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Edited Transcript of SAM.N earnings conference call or presentation 23-Jul-20 9:00pm GMT

Q2 2020 Boston Beer Company Inc Earnings Call

BOSTON Aug 18, 2020 (Thomson StreetEvents) -- Edited Transcript of Boston Beer Company Inc earnings conference call or presentation Thursday, July 23, 2020 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* C. James Koch

The Boston Beer Company, Inc. - Founder & Chairman of the Board

* David A. Burwick

The Boston Beer Company, Inc. - President, CEO & Director

* Frank H. Smalla

The Boston Beer Company, Inc. - CFO & Treasurer

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Conference Call Participants

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* Bonnie Lee Herzog

Goldman Sachs Group, Inc., Research Division - Research Analyst

* Eric Adam Serotta

Evercore ISI Institutional Equities, Research Division - MD

* Kevin Michael Grundy

Jefferies LLC, Research Division - Senior VP & Equity Analyst

* Laurent Daniel Grandet

Guggenheim Securities, LLC, Research Division - Senior Analyst and MD of the Consumer & Retail Team

* Stephen Robert R. Powers

Deutsche Bank AG, Research Division - Research Analyst

* Sunil Harshad Modi

RBC Capital Markets, Research Division - MD of Tobacco, Household Products and Beverages & Lead Consumer Staples Analyst

* Vivien Nicole Azer

Cowen and Company, LLC, Research Division - MD & Senior Research Analyst

* Wendy Caroline Nicholson

Citigroup Inc., Research Division - MD & Head of Global Consumer Staples Research

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Presentation

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Operator [1]

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Greetings. Welcome to The Boston Beer Company's Second Quarter 2020 Earnings Call. (Operator Instructions) Please note, this conference is being recorded.

At this time, I'll turn the conference over to Mr. Jim Koch. Mr. Koch, you may begin.

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C. James Koch, The Boston Beer Company, Inc. - Founder & Chairman of the Board [2]

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Thank you. Good afternoon, and welcome.

This is Jim Koch, Founder and Chairman, and I'm pleased to kick off the 2020 Second Quarter Earnings Call for The Boston Beer Company. Joining the call from Boston Beer are Dave Burwick, our CEO; and Frank Smalla, our CFO.

I'll begin my remarks this afternoon with a few introductory comments, including some discussion on the COVID-19 pandemic and the highlights of our result, and then hand over to Dave, who will provide an overview of our business. Dave will then turn the call over to Frank, who will focus on the financial details of our second quarter results as well as a review of our outlook for 2020. Immediately following Frank's comments, we'll open the line up for questions.

As our world continues to grapple with this COVID-19 pandemic, our primary focus at Boston Beer Company continues to be on operating our breweries and our overall business safely and supporting our partners in the beer industry. Supporting the communities in which we work and live is one of our core values, and we're very happy that our Samuel Adams Restaurant Strong Fund has raised over 4 -- over $5.4 million so far to support bar and restaurant workers who are experiencing hardship in the wake of COVID-19. Working with the Greg Hill Foundation, this fund is committed to distributing 100% of its proceeds to grants to bar and restaurant workers across the country.

While doing this, we also achieved depletions growth of 46% in the second quarter, of which 42% is from Boston Beer legacy brands and 4% is from the addition of the Dogfish Head brands. I'm tremendously thankful for the effort of our coworkers in achieving our ninth consecutive quarter of double-digit growth, while maintaining a focus on quality and innovation.

We're also thankful to our outstanding distributors and retailers for their focus during COVID-19. Our business in the second quarter was strong, but uncertainties due to COVID-19 do remain. These uncertainties include our ability to continue to operate our breweries at a level of safety that meets our standards, the continued ability to distribute to off-premise retail locations and the timing of the reopening of on-premise retail locations. We will continue to work hard through the COVID-19 pandemic and prioritize safety above all else.

I'm proud of the passion, creativity and commitment to community that our company and coworkers have demonstrated during this pandemic. We remain positive about the future growth of our brands and are happy that our diversified brand portfolio continues to fuel double-digit growth.

I will now pass over to Dave for a more detailed overview of our business.

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David A. Burwick, The Boston Beer Company, Inc. - President, CEO & Director [3]

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Okay. Hey, thanks, Jim. Hello, everyone. Before I review our business results, I'll start with the usual disclaimer.

As we state in our earnings release, some of the information we discuss and that may come up on this call reflect the company's or management's expectations or predictions of the future. Such predictions are forward-looking statements. It's important to note that the company's actual results could differ materially from those projected in these forward-looking statements.

Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in the company's most recent 10-Q and 10-K. The company does not undertake to publicly update forward-looking statements, whether as a result of new information, future events, or otherwise. Okay.

Now let me share a deeper look at our business performance. Our depletions growth in the second quarter was a result of increases in our Truly Hard Seltzer and Twisted Tea brands and the addition of the Dogfish Head brands that were only partially offset by decreases in our Samuel Adams and Angry Orchard brands. The growth of the Truly brand led by Truly Hard Lemonade has accelerated and continues to grow beyond our expectations. Since early January, Truly has significantly grown its velocity and has sequentially grown its market share, while many other hard seltzer brands have entered the category. Truly is the only hard seltzer, not introduced earlier this year, to grow its share during 2020. We'll continue to invest heavily in the Truly brand and further improve our position in the hard seltzer category as competition continues to increase.

We're excited about our new Truly advertising campaign that showcases colors, variety and joy to hard seltzer drinkers through 4 different ads. Because we delayed the premier of this campaign to June, given the consumer environment surrounding COVID-19, it's too early to know if it will resonate with drinkers.

Twisted Tea continues to generate double-digit volume growth rates that are well above full year 2019 trends. We expect to increase our brand investments in the second half compared to the first half and see significant distribution and volume growth opportunities for our Truly, Twisted Tea and Dogfish Head brands. Samuel Adams and Angry Orchards volumes continued to decline as they are more deeply impacted by the effect of COVID-19 on on-premise retailers. We're encouraged, however, that Samuel Adams Boston Lager and Angry Orchard Crisp Apple both have experienced double-digit growth in the measured off-premise channels during the quarter. We continue to work on returning these brands to growth, but don't expect them to grow during 2020 because of on-premise closures.

