Company Quick10K Filing
Quick10K
Craft Brew Alliance
Closing Price ($) Shares Out (MM) Market Cap ($MM)
$14.20 19 $275
10-K 2018-12-31 Annual: 2018-12-31
10-Q 2018-09-30 Quarter: 2018-09-30
10-Q 2018-06-30 Quarter: 2018-06-30
10-Q 2018-03-31 Quarter: 2018-03-31
10-K 2017-12-31 Annual: 2017-12-31
10-Q 2017-09-30 Quarter: 2017-09-30
10-Q 2017-06-30 Quarter: 2017-06-30
10-Q 2017-03-31 Quarter: 2017-03-31
10-K 2016-12-31 Annual: 2016-12-31
10-Q 2016-09-30 Quarter: 2016-09-30
10-Q 2016-06-30 Quarter: 2016-06-30
10-Q 2016-03-31 Quarter: 2016-03-31
10-K 2015-12-31 Annual: 2015-12-31
10-Q 2015-09-30 Quarter: 2015-09-30
10-Q 2015-06-30 Quarter: 2015-06-30
10-Q 2015-03-31 Quarter: 2015-03-31
10-K 2014-12-31 Annual: 2014-12-31
10-Q 2014-09-30 Quarter: 2014-09-30
10-Q 2014-06-30 Quarter: 2014-06-30
10-Q 2014-03-31 Quarter: 2014-03-31
10-K 2013-12-31 Annual: 2013-12-31
8-K 2019-02-04 Officers
8-K 2018-12-28 Officers
8-K 2018-12-21 Officers
8-K 2018-10-10 Enter Agreement, M&A, Off-BS Arrangement, Regulation FD, Exhibits
8-K 2018-06-16 Officers, Regulation FD, Exhibits
8-K 2018-06-13 Officers
8-K 2018-05-29 Officers
8-K 2018-05-16 Shareholder Vote
8-K 2018-02-01 Officers
8-K 2018-01-12 M&A, Regulation FD, Exhibits
EXPE Expedia 18,540
WK Workiva 2,280
MLHR Miller Herman 2,220
OXFD Oxford Immunotec Global 417
SFS Smart & Final Stores 412
OFED Oconee Federal Financial 151
CHHE China Health Industries Holdings 0
NWGI Newgioco Group 0
IBAL International Baler 0
DSW DSW 0
BREW 2018-12-31
Part I
Item 1. Business
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Mine Safety Disclosures
Part II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
Note 1. Nature of Operations
Note 2. Significant Accounting Policies
Note 3. Recent Accounting Pronouncements
Note 4. Inventories
Note 5. Acquisitions and Investments
Note 6. Other Current Assets and Other Accrued Expenses
Note 7. Property, Equipment and Leasehold Improvements
Note 8. Goodwill and Intangible, Equity Method Investment and Other Assets
Note 9. Debt and Capital Lease Obligations
Note 10. Derivative Financial Instruments
Note 11. Fair Value Measurements
Note 12. Revenue Recognition
Note 13. Segment Results and Concentrations
Note 14. Stock-Based Plans and Stock-Based Compensation
Note 15. Earnings per Share
Note 16. Income Taxes
Note 17. Employee Benefit Plans
Note 18. Commitments and Contingencies
Note 19. Related Party Transactions
Note 20. Brewing Arrangement and Termination Thereof with Pabst Northwest Brewing Company
Note 21. Assets Held for Sale and Sale of Woodinville, Washington Brewery
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Item 9B. Other Information
Part III
Item 10. Directors, Executive Officers and Corporate Governance
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions, and Director Independence
Item 14. Principal Accountant Fees and Services
Part IV
Item 15. Exhibits and Financial Statement Schedules
Item 16. Form 10-K Summary
EX-10.9 cba-20182131xex109.htm
EX-10.10 cba-2018x1231xex1010.htm
EX-10.11 cba-20181231xex1011.htm
EX-10.12 cba-20181231xex1012.htm
EX-10.14 cba-20181231xex1014.htm
EX-10.16 cba-20181231xex1016.htm
EX-10.19 cba-20181231xex1019.htm
EX-10.29 cba-20181231xex1029.htm
EX-21.1 cba-20181231xex211.htm
EX-23.1 cba-20181231xex231.htm
EX-24.1 cba-20181231xex241.htm
EX-31.1 cba-20181231xex311.htm
EX-31.2 cba-20181231xex312.htm
EX-32.1 cba-20181231xex321.htm
EX-99.1 cba-20181231xex991.htm
EX-99.2 cba-12312018xex992.htm

Craft Brew Alliance Earnings 2018-12-31

BREW 10K Annual Report

Balance SheetIncome StatementCash Flow

10-K 1 cba201810-k.htm CBA 2018 10-K Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
_____________________________
 ☒          ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended: December 31, 2018
OR
☐          TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 0-26542

CRAFT BREW ALLIANCE, INC.
(Exact name of registrant as specified in its charter)
Washington
 
91-1141254
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
929 North Russell Street
 
 
Portland, Oregon
 
97227-1733
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code:  (503) 331-7270
Securities Registered pursuant to Section 12(b) of the Act:
 
 
Title of each class
 
Name of each exchange on which registered
Common Stock, $0.005 par value
 
The NASDAQ Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act: None
 ________________

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes ☐ No☒
 
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes ☐ No ☒
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes ☒ No ☐
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒  No ☐
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form 10-K.   ☒
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. (See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act). Check one: 
Large Accelerated Filer ☐
 
Accelerated Filer ☒
Non-accelerated Filer ☐ (Do not check if a smaller reporting company)
 
Smaller Reporting Company ☐
 
 
Emerging Growth Company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐  No ☒
 
The aggregate market value of the common equity held by non-affiliates of the registrant as of the last day of the registrant’s most recently completed second quarter on June 29, 2018 (based upon the closing price of the registrant’s common stock, as reported by the NASDAQ Stock Market, of $20.65 per share) was $261,465,571.
 
The number of shares outstanding of the registrant’s common stock as of February 28, 2019 was 19,382,641 shares.

Documents Incorporated by Reference
Portions of the registrant’s definitive Proxy Statement for the 2019 Annual Shareholders’ Meeting are incorporated by reference into Part III.
 



CRAFT BREW ALLIANCE, INC.
2018 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
 
 
Page
 
PART I
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 1B.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
PART II
 
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
Item 7.
 
 
 
Item 7A.
 
 
 
Item 8.
 
 
 
Item 9.
 
 
 
Item 9A.
 
 
 
Item 9B.
 
 
 
 
PART III
 
 
 
 
Item 10.
 
 
 
Item 11.
 
 
 
Item 12.
 
 
 
Item 13.
 
 
 
Item 14.
 
 
 
 
PART IV
 
 
 
 
Item 15.
 
 
 
Item 16.
 
 
 
 

1


INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

This annual report on Form 10-K includes forward-looking statements. Generally, the words “believe,” “expect,” “intend,” “estimate,” “anticipate,” “project,” “will,” ”may,” “plan” and similar expressions or their negatives identify forward-looking statements, which generally are not historical in nature. These statements are based upon assumptions and projections that we believe are reasonable, but are by their nature inherently uncertain. Many possible events or factors could affect our future financial results and performance, and could cause actual results or performance to differ materially from those expressed, including those risks and uncertainties described in “Item 1A. - Risk Factors” and those described from time to time in our future reports filed with the Securities and Exchange Commission. Caution should be taken not to place undue reliance on these forward-looking statements, which speak only as of the date of this annual report.
 
THIRD-PARTY INFORMATION

In this report, we rely on and refer to information regarding industry data obtained from market research, publicly available information, industry publications, U.S. government sources or other third parties. Although we believe that the third-party sources of information we use are materially complete, accurate and reliable, there is no assurance of the accuracy, completeness or reliability of third-party information.

PART I

Item 1. Business

Overview

Craft Brew Alliance, Inc. ("CBA") is the seventh largest craft brewing company in the U.S. and a leader in brewing, branding, and bringing to market world-class American craft beers.

Our distinctive portfolio combines the power of Kona Brewing Co., one of the top craft beer brands in the world, with strong regional breweries and innovative lifestyle brands, including Appalachian Mountain Brewery ("AMB"), Cisco Brewers, Omission Brewing Co., Redhook Brewery, Square Mile Cider Co., Widmer Brothers Brewing, and Wynwood Brewing Co. We nurture the growth and development of our brands in today’s increasingly competitive beer market through our state-of-the-art brewing and distribution capability, integrated sales and marketing infrastructure, and strong focus on innovation, local community and sustainability.

CBA was formed in 2008 through the merger of Redhook Brewery and Widmer Brothers Brewing, the two largest craft brewing pioneers in the Northwest at the time. Following a successful strategic brewing and distribution partnership, Kona Brewing Co. joined CBA in 2010. As part of CBA, Kona has expanded its reach across all 50 U.S. states and approximately 30 countries, while remaining deeply rooted in its home of Hawaii.

As consumers increasingly seek more variety and more local offerings, Craft Brew Alliance has expanded its portfolio and home markets with strong regional craft beer brands in targeted markets. In 2015 and 2016, we formed strategic partnerships with Appalachian Mountain Brewery, based in Boone, North Carolina; Cisco Brewers, based in Nantucket, Massachusetts; and Wynwood Brewing Co., based in the heart of Miami’s vibrant multicultural arts district. Building on the success of these partnerships, we acquired all three brands in the fourth quarter of 2018, fundamentally transforming our footprint and paving the way to increase our investments in their growth and drive shareholder value.

Publicly traded on NASDAQ under the ticker symbol BREW, Craft Brew Alliance is headquartered in Portland, Oregon and operates breweries and brewpubs across the U.S. For more information about CBA and its brands, see “Available Information” on page 14 of this report.

We proudly brew and package our craft beers in three company-owned production breweries located in Portland, Oregon; Portsmouth, New Hampshire; and Kailua-Kona, Hawaii. In 2018, we continued to leverage our contract brewing agreement with A-B Commercial Strategies, LLC (“ABCS”), an affiliate of Anheuser-Busch, LLC (“A-B”), through which we brew select CBA brands in A-B’s Fort Collins, Colorado brewery. Additionally, we own and operate five innovation breweries in Portland, Oregon; Seattle, Washington; Portsmouth, New Hampshire; Boone, North Carolina; and Miami, Florida, which are primarily used for small-batch production and limited-release beers offered primarily in our brewpubs and brands’ home markets.

We distribute our beers to retailers through wholesalers that are aligned with the A-B network. These sales are made pursuant to a Master Distributor Agreement (the “A-B Distributor Agreement”) with A-B, which extends through 2028. As a result of this

2


distribution arrangement, we believe that, under alcohol beverage laws in a majority of states, these wholesalers would own the exclusive right to distribute our beers in their respective markets if the A-B Distributor Agreement expires or is terminated. As competition puts increasing pressure on craft brands outside of their home markets, we are continuing our efforts to stabilize and strengthen Widmer Brothers and Redhook in the Pacific Northwest, while expanding distribution of Appalachian Mountain Brewery, Cisco Brewers, and Wynwood Brewing Co. across their respective home markets of North Carolina, New England, and South Miami.

Separate from our A-B wholesalers, we maintain an internal independent sales and marketing organization with resources across the key functions of brand management, field marketing, field sales, and national retail sales.

We operate in two segments: Beer Related operations and Brewpubs operations. Beer Related operations include the brewing, and domestic and international sales, of craft beers and ciders from our breweries. Brewpubs operations primarily include our seven brewpubs, six of which are located adjacent to our Beer Related operations, as well as other merchandise sales, and sales of our beers directly to customers.

Industry Background

We are one of the top seven brewers in the craft brewing segment of the U.S. brewing industry. The domestic beer market includes ales and lagers produced by large domestic brewers, international brewers and craft brewers. As the overall domestic market experienced a decrease in shipments of 1% in 2018, the craft beer segment began to show signs of a slowdown. Shipments of craft beer in the U.S. are estimated by industry sources to have decreased by only 0.6% in 2018 over 2017, compared to a 1.4% increase in 2017 over 2016. Of total beer shipped in the U.S., craft beer shipments were approximately 14.3% in 2018 and 14.2% in 2017. Approximately 29.0 million barrels and 29.2 million barrels, respectively, were shipped in the U.S. by the craft beer segment during 2018 and 2017, while total beer sold in the U.S., including imported beer, was 202.6 million barrels and 204.6 million barrels, respectively. Compared with the other segments of the U.S. brewing industry, craft brewing is a relative newcomer. Twenty years ago, Redhook and Widmer Brothers Brewery were two of the approximately 200 craft breweries in operation. By the end of 2018, the number of craft breweries in operation had grown to more than 7,000. Industry sources estimate that craft beer produced by regional and national craft brewers, similar to us, accounts for approximately two-thirds of total craft beer sales, with one-third of the production brewed by smaller craft breweries.

Our comprehensive portfolio and national scale provide a competitive advantage in today’s market environment, which includes craft brewers, domestic specialty beers, and imports. Our distinctive brand portfolio is positioned to address significant changes in consumer trends, including increased demand for innovative flavors and styles, a growing interest in sustainability, and the increasing importance of local relevance. As an example, Kona Brewing is one of the top craft brewers, with a broad portfolio of beers that reflect a uniquely Hawaii-inspired flavor profile, a recognized track record in sustainable business practices, and deep ties to its local community as Hawaii’s longest-running craft brewery.

Business Strategy

At Craft Brew Alliance, we believe we have an advantaged strategy to sustain long-term growth in today’s increasingly complex beer market.

The central elements of our business strategy include:
Increased focus on topline growth, driving our Kona Plus portfolio strategy, supporting our strong regional craft brands in their home markets, and unlocking the potential of Kona as a global lifestyle brand.
Building on healthy business fundamentals, including strong revenue management and improved supply chain execution to expand gross margin.
Actualizing the future, through leveraging CBA’s enhanced partnership agreements with Anheuser-Busch to drive growth, value and cost savings, while continuing to explore potential new opportunities for innovation and to invest in our talent and culture.

Key Differentiators

Following are key differentiators that create competitive advantage for CBA in today’s rapidly evolving craft beer segment.

A distinctive portfolio of authentic craft beer brands anchored by Kona Brewing Co., which combines the power of one of the largest craft beer brands in the U.S with a strong stable of award-winning regional craft brands.
A transformational strategic relationship with Anheuser-Busch InBev, through which we have been able to gain access to the best route to market in the industry, optimize our brewery footprint, and support Kona’s global growth.

3


A national brewing footprint that allows us to get our beers to market faster, fresher and more efficiently. We have significant flexibility to fully leverage the specific strengths of our distinct breweries and operations, as well as A-B's Fort Collins, Colorado brewery. Additionally, we guarantee the quality and consistency of all of our products through fine-tuned processes designed to ensure that everything, from brewing to quality-assurance to warehousing and distribution, meets our high standards. We believe that maximizing production under our direct supervision and through accomplished and expert partners is critical to our success. Further, we believe that our ability to engage in ongoing product innovation while controlling product quality provides critical competitive advantages. Each of our breweries is modern, has flexible production capabilities, and is designed to produce beer in smaller batches compared to the national domestic brewers, thereby allowing us to brew a wide variety of brand offerings. We believe that our investment in brewing and logistics technologies enables us to minimize brewery operating costs and consistently produce innovative beer styles.
Nationwide sales activation through robust partnerships with leading retailers. We leverage our national sales and marketing capabilities and complementary brand families to create a unique identity in the distribution channel and with the consumer.
National seamless distribution as an aligned brand within the Anheuser-Busch wholesaler network. This distribution footprint provides efficiencies in logistics and product delivery, state reporting and licensing, billing and collections. We have realized these efficiencies while maintaining full autonomy over the production, sale and marketing of our products as an independent craft beer company.
An experienced leadership team with expertise in the beer and beverage industries. The team has a proven ability to manage brand lifecycles, from development to turnaround, in both large and growth-company settings.
A commitment to innovation. In 2018, we launched the most comprehensive consumer research initiative in our company history, including pH, a quick test-and-learn product experiment, and two consumer-based studies with global consultancy Prophet and the Yale Center for Consumer Insights.

