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Edited Transcript of BREW earnings conference call or presentation 17-Mar-17 3:30pm GMT

Thomson Reuters StreetEvents

Q4 2016 Craft Brew Alliance Inc Earnings Call

PORTLAND Mar 20, 2017 (Thomson StreetEvents) -- Edited Transcript of Craft Brew Alliance Inc earnings conference call or presentation Friday, March 17, 2017 at 3:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Edwin Smith

Craft Brew Alliance Inc. - Corporate Controller

* Andy Thomas

Craft Brew Alliance Inc. - CEO

* Joe Vanderstelt

Craft Brew Alliance Inc. - CFO

* Ken Kunze

Craft Brew Alliance Inc. - CMO

* Scott Mennen

Craft Brew Alliance Inc. - COO

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Conference Call Participants

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* Francesco Pellegrino

Sidoti & Company, LLC - Analyst

* Vivien Azer

Cowen and Company, LLC - Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Craft Brew Alliance Q4 2016 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

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

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

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Thank you, Ashley, 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 2016. This morning, I'm again joined on this call by three other members of the CBA leadership team, our CMO, Ken Kunze; our COO, Scott Mennen; and our CFO, Joe Vanderstelt. But before we begin, I'll ask Ed Smith, our newly appointed Corporate Controller, to read our safe harbor statement.

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Edwin Smith, Craft Brew Alliance Inc. - Corporate Controller [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 in 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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Andy Thomas, Craft Brew Alliance Inc. - CEO [4]

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Thanks, Ed. Before beginning, I'd like to acknowledge the inconvenience caused by the twice rescheduling of this call, and to thank all of you for maintaining some flexibility in your schedules to join us today. As Joe will touch upon, the seemingly simple task of ensuring the appropriate accounting treatment for our new agreements with AB became yet another metaphor for the world in which we operate today, simple on the outside, complex and dynamic on the inside. So as I endeavor to provide a backdrop for Q4 and full year 2016, that's actually a good place to start, complexity and dynamism.

More than ever before, we're seeing further examples of that revolutionary change that I spoke about repeatedly over the course of 2016. With those words, complexity and dynamism manifesting themselves throughout our industry. And providing some industry context for this call, I won't mince words, it's messy out there. The only real constant is the constant acceleration in the pace and the scale of change. And what's different about Q4, and perhaps in hindsight about all of 2016, is the tipping point brought about by that accelerating change. Let me again try and paint a picture.

First, let's recall the key drivers of these changes in the market. Consumers, across a vast spectrum of diverse demographics, are drinking differently. It's not just millennials, it's not just Hispanics, it's not just women, it's everyone.

Drinking occasions and channels of trade are being redefined before our very eyes. It's not just the Netflix night, it's not just home delivery and it's not just a change in attitude towards the on-premise. It's all of that and more. And it's not just beer, wine and spirits. It's the numerous varieties of beer, wine and spirits. Local, craft, artisan, imported and more. It's [wheat], it's non-alcoholics, it's flavored alcoholic beverages, it's ciders, it's meads and the list goes on.

But I and many others have largely said all that before, so what's different now? I believe we're seeing three critical developments. Firstly, for the first time, each of these forces of change, consumers, channels and competition, are reaching tipping points on their own and we are now seeing the compounding effect of this three significant mature movements. The collective interaction of these forces is exponentially more dramatic.

Secondly, for the first time, we are seeing the impact of multiple phases of those movements and we need to use multiple tenses to acknowledge that. These movements are both mature and developing at the same time. Not only have consumers, outlets and occasions changed, past tense, they are continuing to change in the present tense from that evolving starting point.

And thirdly, most tangibly, for the first time, we are seeing evidence of a shakeout brought about by the collision of a transformed beer market in a disproportionate number of industry participants largely modeled for yesterday's challenges and yesterday's dynamics. Consider the evidence for this, new breweries continue to open at the same time as other existing breweries are shuttering their doors and drying out their tanks. Drafter and brewpubs are opening at an increasing rate, while traditional on-premise retail powerhouses struggle to maintain traffic and velocity. Incremental high-cost, low-volume brewing capacity is being added to the industry daily at the same time as legacy lower-cost capacity is sitting idly or being decommissioned. Wholesalers are carrying more brands and more inventory, but that increased inventory is more fragmented across those brands and varieties, thereby turning at a lower rate and creating challenges with aged beer. And private equity funds are increasingly pouring into the industry at the same time as banks and lenders are clamping down on brewers and suppliers for nonpayment or failed covenants.

Like I said, several minutes ago, it's messy out there. But with that sobering backdrop, ironically, it's potentially easier to understand my and my team's optimism surrounding the stubbornly mixed bag of results that we have shared with all of you. In a very transparent way, like the very industry in which we operate, CBA's business model is both developed and developing. So perhaps it should be no surprise that our results are mixed and seemingly contradictory at times regardless of how disappointing that fact may be.

I'll hand it over to the team to fill in the details. But in Q4 and in 2016, our Kona Plus strategy unquestionably became more developed while showing no signs of letting up on its development. In response to the changing consumer, as Ken will detail, we demonstrated that with the right brand, with the right positioning and the right style of beers can indeed still grow nationally. Witness the power of Liquid Aloha. Witness 17% annual depletion growth on the Kona brand.

In response to the changing channel dynamics, as Ken will also detail, we sharpened our battle plan, better matching the right brands and beers to the right occasions and outlets, not only are we more deliberate than ever about what brands are marketed in what geographies, but also about what beers and packages are marketed to what channels.

Witness Kona Big Wave draft growing 50% in 2016. In response to the metamorphosing changes in industry capacity and our own capacity needs, as Scott will detail, we fundamentally advanced our brewing infrastructure, redefining our capacity footprint for today and tomorrow. Witness our new contract brewing agreement with AB, our new small batch capacity in Portland and the ongoing efforts to repurpose the Woodinville brewery.

