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| HOOK > SEC Filings for HOOK > Form 10-Q on 14-Nov-2008 | All Recent SEC Filings |
14-Nov-2008
Quarterly Report
In addition to the sale of Redhook-branded and Widmer-branded beer, the
Company also earns revenue in connection with two operating agreements with Kona
- an alternating proprietorship agreement and a distribution agreement. Pursuant
to the alternating proprietorship agreement, Kona produces a portion of its malt
beverages at the Oregon Brewery. Kona purchases raw materials from the Company
prior to production beginning and pays a facility leasing fee based on the
barrels brewed and packaged at the Company's brewery. All sales and fees are
reflected as revenue in the Company's statements of operations. Under the
distribution agreement, the Company purchases and distributes product
manufactured by Kona and then markets, sells and distributes the Kona-branded
products pursuant to the A-B Distribution Agreement. As Kona's distributor, the
Company also markets, sells and distributes any Kona-branded products
manufactured at the Company's Oregon Brewery.
The Company also derives other revenues from sources including the sale of
retail beer, food, apparel and other retail items in its three brewery pubs.
In conjunction with the Merger, the Company acquired from Widmer a 20% equity
ownership in Kona and a 42% equity ownership in FSB, brewer of Goose
Island-branded products. Both investments are accounted for under the equity
method, as outlined by Accounting Principle Board Opinion ("APB") No. 18, The
Equity Method of Accounting for Investments in Common Stock ("APB 18").
From July 1, 2004 through June 30, 2008, the Company produced its specialty
bottled and draft Redhook-branded products in its two Company-owned breweries,
the Washington Brewery and the New Hampshire Brewery. The Company distributed
these products in the midwest and eastern U.S. pursuant to the July 1, 2004 A-B
Distribution Agreement and in the western U.S. through Craft Brands Alliance LLC
("Craft Brands"). In addition to the sale of Redhook-branded beer, the Company
also brewed, marketed and sold Widmer Hefeweizen in the midwest and eastern U.S.
in conjunction with a 2003 licensing agreement with Widmer and brewed
Widmer-branded products for Widmer in connection with contract brewing
arrangements. The Company derived other revenues from sources including the sale
of retail beer, food, apparel and other retail items in its two brewery pubs.
Craft Brands was a joint venture sales and marketing entity formed by the
Company and Widmer in July 2004. The Company and Widmer manufactured and sold
their product to Craft Brands at a price substantially below wholesale pricing
levels; Craft Brands, in turn, advertised, marketed, sold and distributed the
product to wholesale outlets in the western United States through a distribution
agreement between Craft Brands and A-B. (Due to state liquor regulations, the
Company sold its product in Washington state directly to third-party beer
distributors and returned a portion of the revenue to Craft Brands based upon a
contractually determined formula.) Profits and losses of Craft Brands were
generally shared between the Company and Widmer based on the cash flow
percentages of 42% and 58%, respectively. In connection with the Merger, Craft
Brands was merged with and into the Company, effective July 1, 2008. All
existing agreements between the Company and Craft Brands and between Craft
Brands and Widmer terminated as a result of the merger of Craft Brands with and
into the Company.
For additional information regarding Craft Brands and the A-B Distribution
Agreement, see Part 1, Item 1, Business "- Product Distribution," "-
Relationship with Anheuser-Busch, Incorporated" and "- Relationship with Craft
Brands Alliance LLC" of the Company's Annual Report on Form 10-K, as amended,
for the fiscal year ended December 31, 2007.
The Company's sales are affected by several factors, including consumer
demand, price discounting and competitive considerations. The Company competes
in the highly competitive craft brewing market as well as in the much larger
beer, wine, spirits and flavored alcohol markets, which encompass producers of
import beers, major national brewers that produce fuller-flavored products,
large spirit companies, and national brewers that produce flavored alcohol
beverages. The craft beer segment is highly competitive due to the proliferation
of small craft brewers, including contract brewers, and the large number of
products offered by such brewers. Certain national domestic brewers have also
sought to appeal to this growing demand for craft beers by producing their own
fuller-flavored products. The wine and spirits market has also experienced
significant growth in the past several years, attributable to competitive
pricing, increased merchandising, and increased consumer interest in wine and
spirits. In recent years, the specialty segment has seen the introduction of
flavored alcohol beverages, the consumers of which, industry sources generally
believe, correlate closely with the consumers of the import and craft beer
products. Sales of these flavored alcohol beverages were initially very strong,
but growth rates have slowed in recent years. While there appear to be fewer
participants in the flavored alcohol category than at its peak, there is still
significant volume associated with these beverages. Because the number of
participants and number of different products offered in this segment have
increased significantly in the past ten years, the competition for bottled and
draft product placements has intensified.
