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Edited Transcript of BREW earnings conference call or presentation 7-Mar-19 4:30pm GMT

Q4 2018 Craft Brew Alliance Inc Earnings Call

PORTLAND Mar 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Craft Brew Alliance Inc earnings conference call or presentation Thursday, March 7, 2019 at 4:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew J. Thomas

Craft Brew Alliance, Inc. - CEO

* Edwin A. Smith

Craft Brew Alliance, Inc. - Corporate Controller & Principal Accounting Officer

* J. Scott Mennen

Craft Brew Alliance, Inc. - COO & VP

* Kenneth C. Kunze

Craft Brew Alliance, Inc. - CMO & VP

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Conference Call Participants

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* Alexander B. Scharf

Maxim Group LLC, Research Division - Equity Research Associate

* David E. Cohen

Midwood Capital Management, LLC - Co-Founder, Managing Member & Portfolio Manager

* Drew Nolan Levine

BMO Capital Markets Equity Research - Senior Associate

* Gerald John Pascarelli MR

Cowen and Company, LLC, Research Division - Associate

* James Coll

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and thank you for your patience. Welcome to the Q4 2018 Craft Brew Alliance, Inc. Earnings Conference Call. (Operator Instructions) As a reminder, this conference may be recorded.

I would now like to turn the conference over to your host, Mr. Andy Thomas, CEO. Sir, you may begin.

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [2]

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Thank you, Latiff, and good morning, everyone. It's my pleasure to present the Craft Brew Alliance investor conference call to discuss our results for the fourth quarter and full year of 2018. This morning, I'm happy to greet you with aloha, as this call is, once again, coming to you from the beautiful island of Hawaii, home of Kona Brewing Company, where many of us have gathered for the annual Kona Brewers Festival.

On this call, I'm again joined by 2 other members of the CBA leadership team: our CMO, Ken Kunze; and our COO, Scott Mennen.

So in keeping with our standard agenda, before we begin, I'll ask Ed Smith, our Corporate Controller, to read our safe harbor statement.

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Edwin A. Smith, Craft Brew Alliance, Inc. - Corporate Controller & Principal Accounting Officer [3]

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Thank you, Andy. As a reminder, this call may contain forward-looking statements. Forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from those described in any such forward-looking statements. The Risk Factors section and our most recent 10-K lists some of the factors that could cause Craft Brew's actual results to differ materially from the forward-looking statements made on this call. Craft Brew undertakes no obligation to update publicly any forward-looking statements, except as required by law.

Andy?

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [4]

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Thanks, Ed. As we jump into some reflections on Q4 and full year 2018, allow me to begin with a word about Kona, Hawaii, the physical backdrop for this call and, moreover, the home and spiritual center of the Kona brand.

Many of you know the significance of Kona to CBA and can appreciate the symbolism of our earnings call being transmitted once annually from this beautiful island in the Pacific. But what you may not realize is the year 2019's significance to Kona Brewing. Just 3 weeks ago, Kona Brewing marked its 25th anniversary of operations, making 2019 a milestone year for the brand. As you'll hear later in the call, we have planned a year-long celebration for a brand just 25 years young, with the prime of its life still ahead. So I'll begin with a sincere congratulations to those members of the CBA family that made Kona a reality 25 years ago, particularly, founders Cameron Healy and his son, Spoon Khalsa.

Turning to the business at hand. Over the years of speaking with many of you, I've learned that Q&A opportunities aside, the reason you participate in this call is really twofold: one, you're interested in hearing our take, some would say our spin, on the results to hear about what you could already see; and secondly, you're listening for some insights into what's behind the results and what you can read between the lines about all that you can't see. So as we architect the next 30 minutes or so of prepared remarks, we'll evolve the format a bit.

My teammates, Scott and Ken, will do the heavy lifting on point one, our results, our take on them and the commentary on what you could see. And for my part, acknowledging the significance of the year ahead to CBA and to our shareholders, driven by the sheer scale of change in the beer market and driven by the known unknown regarding ABI's qualified offer deadline of August 23, 2019, I'll take some time not just providing context to the results, but offering additional insights to our actions and to our plans for the future, endeavoring to provide a glimpse into our thinking and into what you can't see from the results, at least not yet.

Lastly, as I set up the agenda, a quick word on the absence of a CFO voice on this call. I'm happy to share that we are in the final stages of negotiations with an outstanding candidate and anticipate announcing our new CFO in the coming weeks, with that individual in place by the Q1 call.

So let me begin with just a few thoughts on what we see as we look back at 2018. Cutting to the chase, it was a good year for CBA. We read the market as well as we ever have. We were armed with a better understanding of our own internal capabilities, and, as a result, we had a better command of our results as we stayed more squarely focused on our plan than ever before.

We successfully achieved strategic milestones from the acquisition of our partner breweries, AMB, Cisco and Wynwood, to the advancement of our cross-brewing relationship with ABI, to the work towards local production and commercialization of Kona in Brazil, to inching ever closer to physical construction of the new Kona Brewery in Kona. We achieved record operational performance, from beer gross margins that approached 40% within the year to healthy revenue per barrel development, to improved operating margins, to continued improvements in the engagement and accountability of our workforce, as evidenced by the strongest-ever scores in our internal employee surveys.

And what's especially notable on this litany of operational bests, in 2018, our performance was as pure as it's ever been and devoid of noncore onetime benefits, such as the Pabst shortfall payments in 2017. Our results met most ranges of our original market guidance provided by this time last year, perhaps most strikingly in our ability to clean up our supply chain and deliver on the promised conversions of STRs and shipments, all while lowering days of inventory across our network.

And importantly, for all of you on this call, where we needed to update guidance, it was in expected areas and we did so quickly, explaining the why behind our actions, taking accountability for our new realities and delivering on those updated ranges across the board.

So first, on to Ken and then Scott for a deeper dive into what you could see in Q4 and when looking back across all of 2018. Ken?

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Kenneth C. Kunze, Craft Brew Alliance, Inc. - CMO & VP [5]

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Mahalo, Andy. As Andy just highlighted, 2018 was another record year for CBA on many measures, as we again made progress against our Kona Plus strategy. Our performance was accomplished with the backdrop of a craft segment slowing dramatically for the third consecutive year and accentuated by the slow drift of consumers away from beer. The craft segment was flat overall in 2018, with off-premise volumes up only 1.5% and the on-premise down 3.1%, as measured by the Beer Institute.

With that as a backdrop, Kona's performance in 2018 was resilient, accelerating each quarter, ending the year with Q4 STRs up 11% and full year growth up 8%, outpacing the craft segment by 800 basis points.

The focus of CBA's top line strategy for the past 5 years has been on strengthening our top line results, with strengthening defined as sustainable, profitable volume achieved by optimizing brand mix, geo mix and enhanced revenue management. In that light, for the year, CBA's STRs declined 2%, while beer revenue per barrel increased to healthy 260 basis points, leading to record beer revenues.

With CBA's improved operating performance and strengthened financial position, our top line strategy will shift in 2019 to accelerate growth. This shift will be driven by investing in and fueling the momentum behind the Kona brand and our newly acquired breweries. Kona will see a significant ramp up of investment in commercial spend, bringing spend levels to competitive benchmarks for the first time.