In response to the inventory challenges for wholesalers, as Scott will detail, we accepted a lowering of wholesaler inventories in Q4 2016 and proactively planned for further reductions to facilitate wholesaler needs while ensuring higher quality beers at retail. Witness our 15% reduction in wholesaler inventories.

And importantly, for all stakeholders and shareholders alike, in response to the tightening financial stakes in the market, as Joe will detail, our financial house has never been stronger while still affording us the levels of investment requisite to build our brands for tomorrow. Witness a strengthening balance sheet and healthy stream of operating cash flows. So while Q4 and 2016 were both a short-term disappointment, we believe they were successful steps in our march towards tomorrow.

And without further delay, on to the team for some color. Ken?

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Ken Kunze, Craft Brew Alliance Inc. - CMO [5]

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Good morning, and thank you, Andy, and happy St. Patrick's Day to everyone.

Let's start with Kona and all the momentum it demonstrated again in 2016. We continue to believe in the Kona Plus portfolio strategy, a strategy that makes Kona our clear number one priority, a strategy that's right for the current competitive market environment and the strategy that's right for CBA's long-term success.

Kona continues to differentiate itself in the marketplace, both from a volume and a positioning standpoint. Kona continued to outpace the market in both the fourth quarter and full year with strong depletion growth, plus 12% in Q4; plus 17% for full year 2016.

The Kona brand is uniquely differentiated in the marketplace. First, by the aspirational nature of the Providence, the beauty and essence of the culture of Hawaii provides the foundation for the brand. It informs the beers tropical and sessionable, our iconic packaging and our marketing.

And second, the Kona brand is uniquely differentiated with a very strong marketing idea articulated in the uniqueness of Dear Mainland, "One life. Don't blow it" campaign. These differentiators clearly separate Kona, not only from all other craft players, but also from all other beers. It allows Kona to play both as an import and a craft, sourcing more volume from more consumers across more occasions.

The high end of beer, composed primarily of craft and imports, continues to grab a larger share of total beer volume and more of the margin pool within the overall category for both wholesalers and retailers. For a brand like Kona that plays both as an import and a craft brand, this is a long-term competitive advantage. For 2016, Kona continued to outpace beer import and craft segments.

The Kona opportunity is both domestic as well as international. The Providence of Hawaii, embodied by Kona, is an aspirational, international destination where Aloha translates globally. Our international partners, Craft Can Travel and ABI, are in the early stages of a long-term global play. In 2016, our international Kona shipments grew by plus 43% off a small base.

In the whole market of Hawaii, Kona grew plus 9.3% to an 11% share of total beer. No other craft brand can come close to Kona's dominance in its home market. Domestically, Island Hopper, Kona's variety pack, grew plus 12%; and Kona's seasonal lineup, the Aloha Series, grew plus 133%; and Big Wave Golden Ale, our focus brand, grew plus 49% overall with very consistent plus 49% growth in the on-premise and plus 48% in the off-premise.

The Kona opportunity remains large. Even as a leading craft brand, Kona's basic distribution opportunity remains significant. Kona's highest distributed package, Longboard 6-packs, had only achieved 20% distribution across channels as measured by Nielsen. Big Wave and Longboard 12-packs remain in single-digit distribution. Five years ago, Kona represented a little over 20% of the volume mix. And today, it is over 50% of the mix. We believe CBA's future value will be driven largely by Kona's domestic and international volume opportunity.

Let's look at the current market and competitive situation and how dramatically the market continues to evolve. With new brewery permits now exceeding 7,000, up from 1,500 just a few years ago, the influx of new brands is pressuring established national brands in terms of both on and off-premise distribution, retained buyers and incremental growth. The market is in a state of churn. For brewers, who desire to remain small with brewpubs, a significant portion of the revenue mix, there's still opportunity for more breweries to open. But for breweries that wish to scale, the window is rapidly closing driven by financial realities of achieving scale and by the limits of off-premise retail shelf space, on-premise tack handles and space in wholesaler trucks and warehouses.

Consumers, however, will continue to seek out new, local and variety. The consumer trend by local craft is real, and the proliferation of craft choice and supply will continue to play out in a significant way over the current planning horizon. We believe it's foundational to have brand strength in home markets. It's more efficient and sustainable to build a craft portfolio in this way. Long-term, we continue to believe strong brands and strong operating capability backed by financial strength, like CBA, will be the winners.

The Plus portion of the Kona Plus portfolio strategy is specifically focused to address this reality. Is it defined today less by having other national brands within the portfolio as it was yesterday or by having locally relevant, strong regional brands complementing Kona in targeted geographies? The addition of Cisco Brewers from Nantucket, Mass; Appalachian Mountain Brewery based in Boone, North Carolina; and most recently, the announcement of Wynwood Brewery in Miami, Florida, are a key part of the strategy. They joined our significant Pacific Northwest share brands, Redhook and Widmer Brothers, and our emerging business team is actively working to further round up the portfolio in key markets.

A few notes from the remainder of the Plus portion of the portfolio. Widmer Brothers' stabilization in Oregon behind Hefe continued with legacy brand Hefe, STR is plus 4% in the off-premise for both the fourth quarter and the full year. And overall, Hefe depletions in Oregon were flat for full year 2016. Cisco Brewers and Appalachian Mountain Brewery contributed 4% of the mix for the full year after ramping up mid-year. Wynwood, while small, will contribute in the second half of 2017.

In 2016, we exited the Resignation Brewery KCCO agreement, which represented a drag of about 2% over 2015. And Redhook, the brand most affected by the competitive environment and by its repositioning due to the shift in our portfolio strategies, continues to be a work in progress and has yet to stabilize.

In 2016, we continue to make progress rebalancing our portfolio in line with our overall strategy. In addition, we've ramped up our innovation efforts across the portfolio but specifically behind our legacy brands. With the opening of our innovation brewery at the Widmer Brothers brewery in Portland in anticipation of the Redhook Capitol Hill brewpub in Seattle, we are focused on introducing new award-winning influential beers to help rejuvenate these brands with a new generation of consumers. Much of this effort will be small-batch, brand-building efforts with volume implications playing out by seeding our future innovation pipeline as expected brand life cycles continue to shorten.

