# BOSTON BEER CO INC (SAM) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from BOSTON BEER CO INC's 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/949870/000095017024021189/sam-20231230.htm
Accession: 0000950170-24-021189
Filing date: 2024-02-27
Report date: 2023-12-30
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/SAM/
All MD&A years: /company/SAM/mda/
Previous year: /company/SAM/mda/fy2022/ (FY 2022)
Next year: /company/SAM/mda/fy2024/ (FY 2024)

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The Company has elected to omit discussion of the earliest of the three years covered by the consolidated financial statements presented. Refer to Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" located in the Company's Form 10-K for the fiscal year ended December 31, 2022, filed on February 22, 2023, for reference to discussion of the fiscal year ended December 25, 2021, the earliest of the three fiscal years presented.

Forward-Looking Statements

In this Form 10-K and in other documents incorporated herein, as well as in oral statements made by the Company, statements that are prefaced with the words “may,” “will,” “expect,” “anticipate,” “continue,” “estimate,” “project,” “intend,” “designed,” and similar expressions, are intended to identify forward-looking statements regarding events, conditions, and financial trends that may affect the Company’s future plans of operations, business strategy, results of operations, and financial position. These statements are based on the Company’s current expectations and estimates as to prospective events and circumstances about which the Company can give no firm assurance. Further, any forward-looking statement speaks only as of the date on which such statement is made, and the Company undertakes no obligation to update any forward-looking statement to reflect future events or circumstances. Forward-looking statements should not be relied upon as a prediction of actual future financial condition or results. These forward-looking statements, like any forward-looking statements, involve risks and uncertainties that could cause actual results to differ materially from those projected or anticipated. Such risks and uncertainties include the factors set forth above and the other information set forth in this Form 10-K.

Introduction

The Boston Beer Company is engaged in the business of producing and selling alcohol beverages primarily in the domestic market and, to a lesser extent, in selected international markets. The Company’s revenues are primarily derived by selling its beverages to Distributors, who in turn sell the products to retailers and drinkers.

Most of the Company’s beverages which include flavored malt beverages, hard seltzers, beers, and hard ciders, are primarily positioned in the market for High End beer occasions. High End beers and beer occasions (the “High End category”) are determined by higher price, quality, image and taste, as compared with regular domestic beers. Boston Beer is one of the largest suppliers in the High End category in the United States. The High End category has seen high single-digit compounded annual growth over the past ten years. The Company believes that the High End category is positioned to increase market share in the total beer category, as drinkers continue to trade up in taste and quality. The Company estimates that the High End full year percentage volume changes in 2021, 2022 and 2023 were approximately 2%, (3%) and 1% respectively. These trends are above the estimated United States beer market volume changes in 2021, 2022 and 2023, of (5%), (5%) and (2%) respectively.

The market for hard seltzer products has experienced declining annual volume growth rate trends from estimated growth of 158% in 2020 and 13% in 2021 to an estimated decline of 15% in 2022 and 21% in 2023. The decline in volume trends has negatively impacted the Company's volume of depletions, or Distributor sales to retailers, and shipments, as well as its projections for the future. The decline in volume trends resulted in several supply chain related costs recorded during the second half of 2021 and 2022. These costs included provisions for excess and obsolete inventories, property, plant, and equipment impairments, write-offs of third-party production prepayments, and provisions for costs associated with the termination of various third-party production contracts.

Depletions of the Company’s beverages for the 52 week fiscal period ended December 30, 2023, decreased approximately 6% from the 53 week fiscal period in the prior year.

Depletions of the Company’s beverages for the 53 week fiscal period ended December 31, 2022, decreased approximately 5% from the comparable 52 week fiscal period in the prior year.

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Results of Operations

Year Ended December 30, 2023 (52 weeks) Compared to Year Ended December 31, 2022 (53 weeks)

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Net revenue. Net revenue decreased by $81.7 million, or 3.9%, to $2,008.6 million for the year ended December 30, 2023, as compared to $2,090.3 million for the year ended December 31, 2022, primarily as a result of lower shipment volume of $129.3 million and $12.6 million of product mix impacts, partially offset by price increases of $60.2 million.

