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Edited Transcript of BREW earnings conference call or presentation 8-Nov-18 4:30pm GMT

Q3 2018 Craft Brew Alliance Inc Earnings Call

PORTLAND Jan 22, 2019 (Thomson StreetEvents) -- Edited Transcript of Craft Brew Alliance Inc earnings conference call or presentation Thursday, November 8, 2018 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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* Gerald John Pascarelli MR

Cowen and Company, LLC, Research Division - Associate

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Third Quarter 2018 Craft Brew Alliance Earnings Conference Call. (Operator Instructions) And as a reminder, this conference is being recorded.

Now it's my pleasure to turn the call to Mr. Andy Thomas, CEO. Please go ahead.

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

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Thank you, Carmen, and good morning, everyone. It's my pleasure to present the Craft Brew Alliance investor conference call to discuss our results for the third quarter of 2018. This morning, I'm joined on this call by 2 other members of the CBA leadership team, our CMO, Ken Kunze; and our COO, Scott Mennen.

But 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. Q3 2018 was a particularly busy quarter, with much to discuss, both operational and strategic. So let's jump right in. As I generally do, I'll begin with some high-level thoughts on our third quarter results before having the team provide a more in-depth look and some color on their respective areas of accountability. In the absence of our CFO, I'll bring the call to a close with both some detailed financial numbers as well as provide some thoughts on CBA strategy looking forward. I'll also update our CFO search.

Reflecting on Q3 2018. While the quarter certainly wasn't as optically appealing as Q2, it was, nevertheless, solid across a number of key dimensions, as volumes, particularly Kona, in rates both in revenue and gross margin, developed in line with management's expectations. To that end, in framing this call, let me offer 3 complementary themes which emerged for us in Q3. Those themes are control, confidence and energy. And I'll use them to offer some high-level thoughts before handing off to the team to provide some details.

As for the first theme, control. The quarter delivered largely in line with management's expectation and was another quarter void of any significant surprises, such as those that have plagued our results in years past. This fact is best evidenced by the tightening of our full year guidance within the parameters of our original ranges, with the exception of SG&A, which I'll discuss later. As we find ourselves 3/4 of the way to the annual calendar turn on December 31, comparing our performance with the same period last year, we see that Kona volumes are accelerating and, after starting the year up only 3, are again approaching double digits. Overall CBA shipments are up slightly, despite maintaining lower wholesaler inventory levels. Our beer revenues are up over 3%, in concert with our beer revenue rate, which has also improved over 3%. Our beer and total company gross margin are both up over 200 basis points, even after absorbing anticipated brewery and brand shift mixes in Q3. And while our spend to date is broadly flat, it is far more market-facing than ever before. And remarkably, all of this is not only consistent with management expectations, but it happened while we were simultaneously negotiating and orchestrating 3 distinct and successful acquisitions and amending the terms of our financing agreement with Bank of America. In that sense, looking through the lens of what we accomplished, while the date 10/10/18 stretches the technical definition of the third quarter, it was a fitting exclamation point for CBA's Q3.

The second theme is one of confidence. Confidence not only in our deliberate control of the business, but, moreover, confidence that with our stronger financial foundation we can be more assertive and more assertively invest in our strategy to drive more significant sustainable growth. This confidence can tangibly be seen during Q3 in 3 ways: firstly, the confidence that comes from testing how to “put our money where our mouth is” when it comes to increased spend on our portfolio. As Ken will describe, in Q3, we learned that Kona responds very well to increased spend, providing confidence for how we will deploy our resources in 2019. Secondly, it's the confidence to orchestrate the transformative events of 10/10 and make the requisite investments to bring our 3 newest brands -- AMB, Cisco and Wynwood -- fully into the alliance, enabling us to further invest in realizing their individual potential while maximizing their synergistic role within the Kona Plus strategy. And thirdly, it's the confidence to make the most significant investment in CBA's history in research, to better understand our market and our consumers, to help guide our business decisions today and tomorrow, both tactical and strategic.

