The Boston Beer Company - Earnings Call - Q3 2020

Transcript

Operator (participant)

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

Jim Koch (Founder and Chairman)

Thank you. Good afternoon and welcome. This is Jim Koch, founder and chairman, and I'm pleased to kick off the 2020 third quarter earnings call for the Boston Beer Company. Joining the call from Boston Beer are Dave Burwick, our CEO, and Frank Smalla, our CFO. I'll begin my remarks this afternoon with a few introductory comments, including some highlights of our results, 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 third quarter results, as well as a review of our outlook for the remainder of 2020 and our initial outlook for 2021. Immediately following Frank's comments, we'll open up the line for questions. We achieved depletion growth of 36% in the third quarter.

We believe that our depletion growth is attributable to our key innovations, quality, and strong brands, as well as sales execution and support from our distributors. As the COVID-19 pandemic continues, our primary focus continues to be on operating our breweries and our business safely and working hard to meet customer demand. I'm very proud of the passion, creativity, and commitment to community that our company has demonstrated during this pandemic. We remain positive about our future growth of our brands and are happy that our diversified brand portfolio continues to fuel double-digit growth for the 10th consecutive quarter. We planned some major innovations to be introduced in 2021 for our brands. These include Truly Iced Tea Hard Seltzer, Samuel Adams Just the Haze, our first non-alcoholic beer, Dogfish Head Scratch-Made Canned Cocktails, and Angry Orchard Fruit Cider

We're confident in our ability to continue to innovate and build strong brands to help support our mission of long-term profitable growth. I will now pass over to Dave for a more detailed overview of our business.

Dave Burwick (CEO)

Thanks, Jim. Hello, everyone. Before I review our business results, I'll start with the usual disclaimer. As we stated in our earnings release, some of the information we discuss and that may come up on the 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 in the forward-looking statements is contained in the company's most recent 10-Q and 10-K. 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 depletion growth in the third quarter was a result of increases in our Truly Hard Seltzer and Twisted Tea brands, partly offset by decreases in our Sam Adams, Angry Orchard, and Dogfish Head brands. The growth of the Truly brand, led by Truly Lemonade Hard Seltzer, continues to be very strong, and we expect the Truly brand to continue to lead the growth of the business into 2021. In early 2021, we'll launch Truly Iced Tea Hard Seltzer, Truly Extra, a higher ABV version of Truly, and other new Truly flavors and package sizes as we continue to lead innovation in the Hard Seltzer category. We believe that Truly Iced Tea Hard Seltzer, which combines the refreshment of hard seltzer with real brewed tea and fruit flavor at only 100 calories and one gram of sugar, will further strengthen our position in the category.

Since early in 2020, Truly has grown its velocity and its market share sequentially, despite other national, regional, and local hard seltzer brands entering the category. Truly is the only national hard seltzer not introduced earlier this year to grow its share during 2020. We'll continue to invest heavily in the Truly brand and work to improve our position in the hard seltzer category as competition continues to increase. We'll also invest even more heavily in our Live Truly advertising campaign that showcases variety, colors, and joy to hard seltzer drinkers. Twisted Tea has benefited greatly from increased at-home consumption and continues to generate consistent double-digit volume growth, even as new entrants have been introduced and competition has increased.

Our Samuel Adams, Angry Orchard, and Dogfish Head brands have been most negatively impacted by COVID-19 and the related on-premise closures, but we're pleased that they all finished the month of September with strong growth in the measured off-premise channels compared to last September. For the remainder of 2020 and into 2021, we plan to build upon our success and work to drive our brands to their full potential, with a particular focus on our Truly brand. We've adjusted our expectations for 2020 full-year depletion growth in our earnings guidance to reflect our trends for the first nine months in our current view of the remainder of the year, which is primarily driven by the year-to-date performance of Truly. We're expecting all of our brands to grow in 2021 and are targeting overall volume growth rates to be between 35% and 45%.

We've closely managed our operating costs through the COVID-19 pandemic and achieved our planned cost synergies from the Dogfish Head merger. In 2021, based on our current spending and volume assumptions, we're planning for the growth rate of our operating expenses to be below our top-line growth rate, delivering leverage to our operating income. We've been operating our breweries at full capacity for many months, and like our competitors, we've had out-of-stocks during the quarter. We expect wholesale inventories to return to normal levels in the fourth quarter as we recover from our summer seasonal peak. Improving our supply chain performance continues to be our top priority and we're in the process of doubling our internal and third-party brewery can packaging capacity for 2021. Our new can line at our Cincinnati brewery began production late in the third quarter, and we've recently added additional third-party breweries sleek can capacity.

As reflected in our 2020 and 2021 capital spending guidance, we'll continue to invest heavily to increase capacity as appropriate to meet the needs of our business and take full advantage of the fast-growing hard seltzer category. However, the increased usage of third-party breweries and an increasing percentage of variety packs in the company's overall product mix come at a higher incremental cost. As a result, our gross margins and gross margin expectations will be negatively impacted until the volume growth stabilizes. We began a multi-year supply chain transformation project in 2020 to automate and change internal processes to increase efficiency and reduce costs. The timing of the benefits of this program will depend on the timing and amount of our future volume growth. We'll continue to prioritize volume delivery over margin optimization in this high-growth environment.

While we're in a very competitive business, we're optimistic for continued growth of our current brand portfolio and innovations, and we remain prepared to foresee short-term earnings as we invest to sustain long-term profitable growth in line with the opportunities that we see. Based on information in hand, year-to-date depletions reported to the company through the 42 weeks ended October 17, 2020, are estimated to have increased approximately 39% from the comparable weeks in 2019. Now, Frank will provide the financial details.