Volume. Total shipment volume of 7,678,000 barrels for the year ended December 30, 2023 decreased by 6.2% over 2022 levels of 8,183,000 barrels, reflecting decreases in the Company’s Truly Hard Seltzer, Angry Orchard, Samuel Adams, Dogfish Head and Hard Mountain Dew brands, partially offset by increases in its Twisted Tea brand. On a 52-week comparable basis, shipment volume decreased 5.2%.

Depletions of the Company’s products for the year ended December 30, 2023 decreased by approximately 6% compared to the prior year, reflecting decreases in the Company’s Truly Hard Seltzer, Angry Orchard, Samuel Adams and Dogfish Head brands, partially offset by increases in its Twisted Tea and Hard Mountain Dew brands. On a 52-week comparable basis, depletions decreased 5%.

The Company believes distributor inventory as of December 30, 2023 averaged approximately four weeks on hand and was at an appropriate level for each of its brands.

Net Revenue per barrel. The net revenue per barrel increased by 2.4% to $261.61 per barrel for the year ended December 30, 2023, as compared to $255.44 per barrel for the year ended December 31, 2022, primarily due to price increases, partially offset by product mix impacts.

Cost of goods sold. Cost of goods sold was $150.59 per barrel for the fifty-two weeks ended December 30, 2023, as compared to $150.10 per barrel for the fifty-three weeks ended December 31, 2022. The 2023 increase in cost of goods sold of $0.49, or 0.3% per barrel was primarily due to inflationary cost impacts of $30.0 million, or $3.91 per barrel, increased third-party production shortfall fees of $6.5 million, or $0.85 per barrel, the brewery cost absorption impact due to lower volume of $6.2 million, or $0.80 per barrel, and a contract settlement cost of $4.5 million, or $0.59 per barrel partially offset by contract renegotiations and recipe optimization of $26.6 million, or $3.46 per barrel, and decreases in inventory obsolescence of $14.8 million, or $1.93 per barrel.

Inflationary impacts of $30.0 million consist primarily of increased material costs of $16.0 million, costs of third-party production of $7.6 million, and internal brewery costs of $6.4 million.

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Supply chain constraints in package materials, primarily cans, have impacted production schedules and increased can costs, as a result of using a more expensive supplier. During fiscal 2023 and 2022, the additional can costs related to use of this more expensive supplier were zero and $3.6 million, respectively. These supply chain constraints in package materials did not otherwise have a material impact on the Company’s results of operations or capital resources.

Gross profit. Gross profit was $111.01 per barrel for the year ended December 30, 2023, as compared to $105.33 per barrel for the year ended December 31, 2022. Gross margin was 42.4% for the year ended December 30, 2023, as compared to 41.2% for the year ended December 31, 2022. The increase was primarily due price increases, contract renegotiations and recipe optimization and lower inventory obsolescence partially offset by inflationary costs, increased third-party production shortfall fees and brewery cost absorption impact due to lower volume.

The Company includes freight charges related to the movement of finished goods from manufacturing locations to Distributor locations in its advertising, promotional and selling expense line item. As such, the Company’s gross margins may not be comparable to other entities that classify costs related to distribution differently.

Advertising, promotional, and selling expenses. Advertising, promotional and selling expenses, decreased $22.4 million, or 3.9%, to $556.0 million for the year ended December 30, 2023, as compared to $578.4 million for the year ended December 31, 2022. The decrease was primarily due to decreased freight to distributors of $50.9 million from lower rates and volumes, partially offset by an increase in brand investments of $28.5 million, mainly driven by higher investments in local marketing and media of $15.9 million and increased salaries and benefits costs of $14.0 million.