The final theme is energy. While admittedly ironic, amidst this chaotic market, fragmenting marketplace and hyper-evolving consumer, after 3 quarters this year, there's the most palpable sense ever that because of what we've done, tomorrow will be even better than today -- an energy built on the confidence that our company is stronger than it was yesterday in terms of our operational performance, in terms of the important tangibles of our people and our brands, in terms of the working relationship with our most significant partner, A-B; and, importantly, in terms of our expectations. To be clear, while this energy is being harnessed today, it is even more poised to be unleashed tomorrow.

So before spending time to put our performance into perspective relative to the market, I'd like to first hand over to Ken and Scott to provide some color in their respective areas. Ken?

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

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Thanks, Andy, and good morning, everyone. Kona once again outperformed craft/imports and total beer for both the third quarter and on a year-to-date basis. In Q3, Kona depletions were up plus 9%. Kona demonstrated continued acceleration of trend year-to-date with depletions accelerating from plus 3% in Q1 to plus 7% in Q2 to plus 9% in Q3. Year-to-date, Kona depletions now stand at plus 7%. And growth was broadly achieved, accelerating quarter-to-quarter across both on-premise and off-premise channels. In the highly competitive on-premise channel, Kona was up a healthy plus 12% in Q3.

Focus brand Big Wave Golden Ale continued its growth trajectory with its depletion to performance also accelerated in Q3, up plus 30% overall and up almost 40% in the on-premise. Year-to-date, Big Wave is up over 25% overall. Big Wave's performance reflects both the A-B wholesaler network's embrace of the brand as a result of allying prioritization of commercial goals and consumers' continued acceptance and adoption of both Big Wave's beer profile and Kona's brand image. Kona's accelerated performance in both Q2 and again in Q3 overlaps with the timing of Kona's ramped up marketing investment. Kona's marketing investment is largely tied to volume seasonality, with media investment and partnerships ramping up in the middle of May and running through Labor Day.

In Florida, when we tested increased investment behind a fully integrated retail wholesaler and consumer-facing effort by our sales and marketing teams, Kona saw depletion growth jump plus 44% year-to-date. Kona's performance compares to a beer industry that was down minus 1.6%, a craft segment that was flat and an import segment that was up 4.5% year-to-date, as measured by the Beer Institute data. Kona continues to consistently outperform and speaks to the brand's appeal. Rounding out the lifestyle portion of the Kona Plus portfolio, Omission continues to lead the gluten-removed segment with a 35 share. Total Omission brand family depletions were flat in Q3, while year-to-date depletions were up 6%. The launch of Omission Ultimate Light, the 5-carb, 99-calorie, gluten-removed, healthy active lifestyle brand, continues to build, with depletions up plus 47% in the quarter and up 114% year-to-date as we look to reorient the portfolio around what we believe to be the bigger consumer opportunity.

Shifting to the regional craft brands, the story continues to be a tale of 2 cities. First-generation craft brands from the '80s, Redhook and Widmer Brothers, continued to struggle in Q3 to find the right value equation in their home markets to drive incremental volume; while simultaneously continuing to pull back from national markets far from home. Appalachian Mountain Brewery and Wynwood, both generation 3 craft brands and early in their lifecycles, continued to generate strong growth by penetrating their home markets. Whereas Redhook and Widmer Brothers both exhibited improvement in their home market trends in Q2, in Q3 Redhook maintained its rate of decline relative to Q2. And Widmer Brothers trend softened in Q3, with the Widmer Brothers brand underperforming our internal expectations. Similar to Q1 and Q2, performance in Q3 was negatively impacted by under-performance in supermarket relative to the craft segment.

The strategic and tactical commercial investments tested behind Widmer Brothers in Q3 did not have the same or desired similarly positive impact as in Q2. We are aggressively working with chain retail to better achieve suggested price to consumers that are more reflective of the value consumers drive as we move into Q4. But it remains an ongoing challenge. With the recent announcement of our full acquisition of Cisco Brewers, Appalachian Mountain Brewery and Wynwood Brewery, these brands will play an increasingly important role in key geographies, rounding out the Plus portion of the portfolio; and will begin receiving increased levels of investment. For those of you who have experienced Nantucket Island, you know that Cisco represents a potential lifestyle play for all of New England, rooted in the traditions of Nantucket Island and its seafaring, whaling heritage; while also representing a modern-day, casual, aspirational escape for all, as the brewery compound was recently recognized as the happiest place on earth.