Other firsts include our first national distribution drive in the February through April time frame, focused against Kona's flagship, Big Wave Golden Ale and Longboard Island Lager. A-B wholesaler alignment and commitment is at an all-time high behind this program. 100% of our top A and B wholesalers are fully participating, another first. These wholesalers represent 96% of volume.

Participation was solidified with CBA and Kona's participation in A-B sales and marketing convention in January. We expect to accelerate the pace of distribution gains historically achieved. This will be followed by our second national wholesaler incentive over the summer to drive velocity across the Kona portfolio. We anticipate strong participation again this summer.

To add momentum to these efforts, Kona will run its first-ever national media, bringing Kona's Dear Mainland campaign to everyone across the U.S. The campaign, featuring our beloved Kona Bruddahs and the reminder to connect with what really matters. The media buy is focused on the marquee media event of the spring, the March Madness Basketball Tournament. It includes a national TV presence, heavy regional buys and a strong national digital presence on live streaming of the games on CBS and the Bleacher Report. Spending these -- to support these efforts will be up over 50%. The timing of the spend in Q1 relative to the volume build in Q2 through Q4 will distort quarterly financials. Commercial spending vocations are assumed in our full year guidance.

We're starting 2019 with strong momentum. Flag -- Kona's flagship, Big Wave Golden Ale, continues to grow with a healthy mix of both on- and off-premise volume performance. Q4 Big Wave STRs increased dramatically, up 36% in the on-premise and plus 30% overall. For the full year, STRs were up plus 37% in the on-premise and plus 26% overall.

At the launch of our new Kanaha Blonde Ale, a flavorful 99-calorie beer, it somewhat quietly became the seventh largest new item in craft out of literally thousands of new items that were launched in 2018. Kona ended the year as the #10 national craft brand and only 1 of 3 in the top 10 to grow, per Nielsen.

On the international front, Kona grew plus 29% in Q4 and plus 20% for the full year through a more focused approach in key markets with our partner, Craft Can Travel. We also expanded Kona in Brazil with ABI. ABI staffed a local marketing team who are seeding the brand by engaging local influencers and establishing the Kona Lanai Bars in and around the beaches of Rio. ABI reports that the rate of sale in the entrée is the highest of any ZX innovation launch in Rio, with velocity outpacing other important American craft brands.

Kona's strong performance was supported by positive performance from our newly acquired brands in Omission while offset by negative performance of Widmer Brothers and Redhook. Omission made progress transitioning to a brand targeting a broader audience of active, healthy-lifestyle consumers versus previous narrow gluten avoiders. Omission Ultimate Light, our 99-calorie, 5-carb, gluten-removed entry, grew 83% for the year after launching in late 2017 and drove positive growth for Omission overall, up 3% domestically.

We continue to believe Omission can be a platform for better-for-you offerings, and we'll further innovate in the space. Omission maintained its leading share of the gluten-removed segment with a 33 share.

Wynwood Brewing, out of Miami, is led by its flagship, La Rubia Blonde Ale, and focused on building distribution in South Florida. As measured by Nielsen Miami food, Wynwood grew 116% and craft -- cracked the top 25 of craft to #18 on the strength of distribution growth, up 39 points to 50% of ACB -- ACV. We're also exploring the potential of La Rubia to resonate with Latino and Hispanic consumers more broadly beyond just the craft play and beyond just Florida.

Appalachian Mountain Brewery, out of Boone, North Carolina, moved up to #15 and jumped to the #4 local brewery in North Carolina, per Nielsen. The flagship, Longleaf IPA, became the #2 local IPA in North Carolina and was up 22%. As we recruit new drinkers, the philanthropy, sustainability and community embedded in the brand's DNA, along with award-winning creative beers, are resonating with consumers.

Of the 3 new brands, Cisco is the most established. But we believe its equity, rooted in Nantucket, has run room to resonate with more consumers in New England and to build distribution on both a geo and a channel basis. 75% of Cisco's volume today is within the state of Massachusetts and largely seasonal to summer.

In 2018, Cisco Brewers received a boost with the successful launch of Gripah, its grapefruit IPA, bringing momentum to its on-premise volume, along with Shark Tracker Light Lager, a tie-in with OCEARCH, a nonprofit dedicated to help the oceans. This year, Cisco will undergo its first packaging refresh in its 25-year history. And flagship brands, Whale’s Tale, Gripah, Sharp Tracker, will lead and capitalize on Cisco's opportunity.

In 2019, Wynwood, AMB and Cisco will each receive ramped-up investment to competitive levels to build these brands. Combined, these brands were up plus 17% in 2018.

Moving to the Pacific Northwest. 2018 was a challenging and, quite frankly, disappointing year for both Widmer Brothers and Redhook in their home markets and overall. New items did not receive the chain distribution originally planned as incremental retail space was more difficult to secure. Concerted efforts behind flagships came too little and late. Price elasticity studies indicated price appreciation in these markets is outpacing the value consumers are willing to pay.

A bright spot for Widmer Brothers is Q4 tactical efforts behind flagship, Hefe, on its home market of Oregon began to impact the off-premise trend as trend improved by over 1,000 basis points over Q3, moving closer to positive territory. Hefe remains the largest craft brand in Oregon, over 1.5x bigger than the next largest competitor as measured in Nielsen.

For Redhook in Washington, Big Ballard Imperial IPA continues to gain traction after being the #1 -- named the #1 new craft in 2017. Redhook's BrewLab brewpub on Capitol Hill, Seattle and the new beers developed there continued to receive positive reviews and are slowly helping to reshape perceptions of the Redhook brand.

These positive developments were not enough to overcome weak performance in the rest of the Widmer Brothers and Redhook portfolios in markets outside the Pacific Northwest. More work is needed here, but guidance assumes realistic performance in 2019.

In closing, as the consumer continues to evolve, CBA will evolve with the consumer through insights and innovation to find both what it means to be a craft brewer in the future and how the Plus portion of the portfolio will be defined moving forward.

Kona remains the clear focus and #1 priority. By all indication, A-B remains committed to seeing Kona achieve its full potential and maximize its value. With stronger alignment within the A-B wholesaler network, with CBA's stronger financial position and with Kona's achieving more critical mass, both within our portfolio weighting and in the market, CBA will pivot our top line strategy in 2019 to drive more growth, fueled through increased investments and improved execution. With increased resourcing and the A-B commitment, CBA's internal teams are excited and focused to build on Kona's momentum in 2019.

With that, I'll turn it over to Scott Mennen, our Chief Operating Officer.

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J. Scott Mennen, Craft Brew Alliance, Inc. - COO & VP [6]

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Mahalo, Ken, and aloha, everyone. 2018 was another good year for CBA as we continued to work to strengthen the core health of our business by improving our cost of goods sold and expanding gross margin. Let's jump right into the results.

Q4 total shipments were 160,200 barrels or 1.1% behind Q4 of 2017. Full year shipments were 747,600 barrels, relatively flat with 2017. Shipments for the quarter and full year were closely aligned with depletions, underscoring the great work done by the supply chain team. And note, our inventory position exiting 2018 was well-balanced, putting us in a solid position to support CBA's effort to drive top line growth in 2019.