And our relationship with AB has never been stronger with the renewed and extended agreement covering our master distributor agreement, international market expansion and more efficient brewing opportunities. CBA meets regularly with the president of AB's high-end business unit to help progress our initiatives and our dedicated resources on both sides that facilitate progress. CBA had its strongest present yet at AB's own sales and marketing wholesaler conference, and Kona was designated as a focus brand across the AB wholesaler system for April. It is fair to say the AB teams loves the Kona brand.

And in November, the commercial team restructured the sales force into five regions from three, with clear brand and market priorities and closer alignment with AB's structure to facilitate execution. And in the process, Kona brand resources were increased significantly. So while the craft segment slowed considerably in 2016, we continue to believe in the segment, driven by the consumers' desire for better, more interesting beers, fueled by both retailer and wholesaler desire for higher gross margin and by the segment achieving legitimate critical mass in $100 billion category at retail. Within this hypercompetitive segment, where large legacy brands are defining double digits, CBA's total depletions were flat for full year 2016 with Kona growing plus 17%. These results were within the range of our internal expectations and our external guidance.

Our focus for the last three years has been on improving gross margin through operating improvements, strengthening our top line through our Kona Plus portfolio strategy and by more closely aligning our future with ABI. We believe these efforts will allow us to weather the current turbulence and win in the long term.

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

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

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Thank you, Ken, and good morning, everyone. As Andy stated earlier, Q4 and 2016 were disappointing. I will begin by taking a few minutes to look back on 2016, discussing what went well, what did not go as planned and what we learned. Then I will turn the page and outline what is different in 2017 and how we will use the lessons learned in 2016 to ensure we deliver on our objectives this year.

2016 was a year of contradiction. While 2016 was a transformational year in many ways, that transformation did not deliver the results we expected. The significant accomplishments in 2016 includes, we completed a major bottle line modernization and expansion project in Portland that included the installation of a new bulk glass system; we started up two strategic partnerships with AMB and Cisco, which included bringing on a new can line in our Portsmouth brewery; we installed a new innovation brewery in Portland to keep us on the cutting edge of innovation, allowing for the development of great new beers, like Kona's Hanalei Island IPA, Widmer's PDX Pils, Omission's Ultimate Light, and a great-tasting new IPA in the Redhook family Bi-Coastal, while also enabling the ability for a more extensive small-batch portfolio.

We started up a new contract brewing partnership in Woodinville. However, those volumes did not materialize as anticipated. And we inked a new agreement with AB and kicked off a transformational contract brewing relationship that will help to reshape CBA for years to come. Unfortunately, those accomplishments did not add up to the benefits we expected.

Looking back on the year, my takeaways include, the significant work undertaken by our team created the dilution of focus, resulting in subpar performance; capital improvements were slower to come online and deliver the operational efficiencies planned; and volumes were below expectation. In Q4, CBA began reducing wholesaler inventory levels as our wholesaler partners continued to face challenges due to handling an ever-expanding portfolio of beers. And as stated earlier, planned contract volumes never materialized. These lower volumes exposed the fact that our cost base was too high. Once it became evident that the contract volumes would remain behind plan, we took the steps to reduce staffing levels in Woodinville to better match the volume to that of the brewery. These benefits will carry over into 2017.

Now to the results that were driven by both performance challenges and lower volume. Beer gross margin for Q4 was 32.2%, 230 basis points behind Q4 of last year. 2016 full year growth -- beer gross margin was 32.1%, 120 basis points behind 2015. Owned capacity utilization for 2016 was 67% versus 71% in 2015. Thus, underscoring our need to better align our cost structure to our volume base.

Now shifting discussion to 2017. There are three key areas that we are focused on to ensure we deliver results. First, the team has a sharpened focus on delivering results. Now that the capital projects are behind us and providing the anticipated benefits, we are focused on the basics of ensuring we are delivering great-tasting beers in the most efficient manner possible. We will also quickly and aggressively adjust our cost structure as our brewery footprint evolves with the shifting of volume to AB, winding down Memphis and streamlining our own breweries.

Second, we have undertaken an effort to redesign our supply chain planning process to better harmonize depletions and shipments. This will allow us to further drive down wholesaler inventories, reducing days-on-hand by over 30% in the first half of this year. This effort will ensure fresher beer in the market while supporting wholesalers with adequate inventories on hand to meet the demand of our consumers. In addition, this effort will help smooth production and enable a more efficient brewery and logistics operation.

Third and most significant, is the start-up of production with Anheuser-Busch. While we will be ship -- where we will be shifting up to 300,000 barrels of production to AB annually at a cost savings of $10 per barrel. This project is moving along quickly and successfully. Beer qualifications are ongoing and the first production is planned for April, ramping up to full production through Q2. As this production comes online, plans are in place to streamline operations at our own breweries, ensuring a stable cost base. We expect to close -- to produce close to 150,000 barrels of beer at AB's Fort Collins brewery in 2017.

It should also be noted that we plan to use the free-up capacity to continue to expand our strategic partnership. In Q4 of 2016, we announced Wynwood Brewing in Miami as our third brewing partner, and brewing is planned for Q2, out of Portsmouth.

To summarize, 2017 is all about leveraging efficiency gains from capital projects completed in 2016 while staying on top of our cost base to align with brewery volumes; better managing shipments to synchronize with depletions to drive operational and logistic efficiencies while better servicing our wholesaler partners and bringing on production with AB as quickly as possible. We expect to deliver our 2017 gross margin target of 30.5% to 32.5%. Please note that the change to the 35% long-term gross margin we have discussed in the past is due to the impact of our alternating proprietor partnerships and underutilization of the Woodinville brewery, which Joe will elaborate on.

With that, I'll turn it over to Joe, who will dig deeper into the numbers. Joe?