Advertising, promotional and selling expenses were 27.7% of net revenue, or $72.41 per barrel, for the year ended December 30, 2023, as compared to 27.7% of net revenue, or $70.68 per barrel, for the year ended December 31, 2022. The Company will invest in advertising and promotional campaigns that it believes are effective, but there is no guarantee that such investment will generate sales growth.

The Company conducts certain advertising and promotional activities in its Distributors’ markets, and the Distributors make contributions to the Company for such efforts. These amounts are included in the Company’s statement of operations as reductions to advertising, promotional and selling expenses. Historically, contributions from Distributors for advertising and promotional activities have amounted to approximately 2% of net sales. The Company may adjust its promotional efforts in the Distributors’ markets, if changes occur in these promotional contribution arrangements, depending on the industry and market conditions.

General and administrative expenses. General and administrative expenses increased by $17.0 million, or 10.8%, to $174.5 million for the year ended December 30, 2023, as compared to $157.5 million for the comparable period in 2022. The increase was primarily due to increased consulting costs of $7.5 million and increased salaries and benefits costs of $4.9 million, mainly due to higher incentive compensation.

Impairment of intangible assets. Impairment of intangible assets reflects a $16.4 million non-cash impairment charge recorded primarily for the Dogfish Head brand, taken as a result of the Company’s annual impairment analysis as of September 1, 2023. The impairment determination was primarily based on the latest forecasts of brand performance which have been below the Company’s previous projections. In fiscal 2022, the Company recorded an impairment charge of $27.1 million for the Dogfish Head brand. See further discussion in Note H to the Consolidated Financial Statements within Part II, Item 8 of this Form 10-K.

Impairment of brewery assets. Impairment of brewery assets of $5.4 million increased by $2.6 million from the prior fiscal year, due to higher write-offs of equipment at Company-owned breweries.

Contract termination costs and other. Contract termination costs decreased by $5.4 million primarily due to costs incurred during fiscal year 2022 resulting from negotiations with a supplier that terminated a production agreement.

Income tax provision. The Company’s effective tax rate for fiscal 2023 was a tax provision of 30.2% compared to 26.4% in fiscal 2022, primarily due to an increase in non-deductible officer compensation.

Liquidity and Capital Resources

The Company’s primary sources of liquidity are its existing cash balances, cash flows from operating activities and amounts available under its revolving credit facility. The Company’s material cash requirements include working capital needs, satisfaction of contractual commitments, and investment in the Company’s business through capital expenditures.

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Cash and cash equivalents and restricted cash increased to $298.5 million as of December 30, 2023 from $180.6 million as of December 31, 2022, primarily reflecting cash provided by operating activities and proceeds from the exercise of stock options and sale of investment shares, partially offset by repurchases of Class A common stock and purchases of property, plant, and equipment.

Cash provided by operating activities consists of net income, adjusted for certain non-cash items, such as depreciation and amortization, impairment of intangible assets, stock-based compensation expense, other non-cash items included in operating results, and changes in operating assets and liabilities, such as accounts receivable, inventory, prepaid expenses and other current assets, accounts payable, and accrued expenses.

Cash provided by operating activities for the year ended December 30, 2023 was $265.2 million and consisted of net income of $76.3 million, non-cash items of $124.0 million, and an inflow of $64.9 million from a net decrease in operating assets and liabilities. The inventory decrease of $31.5 million is due to improvements in supply chain process resulting in lower inventory levels and lower volumes. The third-party production prepayments decrease of $27.8 million is due to expensing of these prepayments over the respective contract terms. The accrued expenses and other current liabilities increase of $13.9 million is primarily due to increases in accrued incentive compensation compared to the prior year. The accounts receivable increase of $10.3 million is primarily due timing of shipments in the month of December compared to the prior year.

Cash provided by operating activities for the year ended December 31, 2022 was $199.9 million and consisted of net income of $67.3 million, non-cash items of $142.4 million and outflows of $9.7 million from net increases in operating assets and liabilities. The change is primarily due to a net decrease in operating assets and liabilities in fiscal 2023 compared to a net increase in fiscal 2022.