Our World Class Craft operations excellence programs continues to help improve our brewery operations, driving improved operating efficiencies and reductions in losses. In addition, the benefit of our supply chain redesign and reshape brewery footprint have helped generate improved results.

Q4 beer gross margin was 36.7%, 90 basis points behind Q4 of 2017. As a reminder, our Q4 2017 beer gross margin benefited from the Pabst contract brewing shortfall penalty, which was recorded in revenue. Q4 pub gross margin was 6.6%, a 610-basis-point improvement over Q4 of 2017. Overall, CBA's gross margin was 32.8%, 40 basis points better than Q4 of 2017.

Full year, beer gross margin was 36.8%, 150 point -- 150 basis points better than 2017. This gross margin improvement is attributed to improved revenue rates and a reduction in beer cost of goods sold. Beer COGS improvement reflects better balance of production across our brewery footprint, with more beer produced in Fort Collins and improved operating performance in our breweries and supply chain.

Full year pub gross margin was 5.7%, 100 basis points behind 2017. Our Hawaii pubs' continued strong performance in 2018 was offset by the sale of our Woodinville pub and softness in our Portland and Seattle pubs. I will address our pub improvement focus in a few minutes. Full year CBA gross margin was 33.1%, a 160 basis points improvement over full year 2017 and within our updated guidance.

Looking forward to 2019, we will not lose sight of our primary objective: to continue improving the core health of our business by reducing cost of goods sold and expanding gross margin. In 2019, we will build on the success in brewery operations by, first, continuing to lock the full value of Anheuser-Busch brewing relationship while balancing production across our own breweries. And in 2019, we anticipate maxing out our contractual limit in Fort Collins at 300,000 barrels, approximately 15% more than was shipped in 2018.

In addition, we will continue our cross-brewing of 80 brands in our breweries under the recently renewed cross-brewing contract agreement with A-B outlined in the 8-K released on February 26. As part of this renewed agreement, we will continue to produce A-B's Virtue Cider in Portland and explore additional cross-brewing opportunities to leverage the scale and capabilities of CBA breweries.

Second, we will build on the success of our redesigned supply chain and our World Class Craft continuous improvement program to drive efficiencies in logistics and brewing operations.

Third, the transition of our newly acquired brands, AMB, Cisco and Wynwood, from an alternate proprietorship production relationship will enable cost improvements and margin expansion.

And fourth, we will maintain focus on revenue management to ensure pricing is in line with the market to support top line growth.

And in 2019, we are laser-focused on improving the profitability of our pub operations and returning the segment to double-digit gross margin by the end of year while not losing sight of the importance of the pubs and taps in supporting our brands, much more to come on this in the next quarters.

Next, I'd like to update everyone on our evolving focus on innovation. In early 2018, we dedicated resources to innovation to unlock potential opportunities both in the beer space and beer adjacencies. This group launched our test-and-learn initiative we call pH, where we tested several products, including a pickle juice gose, botanical ciders, hard teas brewed with wine yeast, IP variant -- IPA variants with terpenes and a hop seltzer.

In 2019, we are taking innovation to the next level. Earlier this week, we announced the creation of a new division within CBA, the pH Experiment. The pH Experiment will expand on the innovations team's test-and-learn platform, tapping into CBA's resources, distribution capability and consumer research insights to quickly develop and test a range of new products in select markets across the U.S. The first of these new products will launch in early spring, with additional launches planned this year.

CBA will add additional resources to support the pH Experiment. The new General Manager, Karmen Olson, will build on our test-and-learn philosophy, looking for new solutions to drinkers' needs. We recognize that there will be some miss -- that some misses are expected, but this is how we learn and keep ahead of trends. We have set a long-term goal for the pH Experiment, targeting $25 million in revenue by 2025.

As Ken mentioned, we are expanding Kona in Brazil. To support this key market, CBA has been collaborating with the Ambev team in Rio to bring on local production in the first half of 2019, with the initial test brews now complete. While plans are to start relatively small in 2019, the opportunity is huge. Much more to come in the upcoming quarters.

Let me wrap up my comments with an update on our key capital projects. The new Portland can line was brought online in Q4 of 2018 and is operating as planned. And I'd like to acknowledge the great work our engineering team did starting the new can line up on time and on budget.

And I have exciting news concerning the new state-of-the-art 100,000-barrel brewery here in Hawaii. Earlier this week, we received word that the building permits have been approved. The team is working to update the construction schedule, and we should have the brewery online later this year.

Summarizing our 2018 full year results discussed today and outlined in yesterday's release: depletions were down 2%; shipments were down 0.1%, relatively flat to 2017; net revenue was down 0.6%.; gross profits were up 4.7%; gross margin was up 160 basis points; selling, general and administrative expenses, SG&A, increased by $2.1 million to $62.6 million, resulting in a full year net income of $4.1 million or $0.21 per diluted share; and capital expenditures were $12.8 million compared to $18.3 million in 2017, which reflects the timing of certain progress payments related to the construction of the new Kona brewery that shifted into 2019.

The stage is set for another great year in 2019. I will now turn the call back over to Andy for additional color. Andy?

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [7]

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Thanks, Scott. As we look squarely ahead to 2019 and beyond, let's spend a few moments discussing where we're headed and what's behind our thinking. Specifically, I want to address 4 topics head on: one, what consumer needs and market beliefs are driving our actions; two, where we see opportunity; three, how we're going after those opportunities; and four, what results you can expect to see.

Let's start with our beliefs. As a result of our actions last year, from the work with Yale and Prophet to the end market test-and-learn experiences in Florida with the pH Experiment and elsewhere, we have an updated understanding of the marketplace and a more contemporized understanding of the consumer. That understanding informs some foundational beliefs for us.

Specifically, number one, we believe beer is still a vibrant category, and we believe consumers still love beer. But our reality is that we now live in a world of seemingly infinite drink choices. As a result, beer is simply no longer the unchallenged choice it once was.

Number two, consumer choices in life, not just beer, are driving fragmentation in their patterns of behavior and socialization. It follows logically then that one brand, one style, one size will no longer satisfy all consumers all the time or even nearly as much of the time as it once did.

And number three, contrary to many others, we believe cannabis is indeed impacting our category and our brands, not necessarily in the immediate linear 1:1 way that so many are quick to dismiss, but more profoundly, in the impact it's having on drinking occasions, need states, drink preferences and attitudes. And our research further validates the advanced impact of these influences in key beer states, such as California, Oregon and Washington, that were all early to legalize recreational use.

So those are the somewhat sobering beliefs.

Where in all this seeming doom and gloom do we see opportunity? Specifically, our work suggests that there are 2 all-important buts for the category and for us at CBA.

Firstly, when looking across consumer segments across occasions and across need states, a very bright light emerges. As importantly, some beers and some brands, and specifically, a number of our beers and our brands, still satisfy a set of those consumers better than anything else.

Secondly, further looking through that same lens of consumer segments, occasions and need states, our research suggests that given our unique capabilities, there are indeed commercial opportunities for us to intercept consumers that are being seduced outside the beer category.