I'm pleased that our overall business has shown great momentum and depletion improvements during the first half of the year. Given our trends for the first half and our current view of the remainder of the year, we've adjusted our expectations for higher 2020 full-year earnings, depletions and shipment growth, which is primarily driven by the strong performance of our Truly and Twisted Tea brands.

We've adjusted our business to the COVID-19 environment and continue to work to control what we can control, with our primary focus being the safety of our coworkers, distributors, retailers and drinkers. We've deployed many safety protocols across our business and in our breweries, including entrance screening and temperature checks, face masks requirements, reorganized work spacing to increase physical distancing between and among shifts and adding more cleaning and sanitation time to each shift. We're slowly reopening our hospitality locations, which were closed since March, with a focus on outdoor service and takeout.

Our accelerated depletions growth has been challenging operationally. We've been experiencing out of stocks, and we expect wholesaler inventories to remain very tight for the rest of the summer. We've been operating the capacity for many months and have further increased our usage of third-party breweries in response to the growth. In particular, the additional Truly volumes have come at a higher incremental cost due to an increased usage of third-party breweries, which is negatively impacting our gross margin expectation for the year.

We're investing significantly in our supply chain, but do not expect these pressures to be relieved in the second half of the year. We'll continue to invest to increase capacity as appropriate to meet the needs of our business and take full advantage of the fast-growing hard seltzer category. We're in a very competitive business, but we're optimistic for continued growth of our current brand portfolio. We remain prepared to forsake short-term earnings as we invest to sustain long-term profitable growth in line with the opportunities that we see.

Based on information in hand, year-to-date depletions reported to the company through the 28 weeks ended July 11, 2020, are estimated to have increased approximately 42% from the comparable weeks in 2019. Excluding the Dogfish Head impact, depletion has increased 37%.

Now I'm going to hand over to Frank, who will provide the financial details.

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Frank H. Smalla, The Boston Beer Company, Inc. - CFO & Treasurer [4]

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Thank you, Jim and Dave. Good afternoon, everyone.

For the second quarter, we reported net income of $60.1 million, an increase of $32.3 million or 116% from the second quarter of 2019. Earnings per diluted share was $4.88, an increase of $2.52 per diluted share from the second quarter of 2019. This increase was primarily due to increased revenue driven by shipment growth of 39.8% partially offset by lower gross margins and higher operating expenses.

We began seeing the impact of the COVID-19 pandemic on our business in early March. To date, the direct financial impact of the pandemic has primarily shown a significantly reduced keg demand from the on-premise channel and higher labor and safety-related costs at our breweries.

In the first half of 2020, we recorded COVID-19 pretax related reductions in net revenue and increases in other costs totaling $14.1 million, of which $10 million was recorded in the first quarter and $4.1 million was recorded in the second quarter. The total amount consists of a $5.8 million reduction in net revenue for our estimated cap returns from distributors and retailers and $8.3 million of other COVID-19-related direct costs, of which $5.6 million are recorded in cost of goods sold and $2.7 million are recorded in operating expenses.

In addition to these direct financial impacts, COVID-19-related safety measures resulted in a reduction of brewery productivity. This has shifted more volume to third-party breweries, which increased production costs and negatively impacted gross margins. In April 2020, we withdrew full year fiscal 2020 financial guidance due to uncertainties around COVID-19. Despite the continued uncertainties related to the COVID-19 pandemic, we feel our business outlook has stabilized and that it is now appropriate to give full year fiscal 2020 financial guidance. We will continue to assess and manage this situation and will provide a further update in our third quarter earnings release to the extent that the effects of the COVID-19 pandemic are then known more clearly.

Shipment volume was approximately 1.9 million barrels, a 39.8% increase in the second quarter of 2019. Excluding the addition of the Dogship Head brands beginning July 3, 2019, shipments increased 35.3%. We believe distributor inventory as of June 27, 2020, averaged approximately 2.5 weeks on hand and was lower than prior year levels due to supply chain capacity constraint. We expect wholesale inventory levels in terms of weeks on hand to remain lower than prior year levels for the remainder of the year.

Our second quarter 2020 gross margin of 46.4% decreased from the 49.9% margin realized in the second quarter of 2019, primarily as a result of higher processing costs due to increased production at third-party breweries, partially offset by price increases and cost-saving initiatives at company-owned breweries.

Second quarter advertising, promotional and selling expenses increased by $6.3 million from the second quarter of 2019, primarily due to increases in salaries and benefits costs, increased brand investments in media and production, the addition of Dogfish Head brand-related expenses beginning July 3, 2019, and increased trade to distributors due to higher volumes, partially offset by decreased investments in local marketing and national promotions due to timing of these costs compared to the prior year.

General and administrative expenses increased by $2.9 million in the second quarter of 2019, primarily due to increases in salaries and benefits costs, and the addition of Dogfish Head general and administrative expenses beginning July 3, 2019, partially offset by the nonrecurrence of $1.5 million in Dogfish Head's transaction-related fees incurred in the second quarter of 2019.

Based on information of which we are currently aware, we are now targeting full year 2020 earnings per diluted share of between $11.70 and $12.70. However, actual results could vary significantly from this target. This prediction excludes the impact of ASU 2016-09 on line. Full year 2020 depletions growth, including Dogfish Head, is now estimated to be between 27% and 35%, of which between 1% and 2% is due to the addition of the Dogfish Head brand. We project increases in revenue per barrel of between 1% and 2%. Full year 2020 gross margins are expected to be between 46% and 48%. We plan to increase investments in advertising, promotional and selling expenses of between $70 million and $80 million for the full year 2020. This does not include any increases in freight costs for the shipment of products to our distributors.

We estimate our full year 2020 non-GAAP effective tax rate to be approximately 26%, which excludes the impact of ASU 2016-09. We are continuing to evaluate 2020 capital expenditures and currently estimate investments of between $180 million and $200 million. The capital will be spent mostly on continued investments in our breweries and could be higher if deemed necessary to meet future growth.

We expect that our cash balance of $86.7 million as of June 27, 2020, along with our future operating cash flow and unused line of credit of $150 million, will be sufficient to fund future cash requirements.

We will now open up the call for questions. Before we do that, though, I would like to remind everybody that we are still in different locations due to COVID-19. Hence, Dave will act as an emcee again, when we address your question, similar to how we did it in our last earnings call in April.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from the line of Bonnie Herzog with Goldman Sachs.