The Company used $62.4 million in investing activities during the year ended December 30, 2023, as compared to $88.5 million during the year ended December 31, 2022. Investing activities during both periods primarily consisted of capital investments made mostly in the Company’s breweries to drive efficiencies and cost reductions and support product innovation and potential future growth.

Cash used in financing activities was $84.8 million during the year ended December 30, 2023, as compared to $2.8 million provided by during the year ended December 31, 2022. The change is primarily due to $92.9 million in repurchases of Class A common stock in fiscal 2023.

During fiscal year 2023, the Company repurchased and subsequently retired 276,045 shares of its Class A Common Stock, respectively, for an aggregate purchase price of $92.9 million. As of December 30, 2023, the Company had repurchased a cumulative total of approximately 14.1 million shares of its Class A Common Stock for an aggregate purchase price of approximately $933.5 million and had approximately $266.5 million remaining on the $1.2 billion stock repurchase expenditure limit set by the Board of Directors.

The Company expects that its cash balance as of December 30, 2023 of $298.5 million and future operating cash flows, along with its $150.0 million credit facility agreement, will be sufficient to fund future cash requirements. Refer to Note K of the Notes to the Consolidated Financial Statements within Part II, Item 8 of this Form 10-K for further details of the terms of the credit facility agreement. As of the date of this filing, the Company was not in violation of any of its covenants to the lender under the credit facility.

Critical Accounting Policies

The discussion and analysis of the Company’s financial condition and results of operations is based upon its consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires the Company to make significant estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. These items are monitored and analyzed by management for changes in facts and circumstances, and material changes in these estimates could occur in the future. The more judgmental estimates are summarized below. Changes in estimates are recorded in the period in which they become known. The Company bases its estimates on historical experience and various other assumptions that the Company believes to be reasonable under the circumstances. Actual results may differ from the Company’s estimates.

Provision for Excess or Expired Inventory

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The provisions for excess or expired inventory are based on management’s estimates of forecasted usage of inventories on hand. Forecasting usage involves significant judgments regarding future demand for the Company’s various existing products and products under development as well as the potency and shelf-life of various raw material ingredients and finished goods. A significant change in the timing or level of demand for certain products as compared to forecasted amounts may result in recording additional provisions for excess or expired inventory in the future. Provision for excess or expired inventory included in cost of goods sold was $19.3 million, $35.9 million, and $62.6 million in fiscal years 2023, 2022, and 2021 respectively.

Valuation of Property, Plant, and Equipment

The carrying value of property, plant, and equipment, net of accumulated depreciation, at December 30, 2023 was $642.5 million. For purposes of determining whether there are any impairment losses on brewery assets, as further discussed below, management has historically examined the carrying value of the Company’s identifiable long-lived assets, including their useful lives, semi-annually, or more frequently when indicators of impairment are present. Evaluations of whether indicators of impairment exist involve judgments regarding the current and future business environment and the length of time the Company intends to use the asset. If an impairment loss is identified based on the fair value of the asset, as compared to the carrying value of the asset, such loss would be charged to expense in the period the impairment is identified. Furthermore, if the review of the carrying values of the long-lived assets indicates impairment of such assets, the Company may determine that shorter estimated useful lives are more appropriate. In that event, the Company will be required to record additional depreciation in future periods, which will reduce earnings. Estimating the amount of impairment, if any, requires significant judgments including identification of potential impairments, market comparison to similar assets, estimated cash flows to be generated by the asset, discount rates, the remaining useful life of the asset, and the usefulness of the asset in consideration of future business plans. Impairment of brewery assets classified as property, plant, and equipment included in operating expenses was $5.0 million, $2.6 million and $18.5 million in fiscal years 2023, 2022, and 2021, respectively.

Factors generally considered important which could trigger an impairment review on the carrying value of long-lived assets include the following: (1) significant underperformance relative to historical or projected future operating results; (2) significant changes in the manner of use of acquired assets or the strategy for the Company’s overall business; (3) underutilization of assets; and (4) discontinuance of products by the Company or its customers.

