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| HOOK > SEC Filings for HOOK > Form 10-Q on 15-May-2009 | All Recent SEC Filings |
15-May-2009
Quarterly Report
2008. The comparability of the Company's 2009 first quarter results relative to
the results for the same period in 2008 is significantly impacted by the Merger.
Since July 1, 2008, the Company has produced its specialty bottled and draft
Redhook-branded and Widmer-branded products in its four Company-owned breweries,
one in the Seattle suburb of Woodinville, Washington ("Washington Brewery"),
another in Portsmouth, New Hampshire ("New Hampshire Brewery"), and two in
Portland, Oregon. The two breweries in Portland, Oregon are the Company's
largest production facility ("Oregon Brewery") and its smallest, a manual
brewpub-style brewery at the Rose Quarter ("Rose Quarter Brewery"). The Company
sells these products in addition to the Kona branded products predominantly to
Anheuser-Busch, Incorporated ("A-B") and its network of wholesalers pursuant to
the July 1, 2004 Master Distributor Agreement (the "A-B Distribution
Agreement"), as amended. These products are available in 48 states.
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. The Company sells raw materials to Kona prior
to production beginning and receives from Kona a facility leasing fee based on
the barrels brewed and packaged at the Company's brewery. These 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, whether brewed at its own facility or the Oregon Brewery,
and then markets, sells and distributes the Kona-branded products pursuant to
the A-B Distribution Agreement.
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. The
Company added the third pub, located in Portland, Oregon and in the proximity of
the Oregon Brewery, in the Merger.
In conjunction with the Merger, the Company acquired from Widmer a 20% equity
ownership in Kona and a 42% equity ownership in FSB. Both investments are
accounted for under the equity method, as outlined by Accounting Principles
Board Opinion No. 18, The Equity Method of Accounting for Investments in Common
Stock ("APB 18").
Through June 30, 2008, the Company produced its specialty bottled and draft
Redhook-branded products at the Washington Brewery and the New Hampshire
Brewery. The Company distributed these products in the Midwest and Eastern
United States pursuant to the A-B Distribution Agreement and in the Western
United States 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 United States in conjunction with a
2003 licensing agreement with Widmer and brewed Widmer-branded products for
Widmer in connection with contract brewing arrangements.
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 A-B, 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 for the
fiscal year ended December 31, 2008.
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. These fuller-flavored products have been most
successful within the wheat beer category, including Shock Top Belgian White and
Blue Moon Belgian White. These beers are generally considered to be within the
same category as the Company's Hefeweizen beer, putting them in direct
competition. The wine and spirits market has also experienced significant growth
in the past five years or so, 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.
While the craft beer market has seen a significant growth in the number of
competitors, the national domestic and international brewers have undergone a
second round of consolidation, reducing the number of market participants at the
top of the beer market. A number of factors have driven this consolidation,
including the desire to capture market share and positioning as either the
largest brewer or second largest brewer in any given market. The U.S. beer
market, in which the Company competes, was once dominated by three companies,
A-B, Miller Brewing Company and Adolph Coors Company. During the past decade,
Miller Brewing Company and Adolph Coors Company were merged with international
brewers, South African Brewers and Molson of Canada, respectively, to increase
the global market reach of their brands. During the current year, the resulting
companies, SABMiller and MolsonCoors, completed the terms of a joint venture to
merge their U.S. operations, competing under the name MillerCoors. Likewise, A-B
was acquired by Belgium-based InBev in a deal consummated in the fourth quarter
of 2008. Shipments for the two entities, A-B and MillerCoors, represented nearly
80% of the total U.S. market, including imports, for 2008.
Another factor driving this is the desire on the part of these larger
consolidated national brewers to control the rising cost of the majority of the
inputs to the brewing process, primarily barley, wheat and hops, and packaging
and shipping costs. While consolidation promises to alleviate these cost
pressures for the national brewers, the Company faces these same pressures with
limited resources available to achieve similar benefits.
Management monitors the annual working 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 annual working 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 annual working capacity of each brewery. Among the factors that management
considered in estimating annual working 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 differs (such as age of equipment, local environment, product mix), 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 it brews).
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 the annual working capacity after the Merger for its
breweries as follows:
Annual Working
Capacity at
March 31, 2009
(In barrels)
Oregon Brewery (1) 377,000
Washington Brewery 230,000
New Hampshire Brewery 190,000
797,000
|
Note 1 - Excludes
the annual
working
capacity for
the Rose
Quarter
Brewery,
which is
less than
1,000
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 also affected cost of sales,
gross margins and the comparability of fiscal periods.
Brand Trends
Redhook Beers. The Redhook brand has lagged the trend in the growth of the
craft segment for the last several years, due in part to the life cycle of the
brand family's former flagship, ESB, which had matured in key markets even while
the overall segment continued to grow. To offset this factor, the Company
engaged in systematic initiatives, including rebranding Redhook IPA into Long
Hammer IPA and relaunching this brand with new packaging and a concentrated
focus as the new Redhook flagship in January 2007. Leveraging off of the growth
of the IPA category, this rebranding effort resulted in an increase in shipments
of Long Hammer IPA the Company estimates approximated 15% from 2007 to 2008. As
part of these initiatives, the Company reexamined its pricing strategy and
increased the brand family to price points comparable to the market leaders in
the last couple of years.