To summarize the opportunities, we believe that consumers are not walking away from beer. Beer has been walking away from consumers. And for our part, we believe we have the portfolio, the capabilities and now the learnings to better meet consumers on their terms, in their locations and tie them closer to our brands.

Continuing from beliefs and opportunities to actions, let's move on to how we intend to go after those opportunities. Without giving up any proprietary insights, we unequivocally believe there is a world of upside for CBA, and we will pursue that upside in the following ways.

Number one, more than ever, we believe in Kona, in the brand, in its positioning, in its resonance with consumers and in our ability to brew beers and activate promotional platforms that bring the brand to life. As such, we will firstly and with priority continue to drive the more universal lifestyle appeal of the Kona brand, both domestically and increasingly in global markets.

Secondly, we will double down on more targeted growth opportunities for our Plus brands, with an emphasis on local and regional growth firstly for newly acquired Cisco, AMB and Wynwood, but also for legacy Widmer Brothers and Redhook.

Thirdly, we will actively explore less geographic-based and more consumer segment-based opportunities for Omission, Wynwood La Rubia and for Widmer Hefe.

Fourth, we will use the recently announced pH Experiment as a vehicle to expand our thinking beyond the existing portfolio of brands and beyond our existing definition of beer.

To be specific about what you can expect, armed with a treasure trove of insights to guide our actions on both the existing portfolio and the portfolio to be, we will more boldly pursue opportunities, both as a leader in doing things others aren't and as a fast follower, bringing our proprietary insight and capabilities to fledgling categories where we believe we can differentiate from the masses. pH will not be about piling on, but will be about pulling away.

And lastly, looking at how this all comes together financially, we believe that with the fundamental improvements in the core health of our business achieved over the past 2 years, we can pursue these opportunities with the requisite levels of investment and not erode our bottom line. More specifically, as we pivot to growth, we expect to maintain healthy pricing while still appropriately funding promotional and discounting needs. And we anticipate continued accretion in gross margin as our breweries benefit from volume leverage.

So bringing it all together, let's look at how this comes to life in our market guidance for 2019. Specifically, as detailed in our release, we expect depletions and shipments growth each ranging between an increase of plus 5% to an increase of plus 8%. We still see average price increases of plus 1% to plus 2%. We expect a total company gross margin rate of 34.5% to 36.5%. We will invest commensurate with the top line opportunities, and as a result, SG&A expense will range from $70 million to $74 million. Our capital expenditures will be approximately $15 million to $19 million. And lastly, we expect an effective tax rate of 27%.

And while we do not provide specific quarterly guidance, I do want to offer some direction. Given the nature of the heavy up-spend and expected impact on top line, we anticipate Q1 will bear the burden of some increased SG&A due to initiatives, such as the March Madness Media that Ken detailed, without significant upticks in volume and top line until Q2 and Q3, as initial spend on awareness- and distribution-building activities in Q1 should reap returns in subsequent months, given the volume dynamics and the seasonality. Clearly, we are bullish on the future for our brands, our beers, our innovations and our business.

Before I wrap up, a few words about our biggest known unknown, that will there won't they question with respect to ABI and the qualified offer deadline. Let me begin by unequivocally stating that our relationship with ABI continues to be healthy, productive and mutually beneficial.

When I hosted a call with many of you 2.5 years ago to share details of our new enhanced agreements with ABI, I characterized the relationship between ABI and CBA as "collaborative independence." And I believe that still holds today from our work together in bringing the Kona brand and the rest of our strengthening and outstanding portfolio to retailers through the shared ABI wholesaler network to the cross-brewing benefits for us in Fort Collins and for ABI enforcement in Portland to the work and planning for more global expansion, most concretely evidenced by the recent actions towards local production in Brazil.

And with that healthy, well-functioning relationship as a backdrop, I'll remind our shareholders of our protection in the absence of a qualified offer from ABI. If ABI has not made a qualifying offer for CBA, then CBA would be entitled to the $20 million international incentive payment after the 2019 deadline, and ABI could not force the termination of any of these new agreements.

Further, again, if ABI has not made a qualifying offer, CBA could continue to operate independently or could then undergo a change in control, and ABI would still be required to respect the terms of all agreements, including payment of the $20 million international incentive, continuation of the master distribution agreement at $0.25 a case, continuation of the international distribution agreement and fulfillment of the contract brewing agreement.

So as explicitly as I have ever said it before, I believe the future is bright for CBA regardless of whether that future leads to a qualified offer from ABI or if that future leads to continued collaborative independence. In either case, our shareholders can look forward to the security of the existing ABI agreements; an accelerated top line; a healthier portfolio anchored by Kona, that 25-year young brand with lots of room to run; an emerging, stronger Plus portfolio of flanking brands; and continued progress in the financial performance and financial health of the company.

Before moving to questions, on behalf of the entire leadership team at CBA, a sincere thank-you to each of you who have played a role on the journey so far, to our investors, to those analysts who cover us, to our interested parties and, importantly, to all of our hardworking, passionate and engaged employees and partners, wherever they operate within the world of CBA.

And with that, I will open it up for questions. Latiff?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Amit Sharma of BMP Capital Markets (sic) [BMO Capital Markets].

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Drew Nolan Levine, BMO Capital Markets Equity Research - Senior Associate [2]

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This is Drew Levine on for Amit. So I just wanted to start on the SG&A step-up this year. It sounds like most of it is going to Kona, and we've seen the success of heavy-up in some of the measured channel data. So I'm wondering if you could just expound a little bit on what the expansion plans are for the heavy-up and how you feel comfortable that you're getting good repeat rates on that spend.

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [3]

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I'll take the question, Drew. We'll -- I'll tag team this with Ken. So just to underscore something you said in the front, a lot of our actions in '19 were definitely guided by some test-and-learn in '18. I want to underscore that. It was a decision we made last year that if we were going to go big, we needed to have some level of confidence in kind of what was going to happen. And the second point, you're dead right. A lot of the increase in spend is going to Kona because we really believe there's a window of opportunity open for the Kona brand right now. And it's incumbent upon us to kind of jump through that window right now and, hopefully, orchestrate an elegant landing when we do so. I think one of the things that's clear to state too is the research, as I said in my portion of the prepared remarks. You almost couldn't design a brand better than Kona. And the beauty is that it's not designed, it's real; it's authentic. So for us, when we look at what we did in Florida last year, namely, it gave us a lot of confidence that we knew the toolkit and we knew kind of what levers to pull on the Kona brand, and a lot of what you'll see orchestrated on more of the national stage and also with heavy-ups in certain geographies is a page out of that Florida playbook, which as you said, you could even see pop in the measured media -- measured sources. And what you couldn't even see in the measured sources was some of the on-premise growth. I think a question we get often asked is why are Kona trends so much better than you might see just in Nielsen. And one of the reasons is we're playing the entire field. We're not just playing Nielsen channels. As I said, we have a lot of great insight about where consumers are going after beer and where beer is walking away from them. And we happen to believe that the on-premise, certainly for Big Wave draft and Longboard draft, there's a huge opportunity for us as other people basically kind of run away from that area and turn their attention elsewhere. So with that as a little bit of a backdrop, I'll kind of hand over to Ken maybe to fill in the blanks on what we expect to be doing and why we feel confident in what we'll see as a result. Ken?