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Joe Vanderstelt, Craft Brew Alliance Inc. - CFO [7]

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Thank you, Scott. Good morning, everyone. During my remarks, I will share fourth quarter and full year results for 2016, as well as our 2017 full year guidance. Included will be the financial impact of our planned wholesaler inventory reductions as well as the effective employee severance and deal-related costs discussed in the third quarter of 2016. I'll also add some new color on how we will recognize revenue on the AB international incentive payments going forward.

Although we achieved four of six guidance measures, our wholesaler inventory reductions, combined with the accounting treatment for our AB international incentive payments, resulted in a miss to our shipment and gross margin guidance. Before I get into 2016 results, I would like to provide an update on the accounting treatment for our AB international incentive payments, which should be helpful as we walk through 2016 financial results and our 2017 guidance.

As reported in August of 2016, our international agreement with AB provides for fixed incentive payments over the next three years equaling $3 million for 2016, $5 million for 2017 and $6 million for 2018. As an added incentive for international volume development, AB will pay CBA an additional $20 million international incentive payment in 2019 if AB has not made a qualifying offer by 2019. The combination of the four payments total $34 million between 2016 and 2019.

For the purposes of revenue recognition under GAAP, the combined $34 million total will be straight lined over the term of the 10-year agreement or $3.4 million per year. 2016 revenue recognition under the agreement was $1.2 million with a $3 million owed for 2016 received in January of 2017. The remaining $1.8 million is treated as deferred revenue. Beginning in 2017, revenue recognition will be at that $3.4 million per year until all deferred revenue is depleted in 2026.

It's important to note that our original forecast assumed that $3 million of revenue would be recognized in 2016 and $5 million in 2017 based on the economics and terms of the agreement. The final accounting treatment results in recognize revenue being $1.8 million and $1.6 million for 2016 and 2017, respectfully. This does not in any way affect the payments due under the agreement, nor are there commercial performance requirements tied to the annual payments. We often receive questions from analysts and investors related to the agreements and hope this provides clarity.

Now on to Q4 2016 financial results. Net sales for the quarter were $45.8 million, down $3.4 million or 7% versus the same period last year. Gross margin for the quarter was 29.3% and 210 basis points below Q4 2015. Net income for the quarter was $76,000 and $1.2 million below the same period last year with zero earnings per share, $0.07 below Q4 of 2015. The decrease in net income and EPS as a result of lower shipment volumes and higher COGS per barrel, partially offset by partnership fees and lower SG&A cost. During the quarter, we recorded charges for severance and emerging business cost of approximately $600,000 before tax or $0.02 per diluted share after tax. The estimated fourth quarter gross profit impact of wholesaler inventory reductions is $890,000 before tax or $0.03 per diluted share after tax.

Finally, Q4 gross margin of 29.3% fell below Q4 expectations of 35.6%. This was primarily due to the lower AB incentive recognition discussed earlier and the lowering of wholesaler inventory levels. The combination of the two lowered gross margins in the quarter by 370 basis points including the AB incentive at 270 basis points and wholesaler inventory levels at 100 basis points. Lower brewery utilization and higher costs contributed to the remaining 260 basis points.

Now moving on to 2016 full year performance. Net sales were $202.5 million or minus 1% versus full year 2015. 2016 full year gross margin was 29.4% and 110 basis points below 2015 full year results. Net loss for the year was minus $320,000 or 2.5 million below the same period last year. The loss per share was minus $0.02 and $0.14 below the same period last year. The net loss in 2016 is due to COGS per barrel, higher COGS per barrel, lower shipment volumes and higher SG&A cost, partially offset by higher net revenue per barrel.

Lower net sales for the full year were driven by a 49,000-barrel or 6% reduction in shipment volumes notwithstanding flat depletions versus full year 2015, slightly missing our guided shipment range of minus 3% to minus 5%. Shipment results for the full year were affected primarily by the Portland Brewery shutdown in the first quarter, recent steps to reduce wholesaler inventories and contract brewing. Partially offsetting lower shipment volumes in 2016 was a 3% increase in net revenue per barrel, primarily due to past contract fees, AB incentive revenues, partner fees, higher net pricing and favorable mix.

2016 full year gross margin was 29.4% and 110 basis points below 2015 full year results. The decline in gross margin versus 2015 is due to decreased shipment volumes, lower brewery utilization and higher COGS per barrel.

2016 full year gross margin was 160 basis points below the low end of our guided range. This is primarily due to the lower AB incentive revenue discussed earlier and the lowering of wholesaler inventory levels. The combination of the two lowered full year gross margins in the quarter by 100 basis points, including the AB incentive at 70 basis points and wholesaler inventory levels at 30 basis points. Lower brewery utilization and higher cost contributed to the remaining 60 basis points.

2016 SG&A costs were $59.2 million, an increase of $1.3 million or 2.2% versus the same period last year. The increase in SG&A cost is primarily due to employee severance costs and emerging business professional fees, partially offset by employee benefit cost and lower incentive compensation.

During 2016, we recorded charges for severance and emerging business professional fees of approximately $1.3 million before tax or $0.04 per diluted share after tax. The estimated full year gross profit impact of wholesaler inventory reductions is $890,000 before tax or $0.03 per diluted share after tax.

Finally, media testing for Kona in Q3 totaled $860,000 before tax or $0.03 per diluted share after tax. These tests were for 2017 planning purposes and were conducted in partnership with AB.

Now I'd like to turn to 2017 and share our full year guidance. We expect depletions to be within the range of flat to plus 6% versus 2016, supported by Kona, new partnership brands, our international business and our expanded partnership with Anheuser-Busch. Through the first two months of 2017, February year-to-date depletions are up 1% compared to the same period last year and includes plus 17% growth for Kona in the same period.

Shipments are estimated to be within the range of minus 1% to plus 4%. Through the first two months of 2017, February year-to-date total shipments are up 8% compared to the same period last year. February year-to-date shipments are higher due to last year's Portland Brewery shutdown and favorable depletions, partially offset by the lowering of wholesaler inventories.