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Bonnie Lee Herzog, Goldman Sachs Group, Inc., Research Division - Research Analyst [2]

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I wanted to drill down on this impressive growth that we're seeing for this category, which is -- it's been unbelievable. So I kind of would like to hear a little bit more from all of you about what gives you the confidence that this can really continue, especially as, in the future, more bars and restaurants open. So kind of how do you think about that?

And then maybe help all of us understand how you guys are thinking about the barriers to entry for the category since it seems like the category is obviously attracting a lot of new entrants. And just kind of want to hear your thoughts on how big of a risk you see this as more and more companies and/or brands enter and especially maybe from nonbeer companies? Thoughts on that.

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David A. Burwick, The Boston Beer Company, Inc. - President, CEO & Director [3]

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Great, Bonnie. This is Dave. I think I'll start it and then I'll let then -- if anyone wants to jump in after that, that's great. And so I mean, I think we are very confident, and by -- I presume you're talking primarily about the hard seltzer category?

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Bonnie Lee Herzog, Goldman Sachs Group, Inc., Research Division - Research Analyst [4]

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Yes. I should have said it.

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David A. Burwick, The Boston Beer Company, Inc. - President, CEO & Director [5]

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Okay. And so I look at -- I mean, we're looking at growth this year, we think, about 150%, and it might be like around 8% of total beer volume or share of beer volume. So obviously, we've both seen it. We think there's a number of reasons why we're pretty confident in this. And this one is really it starts with the consumer trends, which we've talked about before.

We look at 3 really important trends in the broader beer category, all of which really apply very directly to hard seltzers. The health and wellness trend, of course, the desire for variety, seeking of flavors of all different kinds and experimenting and discovering new flavors and brands, and also premiumization.

So you have these very solid trends. If you look at the sourcing, the sourcing is still -- even now, it started out more than half of the volumes coming from wine and spirits. Now, most recently, it's maybe about 50% or so, still from wine and spirits. So you're sourcing from outside of the category. And it's a very sessionable occasion more so than beer. We still see there's a lot of upside from a shelf space perspective. So hard seltzers are still significantly under-spaced across channels.

And then when you even go further across channels, convenience in guests' on-premise, still lots of opportunity to develop the brands in those channels. So there's a lot of different opportunities for growth here.

We also think -- we hope that -- I think this came from Nielsen, but I think 90% of people who drink hard seltzer see it as something separate and distinct from beer, right? So they don't see it as a beer. They see it as something that's unique. And we think this is a good thing if you have a brand that's not about beer, but a brand that's made for the category.

So I think -- we talked about before, when you look at the 2 -- and the 2 leaders in this category are about 70% to 80% of the share. We used the energy drink category sort of as a bit of an analog to show the consolidation that could happen when you have legacy brands that are marketed well, innovate aggressively and spend aggressively to maintain their turf, if you will. And we're seeing that play out.

So we're really confident. We think personally that we can play differently than other competitors through innovation. And we know -- the last -- and the last thing I'll say -- I know it's a long answer. But the last thing, I think, we've been working on this now -- this new approach since the end of last year with the reformulation, spending more in terms of -- across all media forms. The lemonade launch, we've been able to gain -- we gained 5 share points this year, about a 28 share point. This is IRI, new low plus convenience. We're about at 28. We gained 5 share points. We've closed the gap that began the year with our very formidable competitor. It was -- I think it was a 41-point share gap. It's now a 15-point share gap.

So it doesn't mean -- this is still early innings, but we do see progress. So we think our view of the world is -- in the categories, it's being validated by our actions, and so that's why we're confident.

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Bonnie Lee Herzog, Goldman Sachs Group, Inc., Research Division - Research Analyst [6]

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Okay. And just to clarify something that you just mentioned in terms of innovation because, obviously, a lot of that has been driving the growth of the category. So should we assume more to come from you this year in terms of your pipeline of innovation? Is that what's contributing to some of this conviction that you have for the category growth continuing or your business continuing?

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David A. Burwick, The Boston Beer Company, Inc. - President, CEO & Director [7]

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I think if I look at like into the next 2 or 3 years, we see innovation coming in a continuous stream. I mean it will determine how we space it out through one or more. Because I think it's really important not to -- when you innovate, sometimes there's an assumption that just innovating and putting a brand out there means you're building a brand. But innovation and brand and strong brands are not necessarily the same thing. So we want to make sure we're building something that's strong that can last.

We think Truly Lemonade has been terrific for us. And the repeat rates are actually very high, 50% higher than all the other new products that were launched this year. The velocity is also very high. And we think it's just providing a differentiated experience within the category.

So we're also going to keep supporting that and aggressively, but there will be -- we think we have other ideas for innovation that will come behind that, that we think also can kind of spark interest and excitement in the category.

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Bonnie Lee Herzog, Goldman Sachs Group, Inc., Research Division - Research Analyst [8]

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Okay. If I can squeeze one more in. I just -- I really wanted to ask you guys about also the industry-wide can shortages that has been going on right now. Just want to get from you how big of an issue or a concern it's been and really how material it's been. And I guess it's my assumption that your main competitor, I think, has been more negatively impacted by the out-of-stock situation. So has that helped to contribute to some of the recent share gains that you've been experiencing? And how sustainable is that?

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Frank H. Smalla, The Boston Beer Company, Inc. - CFO & Treasurer [9]

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Yes. Bonnie, this is Frank. Yes, I mean, it's pretty clear. It's well known in the industry that there's a real can shortage in the industry across the U.S., which is spanning basically all the beverage suppliers and manufacturers.

So far, we've been working well with our suppliers. And I think we've benefited also from the fact that we have prebuilt can inventory. We have prebuilt product inventory for Truly and for tea, as you know. But we've also prebuilt can inventory because we wanted to be prepared for the volume growth. We're running out of that.

So going forward, we believe the impact will not be that dramatic. But it's hard to say because with all the COVID impacts that are coming on top of the explosive growth that you see across the different categories, it's really hard to predict. So far, we might have some tightness, but we hope that with everything that we have pre-built that we kind of can manage through that.

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David A. Burwick, The Boston Beer Company, Inc. - President, CEO & Director [10]

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And just to answer the last part of your question, Bonnie, about the share gains, I think there's a number of things that have led to that. One is the flavor reformulization -- reformulation. And if you look at our velocities, from the time we reformulated, we went from growing 30% to 40% sales per point to over 100% for the last 4 months in a row. So that's part of it.