Appalachian Mountain Brewery, the craft beer pioneer of Boone, North Carolina, is a brand rooted in the creativity of its brewers, its many award-winning beers, the natural, out-of-doors beauty of the Appalachian Mountains, and its philanthropic orientation rooted in its DNA. And Wynwood Brewery, started by a Puerto Rican father-and-son team, born in the Wynwood arts district of Miami, known for Art Basel, draws inspiration from the inherent creativity of the neighborhood, in the city that is the gateway to Central and South America. Wynwood is positioned against the third biggest beer state of Florida. And its La Rubia Blonde Ale has the potential to play both domestically and internationally against a growing Latino market. Cisco Brewers, Appalachian Mountain Brewery and Wynwood were up a combined 18% year-to-date, with AMB moving up the ranks of craft in North Carolina, Wynwood building distribution in South Florida, and Cisco expanding its pub presence off-island with the takeover of our Portsmouth Brew Pub and a pop-up brew pub in Boston seaport.

On the international front. Total shipments were up again plus 10% in Q3, which remains predominantly comprised of Kona, which is up plus 17% year-to-date. Plans to use Brazil as a lead market for ABI International expansion progressed in Q3 after the successful e-commerce pilot. The local marketing team was hired. Local influencers have been identified and initial product orders to seed the market have been shipped, while local production plans are in early formulation stage. With this plan, Rio will become the lead market in Brazil, serving as a template for future international markets. For CBA's total portfolio similar to Q1 and Q2, depletion performance kept pace with the craft segment in Q3, with total CBA depletions down 1% for Q3 and down 2% year-to-date for the first 9 months. Even in the current market, with craft volume trends slowing, pricing leverage remained viable. On a net revenue basis, price increases added approximately plus 2.2% for the quarter and plus 2.4% year-to-date on a revenue per barrel basis.

In closing. Themes across the portfolio in Q3 continued along similar storylines, as witnessed in the first half of the year. Widmer Brothers and Redhook continue to be a drag on top line. The newly acquired brands are outpacing segment growth but off a small base. And as Kona progresses onward to more than 60% of the portfolio, its accelerating performance especially in light of the current competitive environment remains robust. We continue to monitor the current market conditions and invest in understanding the evolving social lubricant consumer, while doubling down and staying focused on strong opportunities today, like Kona's Big Wave Golden Ale. So all while total depletion -- CBA depletion performance remains challenged to move assertively into positive territory, revenue growth continues to progress in line with guidance.

With that, I'd like to 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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Thank you, Ken, and good morning, everyone. While Q3 on the surface may look like a step back in performance, our year-to-date results are a better indicator of our continued improvement in the core health of our business. The work being done with our world-class craft initiatives continue to drive improvements in brewery operations and supply chains. And the ongoing effort to unlock the full value of our relationship with Anheuser-Busch continues to deliver results.

But before I get into the numbers, I would like to recognize our team on their commitment to brewing great beers. Our brewers were awarded 4 medals at last month's Great American Beer Festival in Denver. Omission Pale Ale won a gold medal in the classic English-Style Pale Ale category, beating traditionally brewed beers as a gluten-removed pale ale. Widmer Brothers Hefeweizen won a bronze medal in the American style wheat beer with yeast category. Very few breweries win with their flagship brands year-in and year-out. And Hefe has earned a total of 9 GABF medals. AMB took home 2 medals: gold, in the American light malt liquor category for their AMB lager; and a silver medal in the hyper-competitive IPA category for its ironically named Not An IPA. That's 3 GABF medals in the past 2 years for AMB.

Now to the numbers. Shipments for Q3 were 196,000 barrels, or minus 5.6% compared to Q3 of 2017. Year-to-date shipments increased to 587,000 barrels or 0.2% ahead of the same period in 2017. These results demonstrate the efforts of our supply chain team to better align shipments to depletions while maintaining optimal inventory levels. Year-to-date shipments include increases in contract shipments of A-B cross brewed brands.