Strategic Partner Acquisitions

On October 10, 2018, we announced the acquisition of our three craft partner brands -- North Carolina-based Appalachian Mountain Brewery, Massachusetts-based Cisco Brewers, and Florida-based Wynwood Brewing Co. -- to begin unlocking the full potential of our expanded portfolio. The acquisitions build on our successful craft partnership strategy, launched in 2015. Over the past several years, the partnerships with AMB, Cisco, and Wynwood have bolstered CBA’s portfolio, anchored by Kona Brewing Co., with strong local brands and innovation breweries in key markets. Further, the partnerships helped propel CBA’s strategic brewery evolution by leveraging the production capability and location of the Portsmouth, New Hampshire brewery as CBA rebalanced its brewing footprint.
Under the purchase agreement with AMB, CBA acquired the AMB brand, brewery, and pub. The transaction closed November 29, 2018.
Under the agreement between CBA and Cisco, which closed October 10, 2018, CBA acquired the intellectual property assets of Cisco relating to its malt beverage products. Cisco’s founders continue to own and operate the Cisco Brewers brewpub properties and retail merchandising, including the original brewery and grounds in Nantucket.
Under CBA’s agreement with Wynwood Brewing Co., which also closed October 10, 2018, CBA purchased the remaining 75.5 percent equity interest in the Miami-based brewery, which became a wholly owned subsidiary of CBA. Wynwood’s operations will continue under the leadership of Co-founders Luis and his father “Pops” Brignoni.

Collectively, the acquisitions represent a milestone in enabling CBA and its shareholders to fully participate in the value that the partners will bring as wholly owned CBA brands.

Brand Overview

Our portfolio includes national brands Kona Brewing Company and Omission Brewing, as well as regional craft brands Appalachian Mountain Brewery, Cisco Brewers, Redhook Brewery, Square Mile Cider Company, Widmer Brothers Brewing, and Wynwood Brewing Co. with deep community roots.

We produce a variety of specialty craft beers and ciders using traditional brewing methods complemented by American innovation and invention. We brew our beers using high-quality hops, malted barley, wheat, rye and other natural traditional and nontraditional ingredients. To craft our ciders, we use three apple varieties from the Pacific Northwest and then use a lager beer yeast to make a unique and easy-to-drink hard cider.


4


Below is an overview of our eight owned brands:

Kona Brewing Company
Kona Brewing Company was started in Kailua-Kona on the Island of Hawaii in the spring of 1994 by father and son team Cameron Healy and Spoon Khalsa, who had a dream to create fresh, local island brews made with spirit, passion and quality.

Today, Kona is Hawaii’s largest and favorite craft brewery, known for top-selling flagship beers Big Wave Golden Ale and Longboard Island Lager and award-winning innovative small-batch beers available across the islands. The Hawaii born and Hawaii-based craft brewery prides itself on brewing the freshest beer of exceptional quality closest to market. This helps to minimize its carbon footprint by reducing shipping of raw materials, finished beer and packaging materials. In 2019, Kona will open a new 100,000-barrel solar and battery-powered brewery in Kailua-Kona, which will allow Kona to brew more beer on the islands and meet increasing demand in its home state,while saving precious natural resources.

Kona Brewing Company has become one of the top craft beer brands in the world, while remaining steadfastly committed to its home market through a strong focus on innovation, sustainability and community outreach.

Omission Beer
Founded in 2012, Omission Brewing Co. is the first craft beer brand in the U.S. focused exclusively on brewing great-tasting beers with traditional beer ingredients, including malted barley, that are specially crafted to remove gluten. Each batch of Omission Beer is tested independently using the R5 competitive ELISA test to ensure that it contains gluten levels below the U.S. Food and Drug Administration (“FDA”) gluten-free standard of 20ppm or less. Omission’s line up of beers is the most awarded within the gluten reduced segment, and includes Omission Lager, Omission Pale Ale, Omission IPA, and Omission Ultimate Light Golden Ale, a full-flavored gluten-reduced ale with only 99 calories and 5 carbs, released in 2017.

Appalachian Mountain Brewery
Nestled in the High Country of North Carolina, Appalachian Mountain Brewery is Boone, NC’s beer pioneer. The brewery is dedicated to making seriously delicious craft beer while focusing its business model on community, sustainability and philanthropy. Through its beers, AMB supports a variety of non-profits that are dedicated to enriching the land, water, air and people of the High Country. Appalachian Mountain Brewery has earned numerous awards for its innovative craft beers and ciders, including Boone Creek Blonde Ale, which won a Gold Medal at the 2015 U.S. Open Beer Championships and a Gold Medal at the 2017 Great American Beer Festival Competition, as well as Not a Double IPA, which won a Silver Medal at the 2018 Great American Beer Festival. The brewery’s core portfolio also includes Long Leaf IPA, Spoaty Oaty Pale Ale, and Porter, which was a gold medal winner at the 2015 Great International Beer and Cider Competition.

Cisco Brewers
Located near Cisco Beach on the island of Nantucket, Cisco Brewers is Nantucket’s first craft brewery. Founded by hard-working, entrepreneurial islanders who began selling beer from their outdoor brewery in 1995, Cisco has carved out its own special place on Nantucket where they tough out the winters to celebrate the summers. Over the years they’ve attracted a cult following with visitors to the island and open the door to anyone willing to make the trek. Named a top travel destination by Time Magazine, Huffington Post, Travel & Leisure and Men's Journal, Cisco’s brewery is a common ground where people from all walks of life connect over classic and approachable craft beers like Whale’s Tale Pale Ale, Grey Lady Ale, Sankaty Light Lager, and most recently, Gripah IPA. In addition to its Nantucket location, Cisco operates a brewpub in Portsmouth, New Hampshire and opens seasonal pop-up pubs in New England.

Redhook Brewery
Redhook was born out of the entrepreneurial spirit of the early 1980s in the heart of Seattle. While the term didn’t exist at the time, Redhook became one of America’s first craft breweries with its focus on creating a better beer. From a modest start in a former transmission shop in the Seattle neighborhood of Ballard, to a Fremont trolley barn that housed The Trolleyman brewpub, to its current brewery in Seattle, Washington, Redhook continues its passion for brewing innovative beers that stand apart in today’s crowded craft beer marketplace.

Redhook opened Brewlab, an experimental 10-barrel brewery and pub, in the Capitol Hill neighborhood of Seattle in 2017.

Redhook’s beer lineup includes Big Ballard IPA, Bicoastal IPA, ESB, Long Hammer IPA and a variety of seasonal beers, including My Oh My Caramel Macchiato Milk Stout, Tangelic Halo Tangerine IPA, Winterhook, and more.

Square Mile Cider Company
Launched in 2013, Square Mile Cider is the hard cider for the modern-day pioneers celebrating the spirit of the Pacific Northwest. We set out to reinvigorate an enduringly classic American beverage with a blend of hand-selected apples combined with unique

5


Northwest ingredients. Square Mile Cider produces three varieties of hard cider: Original Apple Cider, Hopped Apple Cider, and Rosé Apple Cider, which debuted in 2017 as one of the first rosé ciders in the market.

Widmer Brothers Brewing
Widmer Brothers Brewing was founded in 1984 in Portland, Oregon. Brothers Kurt and Rob Widmer, with help from their father, Ray, helped lead the Pacific Northwest craft beer movement when they began brewing unique interpretations of traditional German beer styles. In 1986, Widmer Brothers Brewing introduced the original American-style Hefeweizen, which elevated the brewery to national acclaim. Since then, Hefe has grown to become Oregon’s favorite craft beer and the brewery has continued to push the boundaries, developing beers with an unapologetic, uncompromised commitment to innovation.

Widmer Brothers currently brews a variety of award-winning beers. Its flagship Hefe, has won more than 30 medals, including nine from the Great American Beer Festival. The brewery’s other beers include Upheaval IPA, Drop Top Amber Ale, and a full seasonal lineup.

Wynwood Brewing Company
Wynwood Brewing Company is Miami’s first craft production brewery. Founded by Luis Brignoni and his father Luis “Pops” Brignoni Sr., Wynwood is deeply rooted in its founders’ Puerto Rican heritage and the brewery’s namesake neighborhood, the vibrant Wynwood Arts District. Wynwood Brewing Co. operates a 15-barrel brewhouse and taproom in the heart of the Wynwood Art District and distributes a variety of year-round, seasonal and limited beer offerings throughout South Florida, including flagship La Rubia Blonde Ale, Laces IPA, and Pop’s Porter, which earned a Gold Medal at the 2014 Great American Beer Festival.

Developments in Brands and Packaging

Our recent brand and packaging developments include:

Kona Brewing
In 2018, Kona Brewing Co. expanded its portfolio with two new national brands, Kanaha Blonde Ale, a refreshing ale made with real mango fruit, and Gold Cliff IPA, a bold, hoppy IPA with tropical pineapple. Building on increasing consumer trends around living an active lifestyle, Kanaha Blonde Ale is only 99 calories, 4 carbs, and 4.2% ABV.

As with all of Kona’s beers, Kanaha Blonde Ale and Gold Cliff IPA were named for real locations and experiences in Hawaii. The low-calorie and refreshing Kanaha was named for the popular kite-surfing beaches of Kanaha on the North Shore of Maui. And the bold, juicy 7.2% ABV Gold Cliff IPA pays homage to the southern tip of Lanai, where the island’s first pineapple field sits atop cliffs that overlook cobalt blue waters. 2018 represented another year of robust growth for Kona, which grew volumes by 7%, exceeding the growth rate for the overall craft category. Kona’s growth was primarily led by flagship Big Wave, which grew depletions by 8% over 2017, and Longboard Lager, with distribution across all 50 states and approximately 30 international markets. In response to continued demand for its flagships in its home market, Kona also released Big Wave Golden Ale and Longboard Lager in new 18-packs of 12oz cans in Hawaii.

Omission Brewing Co.
Omission Brewing Co. remains the market leader in the gluten-removed beer category. In 2018, Omission expanded distribution of its newest national brand, Omission Ultimate Light, a refreshing 5-carb, 99-calorie gluten removed golden ale. Ultimate Light joins Omission’s national portfolio which includes Omission IPA, Omission Lager,  and Omission Pale Ale - which earned a Silver Medal at the 2018 Great American Beer Festival. In 2018, Omission continued to expand distribution of Ultimate Light in 12oz cans in four U.S markets, Austin, Boston, Denver, and Phoenix.

Widmer Brothers Brewing
In 2018, Widmer Brothers continued to focus on the brewery’s flagship Hefe, which is the best-selling craft beer in Oregon. The brewery celebrated Hefe Day in May 2018 with a celebration at the taproom and adjacent beer garden featuring $0.86 Hefe specials. In December 2018, Widmer Brothers launched co-branded Portland Trail Blazers 16oz. Hefe cans, building on the longest-running craft beer partnership in the NBA and further supporting their award-winning flagship, which picked up its ninth medal from the Great American Beer Festival Competition in 2018.

Widmer Brothers added fan favorites Deadlift Imperial IPA and Green & Gold Kolsch to their 2018 seasonal lineup. Deadlift Imperial IPA, a bold double IPA that packs a flavorful hop punch and a smooth finish, was originally brewed in 2010 under a different name. The beer released in 6-packs, 12-packs, and draft as the spring seasonal and transitioned to a year-round offering in the fall. Green & Gold Kolsch, a crisp, golden-colored beer with aromas of strawberry and cracked black pepper, released in April 2018 as Widmer Brothers’ summer seasonal.


6


As a tribute to the neighborhood and city that has supported the brewery for over 30 years, Widmer Brothers introduced the Portland Pub Series Variety Pack, featuring beers that originated in the 10-barrel innovation brewery, including Russell Street IPA, PDX Pils, Steel Bridge Porter, and Hefe X, a rotating series featuring the brewery’s flagship Hefe with additions of different hop varietals. Widmer Brothers also launched several small-batch cans and bottles from the innovation brewery throughout the year, including Closing Time IPA, brewed in collaboration with rideshare company Lyft, which included a unique code to receive a ride discount. The brewery also released Le Petit Brasseur, one of the first craft beers bottled in reusable 500ml bottles in partnership with Oregon Bottle Drop.

Redhook Brewery
In 2018, Redhook bolstered its year-round portfolio, which includes Big Ballard Imperial IPA, Long Hammer IPA, ESB, and Bicoastal IPA, adding four new beers to its seasonal and Brewlab Limited Release Series lineups. My Oh My Caramel Macchiato Milk Stout, a rich, espresso-driven milk stout brewed with coffee and dark malts, released in January as a spring seasonal, and Tangelic Halo IPA, a tangerine IPA packed with naturally citrusy hops, debuted in May as the summer seasonal.

Building on the success of the Brewlab Limited Release Series in 2017, in 2018 Redhook released two new Limited Release beers based on recipes first brewed on Brewlab’s innovation brewery: Peaches for Me IPA and Continuous Revelation Coffee IPA. Loaded with juicy peach and mango and amplified by a trio of hops, Peaches for Me IPA was released in 6-pack bottles and draft. Continuous Revelation Coffee IPA brings together two Pacific Northwest staples: great beer and great coffee, and the coffee-laced IPA hit shelves in 6-packs in the latter half of 2018. Both limited release brews, as well as Tangelic Halo IPA, were also included in seasonal Hoppy Hook Pack variety packs.

Redhook Brewlab, Redhook’s innovation brewery and pub in the vibrant Capitol Hill neighborhood of Seattle, celebrated its one-year anniversary in August 2018, and was honored to be voted Best Brewery, Best Bar, and Best Happy Hour in Seattle Weekly’s 2018 Best Of issue.

Square Mile Cider Company
In 2018, Square Mile Cider Company added Rosé Apple Cider to its year-round lineup. First released in 2017 as a seasonal offering, Rosé Apple Cider is a dry apple cider made with rose hips and hibiscus for a rosé flavor and pink hue. Square Mile Cider Company, which finds its inspiration from the pioneering spirit of the original Oregon pioneers, continued to focus on distribution in 12 states with their three ciders: Original Apple Cider, a classic American hard cider; Hopped Apple Cider, a hopped version of the classic American hard cider, with the addition of Citra and Galaxy hops; and Rosé Apple Cider.