Average price increases of plus 1% to plus 2% are expected, which excludes $3.4 million in revenue from the AB international incentive. Gross margin is estimated at 30.5% to 32.5%, representing lower utilization of our Woodinville brewery and dilution from partner brands, offset by international -- AB international incentive revenues, AB contract brewing savings, optimization of Brewery Operations, contract brewing fees, higher net pricing and favorable mix.

This guidance falls below our 2017 goal of 35%, which assumed the resolution on the sale of our Woodinville brewery, but did not include our new agreements or the lowering of wholesaler inventories as discussed earlier. Over the course of 2017, CBA management will reconcile the 2017 gross margin range with previously disclosed target of 35%.

SG&A is expected to range between $61 million and $63 million, including increases in marketing spend and reductions in nonmarket-facing spend. CapEx is expected to range between $16 million and $20 million, including our new Kona brewery and new Redhook brewpub in Seattle.

We've now completed or will complete many of the key strategic projects this year that started in 2015. The exception is the Kona brewery project, which will largely be funded in 2018. Our 2017 plan now provides positive free cash flow by the end of the year for the first time since 2012. Debt is forecasted to be under $30 million by the end of 2017.

Key risk and opportunities are as follows for 2017. First, there's a potential for increased competitive discounting activity due to the slowing craft segment growth and excess brewing capacity. Second, as we transition to AB's Fort Collins brewery, there is both risk and opportunity depending on the speed to which we can execute our optimization plans. And third, there is potential upside with our Woodinville brewery should utilization improve as a result of contracts brewing.

In conclusion, our top line expectations for 2017 are firmly rooted in Kona's continued double-digit growth, the tremendous expanded partnership we have with AB and our growing portfolio of local partnerships. We still have some work to do to complete the reset of wholesaler inventories, reduce our COGS per barrel and improve gross margins.

Having said that, targeted wholesaler inventory levels will be achieved before the summer selling season. And Scott's team is actively working to capitalize on AB contract brewing benefits and optimize our own brewery operations.

And with that, I'll turn it over to Andy.

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

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Thanks, Joe. As we wind to a close, I wanted to again reserve some time before taking questions to take a step back and summarize our annual results by evaluating them against the three objectives that this leadership team is consistently committed to delivering on. Firstly, strengthening the top line. Secondly, improving the core health of our business model. And thirdly, actualizing the future.

In evaluating our first objective of strengthening the top line, 2016 brought a tangible reshaping of our portfolio, in line with our Kona Plus strategy. A double-digit growing national cornerstone, Kona, surrounded by our strongest local portfolio ever, Cisco Brewers in the Northeast, Appalachian Mountain Brewery in the high country of the Carolinas, Wynwood Brewery in Florida, Redhook in Washington, and Widmer Brothers in Oregon, clearly the building block for a stronger top line today and tomorrow.

In evaluating our second objective, improving the core health of our business model, we further refined our brewing footprint. And as the calendar turned to 2017 have begun to operationally leverage the capital improvements in our own breweries while reaping the benefits of our new contract brewing partnership with AB. All while more proactively scaling our supply chain in line with the realities of today's shipment pressures.

And as for our third objective, actualizing the future. 2016 brought progress, both big and small, in areas ranging from the series of agreements with AB to the addition of partners such as Wynwood Brewing.

I'll end where I began, it's messy out there. But simply lamenting the passage of the good old days will not serve any of our purposes. Continued conviction, resolve and focus on the future will. In 2016, our business model proved that it isn't just built for yesterday. It's built for today and it's evolving for tomorrow. And on behalf of the entire team at CBA, I can confidently state that as evidenced by our guidance, we believe our results will increasingly demonstrate that fact as well.

Before moving to questions, I'd like to again say thank you to all of you. To our investors, to those analysts who cover us, to our interested parties and importantly, to our hard-working, passionate and engaged employees and partners, be they at our own locations in New Hampshire, Oregon, Washington, California and Hawaii, at our partners in North Carolina, Massachusetts and Florida, or working somewhere remotely between.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Francesco Pellegrino of Sidoti & Company. Your line is open.

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Francesco Pellegrino, Sidoti & Company, LLC - Analyst [2]

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So I can't believe I'm going to be leading off with this question, but I want to talk to you guys about Widmer Brothers because it seems as if (inaudible) there. Let's do the dance, Andy, because I know you can look at shipments, you can look at depletions, not sure how to look at Widmer Brothers, because I want to say it looks as if things are bottoming out when I look at the shipment's number. But then I see that depletion number and I just -- I'm not really sure how to put two and two together.

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

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Okay. So given that it's St. Patrick's Day, Francesco, I'll try not to do a jig here, but thanks for the invitation to dance.

But if we take a look, and I'll toss it over to Ken for some color on kind of what's behind what I'm about to say, but we really do believe that we're seeing tangibly Widmer Brothers stabilize in Oregon. So if you take a look at the overall kind of shipment numbers and depletion numbers, the home market of Oregon or the North West, in general, is actually starting to play the role that we knew it would because there was still significant scale there.

So in Oregon, both the brand and the Hefe specifically, Hefe is growing and the brand overall is stable and there's probably some harmonization between kind of shipments and depletions there. But as a rule of thumb or kind of a general comment, I think you're going to see a lot more harmonization on Widmer Brothers between shipments and depletions certainly as it pertains to the home market in Oregon.

And I'll say definitively, I get asked this question a lot on the call be it the baseball analogy of what inning are we in or the dance, we're in the eighth inning now. I'll say that pretty conclusively on Widmer Brothers, and feel like we're going to be able to pull out the win on the brand in the home market.

So Ken, maybe you can add some color on what's going on in Oregon and particularly with Hefe?