Beer gross margin for Q3 was 34.8%, 330 basis points behind Q3 of 2017. This reduction reflects an increase in beer cost of goods sold, offset improvements in revenue rate. Higher COGS in Q3 were the result of lower fixed cost absorption to the lower volume produced in our own breweries, increases in alt prop production and higher freight and logistics costs, partially offset by a reduction in losses, improved brewery operations and removal of the fixed costs associated with Woodinville.

Pub and taproom gross margins for Q3 were 7.1%, a 220 basis point reduction compared to Q3 of 2017. Pub gross margin for Q3 was impacted by lower performance of our Hawaii pubs as a result of lower guest counts due to hurricane and volcano activity on the big island. I'm happy to say that the blues skies have returned now that the volcano activity has subsided.

Recently rebranded Cisco Pub in Portsmouth is driving positive results. And Redhook's Brew Lab, which was named best brewery, best bar and best happy hour in Seattle's Weekly this past summer, is providing amazing support to increase Redhook's relevance in its home market of Seattle. The team is focused on improving pub operations to drive better gross margin.

Total CBA gross margin for Q3 was 31.6%, 260 basis points behind Q3 of 2017, due to lower beer and pub gross margin. Year-to-date beer gross margin improved to 36.8%, 220 basis points better than 2017. Improvements in beer gross margin is a result of improved revenue rate and cost of goods sold. The improvement in COGS is due to increased Kona shipments from Fort Collins, improved losses in brewery efficiencies; partially offset by increases in freight and logistics costs, lower fixed cost absorption due to lower shipments out of our own breweries, which was partially offset by increases in A-B cross-brewing shipments. In Q3, we started up production of Virtue Cider in Portland, and we continue Goose Island production out of Portsmouth.

Year-to-date pub gross margin was 5.4%, a reduction of 320 basis points from the same period in 2017, reflecting lower pub sales in the absence of our Woodinville pub, offset by solid performance out of the Hawaii operations, improvements in the Cisco Pub operations and ongoing improvement efforts in Seattle and Portland. CBA year-to-date gross margin was 33.2%, 200 basis points better than the same period in 2017, as a result of improvements in beer gross margin, partially offset by lower pub gross margin.

As we announced on October 10, CBA has taken steps to fully acquire our partner breweries. The Wynwood and Cisco deals closed on the day of the announcement and AMB is closing as anticipated later in November. Integration efforts are progressing as planned. And we'll be seeing a partial benefit in Q4 as we move from an alternate proprietorship to an own production, driving margin expansion with the reduction in COGS. Additionally, the taproom integration will result in improved overall pub performance and pub gross margin.

And as Ken mentioned, we are expanding Kona in Brazil. To support this lead market, CBA is collaborating with the Ambev team in Rio to bring local production online in the first half of 2019. More to come in the upcoming quarters. I also want to share a quick update on 2 important capital projects: the New Portland Can line and the new Kona Brewery. Work on the New Portland Can line is progressing nicely. Equipment is installed, and commissioning is underway and will be fully online later in Q4. The Portland Can line will complement the can line in Portsmouth and allow us to meet the growing demand for craft beer in cans while supplying a wide range of can configurations and pack types. Site work is underway for the new 100,000 barrel state-of-the-art Kona Brewery in Hawaii. Due to delays in completing the building permits, we expect construction to be in full swing in Q1 of next year, with startup and commissioning beginning in Q2 of next year and the brewery fully online in Q3 of 2019.

In addition, I want to provide an update on CBA's evolving innovation focus. As Andy introduced on the Q2 call, we are involved in 2 consumer research projects: the Yale Center for Consumer Insight and the global consultancy group, Profit. Both projects will conclude in Q4, and we will use those learnings to inform product and portfolio innovations. More to come on our findings next quarter. In the meantime, our innovation team continues to expand on our test-and-learn initiative called the pH Experiment. Several pH projects are coming to fruition in 2019, including a brut IPA, a tropical sour hazy IPA, cocktail-inspired beers and an IPA with non-CBD contained hemp seeds. While we continue to explore and learn from the emerging cannabis market, we are mindful of the state and federal legalities in this area and are focused on products that are federally legal. And we continue to experiment with variations of spritzes, RTD cocktails, Kombucha, no- or low-alcohol beers. And we will leverage learnings from Yale and Profit research to ensure we are well informed going into the new year.