Brewing Operations

Brewing Facilities
We use highly automated brewing equipment at our owned production breweries and innovation breweries. As of December 31, 2018, our total owned production capacity was 855,000 barrels. Our breweries include:

Oregon Brewery. Our Oregon Brewery is our largest capacity production brewery, which has an annual capacity of 630,000 barrels. In 2018, we completed the installation of a new canning line, which will enable us to produce a variety of can sizes - such as 12oz, 16oz and 19.2oz - to meet consumer demand. The brewery utilizes a CO2 recovery system to capture and repurpose CO2 naturally produced during the brewing process, eliminating the need to purchase and transport CO2, thus further supporting our focus on sustainability.
New Hampshire Brewery. Our New Hampshire Brewery utilizes a 100-barrel brewing system, with an annual capacity of 215,000 barrels, and uses an anaerobic waste-water treatment facility with power co-generation that completes the process cycle.
Hawaii Brewery. Our current Hawaii Brewery utilizes a 25-barrel brewing system, with an annual capacity of 10,000 barrels, and a 229-kilowatt photovoltaic solar energy generating system to supply approximately 50 percent of its energy requirements through renewable energy. In 2018, we continued to make progress on construction of a new 100,000-barrel brewery located steps away from our existing brewery and pub in Kona. The new brewery, which is being built with best-in-class sustainability and innovation, is scheduled to go online in the latter half of 2019.
Innovation Breweries. In 2018, we continued to leverage a 10-barrel small-batch innovation brewery built for Redhook in Seattle. The heart of the new brewery is a High Efficiency Brewing System that uses a mash filter press, allowing us to use significantly less water and energy than a typical brewery. The brewery’s flexibility enables Redhook to produce hundreds of different beer recipes that can be tested in the pub and scaled for larger production based on popularity. Our Portland 10-barrel innovation brewery and New Hampshire 3-barrel innovation brewery - as well as our newly acquired 10-barrel brewery in North Carolina and 15-barrel brewery in Florida, continued to focus on producing small batch beers for the local markets.


7


In addition to our owned brewing capacity, we continued to produce CBA beers in A-B’s Fort Collins, Colo. brewery as part of a brewing agreement with ABCS. This partnership, which began in 2016, allows us to produce up to 300,000 barrels at this location annually.

Packaging
We package our craft beers in cans, bottles and kegs. All of our production breweries, with the exception of the Hawaii Brewery, have fully automated bottling and keg lines, and our Portsmouth and Portland breweries both have canning capability. The bottle fillers at all of the breweries utilize a carbon dioxide environment during bottling, ensuring that minimal oxygen is dissolved in the beer and extending the beer’s shelf life. We offer an assortment of packages to highlight the unique characteristics of each of our beers and to provide greater opportunities for customers to drink our beers in more locations and at more events and occasions, matching the active lifestyles and preferences of our consumers. Additionally, in our Hawaii brewpub and Seattle brewpub, we package our small-batch and innovation beers for consumers in crowlers.

Quality Control
We monitor production and quality control at all of our breweries, with central coordination at the Oregon Brewery. All of the production breweries have an on-site laboratory where microbiologists and lab technicians supervise on-site yeast propagation, monitor product quality, test products, measure color and bitterness, and test for oxidation and unwanted bacteria. We also regularly utilize outside laboratories for independent product analysis. In addition, every batch of beer that we produce goes through an internal taste panel to ensure that it meets our taste and profile standards.

Ingredients and Raw Materials
We currently purchase a significant portion of our malted barley from two suppliers and our premium-quality select hops, mostly grown in the Pacific Northwest, from competitive sources. We also periodically purchase small lots of hops from international sources, such as New Zealand and Western Europe, which we use to achieve a special hop character in certain beers. In order to ensure the supply of the hop varieties used in our products, we enter into supply contracts for our hop requirements. We believe that comparable quality malted barley and hops are available from alternate sources at competitive prices, although there can be no assurance that pricing would be consistent with our current arrangements. We currently cultivate our own yeast supply for certain strains and maintain a separate, secure supply in-house. We have access to multiple competitive sources for packaging materials, such as labels, six-pack carriers, crowns, cans and shipping cases.

Contract Brewing
In an effort to absorb excess capacity, we enter into contract brewing arrangements under which we produce beer in volumes and per specifications as designated by the arrangements.

During 2018, we shipped 28,200 barrels under contract brewing arrangements, compared to 17,700 barrels in 2017 and 26,700 in 2016.

Innovation
In 2018, we launched a comprehensive consumer research effort, beginning with the pH Experiment, a test-and-learn initiative that enabled us to quickly gather insights around consumer taste preferences and consumption trends. Additionally, we embarked on two consumer research projects with global consultancy Prophet and the Yale Center for Customer Insights to help understand new segmentation strategies. Combined with the ongoing learnings from our innovation breweries in Boone, Kailua-Kona, Miami, Portland, Portsmouth, and Seattle, these initiatives will broaden our view of today’s changing consumer landscape and inform the evolution of our business model and portfolio in 2019 and beyond.

Brewpubs Operations

We own and operate brew-pub restaurants and retail stores in our brewery home markets that support consumer awareness and research and development. In the fourth quarter of 2018, as part of the acquisition of our strategic partners, we added the AMB brewpub in Boone, NC and the Wynwood Brewing Co. brewpub in Miami, Florida, expanding our total brewpubs to seven. Our brewpub restaurants allow us to interact directly with over 1.5 million consumers annually in our home markets, which support brand awareness and trial. Our brewers are continually experimenting with different varieties of hops and malts in all styles of beer, and our brewpubs allow us to bring those beers to market in test-size batches in order to evaluate their potential prior to releasing them on a wider basis.


8


Distribution

With limited exceptions, all brewers in the United States are required to sell their beers to independent wholesalers, who then sell the beers to retailers. We are the only independent craft brewer in the U.S. to have established a wholly aligned distribution network through our partnership with A-B. This partnership provides us national distribution, which results in both an effective distribution presence in each market and administrative efficiencies. Our beers are available for sale directly to consumers in draft, cans and bottles at restaurants, bars and liquor stores, as well as in cans and bottles at supermarkets, warehouse clubs, convenience stores and drug stores. We sell beer directly to consumers at our brewpubs and breweries.

We distribute in all 50 states, pursuant to a master distributor agreement with A-B that allows us access to A-B’s national distribution network. For additional information regarding our relationship with A-B, see “Relationship with Anheuser-Busch, LLC” below. Management believes that our competitors in the craft beer segment generally negotiate distribution relationships separately with wholesalers in each locality and, as a result, typically distribute through a variety of wholesalers representing differing national beer brands with uncoordinated territorial boundaries.

In 2018 and 2017, we sold approximately 653,300 barrels and 654,200 barrels, respectively, to the wholesalers in A-B’s distribution network, accounting for 87.4% of our shipment volume for the 2018 and 2017 periods.

Sales and Marketing

In addition to leveraging our owned brewpubs and retail locations, we promote our products through a national sales and marketing network that includes, but is not limited to, i) creating and executing a range of advertising programs; ii) training and educating wholesalers and retailers about our products; and iii) promoting our name, product offerings, brands, and experimental beers at local festivals, venues and brewpubs.

We advertise and promote our products through an assortment of media, including television, radio, billboard, print, digital and social media, including Facebook, Twitter and Instagram, in key markets and by participating in cooperative programs with our wholesalers. We believe that the financial commitment by the distributor helps align the distributor’s interests with ours, and the distributor’s knowledge of the local market results in an advertising and promotion program that is targeted in a manner that will best promote our products.

Our breweries also play a significant role in increasing consumer awareness of our products and enhancing our image as a craft brewer. Thousands of visitors take tours at our breweries each year and all of our production breweries have a retail restaurant or pub where our products are served. In addition, several of the breweries have meeting space that the public can rent for business meetings, parties and holiday events, and that we use to entertain and educate wholesalers, retailers and the media about our products. At our brewpubs, we sell various items of apparel and other merchandise bearing our trademarks, which creates further awareness of our beers and brands. To further promote retail canned and bottled product sales, and in response to local competitive conditions, we regularly recommend that wholesalers offer discounts to retailers in most of our markets.

Relationship with Anheuser-Busch, LLC

As a significant element of our business operations, we have entered into various contractual relationships with A-B as described in more detail below. With regard to agreements with A-B or one of its affiliates that provide for the payment of fees or other compensation in exchange for products or services, due to the related party nature of the agreements, the contract pricing may not be commensurate with amounts that an independent market participant would pay.

Distributor Agreement
The Master A-B Distributor Agreement (the "A-B Distributor Agreement"), as amended in August 2016, provides for the distribution of our brands in all states, territories and possessions of the United States, including the District of Columbia and, except with respect to Kona beers, all U.S. military, diplomatic, and governmental installations in a U.S. territory or possession. Under the A-B Distributor Agreement, we have granted A-B the right of first refusal to distribute our products, including any internally developed new products, but excluding new products that we may acquire. We are responsible for marketing our products to A-B’s wholesalers, as well as to retailers and consumers.

As amended in August 2016, the term of the A-B Distributor Agreement will expire on December 31, 2028. The A-B Distributor Agreement is also subject to immediate termination, by either party, upon the occurrence of standard events of default as defined in the agreement. Additionally, the A-B Distributor Agreement may be terminated by A-B, with six months’ prior written notice to us, upon the occurrence of any of the following events:


9


we engage in incompatible conduct that damages the reputation or image of A‑B or the brewing industry;
any A-B competitor or affiliate thereof acquires 10% or more of our outstanding equity securities, and that entity designates one or more persons to our board of directors;
our current chief executive officer ceases to function in that role or is terminated, and a satisfactory successor, in A‑B’s opinion, is not appointed within six months;
we are merged or consolidated into or with any other entity or any other entity merges or consolidates into or with us without A-B’s prior approval; or
A-B, its subsidiaries, affiliates, or parent, incur any obligation or expense as a result of a claim asserted against them by or in our name, or by our affiliates or shareholders, and we do not reimburse and indemnify A-B and its corporate affiliates on demand for the entire amount of the obligation or expense.

A-B also has the right to deliver a revocation notice and reinstitute the terms of the A-B Distributor Agreement as they existed prior to August 23, 2016, following a “change of control event” that occurs or for which a definitive agreement is entered into prior to August 23, 2019, and is subsequently completed. A “change of control event” includes, with certain exceptions, (i) the acquisition by a person or group of beneficial ownership on a fully diluted basis of 50% or more of our equity securities (or the equity securities of the surviving entity in any merger, consolidation, share exchange or other business combination involving us), (ii) a change in the composition of our board of directors during any consecutive 12-month period such that the incumbent directors cease to constitute at least a majority of the board of directors, or (iii) the completion of a sale, lease, exchange, or other transfer of (A) the Kona brand or (B) 50% or more of our assets based on fair market value.

A-B would have a similar revocation right at any time following the earliest to occur of (x) our rejection of a “qualifying offer” by A-B, (y) the completion of a transaction implementing A-B’s qualifying offer, and (z) our failure to enter into a definitive transaction agreement with A-B within 120 days following receipt of A-B’s qualifying offer, with certain exceptions. A “qualifying offer” means an offer or proposal on customary terms and conditions, with certain exceptions, made by A-B (or one of its affiliates) for the acquisition of all of our outstanding common stock not owned by A-B or its affiliates, for a specified aggregate value (subject to adjustment for changes in capitalization). From and after August 24, 2018, the specified value for a qualifying offer must be at least $24.50 per share.

Under the A-B Distributor Agreement, we pay $0.25 per case-equivalent as a margin fee. Beginning on January 1, 2019, we will reinvest an aggregate amount equal to $0.25 per case-equivalent in sales and marketing efforts for our products. If A-B were to exercise its revocation right described above, the margin fee payable under the A-B Distribution Agreement would revert to $0.75 per case-equivalent.

International Distribution Agreement
On August 23, 2016, we also entered into an International Distribution Agreement (the “International Distribution Agreement”) with Anheuser-Busch Worldwide Investments, LLC (“ABWI”), an affiliate of A-B, pursuant to which ABWI will be the sole and exclusive distributor of our malt beverage products in jurisdictions outside the United States, subject to the terms and conditions of our agreement with our existing international distributor, CraftCan Travel LLC, and certain other limitations, in each case as set forth in the International Distribution Agreement. Under the International Distribution Agreement, following delivery of notice to us, ABWI may also elect to commence brewing outside of the United States some or all of the products to be distributed in the non-U.S. jurisdictions covered by the International Distribution Agreement.

Under the terms of the International Distribution Agreement, with respect to our exported products produced by us, ABWI will pay us our costs of production plus reasonable out-of-pocket expenses relating to export shipment costs. Additionally, ABWI will pay us an international royalty fee based on volume of our products sold by ABWI, equal to either $40 per barrel or $30 per barrel, depending on certain factors described in the International Distribution Agreement, which royalty fee will be subject to escalation annually, beginning in calendar year 2018, on the terms described in the International Distribution Agreement. In addition, for calendar years 2016, 2017 and 2018, ABWI has paid us one-time fees of $3.0 million, $5.0 million and $6.0 million, respectively. The sum of the fees is recognized in Beer Related Net sales on a straight-line basis over the 10-year contract term, while the fees are collected in the first quarter of the year following the applicable calendar year.

The International Distribution Agreement contains specified termination rights, including, among other things, the right of either party to terminate the International Distribution Agreement if (a) the other party fails to perform any material obligation under the International Distribution Agreement, subject to certain cure rights or (b) the Brewing Agreement (as defined below) is terminated pursuant to certain specified provisions thereof. In addition, ABWI has the right to terminate the International Distribution Agreement upon 90 days’ prior written notice to us following (i) a “change of control event” (as defined above) that occurs or for which a definitive agreement is entered into prior to August 23, 2019, and is subsequently completed, or (ii) the earliest of (x) our rejection of a “qualifying offer” (as defined above), (y) the completion of a transaction implementing a qualifying offer, and (z) our failure to enter into a definitive transaction agreement within 120 days following receipt of a qualifying offer, with certain

10


exceptions (each of the foregoing subclauses (x) through (z), a “qualifying offer lapse”). Following termination of the International Distribution Agreement due to a qualifying offer lapse, or any change of control event, ABWI shall have the right to purchase the international distribution rights for each of our brands then being distributed under the International Distribution Agreement at the fair market value of such rights, and on otherwise customary terms and conditions, as set forth in the International Distribution Agreement.

Under the International Distribution Agreement, ABWI will also be required to make a one-time $20.0 million payment to us on August 23, 2019. The payment is being recognized in Beer Related Net sales on a straight-line basis over the 10-year contract term. However, ABWI will not (subject to compliance with certain notice requirements) be obligated to make such one-time payment if, prior to that date, (i) a “change of control event” occurs or a definitive agreement for a transaction constituting a change of control event is entered into, (ii) ABWI (or an affiliate thereof) makes a qualifying offer and there is a qualifying offer lapse or (iii) we enter into a definitive agreement with ABWI (or an affiliate thereof) with respect to a qualifying offer but such agreement is subsequently terminated, other than for certain regulatory reasons (in which case the $20.0 million shall remain payable). Unless terminated sooner, the International Distribution Agreement will continue in effect until December 31, 2026.

Contract Brewing Arrangements
On August 23, 2016, we entered into a Contract Brewing Agreement (the “Brewing Agreement”) with A-B Commercial Strategies, LLC (“ABCS”), an affiliate of A-B, pursuant to which ABCS will brew, bottle and package up to 300,000 barrels of our mutually agreed products annually, in facilities owned by ABCS within the United States, for an initial term through December 31, 2026. Production of CBA's products in ABCS’s brewery in Fort Collins, Colorado, began in the second quarter of 2017. We share equally with ABCS in any cost savings arising from the Brewing Agreement, provided that our cost savings will equal at least $10.00 per barrel on an aggregate basis, following certain adjustments as set forth in the Brewing Agreement. The Brewing Agreement provides specified termination rights, including, among other things, the right of either party to terminate the Brewing Agreement if (i) the other party fails to perform any material obligation under the Brewing Agreement, subject to certain cure rights, (ii) the International Distribution Agreement (as defined above) is terminated pursuant to certain specified provisions thereof, or (iii) subject to certain conditions, if the A-B Distributor Agreement (as defined above) is terminated pursuant to certain specified provisions thereof.

In addition, ABCS has the right to terminate the Brewing Agreement, upon 90 days’ prior written notice to us, following (i) a change of control event (as defined above) that occurs or for which a definitive agreement is entered into prior to August 23, 2019, and is subsequently completed, or (ii) the earliest to occur of (x) our rejection of a “qualifying offer” (as defined above), (y) the completion of a transaction implementing a qualifying offer, and (z) our failure to enter into a definitive transaction agreement within 120 days following receipt of a qualifying offer, with certain exceptions.