Lemonade is certainly providing share right now. So lemonade absolutely is a part of it. And to be fair and to be honest, I think over the last couple of weeks, I think we -- to Frank's point, we've been -- we're more fortunate to have fewer out of stocks. I think that's part of what we've also seen happen as well.

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Operator [11]

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Our next question is from the line of Vivien Azer with Cowen.

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Vivien Nicole Azer, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [12]

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So I was hoping to dive a little bit deeper into your thinking around E&P spend, please. Clearly, it came down a lot in the quarter and not at the expense of your top line. And while you've noted select incremental investment spending, your overall guidance seems to have come down a little bit relative to your pre-COVID guidance. And so you've also called out some timing changes, delay in ad spend in June, Frank, I think you noted as well in your prepared remarks.

So I'm just trying to understand, as we think about the outlook for E&P, like how much of what we saw in the second quarter was just the timing that you've alluded to specifically versus some structural changes that just really reflect the benefit of some brand mix shift in your portfolio?

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Frank H. Smalla, The Boston Beer Company, Inc. - CFO & Treasurer [13]

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Yes, Vivien. The -- we're not really changing much of the spend that was indicated when we first gave you guidance in February. What has happened, the phasing is very different from last year. When we came out, we had a significant increase in the first quarter because we wanted to start the year strong. We knew there were like new competitive entrants, and we wanted to make sure that we're out there at the beginning. So when you look at Q1, there was quite a bit of an increase.

Q2 is a combination. We were flat essentially, a slight increase, but largely flat. And that is a combination of -- it was partly planned, but also partly reduced due to the fact what happened, with COVID, the social discussion that was happening in the country. So we adjusted our spend a little bit on that. And we will definitely spend more in the second half of the quarter.

Within that, you should expect a higher increase in the fourth quarter because we also have to manage our product supply. So if you look at the growth rate in E&P spend in the second half of the year, the growth rate will be twice as high than the growth rate that we have in the first half of the year.

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Vivien Nicole Azer, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [14]

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That's super helpful. If I could follow up. So you're clearly referencing E&P dollars and that makes a ton of sense to me, in particular, given the precommitments that you have to make around that kind of spend. But when I think about SAM historically, your E&P as a percentage of sales has been considerably higher than your peer group. And the 22% and change that you recorded this quarter is the lowest that I can recall in the many years I've been covering the company.

So just to put the question back to you, if you'll indulge me, do you think that dollars is the right way to think about it now? Because it seems to have been tracking as a percentage of sales. But again, because Truly is so much more important and maybe you get more halo, in particular, because like lemonade and like the base business should complement each other on a spend basis. Has there been a philosophical change?

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Frank H. Smalla, The Boston Beer Company, Inc. - CFO & Treasurer [15]

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Vivien, no. There hasn't been a philosophical change. And I think -- we look at percent of net revenue, at the end of the day, we spend what we feel is the right thing to spend. And when you go back, I think you see quite a variability in spend in absolute terms but also in percent of net revenue. Because the way we think about it, if we have something in our hands that we really want to push, we push it. And we say that every time, I think, that we look for the long term because we're building the brand for the long term. And we are not trying to optimize the quarter. We're trying to optimize the year.

We feel fairly comfortable with the significant increase in spend that we have this year. It has to be effective. That's important to us. We don't just want to spend to a certain ratio. We want to spend some money and get something back. And we feel fairly confident that we do that. That's also why we're increasing in the back half of the year. I mean, we had strong growth with not a significant increase this year so far. That was slightly planned differently, as I explained before. But again, it's more guided by the need of the business than hitting a particular ratio.

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Operator [16]

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(Operator Instructions) The next question comes from Kevin Grundy with Jefferies.

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Kevin Michael Grundy, Jefferies LLC, Research Division - Senior VP & Equity Analyst [17]

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Congrats on the really strong results in this environment.

Question perhaps for David and Frank, just on the guidance. So depletions, obviously, outstanding in the first half of the year, north of 40%, including some contribution from Dogfish Head. So the guidance implies, sort of rough math, a deceleration down to 15% to 30% in the back half of the year.

So understanding the comps get tougher, understanding there's some contribution from Dogfish in the first half of the year, can you just kind of box in for us a little bit some of the assumptions around the high end and the low end of guidance?

Dave, I think I heard you say, I could be mistaken, 150% sell-through category growth. Is that kind of down the fairway? Is that what you're expecting where to finish this year and it truly holds the line on -- from a market share perspective from here? So just some commentary on the guidance, and then I have a follow-up.

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David A. Burwick, The Boston Beer Company, Inc. - President, CEO & Director [18]

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Sure thing, Kevin. That's right. On the 150%, that's our best guess for the category and essentially will hold or grow -- continue to grow share. I'll let Frank answer the -- how we get to that range and what the assumptions were.

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Frank H. Smalla, The Boston Beer Company, Inc. - CFO & Treasurer [19]

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Yes. So I think one thing is, if you look at the year-to-date and year-to-go, clearly, it all appears like if you look at the depletions, plus 40%, and then we have -- the guidance is lower.

Some factors, one is the high end of guidance. We are not concerned about the demand. The demand is there. The constraint is around the capacity. And the capacity -- the category has grown much stronger than what we had expected again. It's like it outpaced the capacity that we have put in. And we keep on running out of capacity. So if you don't have any capacity constraints, we will end up in the upper end of the range.

It's really hard to say what's going to happen to the supply chain. And when I say supply chain, the broader supply chain that we depend on. We have a pretty good handle on our own supply chain, but there's also our partners. We don't know what's going to happen there. They are different states. There's like supply -- there are constraints potentially on our suppliers. We've talked about cans before. But that's pretty much true for all the materials. You might not have a structural tightness, but as COVID hits, the supply chain is just tight. So if we hit that, then we're going to get to the low end of the range.

I think the other thing that I want to say on that, one thing is Dogfish has clearly contributed in the first half of the year, whereas the second half of the year, we are comparing to the 6 months that had Dogfish included last year. That's a certain impact.

And the other one is that we -- as you know, we have prebuilt inventory for Truly and for Twisted Tea in the first half to get us through the season. And normally, that inventory peaks at the end of May, beginning of June, and then it carries us throughout the high season. What happened this year, as you know, with COVID and the explosive growth that we had in the category, especially off-premise, we used up the inventory, this prebuilt inventory a little earlier. And that's what you see partly also in the year-to-go number.