In closing. Our focus continues to be on improving the core health of our business by driving improvement in our operations, leveraging our world-class craft initiatives, continuing to drive improvements in pub and taproom operations, fully unlocking the value of our partnership with Anheuser-Busch by pushing the full utilization of Fort Collins, and extending A-B cross-brewing and CBA breweries; and leveraging the opportunities with our newly acquired breweries and taprooms.

And with that, I'll turn the call back over to Andy for additional color on results. Andy?

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

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Thanks, Scott. As stated at the outset, I'd like to first walk you through some key financials for the quarter and then offer some thoughts on the path ahead for CBA. But before doing so, a word about our CFO search. As suggested during our last conference call, we have indeed commenced a CFO search and are pleased with the candidates that we are attracting. Given the importance of this position, we're being deliberate in our process to ensure not only the right skillset but the right cultural fit as well. While we don't yet have a final candidate, we're encouraged by our choices and will update you as appropriate. In the interim, we continue to feel very good about the day-to-day leadership of our finance and accounting areas, given the strong bench that was built in both of those areas.

Turning our attention to financial performance for the quarter. In addition to the commentary provided by Ken and Scott, I'll highlight several other key metrics. Third quarter net sales were $52.9 million or minus 6.6% versus Q3 2017, bringing our year-to-date net sales to $162.2 million, up plus 0.4% versus the first 3 quarters of 2017. Gross profit for the third quarter decreased 13.9% to up $16.7 million, driven by lower gross margins, as Scott detailed. Following SG&A spend, which I'll elaborate upon in a moment, we recorded net income of $61,000 in the third quarter, equating to effectively $0.00 per diluted share, down $1.7 million versus Q3 of 2017; bringing year-to-date net income to $4.7 million or $0.24 per diluted share, an increase of $0.15 from the comparable year ago period.

Sustained improvements in revenue management kept beer revenue per barrel increasing plus 0.8% in Q3 2017, thus bringing year-to-date beer revenue per barrel up 3.3% versus the same period last year. SG&A costs in Q3 increased $384,000 or plus 2.4% versus the third quarter last year. The increase in SG&A costs were primarily due to increased creative, media spend, and initial legal and transaction costs related to our partner acquisitions. On a year-to-date basis, SG&A is $47.3 million, down $40,000 or basically flat versus the comparable year ago period, reflecting ongoing efforts to reallocate spend with revenue-generating activities.

Consistent with the theme of control, as mentioned at the outset, we are tightening our 2018 full year operation guidance with the following commentary. Given marketplace dynamics and 3/4 of actual performance, we still expect volume to converge within our original guidance ranges, but more explicitly at the midpoint of our original range, now between minus 1% and plus 1%. Despite increased evidence of competitive discounting activity, we remain confident in our revenue management trends and now expect pricing to be at the high end of our range, up plus 2% to plus 3%. Consistent with our remarks last quarter and due to transaction and legal expenses, we now expect SG&A will be $2 million to $3 million higher than our original ranges, translating to $62 million to $63 million. Note that $2 million to $3 million in increased spend represents $0.07 to $0.11 in earnings per share.

On the COGS front, we also expect gross margin at the midpoint of our original range, now between 33% and 34%. In contrast with our expectations last quarter, we now expect an effective tax rate of 25.5%, primarily a result of the IRS's still evolving clarifications regarding the tax treatment for certain business expenses. And finally, regarding CapEx. We expect to be at least $2 million below the upper end of our original range of $19 million. And additionally, given building permit-related timing uncertainty in the construction of our new brewery in Kona, we could expect a further shift of up to $6 million from this year into next. As I bring this call to close, let me state that this team firmly believes that CBA is in a great place as we look to close the year and as we look to 2019 with a greater and more explicit orientation to responsibly and sustainably grow our top line.

So to summarize. I'll return to the initial themes that I introduced at the outset. Firstly, our organization's control of the business is evidenced by our sustained year-to-date progress operationally, our tightened guidance for the full year and our significant intangible strategic steps forward. Secondly, our confidence is not only rooted in those tangible signs of how we're controlling our business but, importantly, is also rooted in the fundamentally reshaped business that we now control. A portfolio now led by one of the fastest-growing sizeable brands in the market, Kona, with scale, room to run and more fuel than ever; a reshaped Plus portfolio that now complements Kona with our newly acquired brands, AMB, Cisco and Wynwood; bringing with them the newly acquired home markets of New England, North Carolina and Florida, all of which also have room to run and more fuel than ever.