Valuation of Goodwill and Indefinite Lived Intangible Assets

The Company has recorded intangible assets with indefinite lives and goodwill for which impairment testing is required at least annually or more frequently if events or circumstances indicate that these assets might be impaired. The Company performs its annual impairment tests and re-evaluates the useful lives of other intangible assets with indefinite lives at the annual impairment test measurement date in the third quarter of each fiscal year or when circumstances arise that indicate a possible impairment or change in useful life might exist.

The Company’s annual goodwill impairment evaluation analysis conducted at the end of fiscal August indicated that the fair value of the Company’s goodwill was substantially greater than the carrying value and accordingly there was no impairment to record during fiscal 2023. The guidance for goodwill impairment testing allows an entity to assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the estimated fair value of a reporting unit, of which the Company has one, is less than its carrying amount or to proceed directly to performing a quantitative impairment test. Under the quantitative assessment, the estimated fair value of the Company’s reporting unit is compared to its carrying value, including goodwill. The estimate of fair value of the Company’s reporting unit is generally calculated based on an income approach using the discounted cash flow method supplemented by the market approach which considers the Company’s market capitalization and enterprise value. If the estimated fair value of the Company’s reporting unit is less than the carrying value of its reporting unit, a goodwill impairment will be recognized. In estimating the fair value of the Company’s reporting unit, management must make assumptions and projections regarding such items as future cash flows, future revenues, future earnings, cost of capital, and other factors. The assumptions used in the estimate of fair value are based on historical trends and the projections and assumptions that are used in the latest operating plans. These assumptions reflect management’s estimates of future economic and competitive conditions and are, therefore, subject to change as a result of changing market conditions. If these estimates or their related assumptions change in the future, the Company may be required to recognize an impairment loss for the Company’s goodwill which could have a material adverse impact on the Company’s financial statements.

The Company’s intangible assets consist primarily of a trademark and customer relationships obtained through the Company’s Dogfish Head acquisition. Customer relationships are amortized over their estimated useful lives. The Dogfish Head trademark which was determined to have an indefinite useful life is not amortized. The guidance for indefinite lived

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intangible asset impairment testing allows an entity to assess qualitative factors to determine whether the existence of events or circumstances indicates that it is more likely than not that the indefinite lived intangible asset is impaired or to proceed directly to performing the quantitative impairment test. Under the quantitative assessment, the trademark is evaluated for impairment by comparing the carrying value of the trademark to its estimated fair value. The estimated fair value of the trademark is calculated based on an income approach using the relief from royalty method. If the estimated fair value is less than the carrying value of the trademark, then an impairment charge is recognized to reduce the carrying value of the trademark to its estimated fair value.

Significant judgment is required to estimate the fair value the Dogfish Head trademark. Accordingly, the Company obtains the assistance of third-party valuation specialists as part of the impairment evaluation. In estimating the fair value of the trademark, management must make assumptions and projections regarding future cash flows based upon future revenues, the market-based royalty rate, the discount rate, and the after-tax royalty savings expected from ownership of the trademark. The assumptions and projections used in the estimate of fair value are consistent with recent trends and represent the projections used in the Company’s current strategic operating plans which include reductions in revenues from the Dogfish Head beer products which were partially offset with revenue growth from the new Dogfish Head canned cocktails products that were launched in 2021. These assumptions reflect management’s estimates of future economic and competitive conditions and consider many factors including macroeconomic conditions, industry growth rates, and competitive activities and are, therefore, subject to change as a result of changing market conditions. If these estimates or their related assumptions change in the future, we may be required to recognize an additional impairment charge for the asset. The recognition of any resulting impairment charge could have a material adverse impact on the Company's financial statements.