The Company will continue to look for niche areas of category growth for
Redhook on which to capitalize. For example, during the first quarter of 2009
the Company launched Slim Chance Light Ale to fulfill consumer demand for
full-flavored, low-calorie craft beer. In order to reconnect the Redhook brand
with the craft community, a high-
end line of Redhook beers was launched in late 2008. Each beer in this line is
marketed toward the beer connoisseur, premium-priced, and only available for a
limited time.
Widmer Brothers' Beers. The Widmer Brothers' 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 as 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 such as A-B's Shock Top Belgian White and
MillerCoors' Blue Moon Belgian White attempting to participate in the same
category. Widmer Hefeweizen has also been particularly impacted by the downturn
in the restaurant industry as a result of the U.S. economic recession worsening
during the fourth quarter of 2008 and continuing into the first quarter of 2009.
This brand is significantly more dependent on on-premise sales than any of the
Company's other brands.
As a result of the Merger, the Company now has the ability to sell and market
other Widmer-branded products in the Midwest and Eastern United States. This
will round out the Widmer-brand offering in these regions, giving the consumers
in these areas a true Widmer brand family to enjoy, including Drop Top Amber Ale
and Drifter Pale Ale, which was launched in the first quarter of 2009. In an
effort to keep Widmer Hefeweizen top of mind with consumers and to shift the
emphasis of this brand from the on-premise market, beginning in the second
quarter of 2009, the Company will offer Widmer Hefeweizen in the Western U.S.
markets in a 5-liter steel mini keg. This is expected to allow consumers the
opportunity to enjoy the draft experience of this brand at home.
Except for 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 Brewing Beers. Prior to its association with the Company, the Kona
Brewing brand had experienced strong growth as a result of forming relationships
with Widmer and Craft Brands beginning in 2004. Kona-branded product is
relatively new outside of Hawaii and has been 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. The brand family has a clear
identity, the Company markets it as "Liquid Aloha", which is easily grasped by
consumers, and the beer is of high quality, making it easy to sell to
wholesalers, retailers and consumers.
Despite lapping strong launch volumes in the Kona brand's biggest mainland
market, California, the brand continues to see double-digit growth in this
market, suggesting that consumers have formed a strong bond with the brand,
purchasing it repeatedly. The Company identifies Longboard Island Lager as the
brand family's flagship, creating a direct connection to Hawaii with consumers.
The Company believes that the Kona brand's growth potential is significant not
only from organic growth within its current markets but also from geographic
expansion.
Sales and shipments for Kona-branded product were not reflected in the
Company's statements of operations prior to the Merger.
See Part 1, Item 1A, "Risk Factors" of the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 2008 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
March 31,
2009 2008
Sales 107.3 % 111.5 %
Less excise taxes 7.3 11.5
Net sales 100.0 100.0
Cost of sales 80.2 96.0
Gross profit 19.8 4.0
Selling, general and administrative expenses 21.7 20.3
Merger-related expenses 0.4 0.8
Income from equity investment in Craft Brands - 8.0
Operating loss (2.3 ) (9.1 )
Income from equity investments in Kona & FSB 0.1 -
Interest expense (2.0 ) -
Interest and other income, net 0.3 0.5
Loss before income taxes (3.9 ) (8.6 )
Income tax benefit - (2.8 )
Net loss (3.9) % (5.8) %
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Non-GAAP Financial Measures
The Company's loan agreement, as modified, subjects the Company to a
financial covenant based on earnings before interest, taxes, depreciation and
amortization ("EBITDA"). See "Liquidity and Capital Resources." EBITDA is
defined per the modified loan agreement and requires additional adjustments,
among other items, to (a) exclude merger-related expenses, (b) adjust losses
(gains) on sale or disposal of assets, and (c) exclude certain other non-cash
income and expense items. Per the covenant in the modified loan agreement,
EBITDA is to be measured on a one-quarter basis until September 30, 2009, when
the measurement will be on a trailing four-quarter basis. EBITDA as defined
under the modified loan agreement was $1.4 million for the quarter ended
March 31, 2009. The following table reconciles net loss to EBITDA per the
modified loan agreement for the quarter ended March 31, 2009:
For the Quarter
Ended
March 31, 2009
(In thousands)
Net loss $ (1,075 )
Interest expense 566
Income tax provision 7
Depreciation expense 1,571
Amortization expense 248
Merger-related expenses 112
Gain on sale or disposal of assets (3 )
EBITDA per the modified loan agreement $ 1,426
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Three months ended March 31, 2009 compared with three months ended March 31, 2008 The following table sets forth, for the periods indicated, a comparison of certain items from the Company's Statements of Operations:
Three Months Ended March 31, Increase %
2009 2008 (Decrease) Change
(Dollars in thousands)
Sales $ 29,229 $ 10,446 $ 18,783 179.8 %
Less excise taxes 1,983 1,073 910 84.8
Net sales 27,246 9,373 17,873 190.7
Cost of sales 21,848 8,995 12,853 142.9
Gross profit 5,398 378 5,020 N/M
Selling, general and administrative
expenses 5,908 1,901 4,007 210.8
Merger-related expenses 112 78 34 43.6
Income from equity investment in Craft
Brands - 753 (753 ) (100.0 )
Operating loss (622 ) (848 ) 226 26.7
Income from equity investments in Kona
and FSB 29 - 29 -
Interest expense (566 ) (2 ) (564 ) N/M
Interest and other income, net 91 44 47 106.8
. . .
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