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Ken Kunze, Craft Brew Alliance Inc. - CMO [4]

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Andy, I was going to go maybe just the other way too, I think just in terms of the footprint for Hefe is that it continues to narrow. And in 2017, we have definitive plans to narrow it further. So I think in terms of how widely Widmer Brothers play, that geography will be more narrowly defined and more defined in the Pacific Northwest and California moving forward. And I think with the stabilization in Oregon and Hefe still the most significant part of the portfolio, stabilizing showing growth in the off-premise, Andy's comment about it being the eighth inning would be to me is where that thinking comes from.

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Francesco Pellegrino, Sidoti & Company, LLC - Analyst [5]

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Okay. So Andy, you talked a little bit about this harmonization. To be honest with you, when I just look at where the basis for Widmer Brothers on a barrel, I'm not really as concerned about the harmonization between shipments and depletions because we're working with such -- we're working with smaller numbers now as compared to years past that, fluctuation or maybe not being harmonized wouldn't be as much of a concern, but are you ready to call the bottom? Let me just throw it out.

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

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Yes. Yes, I think that's fair, and I would say we are. And I'll underscore what Ken said and what I kind of said in the script and actions speak louder than words, and those are some of the more tangible results, I think, you can see. Widmer Brothers, we talked about it on this call, still had a really significant volume base in its home market in the Pacific Northwest and a very significant base in Hefe. And rather than kind of try to continue pushing the rope uphill in the Eastern part of the country or in the Southeast with the brand, we basically started retrenching -- oh, man, two and a half years ago to the point where we are basically calling the bottom in Oregon. We are calling the bottom is kind of the foundation.

And what's interesting is you heard the term innovation. We're doing some pretty cool things up here with the Hefe brand with the kind of a fruited Hefe series of Hopfruit. We've got a great fruit Hefe out there right now, some Hefe variety packs in terms of different fruit variance on Hefe. So I'll call the bottom in total. But I'll tell you, our idea isn't just to kind of bottom out and stabilize here in Oregon. It's to take that new starting point that kind of developed and developing and start to grow from there again. So yes, I'll call the bottom, Francesco.

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Francesco Pellegrino, Sidoti & Company, LLC - Analyst [7]

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Okay. I know just looking at the growth rate of shipments by brand, looking at Kona you it see up only 0.5% but we're lapping that fourth quarter where you tried to get ahead of production ahead of the brewery shutdown in the first quarter of 2016. So I don't really want to look at the Kona shipment rate number, but it is -- I see a slowdown in shipment despite depletions still running very high. And then when I see the added commentary about what depletions are running for in the first couple of months in 2017.

Look, I see what you guys are trying to accomplish with reducing wholesaler inventory by a third. But I would just -- I just continue to see demand outpacing supply for Kona obviously a good thing. And sooner or later, like what's the expectation for the brand going forward in 2017? And I know it's a conversation you don't want to have, [you guys] don't really give individual branded guidance. But Kona now represents over 50% of the branded portfolio. And to be honest with you, when you think about the incremental sales you get with some of the other brands, the other brands would really be dead in the water if you didn't have this Kona Plus strategy. No one really cares about the Plus, but given the great performance of Kona, you're able to sell the Plus. And I would think a lot of the metrics that you're providing us with, there are some really key metrics in-house of what Kona needs to do to attain this because you're not leading with what is Widmer going to accomplish, what's Redhook going to accomplish. It's how can we sell Kona and then tack on this incremental product sale?

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

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Yes, so a couple of thoughts there, Francesco. I think a lot of people do care about the Plus, especially if you're in North Carolina you're looking for an AMB. If you're in Nantucket, you're looking for a Cisco. And if you're in Widmer Brothers, you're looking for a Hefe. I think the distinction I'll make is we're not trying to make the Plus national. We're trying to make the Plus appeal to the markets, where it's most relevant.

And you're absolutely right, if I were sitting here as CEO of the company that I took over three years ago, where a third of our volume was Widmer Brothers and a third of our volume was Redhook and a third of our volume was Kona, I would not be nearly as bullish as I am today. So I take your point with the exception a little bit that the Plus is important.

That said, things to look for. I'll put it that way. We don't guide at the brand level. We hazard to guide at the company level and still endeavor to beat that in doing so. So we won't get to the brand level this year.

But what -- I'd draw your attention to a couple of things. We're saying pretty similar things on Kona as we said last year, and we're saying a lot of the change is going to be that we have called the bottom on Widmer Brothers and we think the Plus has joined the battle. So if you reconcile those two things, Francesco, I think it kind of suggests without saying so that we expect continued double-digit growth on the Kona band. And we expect that to not get drained and to not have to fill in as many holes on the draw to decline from the legacy brands.

So if you were looking at modeling out the year, demand continuing to outstrip supply. We have more than adequate supply on the Kona brand, so I don't want anybody to think we're going to run into out-of-stocks. But we do have to accept the fact that wholesalers are carrying less inventory, so there will be a difference between how depletions grow and how shipments grow. Within that, we expect Kona to continue in the double digits and we expect less drain coming from everything else. And we expect brands like Wynwood and Cisco and AMB to join the battle because they can help to add incremental volume in their geographies and not just be a drain.

So net-net, things to look for, we'll continue to be transparent on what's happening on Kona. We continue to think that depletions will outstrip shipments. We think that's something that we have to stop fighting and start facilitating. And we expect still strong double-digit growth on the Kona brand.

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Francesco Pellegrino, Sidoti & Company, LLC - Analyst [9]

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Okay. And last question before I jump in the queue. So it looks as if you've given us some metrics that's going to allow us to sort of back into what your international business was in 2016 and what's contract brewing was. I got international up 93% and contract brewing down 27%. So it looks as if international grew by 20,000 barrels a little bit more. What are the expectations for international growth now that you have this more lucrative master distribution agreement internationally? And I'll jump, thank you.

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Andy Thomas, Craft Brew Alliance Inc. - CEO [10]

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Great question, Francesco. And thanks for the offer to dance, it's been enjoyable.