The Company performed a sensitivity analysis on its significant assumptions used in the Dogfish Head trademark fair value calculation and determined the following:

•
A decrease in the annual forecasted revenue growth rate of 1.0% would result in a 5.2% decrease to the current fair value of $55.6 million.

•
An increase in the discount rate of 1.5% would result in a 11.7% decrease to the current fair value of $55.6 million.

Revenue Recognition and Classification of Customer Programs and Incentives

The Company recognizes revenue when obligations under the terms of a contract with its customer are satisfied; generally, this occurs with the transfer of control of its products. Revenue is measured as the amount of consideration expected to be received in exchange for transferring products. If the conditions for revenue recognition are not met, the Company defers the revenue until all conditions are met. As of December 30, 2023 and December 31, 2022, the Company had deferred revenue of $8.9 million and $6.8 million, respectively, related to product shipped prior to these dates for which the criteria to recognize revenue was not met as of these dates. These amounts are included in accrued expenses and other current liabilities in the accompanying consolidated balance sheets.

The Company is committed to maintaining the freshness of its products in the market. In certain circumstances and with the Company’s approval, the Company accepts and destroys or offers credits for stale beer that is returned or destroyed by Distributors. The Company generally credits approximately fifty percent of the distributor’s cost of beer that has passed its freshness expiration date when it is returned to the Company or destroyed. The Company reduces revenue and establishes an accrual based upon both historical returns, which is applied to an estimated lag time for receipt of product, and knowledge of specific return transactions. Estimating this reserve involves significant judgments and estimates, including comparability of historical return trends to future trends, lag time from date of sale to date of return, and product mix of returns. Stale beer expense is reflected in the accompanying financial statements as a reduction of revenue. Historically, the cost of actual stale beer returns has been in line with established reserves; however, the cost could differ materially from the reserves which would impact revenue. As of December 30, 2023, and December 31, 2022, the stale beer reserve was $8.2 million and $5.6 million, respectively. These amounts are included in accrued expenses and other current liabilities in the accompanying consolidated balance sheets.

Customer programs and incentives are a common practice in the alcohol beverage industry. Amounts paid in connection with customer programs and incentives are recorded as reductions to net revenue or as advertising, promotional and selling expenses, based on the nature of the expenditure. Customer incentives and other payments made to Distributors are primarily based upon the performance of certain marketing and advertising activities. Depending on applicable state laws and regulations, these activities promoting the Company’s products may include, but are not limited to, point-of-sale and merchandise placement, samples, product displays, promotional programs at retail locations and meals, travel and entertainment. Amounts paid to customers in connection with these programs that were recorded as reductions to net revenue or as advertising, promotional and selling expenses totaled $106.4 million, $95.9 million and $126.1 million in fiscal years

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2023, 2022, and 2021, respectively. Estimates are based on historical and projected experience for each type of program or customer and have historically been in line with actual costs incurred.

Customer promotional discount programs are entered into with Distributors for certain periods of time. Amounts paid to Distributors in connection with these programs in fiscal years 2023, 2022, and 2021 were $62.6 million, $54.8 million and $72.7 million, respectively. The reimbursements for discounts to Distributors are recorded as reductions to net revenue. The agreed-upon discount rates are applied to certain Distributors’ sales to retailers, based on volume metrics, in order to determine the total discounted amount. The computation of the discount allowance requires that management make certain estimates and assumptions that affect the timing and amounts of revenue and liabilities recorded. Actual promotional discounts owed and paid have historically been in line with allowances recorded by the Company; however, the amounts could differ from the estimated allowances.

