| BOSTON BEER CO INC Item 1A Risk Factors In addition to the other information in this Annual Report on Form 10-K, you should carefully consider the risks described below before deciding to invest in shares of our Class A Common Stock |
| These are risks and uncertainties that management believes are most likely to be material and therefore are most important for you to consider |
| Our business operations and results may also be adversely affected by additional risks and uncertainties not presently known to us, or which we currently deem immaterial, or which are similar to those faced by other companies in our industry or business in general |
| If any of the following risks or uncertainties actually occurs, our business, financial condition, results of operations or cash flows would likely suffer |
| In that event, the market price of our Class A Common Stock could decline |
| The Company Faces Substantial Competition |
| The Better Beer category within the United States beer market is highly competitive due to the large number of craft brewers with similar pricing and target customers and gains in market share achieved by imported beers |
| The Company anticipates competition among domestic craft brewers to remain strong as craft brewers experienced their second successive year of growth in 2005 |
| Large domestic brewers have developed or are developing niche brands within the Better Beer category and have acquired or are exploring acquiring interests in small brewers to compete in the craft-brewed segment or in import brands to compete with imported beers |
| Imported beers, such as Corona^® and Heineken^®, continue to compete aggressively in the United States beer market |
| These import competitors and these large domestic brewers may have substantially greater financial resources, marketing strength, and distribution networks than the Company |
| Samuel Adams^® is the third largest brand in the Better Beer category of the United States brewing industry, trailing only Corona^® and Heineken^® |
| The continued growth in the sales of craft-brewed domestic beers and in imported beers is expected to increase the competition in the Better Beer category within the United States beer market and, as a result, prices and market share of the Company’s products may fluctuate and possibly decline |
| No assurance can be given that any decline in price would be offset by an increase in market share |
| The Company’s products, including its Twisted Tea^® products, also compete generally with other alcoholic beverages |
| The Company competes with other beer and beverage companies not only for consumer acceptance and loyalty but also for shelf and tap space in retail establishments and for marketing focus by the Company’s distributors and their customers, all of which also distribute and sell other beers and alcoholic beverage products |
| Many of these competitors have substantially greater financial resources, marketing strength and distribution networks than the Company |
| Moreover, the introduction of 10 _________________________________________________________________ [64]Table of Contents new products by competitors that compete directly with the Company’s products, or that diminish the importance of the Company’s products to the retailers or distributors may have a material adverse effect on the Company’s results of operations, cash flows and financial position |
| There Is No Assurance of Continued Growth |
| The Company’s future growth may be limited by both its ability to continue to increase its market share in domestic and international markets, including those markets that may be dominated by one or more regional or local craft breweries, and by the growth in the craft-brewed beer market and the Better Beer market |
| The development of new products by the Company may lead to reduced sales in the Company’s other products, including its flagship Samuel Adams Boston Lager^® |
| The Company’s future growth may also be limited by its ability to enter into new brewing contracts on commercially acceptable terms or the availability of suitable production capacity, and its ability to obtain sufficient quantities of certain ingredients and packaging materials from suppliers, such as hops and bottles |
| The Company’s Advertising and Promotional Investments May Not be Effective The Company’s revenues and results of operations have in the past and may in the future vary from quarter to quarter due to a number of factors, many of which are outside of our control and any of which may cause its stock price to fluctuate |
| As a growth oriented Company, the Company has made, and expects to continue to make, significant advertising and promotional expenditures to enhance its brands |
| These expenditures may not result in higher sales volume |
| Variations in the levels of advertising and promotional expenditures have in the past caused, and are expected in the future to continue to cause, variability in the Company’s quarterly results of operations |
| The Company has in the past made, and expects from time to time in the future to make, significant advertising and promotional expenditures to enhance its brands even though those expenditures may adversely affect the Company’s results of operations in a particular quarter or even for the full year, and may not result in increased sales |
| While the Company attempts to only invest in effective advertising and promotional expenditures, it is difficult to correlate such investments with sales results, and there is no guarantee that the Company’s expenditure will be effective in building brand equity or growing long term sales |