On international, your numbers are directionally right as they are on contract brewing, so I'll confirm directionally that. In terms of what are we expecting for the year, we kind of view that as A Tale of Two Cities in a sense. We've got the partnership with CCT in the existing countries, and we've got the opportunities afforded to us in the new ABI agreement.

If you remember, I think I said this in almost these same words when we announced the AB agreements. The countries that we look to enter with AB are inherently more complicated because of kind of the dynamics of those marketplaces. So you think of countries we've talked about like Chile or Brazil or Mexico, where there's a lot more established business and a lot more, I'll call it, market power kind of concentrated in certain players. So we expect that to be a slower burn, which is why we structured the agreement with AB the way we did because we don't think the volumes would develop as rapidly as the cash flows that we needed to support those volumes and grow them would.

So if I look at the year, we expect the majority of growth to still come from the countries that we're in. We can take a look at some countries in Europe and in the Pacific Rim, where the Kona brand is doing specifically well and I would say we expect to see continued growth in absolute terms about the same level that we saw in 2016. So bright outlook for international. I don't expect to see some of the new countries of ABI go from 0 to 60 in 12 months, but we will start to see them scale up, and that 60 is metaphorical. I want to be clear. That wasn't a barrel or a case estimate. That was just 0 to 60 miles per hour as a metaphor.

So net-net, to answer your question, I'd expect to see more of the same on international. And as we start to scale the agreements with AB on these calls, we'll share more and more detail on what we think that will do to the numbers.

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Operator [11]

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Our next question comes from the line of Vivien Azer of Cowen and Company. Your line is open.

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Vivien Azer, Cowen and Company, LLC - Analyst [12]

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So I wanted to double back to the top line. Obviously, a lot of good questions already and discussions, so I'd like to take you to kind of 10,000 feet, if you don't mind, Andy. So your depletion for your core brands have been flat in each of the last two years. And I appreciate that Kona is growing as a percentage of sales, so it should be a bigger contributor as you guys think about your preliminary guidance range of flat to plus 6%. But you've also acknowledged that not only are things tough out there, it seems like they are getting incrementally tougher. So what gives you confidence that flat should be the appropriate low end of the range?

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Andy Thomas, Craft Brew Alliance Inc. - CEO [13]

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So that's a great question, Vivien. It's interesting. We're kind of an interesting animal out there if you take a look at it. I think in response to kind of the market changes over the course of the last couple of years, a lot of the things we have done have been more medium- to long-term in nature than short term. So let me take 30 seconds and give you a little bit of context on that and then get to the crux of your question.

I think if we only had Widmer Brothers and Redhook in the legacy portfolio to deal with, we might have had to do things like pull the price card. We might have had to do things like try to continue to put more and more brands out there to see what stuck. And I think that's the dynamic you're seeing with some of the national players out there. They have to resort to some shorter-term things to try to stem their double-digit declines because they played their distribution card, their brands are losing relevance in the local markets and they really don't have anything else to do.

Instead of doing that, we said, "Hey, we've got the luxury of having this brand called Kona, which is growing double digits." We can use the air cover from that to retreat from some geographies where we don't think we can compete and we can be clever about kind of embracing where the consumer is going and start to look for up-and-coming partners like Appalachian Mountain or like Wynwood and like Cisco Brewers. And very quietly, nobody really noticed that when we started doing things like the Startup Brewery Challenge and started talking to small brewers. We were actually prospecting on what's going on.

So the first thing, before I answer your question specifically, I'll offer is our actions over the last three years have been deliberate and they've been more medium- to long-term than I think a lot of our peers candidly, and that's not a competitive dig. It's just a statement of fact. So I think what gives us confidence that zero is the low end of the range now is we've done that. So we're not trying to push a rope uphill by making more people drink Widmer Brothers in regions where it's not relevant. We're trying to get people, who love Widmer Brothers and love Hefe, to rediscover it and to start to drink it at an increasing velocity, something we know how to do pretty well.

At the same time, we're playing the distribution game, as Ken pointed to, on a brand that has some natural tailwinds right now and that we believe is somewhat insulated from some of the pressures going on in the marketplace. Kona as a lifestyle brand, surfs, no pun intended, a lot of different demographics and surfs a lot of different imagery that we believe the trio -- or the duo of Longboard and Big Wave, successfully took advantage of. And when Hanalei IPA joins the battle, as Ken said, we think we've got a pretty formidable one, two, three punch on Kona.

So what makes me confident that zero is the low end of the range? We're not trying to do desperate things with tired brands. We're trying to do smart things with brands that are lively and vibrant, and we believe the Kona brand inherently has some intrinsics that make it a little bit insulated from a little bit of what's going on in craft. And we think the rest of our Plus portfolio is just advantaged from a positioning standpoint, be it geographically or be it at the stage of its life cycle.

So the one caveat to that, I'll offer up, Redhook, as Ken acknowledged, we're not there yet. Not going to pull any punches on that one. Redhook was the brand most impacted by everything we did. We expect to see a continued drain on Redhook and I'll contrast it with Widmer Brothers, I'll call the bottom on Widmer Brothers because we're almost exclusively back home and feeling really good and comfortable about it. On Redhook, we have some room to go, and I'd say that's the biggest drain coming in the top line.

So if we were a one-trick pony and had one national brand that was rolling backwards, zero would not be the bottom. If we had only Kona, zero would not be the bottom either, the bottom end of the range would be higher. I think the beauty is that we've got both and that's why we feel good about the range.

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Vivien Azer, Cowen and Company, LLC - Analyst [14]

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That's super helpful. And just thinking about Kona then specifically, clearly, continues to show very good momentum. But now that it's having some more focus within the AB system, can you talk about your outlook for ACV or whatever distribution measure you guys look at? Kind of where is Kona today? Where do you expect it to go over kind of the next one to three years?