So last year, we had a higher inventory level that would carry us a little bit longer into the third quarter. We don't have the same cushion anymore. We are pretty much empty mode at the moment as we speak. And those are the key factors that contributed to the range that we have.

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Kevin Michael Grundy, Jefferies LLC, Research Division - Senior VP & Equity Analyst [20]

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Okay. That's helpful. I'll ask one more and then hop back in the queue. I wanted to -- maybe for Jim and Dave, on the on-premise channel, maybe talk a little bit about what you've seen. And then from a demand perspective, maybe how that progressed as you moved through the quarter and maybe even currently what you're seeing in July?

And then just a follow-up, on-premise-related question. Bonnie mentioned earlier, unique dynamic, of course, with seltzer, where it really doesn't have any presence to speak of in the on-premise channel. Is there any rethink to that? Do you see that changing? Is this true for both you and for Mark Anthony brands as well, where there really hasn't been a push? Is there any rethink to that as that channel recovers? And relatedly, do you think you'll see some demand impact on seltzers as consumers return to that channel just given sort of the lack of availability or presence, if you will, of hard seltzers through at this point?

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David A. Burwick, The Boston Beer Company, Inc. - President, CEO & Director [21]

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Sure. Jim, I'll let you take on -- take this one.

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C. James Koch, The Boston Beer Company, Inc. - Founder & Chairman of the Board [22]

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Sure. We've seen an evolution of the on-premise. In March and through April, it basically just disappeared. We were probably, during that period, took back as much beer as we sold. So it was kind of 0. And it has recovered somewhat, but not even half of what it used to be. And it's faltering. You've seen the new shutdowns. And people, even when bars are open, restaurants are open, people aren't going to them. So the on-premise still is very weak for us. And we anticipate that not changing in the next few months. After that, we'll just have to see.

In terms of the second part of your question, we actually see a much bigger opportunity for hard seltzer on-premise than has been realized yet. We were expecting this summer to be a time when there would be a lot of penetration that we didn't have last summer into the on-premise because it's a natural thing for people to consume on decks, outside, on patios and so forth. But even with the places that have opened their outdoor seating, it's still distanced and it's a fraction of what it used to be. And putting new products in is not high on their list.

So I think it's going to be summer of 2021 when we see a big penetration of hard seltzers. And I expect it will get to the point where you walk into a bar or a restaurant and you expect them to have some hard seltzer, either -- probably either Truly or White Claw. So I do think there's a decent upside for seltzer on-premise, but not -- probably not in the next 6 to 9 months.

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Operator [23]

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The next question is from the line of Eric Serotta with Evercore.

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Eric Adam Serotta, Evercore ISI Institutional Equities, Research Division - MD [24]

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Hoping you could delve in a little bit more into the shelf space opportunity. Our understanding is that the spring shelf sets -- shelf resets didn't occur as would be expected due to COVID. Just wondering how you see the shelf set -- the shelf resets playing out in the fall or whether you think it's more of a 2021 event. And then a quick follow-up for you.

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David A. Burwick, The Boston Beer Company, Inc. - President, CEO & Director [25]

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Sure. Eric, this is Dave. I think you're right. I mean a lot of innovation didn't get out there this spring for the obvious reasons. And we're making -- we're starting to talk to our customers about 2021. And what we're hearing back is, for the most part, that's where the shelf sets are going to occur, is in 2021. So a whole generation of innovation may have been put on hold for that. Within the category itself, I mean, there's still a lot of opportunity for hard seltzer. As you know, it's under-spaced across channels. And we expect to see, with the growth rates we're having now and out-of-stock is pretty much across the board, we're definitely expecting to see more space being allocated to hard seltzer in 2021.

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Eric Adam Serotta, Evercore ISI Institutional Equities, Research Division - MD [26]

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Great. And then Jim and Dave, a follow-up for you. Last year, in the fourth quarter, towards the end of the year, you started to communicate what was a very deliberate plan, which played out very well for you guys to manage through and come out on top of the hard seltzer competitive onslaught that happened earlier this year.

I'm wondering if there is a similar type of plan as you look to first half of '21 or even second half of this year as White Claw ramps up its capacity. Just wondering sort of how you're thinking about the next 12 months and if there's anything you could share with us today, or if we should stay tuned for the fall or if this is more of a -- we'll be talking about this, this time next year.

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David A. Burwick, The Boston Beer Company, Inc. - President, CEO & Director [27]

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Yes, this is Dave. I think the way I look at it is we're still -- for your last question, Eric, like we still haven't fully realized the potential, for example, of Truly Lemonade, which didn't get cut in to a lot of shelves because of COVID. And we're seeing a lot of progress there in terms of -- if you basically look at Q2 versus Q1, we're seeing penetration growth. Actually, it's more than doubled. Repeat has increased by about 1/3, but there's still a long way to go there. Also, because we just reformulated our flavors for the base Truly brand, there's still lots of opportunity there.

So we think the places we're running right now are a good places to run. But as I mentioned before, I think to Bonnie that -- to her question, that we believe innovation will continue to play an important role in the category. And so we're looking far ahead on that. We've nothing to share today. But maybe in our next call, we will be able to share more information on that.

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Operator [28]

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The next question is from the line of Nik Modi with RBC Capital Markets.

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Sunil Harshad Modi, RBC Capital Markets, Research Division - MD of Tobacco, Household Products and Beverages & Lead Consumer Staples Analyst [29]

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So Dave, I have 2 questions. Two questions from my end. One is on -- just on innovation. Just I know the retail landscape has been changing and what they take on to the shelf has been changing. So I just wanted to get to the state of the union on what you're seeing from retailer behavior in terms of accepting new products. That's the first point.

And then the second one is, I guess the million dollar question or, I don't know, maybe it's more than $1 million. I'm sure it's more than $1 million is when gross margins are going to start growing again or expanding again, I mean, it's clear this category has surprised everyone, but I think maybe now it's not so much of a surprise on what its potential could be. So maybe if you could just give us your longer-term vision on how you think about the category growth rate, how you think about capital spending and when maybe we can expect gross margins to start expanding again.