Sales in the craft beer industry generally reflect a degree of seasonality,
with the first and fourth quarters historically being the slowest and the rest
of the year typically demonstrating stronger sales. The Company has historically
operated with little or no backlog, and its ability to predict sales for future
periods is limited.
The Company is required to pay federal excise taxes on the sale of beer. As a
brewer of less than two million barrels annually, the Company is eligible for a
small brewer's federal excise tax exemption, which provides that the Company pay
federal excise taxes at a reduced rate of $7 per barrel, rather than the full
rate of $18 per barrel, on the first 60,000 barrels sold each year. Accordingly,
as annual shipments increase, federal excise taxes will increase as a percentage
of net sales.
Management monitors the working capacity and maximum designed capacity of
each brewery in connection with production and resource planning. Because an
industry standard for defining brewery capacity does not exist, there are
numerous variables that can be considered in arriving at an estimate of working
capacity and maximum designed capacity. Following the Merger, management
reviewed each facility, scrutinized the factors important to the Company in
arriving at a practical definition of capacity, and recomputed the working
capacity and maximum designed capacity of each brewery. Among the factors that
management considered in estimating working capacity and maximum designed
capacity are:
• Brewhouse capacity, fermentation capacity, and packaging capacity;
• A normal production year;
• The product mix and product cycle times; and
• Brewing losses and packaging losses.
Because the conditions under which each brewery operates (such as age of
equipment, local environment, product mix) are slightly different, the impact
that these factors have on the estimate of capacity also vary by brewery. For
example, while the New Hampshire Brewery and the Oregon Brewery are constrained
by the volume of beer that each can ferment (each brewery can brew more beer
than it can ferment), the Washington Brewery is constrained by the size of its
brewhouse (the brewery has adequate capacity to ferment all product that is
brewed).
Management did not consider the impact that seasonality clearly has on the
capacity calculation. Rather, management assumed that each brewery produces beer
at 100% of working capacity throughout a 50 week year. But because seasonality
is a notable factor affecting the Company's sales, the Company expects that the
breweries' capacity will be more efficiently utilized during periods when the
Company's sales are strongest and there likely will be periods where the
breweries' capacity utilization will be lower.
Management estimates that the working capacity and maximum designed capacity
after the Merger were:
As of July 1, 2008
Annual
Annual Maximum
Working Designed
Capacity Capacity
(in barrels)
Oregon Brewery 377,000 491,000
Washington Brewery 230,000 230,000
New Hampshire Brewery 146,700 231,000
753,700 952,000
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In order to accommodate volume growth in the markets served by the New Hampshire Brewery, the Company has expanded fermentation capacity several times during the last several years. In May 2007, the Company completed process control automation upgrades to the brewery and added one 70,000 pound grain silo. In June 2007, the Company completed the installation of four additional 400-barrel fermenters. Installation cost for this expansion totaled $1.3 million and added approximately 21,700 barrels of capacity to the New Hampshire Brewery, bringing the brewery's annual working capacity to approximately 146,700 barrels. The Company's 2008 capital projects include another expansion of brewing and fermentation capacity at the New Hampshire Brewery. The project includes a $3.3 million addition of eight 400-barrel fermenters and four bright tanks, and a $1.8 million upgrade to the incoming water filtration and water treatment systems. The expansion will increase working capacity by approximately 43,300
barrels. The Company anticipates that the expansion will be completed during the
fourth quarter of 2008 and the improvements to the water systems will be
completed in the first quarter of 2009. Further expansion of fermentation
capacity and improvements to the refrigeration facility at the New Hampshire
Brewery, which were originally slated for 2008, have been delayed until 2009 or
later.