On January 30, 2018, we also entered into a Contract Brewing Agreement with Anheuser-Busch Companies, LLC (“ABC”), another A-B affiliate, pursuant to which we agreed to brew, package, and palletize certain malt beverage products of A-B's craft breweries at our Portland, Oregon, and Portsmouth, New Hampshire breweries, as selected by ABC. Under the terms of this agreement, ABC pays us a per barrel fee that varies based on the annual volume of the specified product brewed by us, plus (a) our actual incremental costs of brewing the product, and (b) certain capital costs and costs of graphics and labeling that we incur in connection with the brewed products. The agreement, as extended, will expire on December 31, 2019, unless further extended by mutual agreement. The agreement also contains specified termination rights, including, among other things, the right of either party to terminate it if (i) the other party fails to perform any material obligation under the agreement or any other agreement between the parties, subject to certain cure rights, or (ii) the A-B Distributor Agreement is terminated.

Exchange Agreement
We have also entered into an Amended and Restated Exchange and Recapitalization Agreement (the “Exchange Agreement”) with A-B, pursuant to which we have granted A-B certain contractual rights. The Exchange Agreement originally was entered into in 2004 as part of a recapitalization in which we redeemed preferred shares held by A-B in exchange for cash and the shares of our common stock currently held by A-B. A-B owned 6,069,047, or approximately 31.3%, of our outstanding shares of common stock at December 31, 2018.


11


The Exchange Agreement entitles A-B to designate two members of our board of directors. A-B also generally has the right to have a designee on each committee of the board of directors, except where prohibited by law or stock exchange requirements, or with respect to a committee formed to evaluate transactions or proposed transactions between A-B and us. The Exchange Agreement contains limitations on our ability to take certain actions without A-B’s prior consent, including, but not limited to, our ability to issue equity securities or acquire or sell assets or stock, amend our Articles of Incorporation or Bylaws, grant board representation rights, enter into certain transactions with affiliates, distribute our products in the United States other than through A-B or as provided in the A-B Distributor Agreement, or voluntarily terminate our listing on the Nasdaq Stock Market.

On August 23, 2016, we entered into an amendment to the Exchange Agreement with A-B providing it with rights, following a “change of control event” or a “qualifying offer,” similar to those described above under “Amendment to A-B Distributor Agreement.”

Fees
We pay fees to A-B in connection with the sale of our products, including margin fees, invoicing, staging and cooperage handling fees, and inventory manager fees. In addition, our contract brewing arrangements call for the payment of fees to the respective brewing partner, and A-B pays us distribution costs and fees and royalty fees under the International Distribution Agreement.

See Note 19 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this report for additional information.

Seasonality

Our sales generally reflect a degree of seasonality, with the first and fourth quarters historically exhibiting low sales levels compared to the second and third quarters. Accordingly, our results for any particular quarter are not likely to be indicative of the results to be achieved for the full year.

Competition

We compete in the craft brewing market, as well as in the much larger alcoholic beverage market, which encompasses domestic and imported beers, flavored alcohol beverages, spirits, wine and ciders. Increasingly, we are also monitoring the impact of marijuana as more states pass legalization.

In 2018, the craft brewing industry continued to experience unprecedented change and competition, characterized by three trends: 1) the growing number and popularity of new local craft breweries that captured market share from established craft breweries; 2) continued acquisition and investment activity between craft brewers, large domestic and foreign brewers, and private equity firms; and 3) continued competitive pressure from international brewers, such as Crown, which target both domestic and craft beer drinkers. In 2018, according to industry sources, A-B and MillerCoors accounted for almost 80% of total beer shipped in the U.S., excluding imports. In addition, A-B and MillerCoors continued to invest in smaller craft breweries and nurtured separate craft-focused divisions in an effort to capitalize on the growing craft beer segment and consumer demand for locally produced products.

Competition varies by regional market. Depending on the local market preferences and distribution, we have encountered strong competition from microbreweries, regional specialty brewers and several national craft brewers that include MillerCoors’ Tenth and Blake Beer Company division (“Tenth and Blake”), Constellation Brands, and A-B’s craft division. A-B’s craft division includes Goose Island, Blue Point Brewing, 10 Barrel Brewing Company, Elysian, Golden Road, Shock Top, Karbach Brewing, Devil's Backbone and others. Because of the large number of participants and offerings in this segment, along with the accelerating consumer preference for local offerings, the competition for packaged product placements and especially draft beer placements has intensified. Although certain of these competitors distribute their products nationally and may have greater financial and other resources than we have, we believe that we possess certain competitive advantages. Our unique portfolio strategy combines strong national lifestyle brands with distinctive regional craft brands, supported by the scale and specialization of our production breweries, strategically distributed sales and marketing resources, and alignment within the A-B distribution network.

We also compete against imported brands, such as Heineken, Stella Artois, Corona Extra and Guinness, which typically have significantly greater financial resources than we have. Although imported beers currently account for a greater share of the U.S. beer market than craft beers, we believe that craft brewers possess certain competitive advantages over some importers, including lower transportation costs, no importation costs, proximity to and familiarity with local consumers, a higher degree of product freshness, eligibility for lower federal excise taxes and absence of exposure to currency fluctuations.

In response to the growth of the craft beer segment, the major domestic national brewers have invested in purchasing small craft breweries. The major national brewers, including Tenth and Blake through MillerCoors, and A-B craft brands through A-B, have

12


significantly greater financial resources than we do and have access to a greater array of advertising and marketing tools to create product awareness of their offerings.

In the past several years, several major distilled spirits producers and national brewers have introduced flavored alcohol beverages. Products such as hard seltzers, Smirnoff Ice, the hard soda category, and Mike’s Hard Lemonade have captured sizable market share in the higher-priced end of the malt beverage industry. We believe sales of these products, along with strong growth in the import and craft beer segments of the malt beverage industry, contributed to an increase in the overall U.S. alcohol market. These products are particularly popular in certain regions and markets in which we sell our products.

Competition for consumers of craft beers also comes from wine and spirits, which reflects today’s millennial consumers who typically drink across three alcoholic beverage categories in a single drinking occasion. Growth in this segment appears to be attributable to competitive pricing, targeted advertising, increased merchandising and greater consumer interest in local wine and craft spirits. Recently, the wine industry has been aided, on a limited basis, by its ability to sell outside of the three-tier system, allowing sales to be made directly to consumers. While the craft beer segment competes with wine and spirits, it also benefits from many of the same advantages enjoyed by wine and spirit producers, including consumers who allow themselves affordable luxuries in the form of high quality alcoholic beverages.

A significant portion of our sales continues to be in the Pacific Northwest and in California, which we believe are among the most competitive craft beer markets in the U.S., both in terms of number of participants and consumer awareness. We believe that these areas offer significant competition for our products, not only from other craft brewers but also from the growing wine market and from flavored alcohol beverages. Additionally, we are monitoring the impact of cannabis as more states legalize marijuana for retail sales. Our recent marketing efforts have been focused on promoting the national relevance of Kona as a leading lifestyle brand, the authenticity of our pioneering owned brands and the creativity of our partner brands, along with better segmenting our marketing strategies to communicate the attributes of our portfolio to our target consumers. We believe that our broad array of beers and brands enables us to offer an assortment of flavors and experiences that appeal to more people.

Segment and Enterprise-Wide Information

See Note 13 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this report for the required segment and enterprise-wide information.

Regulation

Our business is highly regulated at federal, state and local levels. Various permits, licenses and approvals necessary for our brewery, wineries and pub operations and the sale of alcoholic beverages are required from a number of agencies, including the U.S. Treasury Department, the Alcohol and Tobacco Tax and Trade Bureau (“TTB”), the U.S. Department of Agriculture, the FDA, state alcohol regulatory agencies, and state and local health, sanitation, safety, fire and environmental agencies. In addition, the beer industry is subject to substantial federal and state excise taxes.

The FDA issued a proposed rule in November 2015 on the use of “gluten-free” labeling for fermented and hydrolyzed foods and beverages that may affect our ability to market our Omission Beer as “crafted to reduce gluten.” The proposed rule was under review by the Office of Management and Budget and was expected to become final in late 2018 but no final rule was ever issued. It appears the adoption will continue to be delayed under the current administration’s executive order to reduce and freeze new regulations. See Item 1A. Risk Factors for additional information.

We operate our breweries, and wineries to produce hard cider, under federal licensing requirements imposed by the TTB. The TTB requires the filing of a “Brewer’s Notice” upon the establishment of a commercial brewery and the filing of an amended Brewer’s Notice whenever there is a material change in the brewing or warehousing locations, brewing or packaging equipment, brewery ownership, or officers or directors. The TTB requires us to obtain a winery permit and registration for each facility we produce hard cider. Our operations are subject to audit and inspection by the TTB at any time.

Management believes that we have all the licenses, permits and approvals required for our current operations. Existing permits or licenses could be revoked if we fail to comply with the terms of such permits or licenses and additional permits or licenses may be required in the future for our current operations or because of expanding our operations.

Beginning January 1, 2018, the federal excise taxes imposed on domestic brewers, such as us, that produce less than 2 million barrels annually, were reduced from $7.00 to $3.50 per barrel on the first 60,000 barrels shipped annually and from $18.00 to $16.00 per barrel on the first 6 million barrels shipped annually for all other brewers and all beer importers. Barrels shipped in excess of 6 million barrels in a given year continue to be subject to a federal excise tax of $18 per barrel on beer sold for consumption

13


in the United States. Certain states also levy excise taxes on alcoholic beverages but are usually paid by the wholesaler. Also, while the existing excise tax on hard cider did not change from $0.226 per gallon, the small producer tax credit for hard cider was expanded to $0.062 on the first 30,000 gallons for an effective rate of $0.164 per gallon; the tax credit on the next 100,000 gallons produced became $0.056 for an effective rate of $0.17 per gallon; and producers like us who produce between 130,000 and 750,000 gallons of hard cider annually receive a $0.033 credit for an effective tax rate of $0.193 per gallon. We pay excise taxes in states where we produce (Hawaii, Oregon, Washington, New Hampshire, North Carolina and Florida).

Although the reductions in federal excise taxes described above are set to expire at the end of 2019, the Beer Institute, of which we are a member, and other industry groups support making federal excise tax relief for all brewers and beer importers permanent. Excise taxes may be increased in the future by the federal government or any state government or both. In the past, increases in excise taxes on alcoholic beverages have been considered in connection with various governmental budget-balancing or funding proposals.

Federal and State Environmental Regulation
Our brewing operations are subject to environmental regulations and local permitting requirements and agreements regarding, among other things, air emissions, water discharges and the handling and disposal of hazardous wastes. While we have no reason to believe the operation of our breweries violates any such regulation or requirement, if such a violation were to occur, or if environmental regulations were to become more stringent in the future, we could be adversely affected.

Dram Shop Laws
The serving of alcoholic beverages to a person known to be intoxicated may, under certain circumstances, result in the server being held liable to third parties for injuries caused by the intoxicated customer. Our restaurants and brewpubs have addressed this issue by maintaining reasonable hours of operation and routinely performing training for personnel.

Trademarks

We have obtained U.S. trademark registrations for numerous products. Trademark registrations generally include brand names and logos and specific product names. The Kona Brewing Co., Widmer Brothers Brewing, Redhook, and Omission marks and certain other marks are also registered in various foreign countries. We regard our Kona, Widmer Brothers, Redhook, Omission, Square Mile, Cisco, AMB, Wynwood and other trademarks as having substantial value and as being an important factor in the marketing of our products. We also have several similar international trademarks. We are not aware of any infringing uses that could materially affect our current business or any prior claim to the trademarks that would prevent us from using such trademarks in our business. Our policy is to pursue registration of our material trademarks in our markets whenever possible and to oppose vigorously any infringement of our trademarks.

Employees

At December 31, 2018, we employed approximately 665 people, including 310 employees in the brewpubs and retail stores, 150 employees in production, 131 employees in sales and marketing and 74 employees in corporate and administration. Included in the totals above are 187 part-time employees and 2 seasonal or temporary employees. None of our employees are represented by a union or employed under a collective bargaining agreement. We believe our relations with our employees to be good.

Available Information

Our Internet address is www.craftbrew.com. There we make available, free of charge, our annual report on Form 10‑K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and any amendments to those reports, as soon as reasonably practicable after we electronically file such material with the Securities and Exchange Commission (“SEC”). Our SEC reports can be accessed through the investor relations section of our website. The other information posted on our website is not part of this or any other report we file with or furnish to the SEC.

Item 1A. Risk Factors
 
If we are unable to gauge trends and react to changing consumer preferences in a timely and cost-effective manner, our sales and market share may decrease and our gross margin may be adversely affected.
The costs and management attention involved in maintaining an innovative brand portfolio have been, and are expected to continue to be, significant. If we have not gauged consumer preferences correctly, or are unable to maintain consistently high quality beers as we develop new brands, our overall brand image may be damaged. If this were to occur, our future sales, results of operations and cash flows would be adversely affected. Also, increased costs associated with developing new products may have a negative effect on our gross margin.

14



We rely on the reputation of our brands.
Our success depends on our ability to maintain and enhance the image and reputation of our existing products and to develop a favorable image and reputation for new products. The image and reputation of our products may be reduced in the future and concerns about product quality, even when unfounded, could tarnish the image and reputation of our products. An event, or series of events, that materially damages the reputation of one or more of our brands could have an adverse effect on the value of that brand and subsequent revenues from that brand or business. Restoring the image and reputation of our products may be costly and may not be possible.

Increased competition could adversely affect sales and results of operations.
We compete in the highly competitive craft beer market, as well as in the much larger specialty beer category, which includes the imported beer segment and fuller-flavored beers offered by major brewers. We face increasing competition from producers of wine, spirits and flavored alcohol beverages offered by the larger brewers and spirit producers. We are also monitoring the impact of cannabis as more states legalize marijuana for retail sale. Increased competition could adversely affect our future sales and results of operations. See "Competition" in Part I, Item 1 of this report.

Our business is sensitive to reductions in discretionary consumer spending.
Consumer demand for luxury or perceived luxury goods, including craft beer, can be sensitive to downturns in the economy and the corresponding impact on discretionary spending. Changes in discretionary consumer spending or consumer preferences brought about by factors such as perceived or actual general economic conditions, job losses and unemployment or underemployment, perceived or actual declines in disposable consumer income and wealth, and changes in consumer confidence in the economy, could significantly reduce customer demand for craft beer in general, and the products we offer specifically. Furthermore, our consumers may choose to replace our products with the fuller-flavored national brands or other more affordable, although lower quality, alternatives available in the market. Any such decline in consumption of our products would likely have a significant negative impact on our operating results.

Changes in consumer preferences or public attitudes about alcohol could decrease demand for our products.
If consumers become unwilling to accept our products or if general consumer trends lead to a decrease in the demand for beer, including craft beer, our sales and results of operations would be adversely affected. There is no assurance that the craft brewing segment will experience growth in future periods. If the markets for wine, spirits or flavored alcohol beverages continue to grow, this could draw consumers away from the beer industry in general and our products specifically. Further, 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. In reaction to these concerns, steps may be taken to restrict advertising by beer producers, to impose additional cautionary labeling or packaging requirements, or to increase excise or other taxes on beer. Any such developments may have a significant adverse impact on our financial condition, operating results and cash flows.