Bolder international prospects, as our progress with Craft Can Travel! will now more significantly be complemented, with our most comprehensive international business endeavor ever, through our partnership with Ambev in Brazil, our brewing ecosystem that has a proven track record in not only brewing exceptional, award-winning innovative beers, but in being able to effectively, profitably and safely scale those beers through an efficient brewing and supply chain infrastructure; a financial house in order and stable, allowing us to better finance the necessary investments in our brands to drive accelerated and sustainable growth; a contemporized knowledge base that combines a deep understanding of the traditional beer market with updated learnings about consumer behaviors, tastes and preferences; and, importantly, a talented team of people motivated to deploy those talents in a more empowered work environment and with the increasingly accountable company culture.

And lastly, there's that last tangible theme of energy: things coming together, the excitement of better performance today, combined with new insights that embolden our expectations for tomorrow; fresh learnings about our marketplace and our consumers that will not only inform how we treat our existing brands and our existing portfolio but will help shape our decisions on what the business will look like tomorrow. We are deep into our planning for 2019 and beyond. And as has become customary, we look forward to sharing with your our expectations for 2019 shortly after the end of this year. While we'll share guidance with you at that time, you can anticipate plans that are still rooted in Kona Plus and still maintaining the margin and operational improvements that we're guiding to for 2018.

But notably, you can also anticipate plans for a significantly accelerated top line, driven by an even more significant role for Kona domestically and internationally, supported by the greatest spend ever on the brand; an expanded emphasis on our newly acquired brands, AMB, Cisco and Wynwood; as well as our mission, driving a rebuilt Kona Plus portfolio in which 85% of our beer business is now growing; a continued focus on our reshaped traditional beerfolio, but, importantly, a focus now coupled with the prospect of portfolio expansion outside the traditional definition of beer.

More specifically, acknowledging the shifting marketplace in which we operate, we will broaden our focus to explore beer adjacencies, rooted in the findings of our research with Yale and Profit, and mindful of leveraging the capabilities that we have successfully built within the organization. And lastly, the expectation of more clarity in our key relationship with ABI. Irrespective of the obvious unknowns surrounding the qualified offer, rooted in the security of long-term wholesaler alignment, tighter commercial cooperation, a growing and mutually beneficial brewing relationship across both of our brewery networks, and upside for tangible efforts towards international development.

Before moving to questions, on behalf of the entire leadership team at CBA, a sincere thank you to each of you who 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. Carmen?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question is from Vivien Azer with Cowen.

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Gerald John Pascarelli MR, Cowen and Company, LLC, Research Division - Associate [2]

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This is Gerald Pascarelli on for Vivien. So Andy, you guys have clearly been putting in a lot of time and doing a lot of consumer research which is certainly encouraging. And while it's still ongoing, is there anything incremental you might have to offer in terms of what you're seeing at this point thus far?

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

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Yes, it's a great question, Gerald. I'll try to couch this because we do competitive research that we don't want to basically give to our competitors. But we also want to be transparent with all of you on what we're learning. So I guess a couple of themes emerge. I think we're starting to understand a little bit of the why behind the kind of frenzied movement away from traditional beer and towards a lot of things ranging from seltzers to flavored malt beverages, to even kind of the rose craze. So I think the first thing I can tell you is, while everybody seems to be running in a certain direction, we're being very deliberate to try to understand why they're running in that direction. Because we don't want to all be caught as off guard as I think the industry was when people started to shift. We want to kind of understand the motivation behind that. So the first thing I can tell you is we're getting a lot of really good insight, which I won't share for competitive reasons, in terms of the why. What are the kind of intrinsic benefits that people are seeing outside of traditional beer? The second thing we're seeing is we're starting to get a much better grasp on some of our own difficulties with the existing portfolio. And we're starting to understand how states like Oregon and Washington don't just perform differently but they actually are different for a lot of kind of real consumer-based reasons in terms of the psyche of consumers in those markets relative to some of our other key geographies. So I'd say the first area we're learning in is why are people leaving beer, [or intrigued] outside of beer, in the second area of great insight so far, is -- hey, why is Washington and Oregon really being a little bit more fickle for us and a little bit more problematic for us than we had anticipated? I think the third area we’re learning is based on kind of consumer orientation, be it in terms of goals or need states or motivations, we're feeling better than ever about Kona. I've got to tell you, we felt bullish going into the research. And when the research came out, a lot of things, you almost looked and saw if there was a camera in the corner and whether we were on Candid Camera. Because consumers almost could've been speaking about the Kona brand, both in terms of the imagery associated with the brand, the kind of ability of that brand to kind of transport somebody to someplace in terms of a different need state or a different mindset, and, importantly, backed up by kind of the refreshment of the beers that have been built into the portfolio. So the third area, I would say, that's been really encouraging for us so far is it's not just validated; I'd say it's really emboldened us about the growth potential and the runway for the Kona brand.