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Kenneth C. Kunze, Craft Brew Alliance, Inc. - CMO & VP [4]

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So 2019, I think, will definitely be an expansion of the learning in what we've been doing in terms of how we've gone to market last year and a little bit the year before. So it's, I think, working in a 3-tier system. It's also about really getting strong alignment from the wholesaler, the retailer as well as the consumer. And so the ramp up of investment will be targeting each of those a little bit separately. The bulk of the investment will go towards the consumer to really activate that. And -- but that strong alignment throughout the 3 tiers is really part of what we're going to do. And Florida was a great example of really working with the wholesalers, the key retail players in Florida and then the consumer to bring it all together to drive momentum. We're putting a big investment in March. The timing of that and the viewership of that is just a good property for us to launch behind. And the spend will be weighted somewhat to volume but also enough to create a national presence to kind of fuel a broader footprint than what we've been able to do previously. So as a marketing guy, having more resources to invest behind the business is exciting. And we've gone back and validated the creative, so we know that the creative is strong, the message resonates, people like the brand and whatnot. And it's just a matter of continuing to build distribution and get more awareness, more consumer activation out there. So we feel really good about where we are for '19.

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Drew Nolan Levine, BMO Capital Markets Equity Research - Senior Associate [5]

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And then on the F&B side, with the pH Experiment and launching the new product in the second quarter, it sounds like, can you just talk about what type of reception you're getting from distributors and retailers and if you've secured incremental shelf space for that product at this point?

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [6]

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Yes. I think the question is watch this -- the answer is watch this space brew, and that's not facetious. We're getting really good reception, but I think we're mindful of the fact that there's a lot going on there, and there's a lot of competition for wholesalers' hearts and minds and, certainly, for their bank accounts, too. So one of the reasons we, again, very consciously and thoughtfully kind of decided to launch pH as a separate arm is to let pH basically go where pH thinks it can be most successful. So rather than have a one-size-fits-all approach and try to force-fit a square peg into a round hole on a broad geography or across a broad class of trade, what we have done is basically say, "Hey, we -- look, we have these consumer insights" -- and it is all rooted in the consumer. "We have these consumer insights, and we think these markets, in particular, or these channels might be the best way to go after it." So we're kind of going in a more targeted wholesaler base on a case-by-case basis, no pun intended, where we're looking to basically get them excited about what we can tell them about their market and about their consumers. And as such, we've been really encouraged by the reaction we've gotten because we're not taking some great learnings from -- theoretically, from a conference room that we build in Oregon or we build in Miami or we build in Boone, and then try to shove them down the throat of somebody in a different market. We're really organically taking learnings. Our consumer research was extensive. I think a lot of you know my background. I'm a researcher by trade. And I can tell you, this is amongst probably the best pieces of research I've ever had the fortune of being a part of. And it gives us the ability to look geographically at some differences on a state-by-state basis as well as really drill down to a consumer basis. So a little bit of a long-winded answer, but I wanted to give some color. We're not just getting a reaction from consumers that are excited we're doing something. We're getting really targeted reaction from the right consumers because we're bringing them something that we think is differentiated from what anybody else is doing. We're not trying to go big everywhere, we're trying to go big and deep in their markets in a very targeted way. And we think that is going to differentiate what pH is doing from what a lot of others are doing in the drink space.

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Drew Nolan Levine, BMO Capital Markets Equity Research - Senior Associate [7]

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And a final one from me on Widmer and then Redhook. You had said that you're baking in realistic assumptions for this year. Obviously, you're still seeing pretty sustained weakness. So just thinking about 2019 versus 2018 for those brands, I mean, if you could give us any sort of help on what you consider realistic expectations? Is that stabilizing? Is that improving? Or just any additional color there would be great.

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [8]

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Yes. It's a great question, Drew. So just a couple of things to take the opportunity to say. You almost couldn't have picked the -- a worst set of circumstances converging for Widmer Brothers and Redhook, especially not only given the legacy, the age of the brands, not only kind of given the kind of momentum and the trends on the brands, but given kind of the market conditions. Again, I don't want to share too much of what we have learned, but Washington and Oregon in the Northwest are different. One of the biggest kind of ahas we got out of the consumer research was -- it at least kind of made us feel a little bit better, it was kind of empiric victory in that we were like, "Well, maybe it isn't just us. There really is something different going on here." So we feel we're smarter about what's going on than we've ever been. And as a result, that's why we feel we can say with some confidence, we're being more realistic. You're not going to see a positive number in front of those brands, so I can say that unequivocally. You shouldn't see a more accelerated negative number. So for us, without giving any market guidance at the brand level, we expect to see at least a stabilization in the decline, if not, an improvement in the trend but still not all the way to 0 or positive on either one of them. That said, something I said in the prepared remarks and it was intentional, we think the learning also suggests to us that a brand like Widmer Hefe might be more about the Hefe than it is about the Widmer. And it might be more about where are the markets where there's an opportunity for an outstanding beer that helped launch a category, American Hefeweizen, outside of the geographies of the Pacific Northwest than we would've thought before, and that is an evolution in our thinking there. So in Widmer Brothers and Redhook, tough markets. Northwest is different. We're armed with a lot more understanding of that than we've ever had. It's a sobering understanding, and we're being realistic about it. But we don't expect things to get worse. We expect them to get better, but we don't expect the tide to turn totally into the positive territory in '19 yet.

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Operator [9]

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Our next question comes from the line of Vivien Azer of Cowen.

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Gerald John Pascarelli MR, Cowen and Company, LLC, Research Division - Associate [10]

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This is Gerald Pascarelli on for Vivien. So based on your comment -- your commentary on kind of outlook for Widmer and Redhook, your guide for plus 5% to 8% in terms of volumes and depletes obviously implies a fairly meaningful acceleration in trend for Kona. I get the investing, in particular in March Madness, and higher investor -- investment spend over the course of the year. But how do you think about the whitespace opportunity for Kona in its current state? Is it going to come from further distribution gains? Is it going to come from velocity? For both? Any kind of color you can give on the drivers behind the acceleration, I think, would be helpful.

