn't be a priority, although I know you're doing the best you can to meet the demands in the U.S., but it still seems like Europe could be a great opportunity down the road. And then my second question, just going back to lemonade, have you seen a different demographic for that specifically relative to core truly, or do you think it's existing truly consumers just switching over to the more sort of stronger flavor profile? Thanks.

Okay, I'll do the second. Maybe Jim can do the first part of that question. On the second part, just on the lemonade, we are seeing a difference. Actually, if you look across all the brands, the major brands in the category, lemonade is used younger than any other brand in hard seltzer. Definitely younger than the base truly business, younger than white wine, younger than floodlight seltzer, younger than Corona, Corona seltzer, younger than all of them. And it seems to be bringing in more new drinkers into the beer category. So, When I say young, I mean 21 to 39. So that is the difference. We weren't sure if it would go there or not, but it seems to be so we like that. In terms of international, Jim's got a longstanding point of view about our global business. I'll let Jim talk about that one.

Thanks. Yeah. Wendy, I would say that, you know, as a company, we are not particularly – internationally focused. You know, we are very focused on the United States. You know, we've been a company that succeeded in many cases just by the strength of our sales force and our distributors. And that's just difficult to duplicate globally. And in the U.S., we have like 500 salespeople. So we're very feet on the street, grassroots people. And with truly, we do have an importer in the EU, a longstanding growing relationship there. But we have spent really very little time or effort on international expansion. We are very focused on the United States because that's what we know well. and that's kind of what we're good at. We have had some success with Truly in Canada. We recently launched it there this year, and it's doing pretty well. So Canada is comfortable for us. Once you get outside that, you know, it's just not good at it, to be honest.

Fair enough. Well, you've got enough growth in the U.S., so that's fine by me. But, you know, if I can squeeze in one more, I remember last year, particularly last summer, part of what you were talking about vis-a-vis the gross margin pressure was the fact that so much of seltzer was sold in variety packs. And, you know, that made a lot of sense 12, 18 months ago when people, you know, wanted to try the product and, oh, I'm not sure what flavor I want, so let me get an assortment of a bunch of different ones. But I'm just wondering, you know, as the business grows and people become more loyal and say, I really like lime, but I'm not such a fan of black cherry, are you seeing a shift in the business to more of the single-slaver packs or cases? And I'm just wondering if that's becoming, you know, anything of a meaningful shift in the business, because I would think that would alleviate some of the gross margin pressure, but maybe I'm off on that. Thanks so much.

Okay, Wendy, I think I'll take that one. I think still we see a large majority, about 75% or so of our businesses writing facts. Consumers still are telling us they like that, they like the experimentation among the different flavors. It doesn't mean that that won't change over time, and we're sort of looking at that, and there are other players out there that have single flavors, certainly six packs as we do, but also 12 packs. You know, when Bud Wright Seltzer launched, they had four packs. Three were single flavor, one was variety. And that variety pack is like 85 or 90% of their total business. So consumers seem to be suggesting that they're not quite ready for that fully. And also the last, the other thing we have to think about is there are only so many SKUs that we can get onto a shelf and get support for. So you have to kind of pick wisely. What are going to be your highest performing configurations? And right now we haven't necessarily been convinced that there's a better way to go, but we can certainly, you know, at the moment's notice we could do that if we saw the opportunity. As it relates to gross margin, that's part of it. That was part of the issue a year ago.

Yes, I think the second part of the question is like when we started the whole business, variety pack was something that was relatively neutralized. We had a little bit, but it was small volume, and it was a very natural operation. And as the volume has grown and we progress through it, of course we've gotten much, much better at it. And we have now automated variety pack lines. It's not 100% of the volume, but we have significantly increased the volume. And that's part of the margin opportunity as well. That's actually what I said earlier. We're making progress. That is, you know, one area where we're making progress. And we still have some runway left there and a pretty clear roadmap on how we're going to address that. So in the future, that margin shouldn't be as significant as it is now or as it was a year ago.

Terrific. Thanks so much for the callers.

Thank you. The next question is from the line of Steven Powers with Deutsche Bank.

Yeah, hey, guys. Good evening. I guess given the challenges you've talked about of meeting the existing demand as well as the potential unlock of future gross margin, could you talk a bit more about the anticipated pacing of the new capacity you've referred to coming online, particularly any of your own new capacity and truly looking out over the next, say, 12, 18 months?