With the completion of the 2008 expansion, the New Hampshire Brewery's annual
working capacity will be approximately 190,000 barrels and the Company's total
annual working capacity will be approximately 797,000 barrels.
The Company's capacity utilization has a significant impact on gross profit.
Generally, when facilities are operating at their working capacities,
profitability is favorably affected because fixed and semi-variable operating
costs, such as depreciation and production salaries, are spread over a larger
sales base. Because current period production levels have been below the
Company's working capacity, gross margins have been negatively impacted. If the
Company is unable to achieve significant sales growth, the resulting excess
capacity and unabsorbed overhead of the Company will have an adverse effect on
the Company's gross margins, operating cash flows and overall financial
performance.
In addition to capacity utilization, other factors that could affect cost of
sales and gross margin include changes in freight charges, the availability and
prices of raw materials and packaging materials, the mix between draft and
bottled product sales, the sales mix of various bottled product packages, and
fees related to the A-B Distribution Agreement. Prior to July 1, 2008, sales to
Craft Brands at a price substantially below wholesale pricing levels and sales
of contract beer at a pre-determined contract price could also have affected
cost of sales and gross margins.
Redhook Brand - Trend
Beginning in 2004, Craft Brands initiated a five-year plan to strengthen the
Redhook brand by improving the volume trend through targeted distribution
growth, systematic pricing increases to enhance perceived value and bolster
brand profitability, and focused marketing programs to attract and retain
consumers of Redhook-branded products. In select western U.S. markets, the
Company had historically elected to price its products below the market leaders.
Over the past four years, Craft Brands had systematically raised Redhook's
in-market pricing to levels comparable to the market leaders. This strategy is
intended to strengthen the perceived value of the Redhook brand over the long
term. However, in the short term, it is expected that the Redhook brand may
continue to experience volume declines in certain markets. In addition to
strengthening the perceived value of the Redhook brand, management has focused
on enhancing value through re-branding efforts and these efforts are showing
some positive results. The initiative to re-brand Redhook IPA into Long Hammer
IPA has resulted in positive momentum for the Company's fastest growing national
brand.
Since these efforts were initiated, the Redhook brand sales trends in the
western U.S. have shown a slowing in the rate of decline and some modest growth
during some periods, driven primarily by a reversal of the negative trend in
Washington state. For the 2008 third quarter, overall shipments of
Redhook-branded products declined approximately 4.9%.
Widmer Brand - Trend
The Widmer brand has experienced significant growth in recent years, led by
the popular consumer response to the Hefeweizen category within the craft beer
segment and the role that Widmer Hefeweizen has enjoyed in being a leader in
this category. This category continues to experience positive trends nationally,
but has more recently seen a significant increase in competitive products from
other craft brewers as well as offerings from large domestic brewers attempting
to participate in the same category. As a result of the Merger, the Company will
begin to promote other Widmer-branded products in the midwest and eastern U.S.
Except for a limited amount of Widmer-branded products brewed and shipped under
the contract brewing arrangements and Widmer Hefeweizen shipped under the
licensing agreement, sales and shipments for Widmer-branded product were not
reflected in the Company's statements of operations prior to the Merger.
Kona Brand - Trend
The Kona brand has experienced strong growth since forming its relationship
with Widmer and Craft Brands in 2004. Kona is a relatively new product and was
recently introduced into a number of new markets in the continental United
States. Kona-branded products have experienced the rapid growth of a new brand
that benefits from growing distribution and new trial from consumers. Sales and
shipments for Kona-branded product were not reflected in the Company's
statements of operations prior to the Merger.
See Item 1A, "Risk Factors" for additional matters which could materially
affect the Company's business, financial condition or future results.