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [11]

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Thanks, Gerald. I'll start here, and Ken will hopefully jump in and keep me from saying something I should have or misstating. So the interesting thing about the Kona brand is it depends on where you're looking. So if you're in a market like we are here in Hawaii, we've got broad distribution and really good velocity. If you're in a market like California, depending on which market there, your distribution opportunities are more about spreading out, not gaining initial distribution but gaining more packages and gaining deeper distribution. And then if you're in a market kind of like the one of the central region markets or even up in the Northeast, your real opportunities are distribution. And then on top of all that, you'll want to accelerate some velocity, right? So those are just some good theoretical kind of truths about any consumer packaged good, certainly about the beer business. So if I dial that down specifically to Kona, in markets where we already have good ACV coverage, we're looking to go deeper with additional packages. And not necessarily additional packages with all additional brands, but maybe different platforms. So where we've got poor distribution on 6 packs for Big Wave bottles and even for 12 packs, you'll start to see 18-pack cans, or you'll start to see us expand kind of our case business in those markets. Whereas in other markets, we're looking to just get on the shelf for the first time and then spread out from there. And then velocity helps all, right? Velocity raises all ships. So I think for us, as we look at a pretty healthy acceleration on Kona specifically -- and I do want to talk about this tipping point kind of concept, too, because both your question and Drew has kind of have this thing kind of tweaking in the back of my mind to make sure I say on the call about kind of where we are from a portfolio perspective that we've never been. But sticking with Kona first, I think when we look at the acceleration, we expect to see a high double-digit number on Kona, probably get another digit to it -- again, without giving guidance. And we believe that will come from a pretty healthy expansion and distribution, both in Q1 and Q2, as Ken talked about, distribution drives. And off that better distribution base, we expect to see velocity increases as we get through the peak summer selling season in the summer. It's not an accident that we're doing March. There happens to be a great marquee property for us to get out there behind with March Madness. But by getting the distribution drive going in March and April, it allows us to get Kona on the shelf in time to really hit the peak selling season and to really try to hit chain resets as effectively as we can. So that's a little bit behind the logic on the acceleration on Kona. The other point I want to make, if you look at the 5% to 8% guide, you can get there a lot of different ways. But one of the important things to note, Widmer Brothers and Redhook, despite the kind of hurt that, that's been putting on the company, that now represents 20% plus or minus of our volume base. So they've kind of contracted to a point where while they're still sizable between the 2 of them, they're not going to have a disproportionate impact on kind of usurping growth or negating growth that they once had. So while independently, any one of them might have been small, the 3 acquired breweries, so AMB, Cisco and Wynwood, with the growth opportunities they have, coupled with Kona, which was already at better than 60% of our portfolio, coupled with Omission, we believe it gives us a much stronger force of brands moving forward that in the face of that the 20% that isn't moving forward won't have as disproportionate an impact on our overall result as it did. And the last piece, which I want to underscore a lot, Big Wave, Longboard, our partner brands, all of that growth for us is margin accretive. And that puts us in a very different position than a lot of our peers right now. It isn't fragmented for us as we grow more Big Wave. It isn't fragmenting for us as we grow more of La Rubia. We're already doing that. It actually is margin accretive because there creates volume leverage in our own breweries. So that's a little bit of context behind why do we feel good about Kona and why do we feel good overall of the 5% to 8% guide without saying that's going to disproportionately hurt the financials.

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Kenneth C. Kunze, Craft Brew Alliance, Inc. - CMO & VP [12]

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Just -- sorry, 3 points maybe. I would just build on that. I think you can't underestimate the importance of having a share of mind with the wholesalers to get distribution and, really, with A-B's endorsement. And we have a really strong program set up for that, so we feel confident in terms of our ability to drive more distribution than we have historically. So in terms of distribution, it will definitely be a big part of the play. I think the other thing I would just comment on is that we did quite a bit of pricing and price elasticity work as well on that. And we're in and around where we need to be, but we can be sharper in terms of exactly where we are in the frequency of what price points that we get in the adds, which will also contribute to velocity. And then finally, the increase in more consumer-facing thing is somewhat gravy on top of kind of the fundamental blocking-and-tackling things that are going to make it happen.

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Gerald John Pascarelli MR, Cowen and Company, LLC, Research Division - Associate [13]

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Very good. That's super helpful. Sticking with Kona, like in terms of the brand family, you're obviously seeing robust growth. But for the 2 big brands, so Big Wave Golden Ale and Longboard Lager, can you just give some color on how you view the competitive dynamics between both of those brands? I know that they play kind of in different categories within beer, so your thoughts between how each of those brands performs against one another, hence, in terms of competition, I think would be helpful.

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [14]

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So I think for me, given that Longboard is a lager and Big Wave is a golden ale, the lager plays more against lagers, right? So I forget exactly what the percentage is, but the vast majority of all beer is lager. So that puts Longboard more kind of within the lager space. And Big Wave Golden Ale plays more differentiated and more within kind of the craft spaces. The simplest way I would articulate it, we're extremely bullish on Big Wave and what that liquid, what that beer and the brand itself represents. And so we feel that's probably just a little bit more differentiated in the marketplace and really has the most long-term upside.

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Gerald John Pascarelli MR, Cowen and Company, LLC, Research Division - Associate [15]

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Great. Last one for me. This is on the international front. Can you just provide us with an update on Brazil, maybe your future plans for expanding within that market, what you're seeing in early results in terms of penetration rates, velocity, that kind of thing? I think that would be helpful.

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [16]

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Thanks, Gerald. So on Brazil, expect a slow burn but with, hopefully, a big bang at the end. And the reason I say that is we're really relying a lot on our partners, Ambev, down there who know how to kind of approach that market. And so starting out in a market like Rio and on the beaches with influencers and starting to grow the brand that way is something that we think will give it deeper roots as we start to expand more broadly beyond the country. So initially, I think as Ken said, we're thrilled with kind of what we're seeing there in -- both in terms of kind of the reaction to the brand, the resonance of the brand. With Brazilians, there's a huge surfing culture and a huge water culture in Rio that we're able to tap into. And we're seeing really good velocity and really good repeat on a small basis. So armed with that and with a healthy balancing of opportunity and discipline, we'll look to continue to stay at that and make sure we seed the brand effectively and then expand beyond there. Local production is going to be a big part of that, though, Gerald. I think I've talked about on this call pretty openly similar barriers to entry in some of the most interesting global markets for us, Brazil being one of them. As we're able to produce locally there and overcome some of the import tariff issues and tax tariff issues, it will create more money in the value chain for everybody to kind of fuel the fire a little bit more. So for now, we're being disciplined to make sure the brand grows well. And given kind of the financial realities of basically still working on imported basis and as we move towards local production, we'll have the benefit of the learnings from that initial seeding period as well as a little bit of a healthier value chain for us to tap into.

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Operator [17]

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Our next question comes from the line of Alexander Scharf of Maxim Group.

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Alexander B. Scharf, Maxim Group LLC, Research Division - Equity Research Associate [18]

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When you talk about gross margin improvement in 2019, what are some of the key drivers on the beer side of that? And do you also think we could see a rebound in the pub side as well?

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [19]

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Thanks, Alexander. So I'm going to pass that over to Scott.