Customer incentives and other payments are made primarily to Distributors based upon the performance of certain marketing and advertising activities. Depending on applicable state laws and regulations, these activities promoting the Company’s products may include, but are not limited to point-of-sale and merchandise placement, samples, product displays, promotional programs at retail locations and meals, travel and entertainment. Amounts paid to customers in connection with these programs in fiscal years 2023, 2022, and 2021 were $43.8 million, $41.1 million and $53.4 million, respectively. In fiscal years 2023, 2022, and 2021, the Company recorded certain of these costs in the total amount of $31.4 million, $29.9 million and $42.0 million, respectively as reductions to net revenue. Costs recognized in net revenues include, but are not limited to, promotional discounts, sales incentives and certain other promotional activities. Costs recognized in advertising, promotional and selling expenses include point of sale materials, samples and media advertising expenditures in local markets. These costs are recorded as incurred, generally when invoices are received; however certain estimates are required at the period end. Estimates are based on historical and projected experience for each type of program or customer and have historically been in line with actual costs incurred.

In connection with its preparation of financial statements and other financial reporting, management is required to make certain estimates and assumptions regarding the amount, timing and classification of expenditures resulting from these activities. Actual expenditures incurred could differ from management’s estimates and assumptions.

Stock-Based Compensation

The Company accounts for share-based awards in accordance with ASC Topic 718, Compensation – Stock Compensation (“ASC 718”), which generally requires recognition of share-based compensation costs in financial statements based on fair value. Compensation cost is recognized over the period during which an employee is required to provide services in exchange for the award (the requisite service period). The amount of compensation cost recognized in the consolidated statements of comprehensive income is based on the awards ultimately expected to vest, and therefore, reduced for estimated forfeitures. Stock-based compensation was $17.0 million, $14.0 million and $18.6 million in fiscal years 2023, 2022, and 2021, respectively.

As permitted by ASC 718, the Company elected to use a lattice model, such as the trinomial option-pricing model, to estimate the fair values of stock options. All option-pricing models require the input of subjective assumptions. These assumptions include the estimated volatility of the Company’s common stock price over the expected term, the expected dividend rate, the estimated post-vesting forfeiture rate, the risk-free interest rate and expected exercise behavior. See Note N for further discussion of the application of the option-pricing models.

In addition, an estimated pre-vesting forfeiture rate is applied in the recognition of the compensation charge. Periodically, the Company grants performance-based stock options. The Company only recognizes compensation expense with respect to these options if it is probable that the performance targets will be met. Consequently, at the end of each reporting period, the Company estimates whether it is probable that performance targets will be met. Changes in the subjective assumptions and estimates can materially affect the amount of stock-based compensation expense recognized in the consolidated statements of comprehensive income.

Business Environment

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The alcoholic beverage industry is highly regulated at the federal, state and local levels. The TTB and the Justice Department’s Bureau of Alcohol, Tobacco, Firearms and Explosives enforce laws under the Federal Alcohol Administration Act. The TTB is responsible for administering and enforcing excise tax laws that directly affect the Company’s results of operations. State and regulatory authorities have the ability to suspend or revoke the Company’s licenses and permits or impose substantial fines for violations. The Company has established strict policies, procedures and guidelines in efforts to ensure compliance with all applicable state and federal laws. However, the loss or revocation of any existing license or permit could have a material adverse effect on the Company’s business, results of operations, cash flows and financial position.

The High End category and the Beyond Beer category within the United States are highly competitive due to large domestic and international brewers and the increasing number of craft brewers in this category who distribute similar products that have similar pricing and target drinkers. The Company believes that its pricing is appropriate given the quality and reputation of its brands, while realizing that economic pricing pressures may affect future pricing levels. Large domestic and international brewers are able to compete more aggressively than the Company, as they have substantially greater resources, marketing strength and distribution networks than the Company. The Company anticipates competition among domestic craft brewers will remain strong, as the number of craft brewers continues to grow. The Company also increasingly competes with wine and spirits companies, some of which have significantly greater resources than the Company. This competitive environment may affect the Company’s overall performance within the High End category. As the market matures and the High End category continues to consolidate, the Company believes that companies that are well-positioned in terms of brand equity, marketing and distribution will have greater success than those who do not. With its over 300 Distributors nationwide and the Company’s sales force of over 475 people, as well as a commitment to maintaining its innovation capability, brand equity and quality, the Company believes it is well positioned to compete in the High End Beer category.