The Food and Drug Administration (“FDA”) issued a proposed rule in November 2015 on the use of “gluten-free” labeling for fermented and hydrolyzed foods and beverages that may affect our ability to market our Omission Beer.
CBA launched Omission beer in May 2012 as the first brand of craft beer to be brewed in the United States using conventional beer ingredients (including malted barley, a gluten-containing grain) and “crafted to remove gluten.” Omission beers are brewed similarly to other craft beers except that, at the point of fermentation, a brewing enzyme called Brewers Clarex™ is added which breaks apart the gluten protein chains. Samples from each batch are tested internally using the R5 Competitive ELISA method for gluten content before packaging. The beers are then packaged into bottles in a closed packaging environment to eliminate any chance of cross contamination. Packaged samples are also sent to an independent third party lab for testing before the lot is released from the brewery. We post all test results on our website for consumers to view before they decide to purchase the beer.

Omission beers are subject to regulation by the Department of Treasury’s Alcohol and Tobacco Tax and Trade Bureau (“TTB”), but as a result of overlapping jurisdictions of the FDA and TTB, the role each agency plays in the regulation of fermented alcohol beverages, and the commitments the two agencies have made to work together to establish consistent gluten labeling policies for comparable alcohol beverage products, the above referenced FDA notice of proposed rulemaking has far-reaching implications for fermented alcohol beverages, like Omission Beer, that are subject to regulation by both the FDA and TTB. In accordance with the TTB’s premarket approval requirements, the TTB approved Omission labeling, including its gluten-related claims, as per their policy concerning gluten content statements in the labeling and advertising of malt beverages.


15


If the FDA's proposed rule becomes final as written, the TTB’s policy may be superseded, which would have a significant impact on our ability to market and sell our Omission beers as “crafted to remove gluten” and negatively impact our operating results. The proposed rule was under review by the Office of Management and Budget in 2017 and was expected to become final in late 2018. It appears adoption of a final rule will continue to be delayed under the current administration’s executive order to reduce and freeze new regulations.

We may identify material weaknesses in our internal control over financial reporting in the future, which, if not remediated, could result in material misstatements in our financial statements.
Our management is responsible for establishing and maintaining adequate internal control over our financial reporting, as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. Management identified a material weakness in our internal control over financial reporting related to accounting for complex revenue transactions for the year ended December 31, 2016, which was subsequently remediated in 2017. However, additional material weaknesses in our internal control environment may be identified in the future, which could result in material misstatements in our financial statements and a loss of investor confidence in the integrity of our financial reporting and other public disclosures, potentially triggering increased sales of our common stock and downward pressure on our stock price.

Product safety and quality concerns may have a material adverse effect on our business.
Our success depends in large part on our ability to maintain consumer confidence in the safety and quality of our products. We have rigorous product safety and quality standards which we expect our breweries and our brewing partners to meet. We take precautions to ensure that our beverage products and our associated packaging materials, such as bottles, crowns, cans and other containers, meet accepted food safety and regulatory standards. We cannot assure, however, that, despite our strong commitment to product safety and quality, we will always meet these standards. If our products fail to satisfy applicable product safety and quality standards or are found to be contaminated or adulterated, we may be required to conduct costly product recalls and may become subject to product liability claims and negative publicity, which could cause our reputation and business to suffer.

We have a continuing relationship with Anheuser-Busch, LLC and the current distribution network that would be difficult to replace.
Most of our products are sold and distributed through A-B’s distribution network. If the A-B Distributor Agreement were terminated, we would be faced with a number of operational tasks, including establishing and maintaining direct contracts with the existing wholesaler network or negotiating agreements with replacement wholesalers on an individual basis, and enhancing our credit evaluation, billing and accounts receivable processes. Such an undertaking would require significant effort and substantial time to complete, during which the distribution of our products could be impaired.

We are dependent on our wholesalers for the sale of our products.
Although substantially all of our products are sold and distributed through A-B, we continue to rely heavily on wholesalers, many of which are independent, for the sale of our products to retailers. Independent wholesalers make their own business decisions that may not align with our interests and there is no assurance that the sales efforts of distributors will be effective in generating sales of our products.

Any disruption in the ability of the wholesalers, A-B, or us to distribute products efficiently due to any significant operational problems, such as widespread labor union strikes or the loss of a major wholesaler as a customer, could hinder our ability to get our products to retailers and could have a material adverse impact on our sales, results of operations and cash flows. A-B has been purchasing distributors in states where it is legally permissible, which could impact our distribution if the A-B relationship were to end. During 2018, 34% of our shipments were through A-B owned distributors.

Our investments in our sales and marketing infrastructure may negatively affect our financial results without increasing sales.
We intend to continue to reinvest cost savings in selling, general and administrative expenses in our sales and marketing infrastructure, including increased spending to support our Kona brand. Also, beginning January 1, 2019, the terms of the A-B Distributor Agreement require that we reinvest an additional $0.25 per case-equivalent in our sales and marketing efforts for our products. While we seek to design effective advertising and promotions to support our brands, these efforts may not lead to enhanced brand equity or higher sales in the long term.

Our agreements with A-B may limit our ability to engage in certain activities and investments.
The Exchange Agreement requires us to obtain A-B's consent prior to undertaking certain activities and investments. For example, we must obtain A-B's consent before acquiring another brewer if the purchase price exceeds $30 million or purchasing a non-brewing entity if the purchase price exceeds $2 million. If A-B opposes strategic or financial investments proposed by our management, A-B may decline to give its consent to activities or investments that our management believes are in the best interest of our shareholders.


16


A-B has an influential voice in decisions of the board of directors and shareholders.
A-B owns 31.3% of our outstanding common stock, making A-B our largest shareholder. In addition, under the Exchange Agreement, A-B may designate two nominees to our board of directors. These directors also participate on our audit, compensation, and nominating and governance committees as non-voting observers, and one of these directors participates on our strategic planning committee as a voting member. As a result, A-B has an influential voice in deliberations of the board of directors and shareholders. A-B and its affiliates also have the right to terminate our contract brewing arrangements and to rescind certain amendments to our other contracts with them upon the occurrence of certain events. See “Relationship with Anheuser-Busch, LLC” in Item 1. Business above for additional information.

Expansion of our Kona brewery may be subject to various risks, including cost overruns, construction delays, and inability to fully utilize additional production capacity, which may adversely affect our financial condition and results of operations.
During 2015, we held a ground-breaking ceremony on the site of a new, state-of-the-art brewing facility in Kailua-Kona, Hawaii, with an annual production capacity of 100,000 barrels at a total estimated cost of approximately $20 million. As with all projects of this magnitude, there is the risk of significant cost overruns, which could require us to increase our borrowing under our revolving credit facility or to find additional financing. We may also experience unforeseen construction delays, which could result in our inability to bring the new Kona brewery into production as scheduled, adversely affecting our results of operations and financial condition. In addition, if we do not achieve sufficient growth in product sales to absorb the increased production capacity, we may be unable to realize our goals for gross margin improvement, which would have a negative impact on our results of operations and return on investment.

We expect to continue to make strategic investments in improvements aimed at increasing the efficiency, capabilities and capacity of our breweries, improving our ordering and logistics systems, and enhancing the customer experience at our brewpubs. Failure to realize the anticipated benefits and generate adequate returns on such capital improvement projects may have a material adverse effect on our results of operations and cash flows.

Unavailability of production at our brewing partner may adversely affect our capacity and disrupt our ability to satisfy demand for our products.
In 2016, we entered into a contract brewing agreement with ABCS and, once fully optimized, anticipate producing up to 300,000 barrels of our beer at this facility annually. If production at this facility should be disrupted due to unforeseen circumstances, our ability to produce and ship sufficient quantities of our beer to meet demand in certain key geographic markets, particularly Texas and the southeastern United States, could be significantly impaired, resulting in decreased sales and a negative impact on our wholesaler relationships in those markets.

Operating breweries at production levels substantially below their current designed capacities could negatively impact our financial results.
As of December 31, 2018, the annual working capacity of our breweries was approximately 855,000 barrels. Due to many factors, including seasonality and production schedules of various draft products and bottled products and packages, actual production capacity will rarely, if ever, approach full working capacity. We believe that capacity utilization of the breweries will fluctuate throughout the year, and even though we expect that capacity of our breweries will be efficiently utilized during periods when our sales are strongest, there likely will be periods when the capacity utilization will be lower. If we experience contraction in our sales and brewing volumes, the resulting excess capacity and unabsorbed overhead will have an adverse effect on our gross margins, operating cash flows and overall financial performance. We periodically evaluate whether we expect to recover the costs of our production breweries over the course of their useful lives. If facts and circumstances indicate that the carrying value of these long-lived assets may be impaired, an evaluation of recoverability will be performed by comparing the carrying value of the assets to projected future undiscounted cash flows along with other quantitative and qualitative analyses. If we determine that the carrying value of such assets does not appear to be recoverable, we will recognize an impairment loss by a charge against current operations, which could have a material adverse effect on our results of operations.

Our sales are concentrated in the Pacific Northwest, California and Hawaii.
Our sales in 2018 were concentrated in Washington, Oregon, California and Hawaii and, consequently, our future sales may be adversely affected by changes in economic and business conditions within these states. We also believe the Pacific Northwest and California are among the most competitive craft beer markets in the United States, both in terms of number of market participants and consumer awareness. The Pacific Northwest and California offer significant competition to our products, not only from other craft brewers, but also from the major domestic brewers, wine producers and flavored alcohol beverages.


17


We are dependent upon the continued service of our senior management and other key personnel.
Our future success is dependent on the continued service of our senior management and other key employees, particularly Andrew Thomas, our Chief Executive Officer. The loss of the services of our senior management and other key employees could have a material adverse effect on our operations. Additionally, the loss of Andrew Thomas as our Chief Executive Officer, and the failure to find a replacement satisfactory to A-B, would be a termination event under the A-B Distributor Agreement.

We also may be unable to retain existing management, sales, marketing, operational and other support personnel critical to our success, which could result in harm to significant customer relationships, loss of key information, expertise or know-how, and unanticipated recruiting and training costs.

Our gross margin may fluctuate.
Future gross margin may fluctuate and even decline as a result of many factors, including: product pricing levels; sales mix between draft and packaged product sales and within the various packaged products, including bottles and cans; level of fixed and semi-variable operating costs; level of production at our breweries in relation to current production capacity; availability and prices of raw materials, production inputs such as energy, and packaging materials; rates charged for freight; and federal and state excise taxes. The high percentage of fixed and semi-variable operating costs causes our gross margin to be particularly sensitive to relatively small changes in sales volume or price increases in the various components of our production and distribution.

We may be subject to litigation that could adversely affect our business and results of operations.
We may be subject to various types of litigation, including fair trade practice, product liability, and employment-related claims. Such litigation may be time consuming, distracting and costly, and could have a material adverse effect on our business and results of operations. See Note 18, "Commitments and Contingencies," in the Notes to Consolidated Financial Statements found in Part II, Item 8 of this report, for additional information related to legal proceedings.

We are dependent on certain suppliers for key raw materials, packaging materials and production inputs.
Although we seek to maintain back-up and alternative suppliers for all key raw materials and production inputs, we are reliant on certain third parties for key raw materials, packaging materials and utilities. Any disruption in the willingness or ability of these third parties to supply these critical components could hinder our ability to continue production of our products, which could have a material adverse impact on our financial condition, results of operations and cash flows.

Our ability to obtain key ingredients for our products, including hops and malt, is dependent on a number of factors, including competition from other brewers, weather, and the decisions of growers regarding which crops to grow.
We purchase most of our raw materials from U.S. brokers, many of which rely on foreign sources, particularly for malt. As a result, prices for these ingredients may be affected by foreign currency fluctuations. Also, as consumer preference for innovative craft beer products increases, the demand for new hop varietals has grown, and many breweries enter into multi-year contracts with growers.

There is a growing concern that carbon dioxide and other greenhouse gases in the atmosphere may have an adverse affect on global temperatures, weather and precipitation patterns and the frequency and severity of extreme weather and natural disasters. In the event that such climate change has a negative effect on agricultural productivity, we may be subject to decreased availability or less favorable pricing for certain agricultural commodities necessary for our products, such as barley, hops, sugar and corn. Climate change may also subject us to water scarcity and quality risks due to large amounts of water required to produce our products, including water consumed in the agricultural supply chain. In the event that climate change causes water over-exploitation or has a negative effect on water availability or quality, the price of water may increase and may result in unfavorable changes to applicable water-related taxes and regulations, which could lead to increased regulatory pressures, production costs or capacity constraints. In addition, public expectations for reductions in greenhouse gas emissions could result in increased energy, transportation and raw material costs and may require us to make investments in facilities and equipment due to increased regulatory pressures.

There is no assurance that we will be able to obtain certain of our ingredients in a timely fashion to meet consumer demand, and our gross margin may be adversely affected if we are required to pay higher prices to obtain needed ingredients that are in high demand. Such factors may also result in lower sales of our products, which would have a negative effect on our financial results.


18


We may experience higher packaging costs and shipping costs, which could adversely affect our financial results.
Many of our packaging materials, particularly glass, are obtained from a single source. Although we believe alternative suppliers of packaging materials, including bottles, cans, carriers and labels, are available, a number of factors, including consolidation in the packaging industry and competition from other manufacturers in need of packaging materials, may result in supply shortages or higher prices, which could adversely affect our financial results. We have also seen recent increases in shipping costs for our products. While we are seeking to manage those costs through more efficient management of brewery operations and logistics, we may not be successful. We also may not be able to pass along increased costs through higher prices for our products, or even maintain our current pricing levels, with a corresponding negative impact on our financial results.

Higher health care costs may have an adverse effect on our operating results.
We are self-insured with respect to health care expenses for our employees. From time to time, we experienced higher than average medical expense claims with a corresponding adverse effect on our Selling, general and administrative expenses. If we experience higher costs in the future, our operating results may be negatively affected.

A failure in any of our supply chain processes could harm our ability to effectively operate our business.
Our results are highly dependent on our ability to accurately forecast and execute throughout the entire supply chain, including sales forecasting, raw material ordering, brewing and distribution. The combination of our recent growth and increased brand complexity has increased the operating complexity of our business. We cannot guarantee that we will effectively manage such complexity without experiencing planning failures, operating inefficiencies, or other issues that could have an adverse effect on our business.

We engage in electronic communications between third parties, including A-B and our wholesalers, as part of our supply chain processes. Any interruptions or errors in our electronic interfaces may negatively affect our operating activities.

Our information systems may experience an interruption or breach in security.
We rely on computer information systems to conduct our business. We have policies and procedures in place to protect against and reduce the occurrence of failures, interruptions, or breaches of security of these systems. However, there can be no assurances that these policies and procedures will eliminate the occurrence of failures, interruptions or breaches of security or that they will adequately restore our systems or minimize any such events. The occurrence of a failure, interruption or breach of security of our computer information systems could result in loss of intellectual property, delays in our production, loss of critical information, or other events, any of which could harm our future sales or operating results.

We manage and store various proprietary information and sensitive or confidential data relating to our business, including sensitive and personally identifiable information. Breaches of our security measures or the accidental loss, inadvertent disclosure or unapproved dissemination of proprietary information or sensitive or confidential data about us, our employees, or our customers, including the potential loss or disclosure of such information or data as a result of hacking, fraud, trickery or other forms of deception, could expose us, our customers or the individuals affected to a risk of loss or misuse of this information. Any such breach, loss, or disclosure could result in litigation and potential liability for us, damage our brand image and reputation, or otherwise harm our business. In addition, our current data protection measures might not protect us against increasingly sophisticated and aggressive threats, while the cost and operational consequences of implementing further data protection measures could be significant.