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David A. Burwick, The Boston Beer Company, Inc. - President, CEO & Director [30]

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Sure. I'll take the first part of that, and I'll hand the gross margin part over to Frank.

I think we know that for the fall, very little innovation is going to get into the marketplace across the board very well. So I think retailers are all -- they're definitely focusing on just very few new things. I think they like what they got right now, which is basically fewer SKUs being more productive. And so if anything, we'll see what happens as we get to next year. But I think there's a lot more productivity and a lot better -- a lot more profitability in the system when there's fewer SKUs delivering growth.

And I think it's really important -- it's going to be an important time to continue to strengthen core brands. And one of the interesting things we've seen -- and I know we're not the only ones, of course, and a lot of brands have seen it, a lot of legacy brands, but particularly with -- for example, Boston Lager and also Angry Orchard Crisp Apple, we've seen those brands in Q2 grow their penetration, grew their repeat, grow -- and obviously, on-premise, double-digit growth, and people coming back to some of the brands they've tried before that they maybe have been distracted from. And so it'll be interesting to see how it plays out and how much core brands participate in growth as we enter next year versus innovation. So it's to be determined.

We're obviously preparing for any alternative there. We have lots of innovation to go into next year, but we haven't determined what we're going to launch and what we're not going to launch because we don't want to go -- we want to get the right balance.

I think customers -- again, based on early conversations with our customers, we're hearing sort of the same thing from that. And plus, I think everybody is just kind of shell-shocked from what's happened. So they're being maybe more thoughtful about the steps to take going forward. So that's the first part of the question, then I'll let Frank address your gross margin -- your million dollar question.

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Frank H. Smalla, The Boston Beer Company, Inc. - CFO & Treasurer [31]

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Yes. So Nik, if you look at the gross margin, it's not what we want it to be, very clearly. We wanted to have it much higher. I'm not particularly happy about it, but I'm not concerned because we know what the reasons are. And if you look at this year, I mean, they are quite a bit more than 3 points below last year.

If you look at this year, what the key reasons are, number one is we have significantly higher growth than what we had expected, okay? So -- and as we've said before, we are servicing the demand as much as we can at any cost because we want to build the brand, we want to build the category. So the incremental cases that we produce, they're external production, they come at a higher cost. But we're happy to do that because once it stabilizes we'll bring in -- we'll get to a better cost structure.

The second point is that we're impacted by COVID, too. So the cost -- a big chunk of the cost that we have due to COVID is on the gross margin line. And you see some slight improvement already this year. If you look at what we had in Q1 as a margin, there was an improvement in Q2. And if you look at the guidance, we'll see us coming in a little above where we are right now. And the reason of that, COVID was a little bit more front-loaded, assuming that no major thing is happening in the second half of the year, and we're adding internal capacity.

When it will substantially improve? It really depends on when we get a better handle on the growth and we can plan it a little bit better. Plans are underway. We are making progress in the efficiencies in our own breweries. We're rethinking the supply chain, and we are not thinking really about like our internal production and external production. We are thinking more of the whole construct as an integrated supply chain. And once you do that, you get to different ways of working into different cost savings.

So at this point, we're driving the growth. And we don't mind that much as that comes at a lower gross margin, because if you look at the gross profit and you look at the leverage that we're getting throughout the rest of the P&L, you look at the operating income -- the operating income margin, that is the right strategy. And we're building the brand.

Once that subsides, we have quite a bit of a runway to improve the gross margin by improving the way we are sourcing. We have relatively clear plans on that. And then we also, as we mentioned last time, a separate project supply chain transformation, which helps us become -- operate that way more efficiently than what we're doing at the moment.

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Operator [32]

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The next question is from the line of Laurent Grandet with Guggenheim.

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Laurent Daniel Grandet, Guggenheim Securities, LLC, Research Division - Senior Analyst and MD of the Consumer & Retail Team [33]

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And congrats on another great quarter. And Jim, I think even in your base dream 3 or 4 years ago, you couldn't think of a quarter where depletion number could approach that 40%.

Okay, diving a bit more into the innovation. So one of the reasons of the Truly success this year can be attributed to the lemonade line expansion. What have you learned, Dave, from this line extension that can help to further develop the Truly franchise going forward? I mean, specifically around differentiation? And what about the tests we are doing in New York? I think, with Truly, is a higher ABV?

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David A. Burwick, The Boston Beer Company, Inc. - President, CEO & Director [34]

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Yes. So Laurent, so I think as it relates to lemonade -- I think with lemonade, I think what we learned -- I think what everybody learned, I guess, from the outside-looking in is that there's a certain expectation of what a hard seltzer is. I think -- we think -- and it's 100 calories or fewer, 1 gram of sugar thereabouts, 2 grams of carbs, nothing artificial, right? And obviously, it just tastes really good and refreshing, and I think that's sort of the -- those are the parameters to play in the space.

I also think a parameter is that it's -- I strongly believe, particularly, when you see the consumers see it as a separate segment, they don't see it as beer, that I think a pure play brand also can resonate more deeply. But I think what we also learned is that people are really craving a variety and different ways to experience those base characteristics, if you will. And sometimes, you just want more flavor -- I mean, right? I mean, it's like how many sparkling waters can you drink without craving the Pepsi, let's say, or something like that? When people want more flavor, they want a sweeter profile at times. And so we were able -- that's something that was helpful for us to understand. That's probably the most important thing that we've learned thus far.

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C. James Koch, The Boston Beer Company, Inc. - Founder & Chairman of the Board [35]

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I wanted to add that basically flavor dominates. And so we just happened, with the lemonade, to hit a flavor profile that people really enjoyed. I mean, to be totally honest, the volume surprised us as well. And the only thing I can attribute it to is we just hit the bull's eye of flavor for the space between seltzer and lemonade.

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Laurent Daniel Grandet, Guggenheim Securities, LLC, Research Division - Senior Analyst and MD of the Consumer & Retail Team [36]

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And I believe, I mean, a bit of this is coming from the fact that you are unique in the lemonade in that space. So along that line, I mean, are the tests you are doing New York with higher ABV another way to differentiate yourselves from the space? Or what's was the goal here?

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David A. Burwick, The Boston Beer Company, Inc. - President, CEO & Director [37]

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Yes. That's -- so yes, one thing I did mention, the base -- like sort of 5% ABV is sort of a given number. But yes, we are testing. White Claw is also testing. There's a product surge on Orchard's Edge. And we're looking at that, but we don't -- that's a possibility.