Frank Smalla (CFO)

Thank you, Jim and Dave. Good afternoon, everyone. For the third quarter, we reported net income of $80.8 million, an increase of $36 million, or 80.6% from the third quarter of 2019. Earnings per diluted share were $6.51, an increase of $2.86 per diluted share from the third quarter of 2019. This increase was primarily due to increased revenue driven by higher shipments, partially offset by lower gross margins and higher operating expenses. Shipment volume was approximately 2.1 million barrels, a 30.5% increase from the third quarter of 2019. We believe distributor inventory as of September 26, 2020, averaged approximately two weeks on hand and was lower than prior year levels due to depletion outpacing supply-constrained shipments. We expect wholesaler inventory levels in terms of weeks on hand to remain between one and four weeks for the remainder of the year.

Our third quarter 2020 gross margin of 48.8% decreased from the 49.6% margin realized in the third quarter of 2019, primarily as a result of higher processing costs due to increased production at third-party breweries, partially offset by cost-saving initiatives at company-owned breweries and price increases. Third quarter advertising, promotional, and selling expenses increased by $11.5 million from the third quarter of 2019, primarily due to increased investment in media and production, increased salaries and benefits costs, and increased freight to distributors because of higher volumes. General and administrative expenses decreased by $1.1 million from the third quarter of 2019, primarily due to non-recurring Dogfish Head transaction-related expenses of $3.6 million incurred in the comparable 13-week period in 2019, partially offset by increases in salaries and benefits costs.

Based on information of which we are currently aware, we are now targeting full-year 2020 earnings per diluted share between $14 and $15, an increase of the previously communicated estimate of between $11.70 and $12.70. However, actual results could vary significantly from this target. This projection excludes the impact of ASU 2016-09. Full-year 2020 depletion growth is now estimated to be between 37% and 42%, an increase and narrowing of the range from the previously communicated estimate of between 27% and 35%. We project increases in revenue per barrel of between 1% and 2%. Full-year 2020 gross margins are expected to be between 46% and 47%, a narrowing down of the previously communicated estimate of between 46% and 48%.

We plan to increase investment in advertising, promotional, and selling expenses of between $55 million and $65 million for the full-year 2020, a change from the previously communicated estimate of between $70 million and $80 million, primarily due to lower selling expenses. This does not include any increases in freight costs for the shipment of products to our distributors. We estimate our full-year 2020 non-GAAP effective tax rate to be approximately 26%, which excludes the impact of ASU 2016-09. We're continuing to evaluate 2020 capital expenditures and currently estimate investments of between $160 million and $190 million, a change from the previously communicated estimate of between $180 million and $200 million, most of which relates to continued investments in the company's breweries. Looking forward to 2021, we're in the process of completing our 2021 plan and will provide further detailed guidance when we present our full-year 2020 results.

Based on information of which we are currently aware, we are targeting depletions and shipments percentage increases of between 35% and 45%. We project increases in revenue per barrel of between 1% and 2%. Full-year 2021 gross margins are expected to be between 46% and 48%. We plan increased investments in advertising, promotional, and selling expenses of between $130 million and $150 million for the full-year 2021, not including any changes in freight costs for the shipment of products to our distributors. We estimate our full-year 2021 non-GAAP effective tax rate to be approximately 26%, excluding the impact of ASU 2016-09. We're currently evaluating 2021 capital expenditures, and our initial estimates are between $300 million and $400 million, which could be significantly higher if deemed necessary to meet future growth.

We expect that our cash balance of $157.1 million as of September 26, 2020, along with our future operating cash flow and unused line of credit of $150 million, will be sufficient to fund future cash requirements. We will now open up the call for questions. Since we are in different locations, Dave will be the emcee on our side, similar to last time, and coordinate the answers.

Operator (participant)

Thank you. We'll now be conducting the question-and-answer session. If you'd like to ask a question today, please press star one from your telephone keypad, and a confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we pull for questions. Thank you. Our first question is from the line of Vivien Azer with Cowen. Please proceed with your question.

Vivien Azer (Managing Director)

Hi. Good evening.

Dave Burwick (CEO)

Hey, Vivien.

Vivien Azer (Managing Director)

Hello. Hello. So my first question has to do with your 2021 guide. Certainly, that's been historically consistent and unique for you guys relative to the broader CPG peer group, where you do do that. But given the uncertainty around COVID and the potential for more closures, I think it would be helpful to understand what's driving that conviction and any underlying detail you could offer. Dave, I think I heard you say that you think all brands are going to grow. And certainly, the Nielsen data from Tuesday would suggest that beer is in a better place, at least in the four weeks. But just any underlying detail, I think, would be helpful because that's well ahead of consensus in my estimate.

Frank Smalla (CFO)

Vivien, that's fine. Let me take the first one on the 2021 guide. I mean, you're right. There's a lot of uncertainty in the market. But when we look at the growth and what's driving the growth of the company, it's clearly hard seltzer and Truly and also Twisted Tea, which are the biggest components of our portfolio. Based on what we know today and how we see the market development developing and the current growth rates, and we look at how we've grown distribution and we project that into 2021, we feel that the range, that this is the range that we're shooting for, actually, we're shooting higher, but something that we can accomplish based on the structure of our portfolio and the growth rates of the categories that we are projecting. I mean, nobody has a crystal ball. Nobody knows exactly where hard seltzer is going to go.

But if you look at the different scenarios and we take a risk-adjusted approach, this is kind of what we had.

Dave Burwick (CEO)

Yeah. And I can actually just to build on what Frank said, I think when you look at those two brands are driving, obviously, a lot of the growth. And if you look at some recent developments in sales right now, it's slowed a little bit, but I think there's a lot of noise with that, with can shortages and other capacity issues that are still being cleared up. But if you dig into some of the data on sales here, you see some new information. One is that we're looking at depth of repeat increasing pretty significantly most recently. So people who purchased a product three times or more are now 31% of all the buyers versus 25% a year ago. So we're seeing people adopt it. Also, we looked at some new data. Category rejectors are declining from about 28% last year to 12% this year.