An increase in excise taxes could adversely affect our financial condition and results of operations.
The U.S. federal government currently levies an excise tax of $18.00 per barrel on beer sold for consumption in the United States. However, brewers, such as us, that produce less than two million barrels annually, are now taxed at $3.50 per barrel on the first 60,000 barrels shipped, with the remainder of the shipments taxed at $16.00 per barrel, due to the passage of the Tax Cuts and Jobs Act in December 2017. If the tax cut is not permanently extended, this new rate is scheduled to return to $7.00 per barrel for the first 60,000 barrels and $18.00 per barrel up to two million barrels annually in 2020. The individual states in which we operate also impose excise taxes on beer and other alcohol beverages in varying amounts. Federal and state legislators routinely consider various proposals to impose additional excise taxes on the production of alcoholic beverages, including beer. Any such increases in excise taxes, if enacted, or the failure of the current federal excise tax rates to be extended permanently, would adversely affect our financial condition, results of operations, and cash flows.

We are subject to tax liabilities imposed by the jurisdictions where we operate.
Tax liabilities may vary significantly and are subject to change. Among others, these taxes include income taxes, property taxes, indirect  taxes  (excise,  sales, use  and  gross receipts  taxes),  payroll  taxes,  and withholding  taxes. We may not be able to pass these tax costs on to consumers and remain competitive. New tax laws and regulations and changes to existing tax laws and regulations could materially and adversely affect our financial results.


19


We are subject to governmental regulations affecting our breweries and brewpubs.
Our business is highly regulated by federal, state, and local laws and regulations. These laws and regulations govern all aspects of the production and distribution of beer, including permitting, licensing, trade practices, labeling, advertising and marketing, distributor relationships and various other matters. A variety of federal, state and local governmental authorities also levy various taxes, license fees and other similar charges and may require bonds to ensure compliance with applicable laws and regulations. Noncompliance with such laws and regulations may cause the TTB or any particular state or jurisdiction to revoke its license or permit, restricting our ability to conduct business, or result in the imposition of significant fines or penalties. One or more regulatory authorities could determine that we have not complied with applicable licensing or permitting regulations or have not maintained the approvals necessary for us to conduct business within our jurisdiction. If licenses, permits or approvals necessary for our brewery or pub operations were unavailable or unduly delayed, or if any permits or licenses that we hold were to be revoked, or additional permits or licenses were required in the future, including as a result of expanding our operations, our ability to conduct business may be disrupted, which would have a material adverse effect on our financial condition, results of operations and cash flows.

Government shutdowns may adversely affect our ability to timely launch new products.
When the U.S. Congress does not pass, or the President does not sign, budget legislation that establishes discretionary spending levels by the start of the U.S. government's fiscal year, funding to certain agencies lapses and non-essential operations cease until the funding is restored. This may affect agencies under the Department of Health and Human Services and Department of the Treasury. Between December 21, 2018 and January 24, 2019, the country experienced the longest government shutdown in U.S. history. Because TTB operations were halted, over 50 of our label and formula applications in need of approval sat idle. The cessation in TTB operations forced us to delay or alter the launch of several new products, resulting in operational, sales and marketing disruptions. The continuation or reoccurrence of such shutdowns in the future may have a material adverse effect on our financial condition and results of operations and may force us to alter our plans for product rollouts and marketing campaigns.

The craft beer business is seasonal in nature, and we are likely to experience fluctuations in results of operations.
Sales of craft beer products are somewhat seasonal, with the first and fourth quarters historically being lower and the rest of the year generating stronger sales. Our sales volume may also be affected by weather conditions and selling days within a particular period. Therefore, the results for any given quarter will likely not be indicative of the results that may be achieved for the full fiscal year. If an adverse event such as a regional economic downturn or poor weather conditions should occur during the second and third quarters, the adverse impact to our revenues would likely be greater as a result of the seasonality of our business.

We may be unable to access public or private debt markets to fund our operations and contractual commitments at competitive rates, on commercially reasonable terms, or in sufficient amounts, if at all.
We depend, in part, on our revolving line of credit with Bank of America, N.A. ("BofA"), to fund our operations and commitments for capital expenditures. This credit line expires on September 30, 2023. Our capital expenditures in 2019 are expected to range from $15 million to $19 million. A number of factors could cause us to incur increased borrowing costs and to have greater difficulty accessing public and private markets for debt. These factors include general economic conditions, disruptions or declines in the global capital markets, our financial performance or outlook, and credit. An adverse change in any or all of these factors may materially adversely affect our ability to fund our operations and contractual or financing commitments.

If our business does not perform as expected, including if we generate less revenue than anticipated from our operations or encounter significant unexpected costs, we may fail to comply with the financial covenants under our credit facilities. If we do not comply with our financial covenants and we do not obtain a waiver or amendment, BofA may elect to cause all amounts owed to become immediately due and payable. Any default may require us to seek additional capital or modifications to our credit facilities, which may not be available or which may be costly. Any of these risks and uncertainties could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

We entered into strategic relationships with certain regional brewers that increased the complexity and execution risks of our operations.
As discussed in more detail in Item 1. Business in this report, we recently acquired the remaining equity in Wynwood Brewing Co. in Miami, Florida, and certain assets of Appalachian Mountain Brewery in North Carolina and Cisco Brewers in Massachusetts. These acquisitions have increased the complexity of our operations, including brewing, packaging, marketing and selling their brands and managing employees in additional geographic locations, with increased demands on our management team. There can be no assurance that we will be able to successfully integrate these strategic acquisitions without experiencing unexpected costs, operating challenges or control deficiencies.

20



Acquisitions subject us to various risks, including risks relating to selection and pricing of acquisition targets, integration of acquired companies into our business and assumption of unanticipated liabilities.
We may continue to pursue acquisitions or joint venture or investment opportunities in the future. We cannot assure that we will be able to identify or take advantage of such opportunities. If we do pursue such transactions, we may not realize the anticipated benefits. Acquisitions and similar transactions, both those completed recently and those that may occur in the future, involve many risks, including risks relating to the assumption of unforeseen liabilities of an acquired business, adverse accounting charges resulting from the acquisition, and difficulties in integrating acquired companies into our business, both from a cultural perspective, as well as with respect to technological integration. Our inability to successfully integrate acquired businesses or manage joint ventures may lead to increased costs, failure to generate expected returns, or even a total loss of amounts invested, any of which could have a material adverse effect on our financial condition and results of operations.

Changes in state laws regarding distribution arrangements may adversely impact our operations.
States in which we have a significant sales presence may enact legislation that significantly alters the competitive environment for the beer distribution industry. Any change in the competitive environment in those states could have an adverse effect on our future sales and results of operations and may impact the financial stability of wholesalers on which we rely.

Any change in, or violation of, federal and state environmental regulations could adversely affect our operations.
Our brewing operations are subject to environmental regulations and local permitting requirements and agreements regarding, among other things, air emissions, water discharges and the handling and disposal of hazardous wastes. While we have no reason to believe the operation of our breweries violates any such regulation or requirement, if such a violation were to occur, or if environmental regulations were to become more stringent in the future, we may be adversely affected.

A small number of shareholders hold a significant ownership percentage of our common stock and uncertainty over their continuing ownership plans could cause the market price of our common stock to decline.
As noted above, A-B has a significant ownership stake in us. In addition, three of our founders, together, beneficially own approximately 2.0 million shares, or 10.3%, of our common stock. Collectively, these two groups own 41.6% of our equity. All of these shares are available for sale in the public market, subject to volume, manner of sale and other requirements under the Securities Act of 1933. Such sales in the public market, or the perception that such sales may occur, could cause the market price of our common stock to decline.

We do not intend to pay and are limited in our ability to declare or pay dividends; accordingly, shareholders must rely on stock appreciation for any return on their investment in us.
We do not anticipate paying cash dividends. Further, under our loan agreement with BofA, we are not permitted to declare or pay a dividend unless we meet certain financial covenants. As a result, only appreciation of the price of our common stock will provide a return to shareholders. Investors seeking cash dividends should not invest in our common stock.

The fair value of our intangible assets, including goodwill, may become impaired.
As a result of recent acquisitions, including the acquisition of Kona Brewing Company in 2010, as of December 31, 2018, we had goodwill of $22.0 million and other various intangible assets, net, of $47.2 million on our Consolidated Balance Sheets, which, combined, represented nearly 29.3% of our total assets. If any circumstances were to occur, such as economic recession or other factors causing a reduction in consumer demand, or for any other reason we were to experience a significant decrease in sales growth, with a corresponding negative impact on our estimated cash flows associated with these assets, our analyses of these assets may conclude that a decrease in the fair value of these assets has occurred. In that event, we would be required to recognize a potentially significant loss on impairment of these assets. Any such impairment loss would be charged against current operations in the period of change and potentially have a material adverse effect on our results of operations.

We may not be able to protect our intellectual property rights.
Our future success depends significantly on our ability to protect our current and future brands and products and to defend our intellectual property rights, including trademarks, patents, domain names, trade secrets and know-how. We have been granted numerous trademark registrations and patents covering our brands and products and have filed, and expect to continue to file, trademark and patent applications seeking to protect newly developed brands and products. We cannot be sure that trademark and patent registrations will be issued with respect to any of our applications. There is also a risk that we could, by omission, fail to renew a trademark or patent on a timely basis or that our competitors will challenge, invalidate or circumvent any existing or future trademarks and patents issued to, or licensed by, us.


21


Although we have taken appropriate action to protect our portfolio of intellectual property rights (including patent applications, trademark registration and domain names), we cannot be certain that the steps we have taken will be sufficient or that third parties will not infringe upon or misappropriate proprietary rights. Moreover, some of the countries in which we operate offer less effective intellectual property protection than is available in Europe or the United States. If we are unable to protect our proprietary rights against infringement or misappropriation, it could have a material adverse effect on our business, results of operations, cash flows or financial condition and, in particular, on our ability to develop our business.

Item 1B. Unresolved Staff Comments

Not applicable.

Item 2. Properties

We own and operate three highly-automated, small-batch production breweries: the Oregon Brewery, the New Hampshire Brewery, and the Hawaii Brewery, as well as five small, innovation brewing systems in Portland, Oregon, Seattle, Washington, Portsmouth, New Hampshire, Boone, North Carolina and Miami, Florida. We lease the sites upon which the Hawaii Brewery and Brewpubs, the New Hampshire Breweries and Brewpub, the Portland Innovation Brewery, and Oregon Brewpub, the Boone Cidery, the Miami Brewery and Taproom are located, in addition to our office space and warehouse locations in Portland, Oregon for our corporate, administrative and sales functions and the office space location in Miami, Florida for administrative and sales functions. In 2014, we entered into a lease for space in Southern California for our national sales office, which expires in 2019. In 2015, we entered into a long-term land lease for the location of our new Kona brewery, which expires in 2064, and in 2016, we entered into a lease for our new Redhook pub in Seattle, which expires in 2026. Certain of these leases are with related parties. See Notes 18 and 19 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this report for further discussion regarding these arrangements.

Certain information regarding our production breweries is as follows (capacity in thousands of barrels):
Production Breweries
 
Square
Footage
 
Current
Annual Capacity
Oregon Brewery
 
185,000

 
630

New Hampshire Brewery
 
125,000

 
215

Hawaiian Brewery
 
11,000

 
10

 
 
 

 
855


Late in the fourth quarter of 2017, we completed several phases of an expansion to increase flexibility of our Oregon Brewery which did not materially impact our overall capacity for 2017 and, in 2016, we broke ground on a new 100,000 barrel brewery near our existing brewery and pub in Kona, which is expected to be fully operational in the latter half of 2019.

In 2016, we entered into a contract brewing agreement with ABCS with the ability to have up to 300,000 barrels produced annually and, during the second quarter of 2017, production began in their facilities.

Substantially all of our personal property and fixtures, as well as the real properties associated with the Oregon Brewery, secure our loan agreement with BofA. See Note 9 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this report.

Item 3. Legal Proceedings

We are involved, from time to time, in claims, proceedings and litigation arising in the normal course of business. We believe that, to the extent that any pending or threatened litigation involving us or our properties exists, such litigation is not likely to have a material adverse effect on our financial condition, cash flows or results of operations.

See Note 18, "Commitments and Contingencies," in the Notes to Consolidated Financial Statements found in Part II, Item 8 of this report, for additional information related to legal proceedings.

Item 4. Mine Safety Disclosures

Not applicable.

22


PART II

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Our common stock trades on the NASDAQ Stock Market (“NASDAQ”) under the trading symbol BREW. The table below sets forth, for the fiscal quarters indicated, the reported high and low closing sale prices of our common stock, as reported on NASDAQ:
 
2017
 
High
 
Low
Quarter 1
 
$
17.25

 
$
12.40

Quarter 2
 
17.45

 
12.25

Quarter 3
 
18.90

 
16.75

Quarter 4
 
19.80

 
17.15

 
 
 
 
 
2018
 
High
 
Low
Quarter 1
 
$
19.90

 
$
17.85

Quarter 2
 
20.85

 
18.25

Quarter 3
 
21.00

 
16.15

Quarter 4
 
18.55

 
14.10


We had 676 common shareholders of record as of February 28, 2019.
 
We have not declared or paid any dividends during our existence. Under the terms of our loan agreement with BofA, we are permitted to declare or pay dividends without BofA’s consent, subject to limitations. We anticipate that, for the foreseeable future, all earnings will be retained for the operation and expansion of our business and that we will not pay cash dividends. The payment of dividends, if any, in the future, will be at the discretion of our Board of Directors and will depend upon, among other things, future earnings, capital and operating requirements, restrictions in future financing agreements, our general financial condition, and general business conditions.

Equity Compensation Plans
Information regarding securities authorized for issuance under equity compensation plans is included in Part III, Item 12 of this report.
 
Recent Sales of Unregistered Securities
None.

Issuer Purchases of Equity Securities
We did not repurchase any of our common stock during the fourth quarter of 2018.


23


Stock Performance Graph
The following line-graph presentation compares cumulative five-year shareholder returns on an indexed basis, assuming a $100 initial investment and reinvestment of dividends, of (a) Craft Brew Alliance, Inc., (b) a broad-based equity market index and (c) an industry-specific index. The broad-based market index used is the NASDAQ Composite Index and the industry-specific index used is the S&P 500 Beverages Index.

Total Return to Shareholders
(includes reinvestment of dividends)
COMPARISON OF CUMULATIVE FIVE YEAR TOTAL RETURN

chart-4a080c9c863d5e668ed.jpg

 
 
 
Base
Period
 
Indexed Returns
Year Ended
Company/Index
 
12/31/2013
 
12/31/2014
 
12/31/2015
 
12/31/2016
 
12/31/2017
 
12/31/2018
Craft Brew Alliance, Inc.
 