| In addition, the Company fills orders from its wholesalers who may choose to independently build their inventories or run their inventories down |
| This change in wholesaler inventories is somewhat unpredictable, and can lead to fluctuations in the Company’s quarterly or annual results |
| The Company’s Dependence on Contract Brewers Could Harm Its Business |
| However, the Alternative of Owning 100prca of Its Production Facilities has High Capital Costs, creates a Larger Fixed Cost Burden on the Company’s Business, and has Greater Uncertainty as to Operating Costs, all of which Could Have A Material Adverse Effect on the Company’s Operations or Financial Results |
| The Company continues to pursue its strategy of combining brewery ownership with contract brewing |
| The Company-owned breweries are located in Cincinnati, Ohio and Boston, Massachusetts and the Company currently has contract brewing arrangements with breweries in Eden, North Carolina, Rochester, New York, and La Crosse, Wisconsin |
| The Company carefully selects breweries with (i) the capability of utilizing traditional brewing methods and (ii) first rate quality control capabilities throughout brewing, fermentation, finishing and packaging |
| The contract brewing arrangements have historically allowed the Company to utilize the excess capacity of other breweries, providing the Company flexibility as well as quality and cost advantages over its competitors |
| However, higher than planned costs of operating under contract arrangement at contract breweries or an unexpected decline in the brewing capacity available to the Company may have a material adverse effect on the Company’s results of operations, cash flows and financial position |
| As the number of available contract breweries declines, the risk of disruption increases, and the dynamics of the brewery strategy of ownership versus contracting changes |
| The Company currently estimates that a 11 _________________________________________________________________ [65]Table of Contents capital investment of dlra70dtta0 to dlra90dtta0 million over two years could be required to pursue a strategy that involves owning 100prca of its production capacity |
| The Company believes that a 100prca ownership strategy could potentially produce some improvement in operating and freight costs |
| This estimate could change based on the actual production capacity and capability built |
| The Company continually evaluates these factors and others in its evaluation of ownership versus contracting |
| The Company continues to brew its Samuel Adams Boston Lager^® at each of its brewing facilities, but at any particular time may rely on only one supplier for its products other than Samuel Adams Boston Lager^® |
| The Company believes that it has sufficient capacity options that would allow for a shift in production locations if necessary, although it is unable to quantify any additional costs, capital or operating, if any, that it might incur in securing access to such capacity |
| In the event of a labor dispute, governmental action, a sudden closure of one of the contract breweries or other events that would prevent either the Cincinnati Brewery or any of the contract breweries from producing the Company’s beer, management believes that it would be able to shift production between breweries so as to meet demand for its beer |
| In such event, however, the Company could experience temporary shortfalls in production and/or increased production or distribution costs, the combination of which could have a material adverse effect on the Company’s results of operations, cash flows and financial position |
| A simultaneous interruption at several of the Company’s production locations would likely cause significant disruption, increased costs, and potentially lost sales |
| The Company Is Dependent on Its Distributors |
| In the United States, where approximately 99prca of its beer is sold, the Company sells its beer to independent beer distributors for distribution to retailers and ultimately consumers |
| Although the Company currently has arrangements with approximately 400 wholesale distributors, sustained growth will require it to maintain such relationships and possibly enter into agreements with additional distributors |
| Changes in control or ownership of the current distribution network could lead to less support of the Company’s products |
| No assurance can be given that the Company will be able to maintain or secure additional distributors on terms favorable to the Company |
| The Company’s distribution agreements are generally terminable by the distributor on short notice |
| While these distribution agreements contain provisions regarding the Company’s enforcement and termination rights, some state laws prohibit the Company from exercising these contractual rights |
| The Company’s ability to maintain its existing distribution agreements may be adversely affected by the fact that many of its distributors are reliant on one of the major beer producers for a large percentage of their revenue and, therefore, they may be influenced by such producers |
| If our existing distribution agreements are terminated we may not be able to enter into new distribution agreements on substantially similar terms, which may result in an increase in the costs of distribution |
| The Company is Dependent on Key Suppliers, Including Foreign Sources; Its Dependence on Foreign Sources Creates Foreign Currency Exposure for the Company; The Company’s Use of Natural Ingredients Creates Weather and Crop Reliability Exposure for the Company |