But if I go back to what Jim said, I think the flavor experience might be more -- you'll find out, might be more powerful than -- necessarily than ABV, if you will. But I think everybody -- everyone is looking at ways to create a differentiated experience.

One thing I should point out actually is that, a couple of things about lemonade. One, it's actually bigger than Mike's now. Number two, that's not -- they're not a competitor. Mike's has done quite well. In fact, Truly is not really sourcing much more -- Truly and Lemonade is not sourcing much more from that brand, because it's addressing the needs of a hard seltzer drinker in that moment.

And so I think again, anything else we would share, I don't want to share much more than that. But I think to Jim's point and to my point, I think we're getting a good sense of what -- or improving sense of what hard seltzer drinkers are looking for. And to the extent that we aim to continue to provide those experiences and because we're working with a brand that hasn't been extended yet -- it's not an extension of another brand, I should say, we have the ability to build out a bigger platform, if you will, on that brand.

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Laurent Daniel Grandet, Guggenheim Securities, LLC, Research Division - Senior Analyst and MD of the Consumer & Retail Team [38]

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One more for me, if I may. I mean one of your objectives at the beginning of the year was to have a more balanced male/female consumer base and, therefore, attract new male consumer into the franchise. Could you please update us on that progress and where should be the right balance for the brand?

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David A. Burwick, The Boston Beer Company, Inc. - President, CEO & Director [39]

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Yes. We are making progress. I think if you look at it, we might be -- still maybe a smidge more female-skewed than, say, like White Claw is, but not as much as we were before. We changed the pack design to be more [billowing]. So we actually have another one that's in the market pretty much right now, that's even get more sort of male-skewed, if you will.

And so if you look at the volume, though, the volume is -- more than 50% of the volume is consumed by men because men just happen to drink more than women. But we have been able to close that gap that when we came out of the gate, as you know, we were very much focused, and we believed that was the opportunity at the time was really targeting women very directly. We've continued to evolve, and we see the numbers and the gender break being pretty much gender-neutral now.

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Operator [40]

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Next question is from the line of Wendy Nicholson with Citigroup.

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Wendy Caroline Nicholson, Citigroup Inc., Research Division - MD & Head of Global Consumer Staples Research [41]

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My two questions are, number one, have you developed any more plans about a potential U.K. launch or expanding further into Europe? It just doesn't seem to me why that wouldn't be a priority, although I know you're doing the best you can to meet the demands in the U.S. But it still seems like Europe could be a great opportunity down the road.

And then my second question, just going back to lemonade, have you seen a different demographic for that specifically relative to core Truly? Or do you think it's existing Truly consumers just switching over to the more sort of stronger flavor profile?

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David A. Burwick, The Boston Beer Company, Inc. - President, CEO & Director [42]

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Okay, Wendy. I'll do the second. Maybe, Jim, can do the first part of that question. On the second part, just on the lemonade, we are seeing a difference. And actually, if you look across all the brands, the major brands in the category, lemonade skews younger than any other brand in hard seltzer, definitely younger than the base Truly business, younger than White Claw, younger than hard seltzer, younger than the Corona seltzer, younger than all of them. And it seems to be bringing in more new drinkers into the beer category. So when I say young, I mean 21 to 39. So we -- so that is a difference. We weren't sure if we'll go there or not, but it seems to be like that.

In terms of international, Jim's got a long-standing point of view about our global business, so I'll let Jim talk about that one.

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C. James Koch, The Boston Beer Company, Inc. - Founder & Chairman of the Board [43]

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Thanks. Yes. Wendy, I would say that as a company, we are not particularly internationally focused. We are very focused on the United States. We've been a company that's succeeded, in many cases, just by the strength of our sales force and our distributors. And that's difficult to duplicate globally. I mean, U.S., we have like 500 salespeople. So we're very feet-on-the-street, grassroots-intensive.

And with Truly, we do have an importer in the EU, a long-standing brewing relationship there, but we have spent really very little time or effort on international expansion. We are very focused on the United States because that's what we know well, and that's kind of what we're good at.

We have had some success with Truly in Canada. We've just recently launched it there this year, and it's doing pretty well. So Canada is comfortable for us. Once you get outside that, it's just not good at it, to be honest.

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Wendy Caroline Nicholson, Citigroup Inc., Research Division - MD & Head of Global Consumer Staples Research [44]

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Fair enough. Well, you've got enough growth in the U.S., so that's fine by me.

But if I can squeeze in one more. I remember last year, particularly last summer, part of what you were talking about on vis-à-vis the gross margin pressure was the fact that so much of seltzer was sold in variety packs. And that made a lot of sense 12, 18 months ago when people wanted to try the product, and "Oh, I'm not sure what flavor I want, so let me get an assortment of a bunch of different ones."

But I'm just wondering, as the business grows and people become more loyal and say, "I really like lime, but I'm not such a fan of black cherry," are you seeing a shift in the business to more of the single-flavor packs or cases?

And I'm just wondering if that's becoming anything of a meaningful shift in the business? Because I would think that would alleviate some of the gross margin pressure, but maybe I'm off on that.

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David A. Burwick, The Boston Beer Company, Inc. - President, CEO & Director [45]

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Okay. Wendy, I think I'll take that one. I think still, we see a large majority, call it, 75% or so of our business is variety packs. Consumers still are telling us they like that. They like the experimentation among the different flavors. It doesn't mean that, that won't change over time, and we're sort of looking at that. There are other players out there that have single flavor, certainly 6 packs, as we do, but also have 12 packs.

Truly Hard seltzer was launched at 4 by 4 packs, 3 were single flavor, 1 was variety. And that variety pack is like 85% or 90% of the total business. So consumers seem to be suggesting that they're not quite ready for that fully.

And also the last -- the other thing we have to think about is there are only so many SKUs that we can get on to a shelf and get support for. So you have to kind of pick wisely what are going to be your highest performing configurations. Right now, we haven't necessarily been convinced that there's a better way to go. But we can certainly tee it up at a moment's notice. We could do that if we saw the opportunity.

As it relates to gross margin, that's part of it. That was part of the issue a year ago. And I don't know...