We're seeing people embrace hard seltzers or make it part of the repertoire. Another thing, too, that I think is a big one is that this year, as you know, because of COVID, many customers were not doing resets. In fact, very few did in the spring, for sure, and even in the fall. There's a lot of space that is going to be allocated, probably 10%-20% of space next year will be allocated to the category. We think there's still a lot of tailwinds in this category. The question will probably come up, so I'll answer it. We think, I mean, this year, we talked about this before, the category will end up growing probably 180%-200%. Next year, we're thinking, in our minds, it's maybe 80%-100%.

So it will decelerate by maybe half, but still, you're looking at 80%-100% growth there. I would also say on the Twisted Tea front, Twisted Tea has really benefited significantly from people consuming more at home. And we've seen it in pretty much everywhere you look at the brand, not just the measured channel growth rates, but the velocity, the household penetration, the repeat rates. And we feel very confident in that brand and that it's still a very small penetrated brand, a very lightly penetrated brand. As it gets more household penetration and more consumers, we can see our way pretty confidently to very, very good growth with Twisted Tea next year.

And then we can talk. I'm not going to worry about the other brands, but there's a lot of innovation that we talked about that we see across the board for Angry Orchard, for Sam Adams, for Dogfish, that all we added up. I think the difference next year to me is I feel like we're going to be growing across the entire portfolio, and we'll continue some very significant growth in hard seltzers, but we're going to have contributors coming from every direction next year.

Vivien Azer (Managing Director)

That's really helpful. Thank you. And in particular, Dave, I commend you for doubling down on those unique consumer insights because you offered them in February of 2020 on the demos around Truly, and you guys were absolutely right on that. So good job on continuing to stay close to the consumer. If I could pivot to my second and last question, it's a little bit more philosophical in nature. I was looking at these results and reflecting back on your May 5th Cinco de Mayo 2017 analyst day. And Jim, one of the things that you asserted, you showed us a very long-term stock chart. You said, "This company knows how to manage through innovation cycles." And I think the proof is in the pudding here.

And so what I'm curious about is whether there is an evolution in your KPIs for the team as you work your way through those cycles. Thanks.

Jim Koch (Founder and Chairman)

Thanks, Vivien. And I do remember that stock day down at the brewery, and I'm glad you recall the assurances from that day because I think what I was talking about is Boston Beer Company for now 36 years has been built for growth. We have a very simple mission: long-term profitable growth. And that has built into the company. It's not just KPIs because people are not primarily coin-operated like that. It is just part of our culture. And part of what we wake up to do every morning is to find new unmet consumer needs or new brands, new products, and to drive growth in the existing products that we have because we've never—I mean, for us, not to be growing significantly is an unusual and very uncomfortable state. Does that help?

Vivien Azer (Managing Director)

Very much so. Thank you.

Operator (participant)

The next question comes from the line of Bonnie Herzog with Goldman Sachs. Please proceed with your questions.

Bonnie Herzog (Managing Director)

All right. Thank you. Hello, everyone. Hi. My first question has to do with your FY 2020 guidance. So your full-year shipment and depletion guidance, it's really a pretty big step up, which implies, I think, quite a big increase in your shipment growth in Q4. So just would love to hear a little bit more color from you in terms of what you're seeing already in October that gives you the confidence in this. And then I think about this also in the context that you're lapping a pretty tough Q4 last year with the sell-in from Truly Lemonade. So how confident are you in Truly Iced Tea Hard, maybe the sell-in already? And then the last question on this is, or are you anticipating that your depletions will outpace your shipments for the full year?

I'm thinking about that as out-of-stock pressures potentially linger still in Q4.

Frank Smalla (CFO)

Bonnie, this is Frank. I'll take the first one on the guidance. What you see, we've taken it up because the increase that we're seeing will come through in Q4, and what has happened in Q3 is our depletions have really outpaced our shipments. And you look at the results, it's about a five-point gap. And that has driven wholesaler inventories to a bare minimum. It's like they basically, whatever we deliver, they ship out. So the hard sales, the depletions, which is, in our minds, the real sale, that has happened already. So we need to catch up. And we couldn't produce everything that we could have sold, and we couldn't produce everything that we depleted. So what will happen, and it has started happening, actually, in Q4 already, is that we started to catch up and replenish the inventory.

So the shipments that we're projecting are, to a large extent, a catch-up of the depletions that have happened already. So that's kind of what's driving the guidance to one extent. The other thing is that based on the market data, we see the, it's a very seasonal business, as you know. We don't see that much of a decline as we had originally projected when we were sitting in the middle of the year, quite frankly. So there's additional volume coming. It's coming towards the end of the fourth quarter. What that means is everything that we're producing is going to replenishment. It's going into higher sales. But the flip side is that we will have less pre-build than what we had projected originally. So the confidence level, and that's why we raised the guidance, is relatively high.

The range, the difference between the lower end and the upper end, really depends on how much we basically can produce. Do we have all the materials, and do we have the capacity? That's what it comes down to.

Bonnie Herzog (Managing Director)

Okay. That's helpful.

Dave Burwick (CEO)

And one, if you want, I can talk about, I mean, just a quick one on Truly Tea. We feel this product is tested very, very well, very similarly to lemonade. And we think, like lemonade, it's unique and it's distinct in the category. And it's going to provide something that's a very different form of variety than what's out there in the category right now. So it's sort of delivering on what sellers are looking for. And also, just for what it's worth, as a read, I mean, our customers, both large-format, small-format customers, are all, I mean, they're all in on this thing. So we've got a lot of support already with our customers and with our wholesalers. And we feel confident that we're going to get off to a really good start with this new product.