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J. Scott Mennen, Craft Brew Alliance, Inc. - COO & VP [20]

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So on the beer side of gross margin expansion, we're going to continue doing a lot of what we're doing. First and foremost, we'll continue to unlock the value with the Anheuser-Busch relationship, maxing out Fort Collins, which gives us a benefit of $10 per barrel. So you'll see us get to the 300,000 barrels shipped from Fort Collins this year. That's our plan. We'll continue to leverage the work we've done in our supply chain in World Class Craft and our brewery operations to improve inefficiencies, reduce losses, both logistics and freight, as well as in the breweries. Another benefit we have is moving from the alternate proprietorship relationship with our new partner brands to owned gives us some opportunities to unlock some cost improvements there and drive margin expansion. So those are really the 3 key drivers of margin expansion. And on top of it, don't lose sight of what we're doing with revenue management to making sure that we're pricing our products to move properly, and that's still what you'll see in our price guidance. So having healthy revenue management and continue to drive improvements in our breweries and unlocking the full value of A-B with the 300,000 out of Fort Collins is going to get us there. On the pubs, the answer to that is yes. Our goal is to get back to a double-digit gross margin this year. How we're able to do is continue to really enhance what's working. As I mentioned, our star performers are really our Hawaii pubs, both here on the Big Island with the Kona pub and over on Oahu with our Koko Marina Pub. Earlier this year, in January, we had to make the tough decision, but it was the right decision for both the brand and financially to close the Portland pub. While it was a great space, it wasn't in a great, proper location to really support the brand. And we couldn't attract enough people to make it profitable, so that's part of it. And then also with the acquisition of our new partners, AMB, so the Boone taproom and with, down in Miami, with Wynwood. The Wynwood taproom, while they're relatively small, they're good performers. So add that all together, continue to work on -- enhance what's working, for lack of a better term, lop off some of the pain points, work on what we need to be working on, such as BrewLab in Seattle, a great space but opportunities to drive improved performance and the addition of Wynwood and AMB's taproom will help us get back to that double-digit gross margin.

Well, it's going to take a lot of work, but, as I said, we're laser-focused on it.

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Alexander B. Scharf, Maxim Group LLC, Research Division - Equity Research Associate [21]

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Great. And then over the last couple of years, there seemed to have been a steady shift from focusing on external partnerships or external acquisitions to internal innovation. And that's really solidified, I think, by the pH Experiment business unit. Can you talk about why that's the right strategy for the company at this point in time?

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [22]

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That's a pretty insightful question, Alexander. I could probably talk for a long time about it. But I think it goes back to kind of a combination of where was the company, where was the market and kind of where we're competitors. In the intersection of those 3 things, you'd find your answer. And it's an answer that will evolve, so I'll explicitly say that. If I go back 3 or 4 years ago, the company didn't have the money to go after some hot target M&A that was out there because they were expecting much different multiples. We didn't have the multiples to spend in our bank account. And as a result, necessity being the mother of all invention, we had to kind of look internally at what we could do and kind of grow in our own way through kind of what we call the planning seed strategy and partners. As we fast forward now 3 years, we look at '19, I'd say we're the healthiest we've ever been. We feel really good. We've got great experience on what it takes to kind of grow a small partner or another brand to move forward. And I think you're seeing the fortunes for a lot of those small brands that were operating independently who decided they were going to try to scale, you've seen their fortunes turn. And while we'd never hope to prosper because of the misfortune of others, we are not apologetic about being able to swoop in and take some opportunity there and help everybody out. So we find ourselves now where there may be more external opportunities for us out there. But in pursuing any of the external opportunities, we'd be doing it from a stronger place. They'd be doing it with a different perspective. And meanwhile, we have the benefit of all that internal learning. And the pH Experiment can be a great vehicle for us, not only organically growing new concepts, but it could be a vehicle for us to take a look at external development for some concepts that we don't currently have within the CBA fold right now. So this, it's evolving. But for us, 3 years ago, dead right answer. For us, today, it's still the right answer, but I think we can be a little bit broader in terms of how we look at external development from an opportunistic perspective.

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Operator [23]

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(Operator Instructions) Our next question comes from the line of David Cohen of Midwood Capital.

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David E. Cohen, Midwood Capital Management, LLC - Co-Founder, Managing Member & Portfolio Manager [24]

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I may have missed this, but did you share investment -- mention the investment in the pH Experiment for '19?

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [25]

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So in terms of absolute level of investment, no, we haven't -- we didn't disclose that. I can give you some broad parameters on that, David. We're looking to almost be kind of self-funding, revenue neutral, if you will, on pH. So if you look within our SG&A, $70 million is a big number, guys. I recognize that. Believe me when I say it isn't something that we're doing lightly. But if you look at what we're trying to do on that $70 million -- with that $70 million, there's a lot of factors in there. We're trying to fully fund Kona and to do some things on the brand we've never done before. We're trying to fully fund acquired brands. We're trying to make sure that we can feed and give pH Experiment and Karmen enough money to go out and do what they need to. And if it hits, it hits. Then, the business case starts to develop kind of organically and independently of everything else. And in order to get all of that done, you are seeing us try to tighten our belts on the G&A side a little bit to make it all still come together, because if you just continue to add to all that, the math just wouldn't work, and we're mindful of that. So on pH, I would say I'd characterize it as appropriate but kind of a meaningful and appropriate but self-funding for now. And then on the merit of every business opportunity as it develops, we'll build a business case. And as we have things to share with you guys, we'll be more than delighted to share them.

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David E. Cohen, Midwood Capital Management, LLC - Co-Founder, Managing Member & Portfolio Manager [26]

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Okay. As it relates to Brazil, as that -- as you evolve towards local production there, would the royalty fee structure of the international agreement start to apply?

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [27]

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Yes.

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David E. Cohen, Midwood Capital Management, LLC - Co-Founder, Managing Member & Portfolio Manager [28]

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And so soon, will there be fairly high -- it'd be a fairly high margin revenue stream, albeit not necessarily a large volume though coming, but that's still relevant, right?

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [29]

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That's still relevant. You're exactly right.

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David E. Cohen, Midwood Capital Management, LLC - Co-Founder, Managing Member & Portfolio Manager [30]

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Okay. And then I guess the last question is a bigger picture question. As you just said, $70 million is a large -- is a big number, and Craft Brew had not necessarily had the scale and margin structure historically to invest that aggressively. And you have sort of slow played the development of the Kona brand portfolio. What, in particular, is giving you the confidence that now is the time to alter the playbook on investing behind Kona to this kind of magnitude?

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [31]

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Research and scale. Really, unequivocally, when we look at where the opportunities are and where kind of the whitespaces and the run room exists, if we were going to go after everything we would go after, it's embodied in the Kona brand. And that comes right out kind of research, geographically, consumer segment-wise or whatnot. And scale is important. We've been on this march, many of you on the call with us, for 4 years now, and we're finally at a point now where we think we can compete in the way we want to. So if Ken wanted to spend $8 million on a March Madness buy 3 years ago, it sounded great. We had a great creative, but we didn't have enough volume concentration in key markets in order to make that kind of pay back. But today, with the concentration we've got in certain markets, the scale we have in certain markets, we believe that we can heavy-up there and get an appropriate level of return, not just on a percentage basis but on an absolute basis in terms of kind of volume return. That actually starts to make it pencil out. So one-two punch, the research suggest to us we've got the right vehicle, the right brand, the right liquids with the right kind of understanding of how to go after it. And secondly, we've got the scale to be able to make the financials pencil.

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Operator [32]

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Our next question comes from the line of Jim Coll of Lombard Securities.

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James Coll, [33]

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My question was on the balance sheet. What do you expect long-term debt to be 2 to 3 years out, barring any major acquisition or increase in CapEx?