Jim, do you want to answer that one?

Sure. Right now, we're trying to get it up and running as quickly as we can. Since the last earnings call, we have added basically one and a half can lines, and next month or in September, we'll add another half. That will help us In the back half of this year, we think that the current supply constraints and basically the retailer out of stocks will continue through the summer. But post-Labor Day, that sort of hand-to-mouth existence, we'll be able to rebuild wholesale with inventories and start building, again, a significant pre-build for 2021. And we are, so we're adding a second can line in Cincinnati in sort of the end of Q2, beginning of Q3 next year. And we signed up additional contract capacity. So we're kind of looking to more than double our capacity a year from now.

Okay. And so I guess that alleviates, you know, any potential pressure on, you know, just your ability to introduce new flavors or pursue the on-premise opportunity next summer that you talked about. It sounds like you've got a line of sight there.

Yes, we think so, though we desperately hope that we will oversell all that and we'll have another hand-to-mouth summer next year with double the volume. Got it.

And I guess just one last question, if I could. You spoke a bit to A&P plans in response to Vivian's earlier question. But if we think about the scalability, maybe this is for Frank, of selling costs and of G&A, clearly a lot of leverage this quarter. I guess as I look forward, how do you think about the scalability of those line items into the future versus the need to ramp those costs up to support a bigger business going forward?

So, I can't give you the exact numbers, but clearly, if you're growing at the rate that we're growing, there's a leverage in the P&L. And we have it as a disadvantage. When we're a smaller business, as we grow, we'll see the leverage. As I said before, it's really hard to predict and give you milestones of where we're going to go because we are always thinking long-term about how do we grow the business, how do we create value. So we're not trying to hit a certain number at a particular given point of time. So you will clearly see leverage over time. You've seen it this quarter. I think you will definitely see it for the full year. And as we grow, there will be leverage. The extent really depends on how much we will support the business and we need to support the business. I know it's not as specific as you might want to hear, but that's kind of how we're managing the business.

No, that's fair enough. Philosophically, you know, we've always prioritized growth over profitability, even recognizing that, you know, in the beer business, growth is expensive. So I think we see no reason to change that philosophy. We, you know, We believe growth is an important component of, you know, value added. And when there's opportunities like we're having now to grow 40%, we're going to spend to maintain the highest growth rate that we can for as long as possible.

Understood. Thank you.

Thank you. As a reminder, you may press star 1 to ask a question. Next question comes from the line of Kevin Grundy. It's Jeffrey.

Hey, guys. Thanks for taking the follow-up. I appreciate it. Frank, I just wanted to follow up. This is kind of building on Steve's question, the shape of the P&L, and then Nick's question earlier on gross margin. Can you help us think about it structurally? So if you go back a decade or so ago, it was a 55% gross market business, skew largely to beer at that point in time. Now beer becomes much less. Cider becomes much less. Flavored malt beverages exceedingly higher. where should this business be? If you sort of set aside some of the rapid growth and volatility that the business is seeing now, so set aside like the next 12 to 24 months, but on a four to five year basis, should this be a 55% gross margin business? Should it be closer to some of the targets more recently in the 51, 53% sort of range? Can you help us think about that a little bit, even on a longer term basis? I think that'd be helpful.

Yeah, again, yeah, I was here 10 years ago, but I know clearly I know the growth margins, and it was a very different business. It was a much simpler portfolio, and we had a different balance between demand and capacity that we had. So, and then all the sweet spots, and, you know, we were at 54% at a point in time, but then it was like 52, 53 percentage point. We should definitely be in the 50s, and, you know, getting closer to the mid-50s, maybe not exactly 55, but as we stabilize the business and we get a better handle on the supply chain and optimize that, that's definitely the target that we have. Okay. Very helpful. Thanks, guys.

I appreciate the follow-up. Thank you. At this time, we'll turn the floor back to Mr. Cook for closing remarks.

Thank you. Thanks to everybody for being on the call. It was certainly an exciting quarter with almost outlandish roads, coupled with a lot of changes to accommodate this pandemic. And I'm grateful to a lot of people that helped us get through this with their creativity and their flexibility from our coworkers, to our wholesalers, to the retailers that we work with, to canned suppliers and special hugs to the canned suppliers for this quarter. And we're looking forward to continuing the winning streak in a few months and hope to talk to you then. Thanks.

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