Results of Operations
The following table sets forth, for the periods indicated, certain items from
the Company's Statements of Operations expressed as a percentage of net sales:
Three Months Ended Nine Months Ended
September 30, September 30,
2008 2007 2008 2007
Sales 106.5 % 111.6 % 108.4 % 112.3 %
Less excise taxes 6.5 11.6 8.4 12.3
Net sales 100.0 100.0 100.0 100.0
Cost of sales 79.0 87.2 85.0 86.6
Gross profit 21.0 12.8 15.0 13.4
Selling, general and administrative expenses 24.3 19.4 23.2 19.6
Merger-related expenses 1.5 2.5 3.2 1.4
Income from equity investment in Craft Brands - 5.1 2.7 7.0
Operating loss (4.8 ) (4.0 ) (8.7 ) (0.6 )
Income from equity investments in Kona & FSB - - - -
Interest expense 1.3 0.8 0.9 0.8
Other income, net 0.1 1.1 0.2 1.3
Loss before income taxes (6.0 ) (3.7 ) (9.4 ) (0.1 )
Income tax provision (benefit) (2.0 ) (1.1 ) (3.2 ) 0.2
Net loss (4.0) % (2.6) % (6.2) % (0.3) %
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Three Months Ended September 30, 2008 Compared to Three Months Ended
September 30, 2007
The following table sets forth, for the periods indicated, a comparison of
certain items from the Company's Statements of Operations:
Three Months Ended
September 30, Increase / %
2008 2007 (Decrease) Change
Sales $ 33,498,577 $ 12,357,004 $ 21,141,573 171.1 %
Less excise taxes 2,031,390 1,285,374 746,016 58.0
Net sales 31,467,187 11,071,630 20,395,557 184.2
Cost of sales 24,846,103 9,653,674 15,192,429 157.4
Gross profit 6,621,084 1,417,956 5,203,128 366.9
Selling, general and administrative
expenses 7,632,298 2,151,417 5,480,881 254.8
Merger-related expenses 474,025 278,404 195,621 70.3
Income from equity investment in Craft
Brands - 562,210 (562,210 ) 100.0
Operating loss (1,485,239 ) (449,655 ) (1,035,584 ) 230.3
Income from equity investments in Kona
and FSB 1,449 - 1,449 -
Interest expense 446,871 80,875 365,996 452.5
Other income, net 40,271 120,589 (80,318 ) 66.6
Loss before income taxes (1,890,390 ) (409,941 ) (1,480,449 ) 361.1
Income tax provision (benefit) (641,974 ) (121,373 ) (520,601 ) 428.9
Net loss $ (1,248,416 ) $ (288,568 ) $ (959,848 ) 332.6 %
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The following table sets forth a comparison of sales (in dollars) for the periods indicated:
Three Months Ended
September 30, Increase / %
2008 2007 (Decrease) Change
A-B $ 27,247,393 $ 4,831,622 $ 22,415,771 463.9 %
Craft Brands - 3,579,747 (3,579,747 ) (100.0 )
Contract brewing - 1,776,899 (1,776,899 ) (100.0 )
Alternating proprietorship 3,362,477 - 3,362,477 -
Pubs and other (1) 2,888,707 2,168,736 719,971 33.2
Total sales $ 33,498,577 $ 12,357,004 $ 21,141,573 171.1 %
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(1) Other includes international, non-wholesalers and other
Sales. Total sales increased $21,142,000 in the third quarter of 2008
compared to the third quarter of 2007. Comparability of sales reported for the
2008 and 2007 quarters is significantly impacted by the July 1, 2008 Merger,
including the following factors that contributed most to the significant change:
• An 85% increase in overall shipments, driven by shipments of Widmer-branded
products acquired in the Merger and shipments of Kona-branded products
pursuant to a distribution arrangement with Kona;
• An increase in overall pricing, driven by the sale of all wholesale beer to A-B at wholesaler pricing levels;
• The elimination of shipments to Craft Brands and shipments of beer brewed on a contract basis, both of which were at prices that were substantially below wholesale prices;
• Additional revenue generated by the alternating proprietorship arrangement with Kona, an arrangement performed by Widmer prior to the Merger;
• An increase of 33% in pub and other sales, primarily driven by the addition of a third pub pursuant to the Merger.
Shipments - Brand. The following table sets forth a comparison of shipments by brand (in barrels) for the periods indicated:
Three Months Ended September 30,
2008 2007
Draft Bottle Total Draft Bottle Total Increase / %
Shipments Shipments Shipments Shipments Shipments Shipments (Decrease) Change
. . .
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