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [34]

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Yes. That's a great question, Jim. It's always good to hear you on the call, too. Jim's one of our longest kind of individual supporters here, so you've stuck with us for a while, Jim. And as such, you kind of can probably appreciate what I'm about to say. We expect our long-term debt position to actually not only normalize relative to historical levels but to probably be really, really strong. So if you take a look at a couple of things on the horizon, right, the elephant in the room question of the qualified offer, with the advent of August, we'll have a $20 million infusion. If we're on this call at this point last year -- next year, we'll have basically taken that $20 million to buy down the kind of debt level, so that's one thing. Secondly, right now, our CapEx, we expect to start to normalize after '19. And when I say normalize, if you take a look in '19, we're still basically doing 2 major things -- we have 3 major capital projects kind of on the horizon. We're finishing up the Kona brewery, which we started. We're later in getting that done because of building permits. Secondly, we will do a pretty significant remodel of the campus here in Kona once the new brewery is built, continuing to make sure that we invest in the pub and continuing -- while we make -- invest in the consumer experience here at the heart, as I call it, of the spiritual center of the brand. And thirdly, we have some upgrades to ERP systems that we need to get done. We're not launching SAP, so I don't want anybody to go crazy on the phone. But we have some maintenance to do there. Those are 3 kind of significant projects on the horizon for '19. And then candidly, I can tell you without giving any long-term guidance, after the calendar turns and those projects are completed, you'll see our CapEx levels drop down to levels that you have never seen. And that, coupled with the fact that we'll have that $20 million cash infusion kind of puts us on a balance sheet perspective in a really, really good debt position as we look forward to '20 and '21 and beyond. That said, kind of back to the answer I gave to Gerald -- or back to the answer I gave to Alexander, we will continue to pursue and explore opportunities that come our way. And we think we have really adequate funding. We've got a great relationship with BofA in terms of financing our activities. And so I think if you look at our balance sheet, it will basically be another thing that finally gets in line as we come to '20 and '21.

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James Coll, [35]

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And how about the depreciation and amortization expense? They gradually increase? Nothing significant?

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [36]

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Yes. We'll see a spike in that a little bit this year, Jim, just because of how much new stuff we've got. I mean, at the Kona brewery, you've got BrewLab, you've got some hard assets that we're starting to depreciate because it follows that after you spend at a level we've spent on the CapEx lines for the last couple of years, you're going to see the knock-on effect of that in your depreciation for a couple of years. But that's all factored into our guidance and into our financial planning, and we're feeling pretty good about it. So nothing abnormal, I would say, there, other than what you'd expect given our historical levels.

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James Coll, [37]

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And that new aperitif, I think it's sort of an Italian-type aperitif, can you give me a little bit of an idea with that -- what's about that and -- besides what I've read?

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [38]

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Sure. Scott, do you want to take -- tackle that?

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J. Scott Mennen, Craft Brew Alliance, Inc. - COO & VP [39]

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Yes. It's actually a cider-based, but we've done some work with botanicals to kind of go after the Aperol type of spritz, which is an Italian-type of drink. It's really based in bitterness. It's refreshing. It's a little bit bubbly. And so we're trying to go after that drinker and consumer out there that's looking at something different than beer that kind of fits that segment. It's more refreshing. It could be poured over ice. And that's where, I think, you'll see most of them done that way. But it's refreshing, and it's really a knock off on the Aperol type of spritz. It's very refreshing.

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James Coll, [40]

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So it's more of a -- it's like a spritzer?

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J. Scott Mennen, Craft Brew Alliance, Inc. - COO & VP [41]

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Yes, a spritzer.

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [42]

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It's like a spritzer. I think a couple of interesting things, Jim. I mean, I could talk about this for a while. Our innovation group is innovative, right? So we were looking and everybody's kind of running in certain directions and we started playing around -- or they started playing around with cider as a base, which we thought was brilliant. First and foremost, we don't have a lot of other folks who are doing that. It's easy to do. It's scalable for us. We can do it within our existing capabilities. So that kind of is differentiating for us, first and foremost. And then armed with a lot of the insights we get out of the research, and some of the nuts and bolts we get out of Yale, if you see the packaging, even the fact that it's in clear bottles, that's intentional. And it's not just because today clear is cool, there is a consumer insight behind putting that beverage in a clear bottle. And not only how it allows the product to shine through, literally through the clear, but the statement it makes about the liquid inside to the target consumer. So again, really good insights driving some really good actions and opportunities, and we'll get out there and test it. And now that we've kind of gotten out there and talked about it, you can rest assured we'll let you know how that develops over the coming months and quarters.

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Operator [43]

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Our next question comes from [Steve Casbel] of [R&J and Associates].

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Unidentified Shareholder, [44]

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Another long-term shareholder, so I guess, we get to go back to back.

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [45]

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Absolutely. I love it.

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Unidentified Shareholder, [46]

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You guys touched on this a little bit earlier, but just could you kind of, I guess, talk about where Kona is in its life cycle? I guess, if it's a baseball game, what inning we're in? And then also on the research, is it kind of viewed as like a craft Corona? Or how do people view the brand?

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [47]

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Yes. That is a great question, Steve. I think if you take a look at it, I think what we've learned is not all brands have the same life cycle. So if I was going to look at a brand like Kona, I would basically look at our reference brand like you just mentioned in Corona. And so if you look at where was the Corona brand after 25 years relative to its growth trajectory and where is the Kona brand, I think you'll find some validity for what I'm about to say, because I think we're in the early innings. The reason I say that is, I think if you've got a brand that's rooted in a locale that has less universal appeal, that has products that are more polarizing and might not have universal appeal, you'll see an acceleration in the life cycle. We're living that with Redhook, right, a brand that was all about the Northwest. It was early on, its flagship was ESB. All of those things had a life cycle, but they were probably more finite. If I juxtaposition that with Kona, we're blessed with the fact that the Kona brand is rooted here where many of us are today in Hawaii, which has universal appeal. The concept of kind of that liquid sunshine, that Liquid Aloha we call it, kind of in the bottle, is something that is resonating with a lot of consumers. And as such, we think the brand has a longer trajectory, a longer arc of growth than a lot of other brands will because it's rooted in something that has a pretty long arc in terms of a life cycle. Secondly, if you take a look at the brands, as Ken said, Longboard Island Lager and Big Wave Golden Ale being the flagships, they're both really accessible, relatively easy-drinking brands that deliver on that kind of promise. So the liquids in a bottle, I would say, from a functional standpoint have a longer arc and a longer trajectory as a life cycle, coupled with a brand that we think has a longer arc. So if I was going to tell you what innings we're in, I would say we're early innings. I don't know if we're in the third inning or the fourth inning. But we're probably in the -- somewhere around there. And I think there's a lot of run room for us. And I would say take a look out of the Corona playbook, I remind people when I joined the beer industry back, and I hesitate to say it, 1995, the Heineken brand was bigger than Corona. That was a long time ago. I get it. But if you think about what Corona has done in the decades since then and how it's distanced itself, it's something that I think is relevant when we take a look at the life cycle question on the Kona brand.

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Operator [48]

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At this time, I'd like to turn the call back over to our CEO, Andy Thomas, for any closing remarks. Sir?

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [49]

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Thanks, Latiff. I appreciate everybody's continuing support of CBA and being available for this call. We look forward to discussing the results of the first quarter of 2019 with you soon. Thank you, and have a great day.

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Operator [50]

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Ladies and gentlemen, this includes today's conference. Thank you for your participation. You may disconnect your lines at this time.