| The Company purchases a substantial portion of the raw materials used in the brewing of its products, including its malt and hops, from a limited number of foreign and domestic suppliers |
| The Company purchased the majority of malt used in the production of its beer from one major supplier during 2005 |
| The Company is exposed to the quality of the barley crop each year, and significant failure of a crop would adversely affect the Company’s costs |
| The Company believes that there are other malt vendors available that are capable of supplying its needs |
| The Company uses Noble hops for its Samuel Adams^® lagers |
| Noble hops are varieties from several specific growing areas recognized for superior taste and aroma properties and include Hallertau-Hallertauer, Tettnang-Tettnanger and Spalt-Spalter from Germany |
| Noble hops are rare and more expensive than most other varieties of hops |
| Traditional English hops, namely, East Kent Goldings and English Fuggles, are used in the Company’s ales |
| The Company enters into purchase commitments with two hops dealers, based on the Company’s projected future volumes and 12 _________________________________________________________________ [66]Table of Contents brewing needs |
| The dealers then contract with farmers to ensure that the Company’s needs are met |
| However, the performance and availability of the hops may be materially adversely affected by factors such as adverse weather, the imposition of export restrictions (such as increased tariffs and duties) and changes in currency exchange rates resulting in increased prices |
| The Company maintains over one year’s supply of essential hop varieties on-hand in order to limit the risk of an unexpected reduction in supply |
| The Company stores its hops in multiple cold storage warehouses to minimize the impact of a catastrophe at a single site |
| Hops and malt are agricultural products and therefore many outside factors, including weather conditions, crop production, government regulations and legislation affecting agriculture, could affect both price and supply |
| Historically, the Company has not experienced material difficulties in obtaining timely delivery from its suppliers |
| Although the Company believes that there are alternate sources available for the ingredients and packaging materials, there can be no assurance that the Company would be able to acquire such ingredients or packaging materials from substitute sources on a timely or cost effective basis in the event that current suppliers could not adequately fulfill orders |
| The loss of a supplier could, in the short-term, adversely affect the Company’s results of operations, cash flows and financial position until alternative supply arrangements were secured |
| The Company’s contracts for hops are payable in Euros for German hops and in Pounds Sterling for English hops, and therefore, the Company is subject to the risk that the Euro or Pound may rise against the US dollar |
| The cost of hops is approximately 10prca of the Company’s product cost |
| The Company has, as a practice, not hedged this exposure although this practice is subject to review |
| However, significant adverse fluctuations in foreign currency exchange rates may have a material adverse effect on our results of operations, cash flows and financial position |
| Management is currently reviewing the Company’s hops commitments in relation to existing exchange rates and related implications on future profit margins and considering the need to adopt strategies designed to minimize or eliminate currency exchange rate exposure |
| The Company maintains competitive sources for the supply of packaging materials, such as shipping cases, six-pack carriers and crowns |
| Currently, glass and labels are each supplied by a single source, although the Company believes that alternative suppliers are available |
| The loss of either the Company’s glass or labels supplier could, in the short-term, adversely affect the Company’s results of operations, cash flows and financial position until alternative supply arrangements were secured |
| If packaging costs increase, there is no guarantee that they may be passed along to consumers through increased prices |
| The Company has entered into long term supply agreements for certain packaging materials that have shielded it from some cost increases |
| These contracts have varying lengths and there is no guarantee that the economics of these contracts can be duplicated at time of renewal |
| This could expose the Company to significant cost increases in future years |
| The Company initiates bottles deposits and reuses some of the glass bottles that are returned pursuant to certain state bottle recycling laws and derives some economic benefit from this practice |
| The cost associated with reusing the glass varies, based on the costs of collection, sorting and handling, including arrangements with retailers, wholesalers and dealers in recycled products |
| The Company believes that it benefits economically from washing and reusing these bottles which result in a lower cost than purchasing new glass, and that it benefits the environment by the reduction in landfill usage, the reduction of usage of raw materials, and the lower utility costs for reusing bottles versus producing new bottles |
| The economics of using recycled glass varies based on the cost of collection, sorting and handling, and may be affected by local regulation, retailer, distributor and glass dealer behavior |