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Andy Thomas, Craft Brew Alliance Inc. - CEO [15]

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Thanks, Vivien. That's a great question. And Ken, I'm going to toss it to you in a second. I will say, Ken mentioned a couple of things in the script and I want to highlight. As we continue to work with AB, we're mindful of the fact these are still our brands. The responsibility is incumbent upon us to make sure we do the right things with these brands, working with our partners where it make sense. The beauty of the Kona brand isn't just the brand, is that if you take a look at the entire kind of AB craft high-end portfolio, Kona's very complementary and fits in very nicely.

So unlike a lot of other brands, it's not just another IPA and I don't mean that in a pejorative sense that we're trying to fit in somewhere in a conference room, looking at a bunch of 2 by 2 matrices. The Kona brand, lifestyle-wise, and the styles within the Kona brand, be that Longboard Lager or Big Wave Golden Ale, are complementary to the kind of portfolio that an Anheuser-Busch wholesaler will carry and will bring to market now.

So with that, kind of as a foundation, we take a look at those numbers Ken shared. Kona 6-packs only still have 20% ACV. If you look at peers, there's no reason that, that number can't candidly double if not triple. Now is that going to be an annual thing? No. But over the course of the next three years, I would think there's probably distribution growth in the off-premise alone that's two and three times as great is what we're seeing now from a points of distribution level on the Kona brand.

How that starts to translate and how that starts to kind of trickle down between brands, be it Longboard, Big Wave, Hanalei, Island Hopper, between packages be it 6-packs, 12-packs, cases or be it in the on-premise, on draft, another reason zero feels good, I think you're hard pressed to find another company whose focused brand is up 50% in draft, like Big Wave is.

So distribution, we expect to see a big driver, but I don't want anybody to think we're not learning from what we have in the past. The Kona brand isn't just growing because we're growing distribution, the velocity gains are significant and they're, we believe, sustainable as well.

And Ken, maybe your closer to it, in the conversations you guys have had with your team and with the sales team in terms of what the distribution plans are. So without offering some specific guidance, maybe you can provide some color to Vivien.

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Ken Kunze, Craft Brew Alliance Inc. - CMO [16]

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So I think for me, those others, when you just look at it, basic distribution, there's still a lot of opportunity given where we currently stand. I think when you begin to break it apart, right, in terms of the sub-brands, whether it's Longboard, Big Wave, the Aloha Series back a couple of years ago when we did the SKU rationalization, got caught up in that, and we probably went a little bit too far. So that was brought back into the portfolio.

So we define kind of the core four brands that we're really focused on, being Longboard, Big Wave, Wailua Wheat and something new that we're launching this year called Hanalei Island IPA, which is a fruit forward IPA made with POG juice. And just FYI, kind of the first eight weeks into the year in California, it's the number three new item as measured by Nielsen.

So I think when you begin to look at the individual brand levels and then at the individual package levels, each year, we get more prescriptive in terms of the targets. And part of the reorganization was to put a better focus on what I would describe as the independent channel driven through the wholesalers to drive more distribution we're probably better in chain than we are in kind of independent up-and-down the street distribution. So that's a big focus.

I think channel opportunities, specifically C store, where the brand is more developed to continue to blow that out, are also opportunities. Some of the things from a capabilities standpoint, with AB our can capability will improve. So when you think about single-serve can packages, we'll have more production capability in order to supply kind of the C-store channel with that type of packaging.

So I think my broad kind of answer is, one, reorg. We're more focused. We're more prescriptive about what we're trying to get to you. And them from a brand package, channel target. All that is wired into what the plan is for 2016. And it will be year-by-year in terms of how much progress and how we go after it. Does that help, Andy?

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Andy Thomas, Craft Brew Alliance Inc. - CEO [17]

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Yes. No thanks, Ken.

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Vivien Azer, Cowen and Company, LLC - Analyst [18]

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That's helpful. Thank you, Ken and Andy both. My last one, Joe, please, just given kind of where we finished the year from a gross margin perspective, given the focus on inventory rationalization in the first half of the year, can you just give us any color around kind of the cadence of gross margin progression, maybe specifically speaking to the first quarter so that no one gets caught off guard?

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Joe Vanderstelt, Craft Brew Alliance Inc. - CFO [19]

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Sure, Vivien. So I think we're still in a pretty seasonal business, right? No secret to you, obviously. But being a seasonal business, we're going to have lower gross margins in the first quarter like we typically do. We do expect some upside related to contract brewing, which will be an improvement over last year. And then by the time we get to -- really around April, we should be down at the bottom level of our wholesaler inventory targets, so we're ready for the summer. And at that point, the breweries are coming online to really produce beer for the month of May and June.

So we're up and running at that point. So we'll continue to see improvements beginning in Q2, Q3. And the AB incentives will be incurred at the end of each quarter, so we'll have that on top of it. So hopefully, that gives you a little bit of flavor for it -- it will be lower, I would say, consistently lower in the first quarter to what you'd expect from a seasonality perspective and then we'll be off to the races.

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Operator [20]

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And I'm showing no further questions. I would now like to turn the call back to Andy Thomas for closing remarks.

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Andy Thomas, Craft Brew Alliance Inc. - CEO [21]

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Thanks. But before I close with some prepared remarks, a sentence or two. One of the wonderful things about our industry isn't just the great products that we can work with and the wonderful sociability we can bring to people, it's the people you get to work with. And a lot of those are familiar voices on this call.

One of the familiar voices on this call that you didn't hear was a gentleman named Tony Brenner, who I'm happy to say is on the call but as a private investor. Tony was the analyst who covered us for ROTH and Partners and Tony is now enjoying some hard-earned retirement. So I wanted to give a shout-out to Tony and tell him that he was missed on this call, let him know that he is not forgotten and that it gave all of us a big smile to know that he was dialing in as a private investor. So Tony, we all wish you very well in your retirement and we hope you're enjoying a few Big Waves in the process of doing so.

And with that, I will close by saying that I appreciate everybody's continuing support of CBA and being available for this call on such short notice. We look forward to discussing the results of the first quarter of 2017 with you very soon. Thank you very much.

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Operator [22]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.