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Gerald John Pascarelli MR, Cowen and Company, LLC, Research Division - Associate [4]

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That's super helpful. My second question is around the A-B consent decree. Given the incremental progress around the consent decree, can you maybe offer your high-level thoughts on what next steps might look like, given that this does, in fact, seem like a primary hurdle in terms of A-B executing against the outstanding qualified offer?

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Andrew J. Thomas, Craft Brew Alliance, Inc. - CEO [5]

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Yes, thanks, Gerald. So a lot of questions, obviously, are going to be nothing more than my perspective on it. Because it's probably a better question for A-B, unfortunately, to answer than it is for me. What I can tell you is, yes, it was a primary hurdle. So now with the consent decree signed, we believe that primary hurdle is removed; albeit having only been 3 weeks ago. So I think there's a regency kind of phenomenon that we've got to kind of expect. As much as we've all been waiting here patiently for it to happen, I think we're all surprised that it actually happened when it did. So that's a little bit of the irony in life. That said, for us candidly, and for everybody on the phone and all of our shareholders and stakeholders, I really feel like we're in a great spot given our relationship with A-B. We continue to do really remarkable things together. As Ken said, a lot of the great growth we saw on the heavy up-testing on Kona was related to some commercial alignment down in the state of Florida. And I think we see how the Kona brand and how better aligned with all of our brands is commercially beneficial to us. In the second area, I think we look at what's been going on in cross-brewing and with contract brewing, in not only the ability for us to kind of fully utilize our capacity in Fort Collins but kind of the advent of brewing Virtue out here in Portland and continuing to brew Goose in Portsmouth. And in a way, I would kind of loop Kona in Brazil into that, too. Because we're starting to understand how the brewing networks are complementary to each other. And Brazil is a big deal. And when I say it's a big deal, I don't necessarily mean to stoke everybody's expectations that we're going to see hundreds of thousands of barrels like a light switch. But for us to have methodically been able to work with A-B and with Ambev in Brazil to understand, hey, is there a place for the Kona brand in this market, and what's the best way to go about it; and then how do we basically marshal the right resources and kind of harness the right infrastructure changes to make that happen; I think speaks volumes about the way the companies are working together. In a little bit of a peek-under-the-tent there -- and I've had this conversation with several of our stakeholders -- I know the international world pretty well. I think a lot of you know I spent 5 years internationally with Heineken. And when you see consumer opportunity in market, you have to make sure that the value chain can sustainably deliver on that consumer opportunity. And in the case of a lot of countries, Brazil being one of them, the kind of structure around import tariffs or around importing or around customs regulations almost make that prohibitive unless you're working with a local partner that can allow you to locally produce, to basically ensure the sustainability of the supply chain. And I think the fact that we took our time to understand was there a consumer opportunity, and then secondly, what did the value chain need to look like; and thirdly had the commitment to say yes, we will marshal some resources for local production in Brazil, speaks volumes about the intent for both companies to work together into the future. So that will take me to my third piece, Gerald, in terms of really kind of getting as close to saying something I can't say or don't know to say. I think if you look at the long-term initiatives we've got in place, be it the continued commercial alignment on Kona, the continued movement to brew more beer together and the movement to start locally producing in foreign countries and in international markets, it says both countries really believe there's a future for us to work together. Whether that is as partners or as a merged company after a qualified offer is made, I don't have the answer to that yet. But I can reassure everybody, if there is a qualified offer at [24.50], which is where we're at, I'll feel very good that I did my job and my team did their job on behalf of all of our shareholders. And if there's not a qualified offer, because of everything we've been working on together -- and again, I'll remind everybody, the security that these agreements will remain in force for another 7 years at our unilateral election beyond August of next year, given what we've worked on together, there's a great platform for value creation together, even if it's not as one company. So more than that I can't say. The primary hurdle was removed, yes. We still have expectations that there will be time for us to have the conversation before August of next year, when the clock proverbially goes off, when the alarm clock proverbially goes off. And in the meantime, I think actions speak louder than words. And the actions really suggest that those companies enjoy working together and see a mutually beneficial future.