Bonnie Herzog (Managing Director)

No, that's helpful. And that's consistent with what I'm hearing. And then that kind of brings me to my next question was, as I think about your FY 2021 guidance, which, again, it's great that you have the visibility and confidence in your business. So just on the Truly point, just want to confirm that that guidance for next year does imply that you expect Truly to double again. That's just a quick question or verification. And then I would love to get a little bit more color or understanding on your guidance for the incremental spend in 2021, which is a pretty big step up. So just trying to understand the magnitude of that and if that might end up proving to be too large of a step up.

I'm saying that or asking that, especially given what I see as probably efficiencies and scale you're likely getting as your company really is getting so much bigger and Truly is becoming such a large part of your portfolio.

Frank Smalla (CFO)

Yes. So what's. I'm sorry.

Dave Burwick (CEO)

What's the question?

Frank Smalla (CFO)

These are guidance because we have a doubling.

Dave Burwick (CEO)

Yeah, I'm sorry. So for the first question, we have the midpoint. We have 35%-45%. What we're projecting is that the hard seltzer category can double. That's not fully reflected in the guidance, as you can imagine. It's, as I said before, there's like everybody has different projections. We're looking at different scenarios. And we look at what are the different growth scenarios that we have, how much can we produce. We're definitely resourcing against the upper end of the range, but the guidance doesn't fully reflect yet a doubling of Truly. That's number one. The second one related to the APS spend, you're looking at the growth that we're having. And I tend to mention that in the earnings calls. We don't want to really spend our APS based on a formula, based on dollar per case or percent of net revenue.

We're looking at what do we need to invest to drive the business. We frequently adjust during the year depending on what is working, what is not working. This year, we started the year. We clearly wanted to spend more. COVID happened. We had the impact on the on-premise. So we didn't spend as much as we said at the beginning of the year. We are prepared to spend against the growth because we believe now is the time as we're building, as the category is being built, to capture the market share, to capture our place in the category. And then we will optimize later on. We clearly believe we're going to get leverage out of the growth that we're having. We don't know exactly what the leverage is. We're not targeting a specific leverage. We're targeting the long-term growth of our brands and invest what is needed.

But even at the high end, we believe we're getting leverage within the P&L. How that exactly looks like, we'll see as the year unfolds.

Bonnie Herzog (Managing Director)

Okay. So even in FY 2021, you expect there could be leverage on the bottom line?

Frank Smalla (CFO)

Yes.

Bonnie Herzog (Managing Director)

Okay. Thank you so much.

Operator (participant)

Next question. I'm serving the line of Eric Serotta with Evercore. Please proceed with your question.

Eric Serotta (Managing Director)

Good afternoon. First, I wanted to.

Dave Burwick (CEO)

Good afternoon.

Eric Serotta (Managing Director)

Hi. First, I wanted to see if you could give some perspective in terms of how you're looking at lemonade for year two. Obviously, some new heavy-hitting competitors coming on with some big lofty ambitions behind it. If you could give some perspective as to how you're thinking about how that performs in year two, that would be helpful. And also what your consumer testing is showing in terms of interaction between lemonade and Truly Iced Tea Hard Seltzer. Are you seeing any interaction there? And what degree of incrementality do you expect from the Iced Tea variant? Thank you.

Dave Burwick (CEO)

Yeah. Great. Okay, Eric. So let me take a shot at that. I think, first of all, as it relates to lemonade, we've invested a lot in building that brand to a 10% share thus far. And we will continue. In fact, we'll be investing more in that brand next year. So we entered the year at a 10% share, the largest penetration base, and repeat rates of any of the new products that we'll launch this year and the great-tasting products. We entered in a really good place. I think what we like about this is that it's going after, here's an interesting point. It doesn't really interact with Mike's Hard Lemonade. It's a very light interaction with Mike's because the FMB consumer is looking, well, we've learned they're looking for something a little different drinking experience at different occasions. It's going after, it's really attracting seltzer consumers.

So we think we're targeting the right consumer with this brand. And there's a reason why it's under Truly. And for the same reason why we wouldn't do a Twisted Tea Hard Seltzer because we just don't think it's the right consumer or the right direction to go. We like Truly being the hard seltzer brand that provides ultimate refreshment and seltzerizes different flavor experiences, many of them bold flavor, but only 100 calories, one gram of sugar. And tea plays there. Lemonade plays there really well. And so we'll continue to build this brand because it's obviously a big part of the portfolio. I mean, theoretically, the cannibalization rates across the brand, we're not that concerned about, really, because it's the Truly brand. It's one brand. What the mix looks like a year from now, personally, I don't care as long as we're growing share.

That's all I care about. We're going to grow share. But having said that, we have looked at some of the data. There's a couple of sources. So for example, just to understand lemonade this year, how incremental was lemonade to the Truly brand, which I think you were asking. If you look at different sources, we've looked at Numerator had it at, it's going to be pretty precise, and it's not this precise, but they had it at 71% incremental. Nielsen had it at 95% incremental. I don't believe either of those numbers. But from a pure consumer perspective, it's called between 70% and 95% incremental. And what you got to remember too is that there's cannibalization that happens because you have to go through a wholesaler. You have to get your wholesaler to be supportive. There's cannibalization that goes when you have to go through the customer.

So that 71-95 is probably understated, but it's certainly at a point where we're happy with it. And if anyone's going to cannibalize us, it might as well be us. So I think as it relates to tea, we don't know yet. Truly Tea, until we put it out there, my guess is it might be similar in that range, only because it's very distinct from the base Truly flavor experience as well as the Truly Lemonade flavor experience.