| There is no guarantee that the current economics of using returned glass will continue, nor that the Company will continue to do so |
| In the last two years, the Company has experienced significant increases in energy costs, and energy costs could continue to rise, which would result in higher transportation, freight and other operating costs |
| The Company’s future operating expenses and margins will be dependent on its ability to manage the impact of cost increases |
| If energy costs continue to increase, there is no guarantee that they may be passed along to consumers through increased prices |
| The Company’s Operations are Subject to Certain Operating Hazards |
| The Company’s operations are subject to certain hazards and liability risks faced by all brewers, such as potential contamination of ingredients or products by bacteria or other external agents that may be wrongfully or accidentally introduced into products or packaging |
| While the Company has never experienced a contamination problem in its products, the occurrence of such a problem could result in a costly product recall and serious damage to the Company’s reputation for product quality, as well as claims for product liability |
| The Company is Subject to Existing and Potential Additional Regulation and Taxation, which Can Impose Burdens on Its Operations and Narrow the Markets for Its Products |
| The manufacture and sale of alcoholic beverages is a business that is highly regulated and taxed at the federal, state and local levels |
| The Company’s operations may be subject to more restrictive regulations and increased taxation by federal, state and local governmental agencies than are those of non-alcohol related businesses |
| For instance, brewery and wholesale operations require various federal, state and local licenses, permits and approvals |
| In addition, some states prohibit wholesalers and retailers from holding an interest in any supplier such as the Company |
| Violation of such regulations can result in the loss or revocation of existing licenses by the wholesaler, retailer and/or the supplier |
| The loss or revocation of any existing licenses, permits or approvals, failure to obtain any additional or new licenses, permits or approvals or the failure to obtain approval for the transfer of any existing permits or licenses, including any transfers required in connection with the recapitalization, could have a material adverse effect on the ability of the Company to conduct its business |
| Because of the many and various state and federal licensing and permitting requirements, there is a risk that one or more regulatory authorities could determine that the Company has not complied with applicable licensing or permitting regulations or does not maintain the approvals necessary for it to conduct business within their jurisdictions |
| There can be no assurance that any such regulatory action would not have a material adverse effect upon the Company or its operating results |
| Under a federal regulation that became effective on January 3, 2006, a reformulation of most flavored malt beverage products was required so that a greater proportion of the final alcohol content is a product of brewing |
| The Company recently reformulated its Twisted Tea^® products to meet these requirements |
| This reformulation may affect the Company’s Twisted Tea^® brand products potentially in a number of ways: revenue, cost of goods, taste profile, consumer acceptance, future growth and profit potential, among others |
| Should the reformation have a negative effect on the sales of the Company’s Twisted Tea^® brand products, the reformulation may have a material adverse effect on the Company’s business, financial position, results of operations and cash flows |
| Further regulations at federal or state level could be forthcoming that would have a material adverse affect on our ability to produce product acceptable to the Company’s drinkers at current economics, and would therefore significantly affect the Company’s results |
| In addition, if federal or state excise taxes are increased, the Company may have to raise prices to maintain present profit margins |
| The Company does not believe that a price increase due to increased taxes will reduce unit sales, but the actual effect will depend on the amount of any increase, general economic conditions and other factors |
| Higher taxes may reduce overall demand for beer, thus negatively impacting sales of the Company’s products |
| 14 _________________________________________________________________ [68]Table of Contents Further federal or state regulation may be forthcoming that could limit distribution and sales of alcohol products |
| Such regulation might reduce the Company’s ability to sell its products at retail and at wholesaler and could severely impact the Company’s business |
| The alcoholic beverage industry has become the subject of considerable societal and political attention in recent years due to increasing public concern over alcohol-related social problems including drunk driving, underage drinking and health consequences from the misuse of alcohol, including alcoholism |
| As an outgrowth of these concerns, the possibility exists that advertising by beer producers could be restricted, that additional cautionary labeling or packaging requirements might be imposed, that further restrictions on the sale of alcohol be imposed, or that there may be renewed efforts to impose increased excise or other taxes on beer sold in the United States |