$
100.00

 
$
81.24

 
$
50.97

 
$
102.92

 
$
116.93

 
$
87.15

NASDAQ Composite
 
100.00

 
113.40

 
119.89

 
128.89

 
165.29

 
158.87

S&P 500 Beverages Index
 
100.00

 
112.53

 
122.62

 
122.63

 
141.95

 
133.64



24


Item 6.  Selected Financial Data

The selected consolidated financial data below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes thereto included elsewhere in this report.
In thousands,
except per share amounts
 
Year Ended December 31,
Statement of Operations Data
 
2018
 
2017
 
2016
 
2015
 
2014
Net sales (1)
 
$
206,186

 
$
207,456

 
$
202,507

 
$
204,168

 
$
200,022

Cost of sales
 
137,863

 
142,198

 
142,908

 
141,972

 
141,312

Gross profit
 
68,323

 
65,258

 
59,599

 
62,196

 
58,710

Selling, general and administrative expenses(2) (3)
 
62,572

 
60,463

 
59,224

 
57,932

 
53,000

Operating income
 
5,751

 
4,795

 
375

 
4,264

 
5,710

Interest expense and other income (expense), net
 
(322
)
 
(754
)
 
(681
)
 
(546
)
 
(611
)
Income (loss) before provision for income taxes
 
5,429

 
4,041

 
(306
)
 
3,718

 
5,099

Income tax provision (benefit)(4)
 
1,287

 
(5,482
)
 
14

 
1,500

 
2,022

Net income (loss)
 
$
4,142

 
$
9,523

 
$
(320
)
 
$
2,218

 
$
3,077

Basic and diluted net income (loss) per share
 
$
0.21

 
$
0.49

 
$
(0.02
)
 
$
0.12

 
$
0.16

Shares used in basic per share calculations
 
19,349

 
19,284

 
19,225

 
19,152

 
19,038

Shares used in diluted per share calculations
 
19,557

 
19,447

 
19,225

 
19,175

 
19,126


 
 
December 31,
 
 
2018
 
2017
 
2016
 
2015
 
2014
Balance Sheet Data
 
 
 
 
 
 
 
 
 
 
Cash, cash equivalents and restricted cash
 
$
1,200

 
$
579

 
$
442

 
$
911

 
$
981

Working capital
 
13,673

 
38,005

 
13,082

 
8,933

 
6,380

Total assets
 
236,047

 
209,637

 
200,405

 
188,429

 
176,931

Current portion of long-term debt and capital leases
 
919

 
699

 
1,317

 
507

 
1,157

Long-term debt and capital leases, net of current portion
 
46,573

 
32,599

 
27,946

 
18,991

 
13,720

Other long-term obligations
 
15,177

 
14,764

 
19,844

 
19,057

 
18,068

Shareholders’ equity
 
136,435

 
130,791

 
119,661

 
118,738

 
115,417


(1) Net sales in 2017 includes a $3.4 million fee from Pabst, related to the termination of the brewing agreements.
(2) Selling, general and administrative expenses in 2018 includes a gain of $0.5 million related to the sale of the Woodinville brewing and bottling equipment.
(3)
Selling, general and administrative expenses in 2017 includes a $1.0 million fee from Pabst related to the termination of a purchase option agreement, as well as a $0.5 million impairment charge related to the sale of our Woodinville brewery.
(4)
The income tax benefit in 2017 includes a $6.9 million benefit related to the effect on our deferred tax assets and liabilities of a change in Federal income tax rates from 34% to 21%.


25


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

Overview

Craft Brew Alliance, Inc. ("CBA") is the seventh largest craft brewing company in the U.S. and a leader in brewing, branding, and bringing to market world-class American craft beers.

Our distinctive portfolio combines the power of Kona Brewing Co., one of the top craft beer brands in the world, with strong regional breweries and innovative lifestyle brands, including Appalachian Mountain Brewery, Cisco Brewers, Omission Brewing Co., Redhook Brewery, Square Mile Cider Co., Widmer Brothers Brewing, and Wynwood Brewing Co. We nurture the growth and development of our brands in today’s increasingly competitive beer market through our state-of-the-art brewing and distribution capability, integrated sales and marketing infrastructure, and strong focus on innovation, local community and sustainability.

CBA was formed in 2008 through the merger of Redhook Brewery and Widmer Brothers Brewing, the two largest craft brewing pioneers in the Northwest at the time. Following a successful strategic brewing and distribution partnership, Kona Brewing Co. joined CBA in 2010. As part of CBA, Kona has expanded its reach across all 50 U.S. states and approximately 30 countries, while remaining deeply rooted in its home of Hawaii.

As consumers increasingly seek more variety and more local offerings, Craft Brew Alliance has expanded its portfolio and home markets with strong regional craft beer brands in targeted markets. In 2015 and 2016, we formed strategic partnerships with Appalachian Mountain Brewery, based in Boone, North Carolina; Cisco Brewers, based in Nantucket, Massachusetts; and Wynwood Brewing Co., based in the heart of Miami’s vibrant multicultural arts district. Building on the success of these partnerships, we acquired all three brands in the fourth quarter of 2018, fundamentally transforming our footprint and paving the way to increase our investments in their growth and drive shareholder value.

Publicly traded on NASDAQ under the ticker symbol BREW, Craft Brew Alliance is headquartered in Portland, Oregon and operates breweries and brewpubs across the U.S. For more information about CBA and its brands, see “Available Information” on page 14 of this report.

We proudly brew and package our craft beers in three company-owned production breweries located in Portland, Oregon; Portsmouth, New Hampshire; and Kailua-Kona, Hawaii. In 2018, we continued to leverage our contract brewing agreement with A-B Commercial Strategies, LLC (“ABCS”), an affiliate of Anheuser-Busch, LLC (“A-B”), through which we brew select CBA brands in A-B’s Fort Collins, Colorado brewery. Additionally, we own and operate five innovation breweries in Portland, Oregon; Seattle, Washington; Portsmouth, New Hampshire; Boone, North Carolina; and Miami, Florida, which are primarily used for small-batch production and limited-release beers offered primarily in our brewpubs and brands’ home markets.

We distribute our beers to retailers through wholesalers that are aligned with the A-B network. These sales are made pursuant to a Master Distributor Agreement (the “A-B Distributor Agreement”) with A-B, which extends through 2028. As a result of this distribution arrangement, we believe that, under alcohol beverage laws in a majority of states, these wholesalers would own the exclusive right to distribute our beers in their respective markets if the A-B Distributor Agreement expires or is terminated. As competition puts increasing pressure on craft brands outside of their home markets, we are continuing our efforts to stabilize and strengthen Widmer Brothers and Redhook in the Pacific Northwest, while expanding distribution of Appalachian Mountain Brewery, Cisco Brewers, and Wynwood Brewing Co. across their respective home markets of North Carolina, New England, and South Miami.

Separate from our A-B wholesalers, we maintain an internal independent sales and marketing organization with resources across the key functions of brand management, field marketing, field sales, and national retail sales.

We operate in two segments: Beer Related operations and Brewpubs operations. Beer Related operations include the brewing, and domestic and international sales, of craft beers and ciders from our breweries. Brewpubs operations primarily include our seven brewpubs, six of which are located adjacent to our Beer Related operations, as well as other merchandise sales, and sales of our beers directly to customers.



26


Following is a summary of our financial results:
 
 
Net Sales
 
Net Income (Loss)
 
Number of
Barrels Sold
2018
 
$206.2 million
 
$4.1 million
 
747,600
2017
 
$207.5 million
 
$9.5 million
 
748,300
2016
 
$202.5 million
 
$(0.3) million
 
775,600

Sale of Woodinville Brewery
See Notes 20 and 21 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this report for a discussion of the termination of our agreements with Pabst Brewing Company, LLC, and Pabst Northwest Brewing Company, LLC (collectively, "Pabst"), the determination in 2017 to classify our Woodinville Brewery assets as held for sale and a $0.5 million impairment charge recorded related to the assets held for sale. The sale was completed in early 2018 and when settled, resulted in a $0.5 million gain on sale of assets (see Note 21 of Notes to Consolidated Financial Statements).

Agreements with Anheuser-Busch, LLC

On August 23, 2016, we entered into a Contract Brewing Agreement (the “Brewing Agreement”) with A-B Commercial Strategies, LLC (“ABCS”), an affiliate of A-B, pursuant to which ABCS has agreed to brew, bottle and package up to 300,000 barrels of our mutually agreed products annually, in facilities owned by ABCS within the United States, for an initial term through December 31, 2026. Production began in A-B's Fort Collins, Colorado brewery in the second quarter of 2017.

In December 2015, we partnered with Ambev, the Brazilian subsidiary of Anheuser-Busch InBev SA, to distribute Kona beers in Brazil. On August 23, 2016, we also entered into an International Distribution Agreement (the “International Distribution Agreement”) with Anheuser-Busch Worldwide Investments, LLC (“ABWI”), an affiliate of A-B, pursuant to which ABWI will be our sole and exclusive distributor of our malt beverage products in jurisdictions outside the United States, subject to the terms and conditions of our agreement with our existing international distributor, CraftCan Travel LLC, and certain other limitations, in each case as set forth in the International Distribution Agreement. Unless terminated sooner, the International Distribution Agreement will continue in effect until December 31, 2026.

On August 23, 2016, we entered into Amendment No. 3 to the A-B Distributor Agreement. Pursuant to Amendment No. 3, the A-B Distributor Agreement was extended through December 31, 2028 (the “Term”). The existing margin fee structure of $0.25 per case-equivalent will apply throughout the Term. Without Amendment No. 3, beginning on January 1, 2019, a margin fee of $0.75 per case equivalent would have been payable by us under the A-B Distributor Agreement. Amendment No. 3 also provides that, beginning on January 1, 2019, we will reinvest an aggregate amount equal to $0.25 per case equivalent in sales and marketing efforts for our products, subject to specified terms and conditions.

On January 30, 2018, we entered into a Contract Brewing Agreement with Anheuser-Busch Companies, LLC (“ABC”), another
A-B affiliate, pursuant to which we agreed to brew, package, and palletize certain malt beverage products of A-B's craft breweries at our Portland, Oregon, and Portsmouth, New Hampshire, breweries as selected by ABC. Under the terms of this agreement, ABC pays us a per barrel fee that varies based on the annual volume of the specified product brewed by us, plus (a) our actual incremental costs of brewing the product, and (b) certain capital costs and costs of graphics and labeling that we incur in connection with the brewed products. The agreement, as extended, will expire on December 31, 2019.

For additional information, see Note 19 of Notes to Consolidated Financial Statements, included in Part II, Item 8 of this report.


27


Results of Operations

The following table sets forth, for the periods indicated, certain information from our Consolidated Statements of Operations expressed as a percentage of Net sales(1):
 
 
Year Ended December 31,
 
 
2018
 
2017
 
2016
Sales
 
105.4
 %
 
105.8
 %
 
106.5
 %
Less excise tax
 
5.4

 
5.8

 
6.5

Net sales
 
100.0

 
100.0

 
100.0

Cost of sales
 
66.9

 
68.5

 
70.6

Gross profit
 
33.1

 
31.5

 
29.4

Selling, general and administrative expenses
 
30.3

 
29.1

 
29.2

Operating income
 
2.8

 
2.3

 
0.2

Interest expense
 
(0.3
)
 
(0.3
)
 
(0.4
)
Other income (expense), net
 
0.1

 

 

Income (loss) before income taxes
 
2.6

 
1.9

 
(0.2
)
Income tax provision (benefit)
 
0.6

 
(2.6
)
 

Net income (loss)
 
2.0
 %
 
4.6
 %
 
(0.2
)%

(1)
Percentages may not sum due to rounding.

Segment Information
Net sales, Gross profit and Gross margin information by segment was as follows (dollars in thousands):
 
 
Year Ended December 31,
2018
 
Beer Related
 
Brewpubs
 
Total
Net sales
 
$
182,163

 
$
24,023

 
$
206,186

Gross profit
 
$
66,958

 
$
1,365

 
$
68,323

Gross margin
 
36.8
%
 
5.7
%
 
33.1
%
2017
 
 
 
 
 
 
Net sales
 
$
179,830

 
$
27,626

 
$
207,456

Gross profit
 
$
63,412

 
$
1,846

 
$
65,258

Gross margin
 
35.3
%
 
6.7
%
 
31.5
%
2016
 
 
 
 
 
 
Net sales
 
$
173,657

 
$
28,850

 
$
202,507

Gross profit
 
$
55,667

 
$
3,932

 
$
59,599

Gross margin
 
32.1
%
 
13.6
%
 
29.4
%

Net Sales by Category
The following tables set forth a comparison of Net sales by category (dollars in thousands):
 
 
Year Ended December 31,
 
Dollar
Change
 
% Change
Sales by Category
 
2018
 
2017
 
A-B and A-B related(1)
 
$
167,638

 
$
164,491

 
$
3,147

 
1.9
 %
Contract brewing and beer related(2)
 
25,608

 
27,430

 
(1,822
)
 
(6.6
)%
Excise taxes
 
(11,083
)
 
(12,091
)
 
1,008

 
(8.3
)%
Net beer related sales
 
182,163

 
179,830

 
2,333

 
1.3
 %
Brewpubs(3)
 
24,023

 
27,626

 
(3,603
)
 
(13.0
)%
Net sales
 
$
206,186

 
$
207,456

 
$
(1,270
)
 
(0.6
)%


28


 
 
Year Ended December 31,
 
Dollar
Change
 
% Change
Sales by Category
 
2017
 
2016
 
A-B and A-B related(1)
 
$
164,491

 
$
167,725

 
$
(3,234
)
 
(1.9
)%
Contract brewing and beer related(2)
 
27,430

 
19,052

 
8,378

 
44.0
 %
Excise taxes
 
(12,091
)
 
(13,120
)
 
1,029

 
(7.8
)%
Net beer related sales
 
179,830

 
173,657

 
6,173

 
3.6
 %
Brewpubs(3)
 
27,626

 
28,850

 
(1,224
)
 
(4.2
)%
Net sales
 
$
207,456

 
$
202,507

 
$
4,949

 
2.4
 %

(1)
A-B and A-B related includes domestic and international sales of our owned brands sold through A-B and Ambev, non-owned brands sold pursuant to master distribution agreements, contract brewing fees earned from ABC which began in 2018, international distribution fees earned from ABWI and the sale of hops to A-B.
(2)
Beer related includes international and domestic beer sales not sold through A-B or Ambev, as well as fees earned through alternating proprietorship agreements.
(3)
Brewpubs sales include sales of promotional merchandise and sales of beer directly to customers.

Shipments by Category
Shipments by category were as follows (in barrels):
Year Ended December 31,
 
2018 Shipments
 
2017 Shipments
 
Increase
(Decrease)
 
%
Change
 
Change in
Depletions(1)
A-B and A-B related(2)
 
653,300

 
654,200

 
(900
)
 
(0.1
)%
 
(2
)%
Contract brewing and beer related(3)
 
86,700

 
84,800

 
1,900

 
2.2
 %
 
 

Brewpubs
 
7,600

 
9,300

 
(1,700
)
 
(18.3
)%
 
 

Total
 
747,600

 
748,300

 
(700
)
 
(0.1
)%
 
 


Year Ended December 31,
 
2017 Shipments
 
2016 Shipments
 
Increase
(Decrease)
 
%
Change
 
Change in
Depletions(1)
A-B and A-B related(2)
 
654,200

 
693,300

 
(39,100
)
 
(5.6
)%
 
(1
)%
Contract brewing and beer related(3)
 
84,800

 
72,600

 
12,200

 
16.8
 %
 
 

Brewpubs
 
9,300

 
9,700

 
(400
)
 
(4.1
)%
 
 

Total
 
748,300

 
775,600

 
(27,300
)
 
(3.5
)%
 
 


(1)
Change in depletions reflects the year-over-year change in barrel volume sales of beer by our wholesalers to retailers.
(2)
A-B and A-B related includes domestic and international shipments of our owned brands distributed through A-B and Ambev, non-owned brands distributed pursuant to master distribution agreements and contract brewing volume produced for ABC which began in 2018.
(3)
Beer related includes domestic and international shipments of our beers not distributed through A-B or Ambev.

The increase in sales to A-B and A-B related in 2018 compared to 2017 was primarily due to an increase in average unit pricing, contract brewing fees earned and the sale of hops, partially offset by unfavorable brand family mix.