Eric Serotta (Managing Director)

Great. That's real helpful. And hoping for a little bit of perspective on what you alluded to in terms of the noise or in terms of the slowdown in the hard seltzer category recently. Obviously, continued slim can shortages and overall out of stocks. But any additional color that you're seeing in the marketplace? Are there any signs of consumer demand weakening? Are you looking at this as purely a supply issue? You guys are clearly outperforming the category. But any perspective as to where the category is going in the short term would be really helpful.

Dave Burwick (CEO)

I think it would be an easier question to answer in a month or two from now. But I think this is just my personal opinion. Maybe Jim or Frank might have different points of view. But I do think there's still a can shortage in Q4. There's no question about it. I think it's affected everybody. There's still capacity issues out there. But when I look at our, I look at the Truly. Actually, I look at the category. I mean, Truly and White Claw are both growing. Penetration, repeat rates are going up. Truly's velocity has been, growth has been at triple digits for six months, and it's not slowing down. So I don't see any fundamental issue. But ultimately, if we're growing 200% now of the category or close to that, it clearly can't sustain.

Whether this is the beginning of a metering down to 100%, we'll know more probably that and more in a few months. There's nothing else I've seen. As I mentioned, I was answering Vivian's question. When we look at the consumer data, there's nothing in the consumer data that would suggest anything really changing. When you look at the market data, yes, there's something that might be afoot. Again, I think it's too early to draw any conclusions on that.

Eric Serotta (Managing Director)

Great. Thanks so much. I'll pass it on.

Operator (participant)

Thank you. As a reminder to ask a question today, you may press star one from your telephone keypad. The next question comes from the line of Kevin Grundy with Jefferies. Please proceed with your questions.

Kevin Grundy (Managing Director)

Hey, great. Good evening, guys, and congrats on the strong result. First one for Dave and Jim. Just perhaps a little bit more color on your on-premise trends, specifically how that part of your business performed in the quarter and what you have contemplated in your initial outlook for 2021, of course, with that channel being in that part of your business more relevant for your beer and cider brands, and then I have a follow-up on hard seltzers. Thanks.

Dave Burwick (CEO)

Okay. I might say in terms of on-premise trends this year, as we face the back half of the year, think of it as probably down 50% or thereabouts is probably the way to think about it. Pretty consistent across all brands. I think now, again, we look at 2021. I'm not sure if we really talk in detail by channel, but I agree, but I guess I got that sense, but we don't think it's going to come back really quickly. It just doesn't seem that way. Until there's herd immunity one way or the other, people are not going to be going back to bars and restaurants the way they had before. I don't know, Jim. Jim, I don't know if you have any other thoughts because you've been talking to a lot of folks lately about that world.

Jim Koch (Founder and Chairman)

Yeah. I'm pretty much in agreement. Our business was just sort of devastated because not only were we more heavily on-premise, but our on-premise is heavily draft. And even within the on-premise segment, as people opened up, they didn't fill all their draft lines. They emphasized package because package is easier to sell to go. So the on-premise has just been really tough. And we pulled our sales force in and just had them start to go out tentatively a few weeks ago. So it's been probably even disproportionately hurt. And we're just looking at the same murky crystal ball that everybody else is. And we're projecting that consumers just can be hesitant to go out to a bar and to drink for a while. Maybe this time next year, things will be looking like whatever the normal is, but behavioral patterns will have changed. Bars will have closed.

Restaurants will have closed, so I don't see it fully recovering even next year.

Kevin Grundy (Managing Director)

Got it. Jim, just to stick with that for a moment. Given that dynamic and the fact that you guys are cautious on that front, what's the level of visibility? And I appreciate that it's difficult. So I know it's a tough question. But you guys are planning for all of your brands to grow next year. And it sounds like the expectation is the on-prem is going to be challenged. So outside of the fact that you'll be cycling some easy year-over-year comparisons and there's some hope on the innovation front, what gives you confidence then that the Dogfish Head and Sam Adams and Angry Orchard can indeed return to growth next year?

Jim Koch (Founder and Chairman)

Well, you hit the two biggest. One is recycling really crappy numbers, and the other is some innovations. I think I would, on top of that, put the tendency that arose during these pandemic times on the part of retailers as well as wholesalers to focus on their bigger brands, on their better-known brands, the strong brand pull. There's certainly a decline in consumers wanting to spend a lot of time in the grocery store shopping in front of the beer cooler. People want to get in and get out. So we believe that as on-premise does come back, it'll focus more on strong brands. And similarly, the trends at off-premise retailers and wholesalers have been to clear out some of the clutter and devote more space to the brands that are leaders in their category.

Samuel Adams and Twisted Tea and Angry Orchard are number one and Truly is a very strong number two in its category. We think that strong brands will benefit disproportionately even throughout next year.

Kevin Grundy (Managing Director)

Got it. Thanks, Jim. One quick follow-up, and then I'll pass it on. Just a broader question on what you're contemplating in your guidance next year with respect to competitive intensity. And I think the context is here broadly within the industry. You saw a big pullback in investment spending given the negative implications from the pandemic. But I think that's widely expected to change, both around advertising and marketing, perhaps trade support, etc. We touched earlier in the call, the discussion around Mark Anthony Brands, and that innovation is clearly aimed at your portfolio and the success you've had with the lemonade product. Coors now just sort of leaning in. Topo Chico. At least they will be early next year. They just launched Coors and Vizzy, etc.

I mean, we could spend the rest of the call kind of going through the litany of products that will be entering the category. What are you contemplating in your guidance with respect to competitive intensity? How do you expect this to evolve? I mean, I can't recall a product category kind of like this where there's just been so much interest, so much innovation, so much investment, companies previously only operating in non-alcohol space, moving into the alcohol space. It's very, very unique. So how are you guys thinking about that, and how has that been contemplated in your initial 2021 outlook? And I'll pass it on. Thanks, guys.