| The entire domestic beer industry, excluding Better Beers, has experienced a slight decline in shipments over the last ten years |
| The Company believes that this slower growth is due to both declining alcohol consumption per person in the population and increased competition from wine and spirits companies |
| If beer consumption in general were to come into disfavor among domestic consumers, or if the domestic beer industry were subjected to significant additional governmental regulations, the Company’s business could be materially adversely affected |
| There Is No Guarantee that Other Potential Litigation Could Develop that Could Harm the Company’s Business |
| The Company, along with numerous other beverage alcohol producers, has been named as a defendant in a number of class action law suits in several states relating to advertising practices and underage consumption |
| Each complaint contains substantially the same allegations that each defendant marketed its products to underage consumers and seeks an injunction and unspecified money damages on behalf of a class of parents and guardians |
| The Company has been defending this litigation vigorously |
| In September 2005, one of the complaints was withdrawn by the plaintiffs |
| In February 2006, two of the complaints were dismissed; however, the plaintiffs have appealed the dismissal in one of the actions |
| The actions are in their earliest stages and it is not possible at this time to determine their likely impact on the Company |
| In November 2004, Royal Insurance Company of America and its affiliate (“RICA”), the Company’s liability insurer during most of the period covered by the above-referenced complaints, filed a complaint in Ohio seeking declaratory judgment that RICA owes no duty to defend or indemnify the Company in the underlying actions filed in Ohio and has subsequently filed a motion for summary judgment |
| In July 2005, Royal Indemnity Company, successor in interest to RICA and its affiliate (“Royal”), filed a complaint in New York seeking declaratory judgment that Royal owes no duty to defend or indemnify the Company in five underlying actions filed in states other than Ohio |
| In August 2005, the Massachusetts Bay Insurance Company (“MBIC”), the Company’s liability insurer for parts of 2004 and 2005, filed a complaint in Massachusetts seeking declaratory judgment that MBIC owes no duty to defend or indemnify the Company in the underlying actions filed during the policy period and that MBIC owes no duty to contribute to any obligation of Royal to defend or indemnify the Company as to those underlying actions |
| While all three declaratory judgment actions against the Company are in their very early stages, the Company believes it has meritorious defenses, that it is entitled to insurance coverage of its defense costs with respect to the underlying class actions, and that it is premature to litigate indemnification issues for the class actions |
| However, the Company is not able to predict at this time the ultimate outcome of these insurance coverage disputes |
| While the Company believes it conducts its business appropriately in accordance with laws, regulations and industry guidelines, further litigation in addition to the above could develop and might severely impact the Company’s results |
| The Company’s Class A Common Stock is not entitled to any voting rights, except for the right as a class to approve certain mergers and charter and by-law amendments and to elect a minority of the directors of the Company |
| Consequently, the election of a majority of the Company’s directors and all other matters requiring stockholder approval is decided by C James Koch, Chairman of the Board of Directors of the Company, as the current holder of 100prca of the Class B Common Stock |
| Koch is able to exercise substantial influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions |
| This could have the effect of delaying or preventing a change in control of the Company and will make some transactions difficult or impossible to accomplish without the support of Mr |
| Continued Health of our Brands, and Role of our Founder in the Samuel Adams Brand Communication There is no guarantee that the Brand Equities that we have built in our brands will continue to appeal to drinkers |
| Changes in drinker attitudes or demands could severely affect the strength of our brands and the revenue that is generated from that strength |
| It is possible that the Company could react to such changes and reposition the brands, but there is no certainty that the Company’s reaction would maintain volumes, pricing power, and profitability |
| It is also possible that marketing messages or other actions taken by the Company could damage the Brand Equities as opposed to building them |
| If such damage should occur it could have a negative effect on the financial condition of the Company |
| In addition to these inherent brand risks, the Founder and Chairman of the Company, C James Koch, is an integral part of our current Samuel Adams^® brand message |
| Koch as founder, brewer and leader of the Company is emphasized as part of our brand communication and has appeal to some drinkers |
| Koch were not available to the Company to support this messaging, the Company would need to develop an alternative strategy to communicate its traditional brewing processes, brewing heritage and quality |
| This could have a detrimental impact on the future growth of the Company |