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Frank H. Smalla, The Boston Beer Company, Inc. - CFO & Treasurer [46]

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Yes, yes. I think the second part of the question is like, when we started with the whole business, variety pack was something that was relatively new to us. We had a little bit, but it was a small volume, and it was a very manual operation. And as the volume has grown and we progress through it, of course, we've gotten much, much better at it. And we have now automated variety pack lines. 100% of the volume, but we have significantly increased the volume. And that's part of the margin opportunity as well.

That's actually what I said earlier, we are making progress. That is one area where we're making progress. And we still have some runway left there and a pretty clear road map on how we're going to address that. So in the future, that margin shouldn't be as significant as it is now or as it was a year ago.

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Operator [47]

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The next question is from the line of Stephen Powers with Deutsche Bank.

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Stephen Robert R. Powers, Deutsche Bank AG, Research Division - Research Analyst [48]

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I guess, just given the challenges you talked about of meeting existing demand as well as a potential unlock of future gross margin, could you talk a bit more about the anticipated pacing of the new capacity you referred to coming online, particularly any of your own new capacity in Truly looking out over the next, say, 12, 18 months?

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David A. Burwick, The Boston Beer Company, Inc. - President, CEO & Director [49]

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Hey, Jim, do you want to hit that one?

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C. James Koch, The Boston Beer Company, Inc. - Founder & Chairman of the Board [50]

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Sure. Sure. Right now, we're trying to get it up and running as quickly as we can. Since the last earnings call, we have added basically 1.5 can lines. And next month or in September, we'll add another half. That will help us in the back half of this year.

We think that the current supply constraints and the -- basically, the retailer out-of-stocks will continue through the summer. But post-Labor Day, that's sort of the hand-to-mouth existence. We'll be able to rebuild wholesalers' inventories and start building again a significant prebuild for 2021.

And we are -- so we're adding a second can line in Cincinnati in sort of the end of Q2, beginning of Q3 next year. And we've signed up additional contract capacity. So we're kind of looking to more than double our capacity a year from now.

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Stephen Robert R. Powers, Deutsche Bank AG, Research Division - Research Analyst [51]

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Okay. And so I guess that alleviates any potential pressure on just your ability to introduce new flavors or pursue the on-premise opportunity next summer that you talked about. It sounds like that you've got line of sight there.

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C. James Koch, The Boston Beer Company, Inc. - Founder & Chairman of the Board [52]

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Yes, we think so. Though we desperately hope that we will oversell all that, and we'll have another hand-to-mouth summer next year with double the volume.

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Stephen Robert R. Powers, Deutsche Bank AG, Research Division - Research Analyst [53]

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Got it. And I guess just one last question, if I could. You spoke a bit to A&P plans in response to Vivien's earlier question. But if we think about the scalability, maybe this is for Frank, of selling costs and of G&A, clearly, a lot of leverage this quarter. I guess, as I look forward, how do you think about the scalability of those line items into the future versus the need to ramp those costs up to support a bigger business going forward?

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Frank H. Smalla, The Boston Beer Company, Inc. - CFO & Treasurer [54]

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So Steve, I can't give you an exact number. But clearly, if you're growing at the rate that we're growing, there's leverage in the P&L. And we had the disadvantage that we're a smaller business, as we grow, we'll see the leverage. As I said before, it's really hard to predict and give you milestones of where we're going to go because we are always thinking long term about how do we grow the business, how do we create value longer term. So we're not trying to hit a certain number at a particular given point of time.

So you will clearly see leverage over time. You've seen it this quarter. Yes, I think you will definitely see it for the full year. And as we grow, there will be leverage. The extent really depends on how much we will support the business, and we need to support the business. I know it's not as specific as you might want to hear, but that's kind of how we're managing the business.

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Stephen Robert R. Powers, Deutsche Bank AG, Research Division - Research Analyst [55]

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No, that's fair enough. I totally appreciate it.

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C. James Koch, The Boston Beer Company, Inc. - Founder & Chairman of the Board [56]

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Philosophically, we've always prioritized growth over profitability, even recognizing that in the beer business, growth is expensive. So I think we see no reason to change that philosophy. We believe growth is an important component of value added. And when there's opportunities like we're having now to grow 40%, we're going to spend to maintain the highest growth rate that we can for as long as possible.

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Operator [57]

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(Operator Instructions) Next question comes from the line of Kevin Grundy with Jefferies.

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Kevin Michael Grundy, Jefferies LLC, Research Division - Senior VP & Equity Analyst [58]

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Frank, I just wanted to follow up, just kind of building on Steve's question, the shape of the P&L, and then Nik's question earlier on gross margin. Can you help us think about it structurally?

So if you go back a decade or so ago, it was a 55% gross margin business; SKU, largely a beer at that point in time. Now beer becomes much less, cider becomes much less, flavored malt beverages, exceedingly higher. Where's sort of -- like where should this business be?

If you sort of set aside some of the rapid growth and volatility that the business is seeing now -- so set aside over the next 12 to 24 months. But on a 4- to 5-year basis, should this be a 55% gross margin business? Should it be closer to some of the targets more recently in the 51%, 53% sort of range? Can you help us think about that a little bit, even on a longer-term basis? I think that would be helpful.

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Frank H. Smalla, The Boston Beer Company, Inc. - CFO & Treasurer [59]

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Yes. And again, yes, I wasn't here 10 years ago, but I know -- clearly, I know the gross margins, and it was a very different business. It was a much simpler portfolio. And we had a different balance between demand and capacity than we have. So -- and then all the sweet spots and we were at 54% at a point in time, but then it was like 52, 53 percentage points.

We should definitely be in the 50s and getting closer to the mid-50s, maybe not exactly 55. But as we stabilize the business and we get a better handle on the supply chain and optimize that, that's definitely the target that we have.

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Operator [60]

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At this time, I will turn the floor back to Mr. Koch for closing remarks.

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C. James Koch, The Boston Beer Company, Inc. - Founder & Chairman of the Board [61]

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Thank you. Thanks to everybody for being on the call. It was certainly an exciting quarter with almost outlandish growth, coupled with a lot of changes to accommodate this pandemic. And I'm grateful to a lot of people that helped us get through this with their creativity and their flexibility, from our coworkers to our wholesalers, to the retailers that we work with, to can suppliers. And special hugs to the can suppliers for this quarter. And we're looking forward to continuing the winning streak in a few months, and hope to talk to you then. Thanks.

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Operator [62]

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Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.