Dave Burwick (CEO)

Okay. Thanks, Kevin. Maybe I'll start that one. I think everything you mentioned, we've contemplated. Obviously, we're very aware of everything that's happening. And in fact, nothing that's been announced has really been a surprise to us. I think if you go back, interestingly, if you go back two years ago, Truly and White Claw were about 75% of the category. And I think there were like 12 brands or something like that in the category. This year, there's something like 120 or 30 brands in the category. And Truly and White Claw are still 75% of the category. So we think it's going to, we're not in any way resting on our laurels or assuming it's going to happen by itself. We're going to fight until the end to make sure that we're a very strong number two or ideally number one.

And we're investing aggressively in building the brand, the Truly brand, which we think has come a long way in the last couple of years in terms of brand awareness, in terms of household penetration, repeat rates, all the rest. And we can't stop what everyone else is going to do. And it's going to be another food fight in 2021. But we feel like we're ready for that. And we have plans. And as Frank had mentioned before, we're going to spend whatever it takes. So yes, we're going to get operating leverage next year. That's what we plan to do. But guess what? If things change competitively, we're going to—we'll tell you on the earnings call what we're going to do. But it's going to be to continue to invest. This category is way too valuable to not fight to win. And that's what we're going to do.

I would also say that the innovation, I think, being first and looking at – and Mark Anthony Brands has done an amazing job, an amazing job with their brands. Obviously, Mike's is a great brand. But we've been in the same – we'll have a 15-month head start in a 10-share brand. That gives us an advantage. We're going to do everything we can to save every ounce of that share. Guess what? We're launching a tea brand, which, by the way, we know how to do tea. I think we've proven over the years that we're the only ones that really understand how to do tea well. It's tea and fruit. It's a tremendous product. It's going to give people something else to go to. We also know in this category, people, consumers are looking for what's new.

They're looking for variety, and they want whatever's next. And honestly, like lemonade, it's already happened. We'll continue to make it happen. But what's next next year, in our minds, is going to be tea and maybe some other things too. But honestly, this is what makes it fun. It wouldn't be fun if we were by ourselves. But we've contemplated everything. Nothing has shocked us. No announcements. And we're ready to go.

Kevin Grundy (Managing Director)

Got it. I appreciate all the time. Good luck, guys.

Dave Burwick (CEO)

Thanks. Thank you.

Operator (participant)

Next question is from the line of Steven Powers with Deutsche Bank. Please proceed with your question.

Steve Powers (Equity Research Analyst)

Yeah. Hey, thanks. Good evening. Just a few more clarifying questions on the 2021 outlook. I guess first, you talked about Truly Tea relative to base Truly. But how do you expect Truly Tea to interact with Twisted Tea, if at all, with any meeting? And then appreciating that you don't really care, I get it, what leg of the Truly offering leads growth so long as the overall trade market's growing. Can you talk at all, I guess, whether you expect lemonade to ultimately be bigger than base Truly by the time we get to the end of 2021? It feels like that's the trajectory we're on. I just want to just kind of clarify your thinking on lemonade versus the base offering.

Dave Burwick (CEO)

Okay. Okay, Steve, I'll take that straight. I think when it comes to, we don't know how much Truly Tea is going to cannibalize Twisted Tea. But what we can do is look at the interaction between Truly Lemonade and Mike's Hard Lemonade, which I think is a fair proxy. And as I mentioned before, I think only about 10%-15% of Truly Lemonade's volume comes from Mike's Hard Lemonade. And it was actually never. That was not our goal, was to steal consumers from there because we think it's just a very different. It's different occasion, different consumer. And so if you apply that to Truly Tea versus Twisted Tea, so say 10%-15% interaction. So we don't think it's huge. And again, the drinking experiences are very different. And the consumers are very different.

In fact, if you look at the Truly consumer, the Truly consumer is younger, more educated, more upscale, and more diverse than the Twisted Tea drinker. So we think in terms of managing cannibalization as much as you can, I think we've got to manage. And then whatever happens, happens. And we feel pretty good about that. As it relates to lemonade becoming, I don't know. I mean, we're not planning on that.

I mean, it's probably very unlikely. We think that we'll continue to obviously have news on the base Truly business next year that we're excited about. I think it's very unlikely that lemonade would be bigger than that. But again, at the end of the day, all that matters is that we grow share in total. And that's where we're going to be - that's how we're going to measure success next year is gaining share through the Truly trademark.

The last thing I'll say is that one of the reasons I can say this is because we have a pure play brand called Truly that stands for hard seltzer. So it's much easier to innovate within that platform than it is if we were coming from another place.

Steve Powers (Equity Research Analyst)

Yeah. Thank you. That makes a lot of sense. And I appreciate the color. I guess if I could also ask about it, kind of slicing it by channel, you talked about 10%-20% of off-premise space being allocated to seltzer next year. I guess how does that compare to what you estimate the category was allocated or has been allocated in 2020? What's really your true visibility to that number? And I'm assuming you do, but do you expect Truly's relative share of shelf or of cooler space to sustain itself in 2021 against that backdrop? And then a little bit on the on-premise side, Jim, you had talked about this, I think, on the last call, just about maybe some untapped upside in seltzer and Truly on-premise.

I guess I just would love a little bit of insight as to how much that thinking has factored into your 2021 outlook. Do you think that on-premise demand can be material to Truly in 2021, or is it really just a story of continued off-premise strength? Thanks.