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Gerald John Pascarelli MR, Cowen and Company, LLC, Research Division - Associate [6]

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Super helpful. My last question has to do with the potential implications around the farm bill. Can you offer your thoughts or speak to whether or not CBA would have an interest in entering into the non-psychoactive hemp derived CBD-infused beverage category?

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

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Well, I was going to hand it to Scott because I thought you were going to start talking about grain and [hops] and some tariffs. But maybe to start out with, I'll ask Scott to jump into it.

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J. Scott Mennen, Craft Brew Alliance, Inc. - COO & VP [8]

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We were really careful with the language as everybody was probably listening very keenly. We know there's been a lot of rumor. And I think you probably know better than anybody, Gerald, given we've talked about weed probably earlier on this call than a lot of other companies did. We really believe that cannabis is having an impact on our market. Another part of the research, which I don't want to get into too much -- we included cannabis where legal in all of our research, be it with Yale or be it our research with Profit. And what I can tell you is in contrast to a lot of the rhetoric and a lot of the narratives that I think people are pulling forward, we're seeing a real level of interaction with consumers that's impacting our marketplace. Whether it's a 1-to-1 impact, whether they're drinking less beer because of their involvement in cannabis or not, those are questions we're still getting a little bit more refinement on. But as to involvement and interaction, to me, it's a black and white case now. There is interaction. That said, as a publicly traded company that trades across state lines and has to worry about the federal banking system, we would be negligent if we were actively pursuing plans to commercialize something that wasn't federally legal. Regardless of what our own individual views are, regardless of what consumers are telling us, those are the rules of the game right now. So the way we basically kind of reconcile both of those is we continue to spend a ton of time looking at what's going on with cannabis. We spend a ton of time trying to understand what could we do, even in areas that you mentioned that the farm bill may enable. But before we just jump on the bandwagon and say, well, weed is illegal, but this is kind of weed, and it's legal, we don't really know if that's worth the run to go there. Because I think a lot of people are so enamored with the category that they'll do anything to associate themselves with it, as opposed to taking the time and being deliberate enough to understand, is it worth associating with a lesser version of what consumers really want? And I think with respect to what I know about the farm bill, what it would make legal isn't necessarily in line with what we're learning from research: consumers really are interested in participating. And it's not necessarily what's really having a lot of interaction with the alcoholic beverage market. So in that case, to answer your question maybe a little bit more directly after 3 minutes, we won't settle for a cheap secondary alternative, if the real thing to do is to understand what do people really want, and either be patient in waiting for legality and be ready to pounce when legality comes to pass; or be clever in being able to provide them something that is legal but still basically goes at that primary occasion, not the secondary booby prize or kind of consolation prize. Does that help?

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Gerald John Pascarelli MR, Cowen and Company, LLC, Research Division - Associate [9]

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It sure does. Clear and understood.

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Operator [10]

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(Operator Instructions) And I'm not showing any further questions in the queue. I would like to turn the call back to Andy Thomas for his final remarks.

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

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Thanks, Carmen. I appreciate everybody's continuing support of CBA and being available for this call. We look forward to discussing the results of the fourth quarter and full year 2018 with you soon.

Thank you, and have a great day.

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Operator [12]

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And with that, ladies and gentlemen, we thank you for participating in today's conference. This concludes the program, and you may all disconnect. Have a wonderful day.