Dave Burwick (CEO)

Okay. So, Steve, I'll take the first part, then I'll hand it over to Jim for the second part. I think in terms of space, it obviously varies by customer and by geography today where it's at, but it's probably around 10%. I mean, in some places, it could very well be higher. Now, it could be as high as 20% in certain places now. But on average, we're thinking right now it's probably about 10%. And based on what our customers have been telling us this fall is that they expect the category to be 15%-20% of total beer. And they're going to give it its fair share of space. So we could be going from 10%-15%-20%. And again, I think this year was kind of everything was sort of aborted because of the pandemic.

So it's hard to really understand where we're starting from or where we would have been. But I think because we didn't have that chance to do resets this year, next year could be that much more impactful. And I think what customers are looking to do, it's going to be more cold space. It's going to be more end caps. It's going to be more freestanding displays. They're going to look to find to put inventory anywhere they can to help to support to represent the size and the growth rate of the category. So with that, I'll hand it over to Jim to talk more on-premise.

Jim Koch (Founder and Chairman)

Yeah. My guess as to how hard seltzer's fared on-premise this year was not as well as one would have expected given the sprawling number of hard seltzer drinkers who are going to on-premise places and carrying their drinking patterns with them. But during these COVID times, the on-premise operators were not looking for new items. They weren't looking to add stuff. They weren't often even taking sales calls from distributor salespeople or supplier salespeople. So there were very limited opportunities to pitch new items. And retailers were not especially focused on that. They had their hands full with everything else they were trying to do. And I think I still believe that the seltzer category is underdeveloped on-premise. Now, on-premise, when it reopens, I think we'll all be thrilled if it ends up at 15% of overall consumption.

So that tells you the slice that we're aiming at when on-premise does start to come back. So I think it'll be basically seltzer on-premise will be a slow growth that won't explode as much as it did on-premise. I mean, I'm sorry, off-premise, where people are talking about it being 15% or 16% of the beer category within a year or two.

Steve Powers (Equity Research Analyst)

Thank you very much to both of you for your commentary. Appreciate it. Thank you.

Dave Burwick (CEO)

Thanks, Steve.

Frank Smalla (CFO)

Thanks, Steve.

Operator (participant)

Thank you. As a reminder, you may press star one to ask a question at this time. The next question is from the line of Laurent Grandet with Guggenheim. Please proceed with your question.

Laurent Grandet (Senior Analyst and Managing Director)

Hello, Jim. Frank. Well, congrats on another Truly exceptional quarter. First question is really just a check because I may not have heard you well. Are you saying that you would be shipping Truly Iced Tea Hard Seltzer at the end of this year or just starting next year?

Dave Burwick (CEO)

No. So I can answer that one right away. We will ship next week. Truly Tea will not be shipped this year. That's definitely next year.

Laurent Grandet (Senior Analyst and Managing Director)

Thank you.

Dave Burwick (CEO)

And.

Laurent Grandet (Senior Analyst and Managing Director)

Thank you. Dave, one for you, and then I've got one for Jim, but I understand very well the purpose and the potential, I think, of Truly iced tea. We wrote about this in the last few weeks. I wanted to understand a bit better about the role and potential of Truly Extra. You've been testing it in some places in New York and some other places, so you need to attract a younger, more male consumer into the franchise. What's the role for Truly Extra? And what's the potential here? I believe a bit more limited.

Dave Burwick (CEO)

Yeah, so I think. One more question. Jim. You go.

Jim Koch (Founder and Chairman)

Thanks. I believe it is focused on convenience stores. That is a channel where Truly is less developed than in food and multi-outlet stores. It does bring in a different customer that is maybe a little less calorie-conscious, health and wellness-conscious in a sense because base hard seltzer tends to be 100 calories, 5% ABV, maybe one gram of sugar. All of that changes in a C-store because it's 8% ABV. It's in a 16-ounce can. You're going to end up with 220-230 calories in it. The consumer is approaching something like Truly Extra with a different mentality. They want something refreshing, easy to drink. They're a hard seltzer drinker. They're in a C-store. They're picking up a single serve. It's a different occasion for hard seltzer than we've seen so far. How big is it? We don't really know.

The tests did well, but again, it's crazy times, and it was New York, and it's maybe a little different market than the bulk of the C-store. This is the bodega and the small store. It's a little different than a C-store in Arizona.

Laurent Grandet (Senior Analyst and Managing Director)

And Dave, really, just building on Truly Extra, I mean, I really like what we've been doing in marketing and building that brand over the last years. But is that not potentially confusing for the consumer, the Truly consumer, that it would be a Truly with more calories? And I mean, that's definitely not responsive to the, I would say, to the seltzer playbook. So could you explain this to me, please?

Dave Burwick (CEO)

I'm sorry, Laurent. Can you repeat the question? I missed the question. Can you repeat that again?

Laurent Grandet (Senior Analyst and Managing Director)

Yeah. Sure. I really like everything you've been doing on Truly and building that brand over the last two years. But I really like to understand, I mean, the Truly Extra is not adding some more, maybe some confusion for the Truly consumer, adding much more calories. So is that kind of, I mean, a risk to the franchise? I mean, how do you see that? And why taking that potential risk?

Dave Burwick (CEO)

Okay. I got it. I got it. So I think Jim sort of answered that question by saying that I think it's different. We see it as it's a different consumer. It's a C-store consumer. It's a more younger male who might be buying traditional FMBs, who might be looking to branch out and try something different. So we're sort of appealing to somebody with that who isn't necessarily looking for the 100 calories per se. And because we're sort of putting it into convenience stores, it's not going to be broadly, at least not our intent right now, to make it broadly available in large format stores or multi-packs, where we think we can. We're narrowcasting to that consumer. And we think it will be successful, but we're not banking the year on it necessarily. But as Jim said, it was well received in New York City.

New York City is not necessarily your average convenience store, your average Circle K in Arizona or California, but we think the brand, because it's sub-branded, we sub-branded extra, and the sub-branding is actually very large, and it's actually, I think, bigger than Truly, so it clearly says to the consumer it's from Truly, but it's something different, and we're trying to thread the needle there. We think we can, but we'll find out next year.

Laurent Grandet (Senior Analyst and Managing Director)

Dave, question on the capacity for Truly. You increased significantly CapEx for this coming year. I mean, planning for doubling Truly next year. Are you starting to rebalance between contract manufacturing and your in-house manufacturing starting a bit next year or having a larger percentage of your manufacturing in-house? Could you maybe give some color here to understand a bit more what's the split between in-house and contract manufacturing for next year?

Frank Smalla (CFO)

Yeah. Laurent, this is Frank. Clearly, the long-term goal is to rebalance between internal and external, but the number one priority, quite frankly, at the moment is to get the capacity to be able to support a doubling of the category. That's the base premise, and naturally, it's a little faster to add it externally because you can talk to different parties, and that's what's happening, so our share of internal manufacturer versus external manufacturer will continue to shift towards external manufacturing in the short term within 2021. Clearly, we're also looking. We're building capacity internally and externally, but it's a little faster externally, and that's what's shifting the balance. Longer term, clearly, we're looking at bringing more in-house and thereby also bringing the cost down and getting the margin up.

Laurent Grandet (Senior Analyst and Managing Director)

Thanks. Thanks, Frank. My very last question for you, Jim. For a beer lover like you, I mean, what does it mean to launch zero-alcohol beer? And why are you doing this? And what's potential and taste that you're expecting from that beer and the reception from consumers?

Dave Burwick (CEO)

Jim, did you hear that one?

Jim Koch (Founder and Chairman)

Oh, sorry. I was on mute. Good question, Laurent. And I'll start out with a confession because after I finished my introduction, I poured myself a Sam Adams Just the Haze non-alcoholic IPA, and I'm almost at the bottom of the glass. So it's my way of illustrating that something like Sam Adams Just the Haze is a product that has really never existed before. There've been plenty of non-alcoholic beers, but they were always compromises. You knew you were drinking an inferior product, and it didn't have that much appeal other than odd occasions or people who'd used up their quota and couldn't drink alcohol anymore. And so we don't have big volume projection numbers for it. We know it's going to be, again, a long-term build. But it is something that what I'm excited about is it is as good as an alcoholic IPA.

We've tested it in consumer testing and had it rated in blind, double-blind testing with consumers, had it rated at or above the leading alcoholic IPAs out there. Bottom line, we think that by introducing a new product that's never existed before, it will find, just by virtue of its product characteristics, it will find new drinkers and new occasions for drinkers. How big and how quick, we really don't know. It's always been our experience is if you give some consumers something that they've never had before that really is an improvement in terms of taste and quality and character over any of the other options out there, you're going to have a market. How big depends.

Laurent Grandet (Senior Analyst and Managing Director)

Thanks, Jim, and I pass it down. Cheers, and keep it up. Good work.

Dave Burwick (CEO)

Thank you. It's fun having a beer while I do this.

Operator (participant)

Our next question is from the line of Sean King with UBS. Please proceed with your questions.

Sean King (Equity Research Analyst)

Hi. Thanks for the question. I guess with respect to variety packs and gross margins, I recognize that variety packs are becoming a bigger part of the portfolio, which is really a function of Truly's weight in the portfolio. But I guess within Truly itself, are you starting to see consumers start to settle into preferred flavors and moving away from variety packs?

Dave Burwick (CEO)

Yeah. This is Dave. Dave, I'm sorry. Do you want to go? You want to do it?

Frank Smalla (CFO)

I was just going to say that's basically no. We wondered when it's going to happen. Hasn't happened yet.

Sean King (Equity Research Analyst)

Okay. All right. Understood. Thank you.

Frank Smalla (CFO)

Go stand next to a big display of LaCroix and watch people shop it. Almost nobody buys three 12-packs of the same flavor. They don't have variety packs, but consumers will typically buy at least two different flavors when they shop. So I don't know, but it just hasn't happened, and we've been thinking it would, but we haven't seen it.

Sean King (Equity Research Analyst)

All right. Very helpful. Thank you.

Operator (participant)

The next question is from the line of Bill Kirk with MKM Partners. Please proceed with your question.

Bill Kirk (Managing Director)

Hey. Thanks for taking the question. So mine's on loyalty within seltzer. Do you have any research that shows how many brands are in the seltzer drinker's proverbial fridge and maybe how that would compare to how many brands are in, say, a craft beer drinker's fridge?

Dave Burwick (CEO)

Yeah. I mean, the last time I looked at it, and this might be dated, this was probably six months ago. It was small. It was a small repertoire, like two or three at most. It's probably a good thing for us to look at now. But again, I think if you just look at the shared distribution and the category being the top two at 75%, by definition, I think that's going to tell you it's going to be a small repertoire than craft, for sure. But don't have the exact number to share with you.

Frank Smalla (CFO)

Yeah. From the research, that it's not really quantitative, but focus groups and qualitative and sort of anthropological-type research, general truth would be that I think White Claw and Truly are substitutable. You have people who drink one, but they'll drink the other. The substitution for the smaller brands, the beer-branded seltzers, is less. So you've kind of got two leaders that share preferences. And we didn't find lots of people who are only drinking one of the smaller brands.

Bill Kirk (Managing Director)

Got it. That's super helpful and all for me. Thank you.

Operator (participant)

Thank you. At this time, we've reached the end of our question-and-answer session. I'll now turn the call over to Mr. Jim Koch for closing remarks.

Jim Koch (Founder and Chairman)

Great. Thanks, everybody. Thank you for your patience going through all of this. We will speak again in a few months. Cheers. I did finish my Just the Haze. Thank you for joining me for a beer.

Dave Burwick (CEO)

Thank you.

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