The decrease in sales to A-B and A-B related in 2017 compared to 2016 was primarily due to a decrease in shipment volume as we continued to reduce our inventory levels at our wholesaler partners as part of our ongoing efforts to address slowing craft segment growth and the on-going inventory pressures facing distributors in today’s complex craft beer market, partially offset by an increase in average unit pricing. The decrease was also partially offset by $3.4 million of international distribution fees earned in 2017 compared to $1.2 million earned in 2016 related to our international distribution agreement with ABWI, which began in the third quarter of 2016.

The average gross revenue per barrel, excluding excise taxes and net of discounting, on shipments of beer through the A-B distribution network increased by 1.4% in 2018 compared to 2017, primarily due to pricing increases, partially offset by shifts in brand family mix. The average gross revenue per barrel, excluding excise taxes and net of discounting, on shipments of beer through the A-B distribution network increased by 2.4% in 2017 compared to 2016, primarily due to pricing increases and shifts in brand family, package and geographic mix. Price changes implemented by us have generally followed craft beer market pricing

29


trends. During 2018, 2017 and 2016, we sold 87.4%, 87.4% and 89.4%, respectively, of our beer through A-B at wholesale pricing levels.

The decrease in contract brewing and beer related sales in 2018 compared to 2017 was primarily due to $3.4 million of non-recurring fees earned in the 2017 period from Pabst Northwest Brewing Company ("Pabst") related to a contract brewing volume shortfall and termination fees, partially offset by an increase in international shipments of our beers not distributed through A-B or Ambev and an increase in our alternating proprietorship fees. As a result of our asset purchase of Cisco and acquisitions of AMB and Wynwood, we no longer have alternating proprietorship agreements as of the respective asset purchase and acquisition dates. We expect this to have an unfavorable impact on our 2019 and future Contract brewing and beer related sales.

The increase in contract brewing and beer related sales in 2017 compared to 2016 was primarily due to an increase in our alternating proprietorship volume and an increase in international shipments of our beers not distributed through A-B or Ambev. Contract brewing shortfall and termination fees earned from Pabst were $3.4 million in 2017 compared to a contract brewing shortfall fee of $1.6 million in 2016. In addition, we had a slight increase in our contract brewing volume in 2017 compared to 2016.

Brewpubs sales decreased in 2018 compared to 2017, primarily as a result of the closure of our Woodinville brewpub which occurred at the end of 2017, partially offset by increased sales at our Kona brewpub on the big island of Kailua-Kona in Hawaii and our Redhook Brewlab being operational for a full year.

Brewpubs sales decreased in 2017 compared to 2016, primarily as a result of decreased guest counts across our mainland brewpubs, partially offset by an increased guest count at our Kona brewpub on the big island of Kailua-Kona in Hawaii and the opening of our newest brewpub, Redhook Brewlab, in Seattle, Washington. Our Woodinville brewpub closed at the end of 2017.

Excise taxes vary directly with the volume of beer shipped. Additionally, beginning January, 1, 2018, the federal excise taxes imposed on domestic brewers, such as us, that produce less than 2 million barrels annually, were reduced from $7.00 to $3.50 per barrel on the first 60,000 barrels shipped annually and from $18.00 to $16.00 per barrel on the first 6 million barrels shipped annually for all other brewers and all beer importers. Also, while the existing excise tax on hard cider did not change, the small producer tax credit for hard cider was expanded. Producers like us, who produce between 130,000 and 750,000 gallons of hard cider annually, receive a $0.033 credit for an effective tax rate of $0.193 per gallon.

Shipments by Brand
The following table sets forth a comparison of shipments by brand (in barrels):
Year Ended December 31,
 
2018 Shipments
 
2017 Shipments
 
Increase
(Decrease)
 
%
Change
 
Change in
Depletions
Kona
 
456,300

 
424,600

 
31,700

 
7.5
 %
 
8
 %
Widmer Brothers
 
98,700

 
123,300

 
(24,600
)
 
(20.0
)%
 
(19
)%
Redhook
 
71,200

 
94,200

 
(23,000
)
 
(24.4
)%
 
(27
)%
Omission
 
44,700

 
44,000

 
700

 
1.6
 %
 
 %
All other(1)
 
48,500

 
44,500

 
4,000

 
9.0
 %
 
12
 %
Total(2)
 
719,400

 
730,600

 
(11,200
)
 
(1.5
)%
 
(2
)%

Year Ended December 31,
 
2017 Shipments
 
2016 Shipments
 
Increase
(Decrease)
 
%
Change
 
Change in
Depletions
Kona
 
424,600

 
397,400

 
27,200

 
6.8
 %
 
10
 %
Widmer Brothers
 
123,300

 
148,100

 
(24,800
)
 
(16.7
)%
 
(16
)%
Redhook
 
94,200

 
127,200

 
(33,000
)
 
(25.9
)%
 
(24
)%
Omission
 
44,000

 
42,900

 
1,100

 
2.6
 %
 
(2
)%
All other(1)
 
44,500

 
33,300

 
11,200

 
33.6
 %
 
17
 %
Total(2)
 
730,600

 
748,900

 
(18,300
)
 
(2.4
)%
 
(1
)%

(1)
All other includes the shipments and depletions from our Appalachian Mountain Brewing, Cisco Brewers, Square Mile, and Wynwood Brewing brand families.
(2)
Total shipments by brand include international shipments and exclude shipments that we produced for others under our contract brewing arrangements.

The increase in our Kona brand shipments in 2018 compared to 2017 was due to increases in both in domestic and international shipments, primarily led by demand for Big Wave Golden Ale and Kanaha Blonde Ale, partially offset by a decline in Longboard Lager.

The increase in our Kona brand shipments in 2017 compared to 2016 was due to increases in both in domestic and international shipments, primarily led by demand for Hanalei Island IPA and Big Wave Golden Ale, partially offset by a decline in Castaway IPA.

The decrease in our Widmer Brothers brand shipments in 2018 compared to 2017 was led by a decrease in Hefeweizen brand shipments, primarily due to a continued strategic focus on the home market of Oregon, partially offset by the release of Green and Gold Kolsch and Deadlift IPA.

The decrease in our Widmer Brothers brand shipments in 2017 compared to 2016 was led by a decrease in Hefeweizen brand shipments, primarily due to a continued strategic focus on the home market of Oregon, partially offset by the release of Drifter and the Hefe Fruit variety pack.

The decrease in our Redhook brand shipments in 2018 compared to 2017 was primarily due to a continued strategic focus on the home market of Washington, led by a decline in Longhammer IPA and ESB brand shipments, partially offset by an increase in Big Ballard IPA.

The decrease in our Redhook brand shipments in 2017 compared to 2016 was primarily due to a continued strategic focus on the home market of Washington, led by a decline in Longhammer IPA and ESB brand shipments, partially offset by higher demand for Big Ballard IPA and the release of Bicoastal IPA.

The slight increase in our Omission brand shipments in 2018 compared to 2017 was primarily led by increased demand for Omission Ultimate Light brand, offset by a decrease in our Pale Ale and Lager brands.
 
The increase in our Omission brand shipments in 2017 compared to 2016 was primarily led by increased demand for our new brand Omission Ultimate Light, which was introduced in the first quarter of 2017, offset by a decrease in Omission Pale Ale.

The increase in our All other shipments in 2018 compared to 2017 was primarily due to an increase in shipment volumes related to our distribution agreements with Wynwood Brewing and Appalachian Mountain Brewing. During the fourth quarter of 2018, the distribution agreements with Wynwood Brewing and Appalachian Mountain Brewing terminated when their shipments began being treated as owned.

The increase in our All other shipments in 2017 compared to 2016 was primarily due to an increase in shipment volumes related to our distribution agreements with Wynwood Brewing, Cisco Brewers and Appalachian Mountain Brewing.

Shipments by Package
The following table sets forth a comparison of our shipments by package, excluding contract brewing shipments produced under our contract brewing arrangements (in barrels):
Year Ended December 31,
 
2018
 
2017
 
2016
 
Shipments
 
% of Total
 
Shipments
 
% of Total
 
Shipments
 
% of Total
Draft
 
169,200

 
23.5
%
 
165,600

 
22.7
%
 
171,100

 
22.8
%
Packaged
 
550,200

 
76.5
%
 
565,000

 
77.3
%
 
577,800

 
77.2
%
Total
 
719,400

 
100.0
%
 
730,600

 
100.0
%
 
748,900

 
100.0
%

The package mix was relatively consistent through the three-year period.


30


Cost of Sales
Cost of sales includes purchased raw materials, direct labor, overhead and shipping costs.


31


Information regarding Cost of sales was as follows (dollars in thousands):
 
 
Year Ended December 31,
 
Dollar
 
 
 
 
2018
 
2017
 
Change
 
% Change
Beer Related
 
$
115,205

 
$
116,418

 
$
(1,213
)
 
(1.0
)%
Brewpubs
 
22,658

 
25,780

 
(3,122
)
 
(12.1
)%
Total
 
$
137,863

 
$
142,198

 
$
(4,335
)
 
(3.0
)%

 
 
Year Ended December 31,
 
Dollar
 
 
 
 
2017
 
2016
 
Change
 
% Change
Beer Related
 
$
116,418

 
$
117,990

 
$
(1,572
)
 
(1.3
)%
Brewpubs
 
25,780

 
24,918

 
862

 
3.5
 %
Total
 
$
142,198

 
$
142,908

 
$
(710
)
 
(0.5
)%

The decrease in Beer Related Cost of sales in 2018 compared to 2017 was primarily due to a decrease in Beer Related Cost of sales on a per barrel basis. The decrease in our Beer Related Cost of sales on a per barrel basis was primarily due to the lower cost of having a portion of our beer produced by A-B in its Fort Collins, Colorado brewery, as well as cost savings associated with removing the Woodinville facility from our brewing footprint and the termination of our contract brewing agreement in Memphis, which had higher costs on a per barrel basis. The decreases were partially offset by increases in brewery costs due to higher fixed overhead, distribution rates on a per barrel basis and an increase in the quantity of hops shipped from our inventory. As a result of our asset purchase of Cisco and acquisitions of AMB and Wynwood we no longer have alternating proprietorship agreements. We expect this to have a favorable impact on our 2019 and future Beer Related Cost of sales.

The decrease in Beer Related Cost of sales in 2017 compared to 2016 was primarily due to a decrease in cost of goods related to lower shipment volume, efficiency improvements and improved distribution rates on a per barrel basis, partially offset by an increase in brewery costs on a per barrel basis and alternating proprietorship volume.

Early in the fourth quarter of 2016, we laid off approximately half of our production employees at our Woodinville brewery. The fourth quarter costs of the layoff were immaterial and effectively offset by the cost savings in the fourth quarter.

Brewpubs Cost of sales decreased in 2018 compared to 2017 primarily due to closure of the Woodinville brewpub and conversion of the Portland brewpub into a taproom, partially offset by the costs of opening our new brewpub in Seattle.

Brewpubs Cost of sales increased in 2017 compared to 2016 primarily due to increases in employee related costs and rent and other startup costs related to our Seattle brewpub, partially offset by a decrease in guest counts.

Capacity Utilization
Capacity utilization is calculated by dividing total shipments from our owned breweries by approximate working capacity of those breweries and was as follows:
 
 
Year Ended December 31,
 
 
2018
 
2017
 
2016
Capacity utilization
 
57
%
 
60
%
 
67
%

In June 2014, we initiated full-scale brewing with our brewing partner in Memphis, Tennessee. This partnership provided us scalable capacity and we had the ability to produce up to 100,000 barrels at this location annually. Production ceased with this brewing partner during the second quarter of 2017. In 2016, we entered into a contract brewing agreement with ABCS with the ability to have up to 300,000 barrels produced annually and, during the second quarter of 2017, production began in their facilities.

Our capacity utilization declined in 2018 compared to 2017 due to a larger percentage of our beer being brewed by ABCS as part of our contract brewing relationship and evolving brewery footprint.

Our capacity utilization declined in 2017 compared to 2016 due to reductions in wholesaler inventories, as well as a larger percentage of our beer being brewed by ABCS as part of our contract brewing relationship and shifts in our brewery footprint.

As discussed in Notes 20 and 21 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this report, we ceased production at our Woodinville, Washington brewery during the second quarter of 2017, which reduced the capacity of our owned breweries beginning in the third quarter of 2017. As a result, beginning with the third quarter of 2017, our capacity utilization calculation was revised to exclude, from the denominator, the production capacity of our Woodinville, Washington brewery, which we estimated to be approximately 220,000 barrels per year.

Gross Profit
Information regarding Gross profit was as follows (dollars in thousands):
 
 
Year Ended December 31,
 
Dollar
 
 
 
 
2018
 
2017
 
Change
 
% Change
Beer Related
 
$
66,958

 
$
63,412

 
$
3,546

 
5.6
 %
Brewpubs
 
1,365

 
1,846

 
(481
)
 
(26.1
)%
Total
 
$
68,323

 
$
65,258

 
$
3,065

 
4.7
 %

 
 
Year Ended December 31,
 
Dollar
 
 
 
 
2017
 
2016
 
Change
 
% Change
Beer Related
 
$
63,412

 
$
55,667

 
$
7,745

 
13.9
 %
Brewpubs
 
1,846

 
3,932

 
(2,086
)
 
(53.1
)%
Total
 
$
65,258

 
$
59,599

 
$
5,659

 
9.5
 %

Gross profit as a percentage of Net sales, or gross margin rate, was as follows:
 
 
Year Ended December 31,
 
 
2018
 
2017
 
2016
Beer Related
 
36.8
%
 
35.3
%
 
32.1
%
Brewpubs
 
5.7
%
 
6.7
%
 
13.6
%
Total
 
33.1
%
 
31.5
%
 
29.4
%

The increase in Beer Related Gross profit and gross margin in 2018 compared to 2017 was primarily due to increased unit pricing, lower excise tax rates, and the lower costs related to having a portion of our beer produced by A-B in Fort Collins, partially offset by $3.4 million of non-recurring fees earned from Pabst related to a contract brewing volume shortfall in 2017, and increases in brewery costs and distribution rates on a per barrel basis.

The increases in Beer Related Gross profit and gross margin rate in 2017 compared to 2016 were primarily due to increased unit pricing and higher alternating proprietorship volume, as well as a $2.2 million increase in the ABWI international distribution fee earned and $1.8 million of additional fees earned from Pabst related to contract brewing volume shortfall and termination fees in 2017 compared to 2016, and a decrease in distribution rates on a per barrel basis. The favorable benefits to Beer Related Gross profit were partially offset by an increase in brewery costs on a per barrel basis and a decrease in shipment volume.

The decreases in Brewpubs Gross profit and gross margin in 2018 compared to 2017 were primarily due to the closure of our Woodinville brewpub and the net costs associated with our brewpub in Seattle, partially offset by the increased sales at our Kona brewpub.

The decreases in the Brewpubs Gross profit and gross margin rate in 2017 compared to 2016 were primarily due to decreased guest counts, increased employee related costs and costs related to preparations to open our Seattle brewpub.

Selling, General and Administrative Expenses
Selling, general and administrative expenses (“SG&A”) include compensation and related expenses for our sales and marketing activities, management, legal and other professional and administrative support functions.


32


Information regarding SG&A was as follows (dollars in thousands): 
 
 
Year Ended December 31,
 
Dollar
Change
 
% Change
 
 
2018
 
2017
 
 
 
$
62,572

 
$
60,463

 
$
2,109

 
3.5
%
As a % of Net sales
 
30.3
%
 
29.1
%
 
 

 
 


 
 
Year Ended December 31,
 
Dollar
Change
 
% Change
 
 
2017
 
2016
 
 
 
$
60,463

 
$
59,224

 
$
1,239

 
2.1
%
As a % of Net sales
 
29.1
%
 
29.2
%
 
 

 
 


The increase in SG&A in 2018 compared to 2017 was primarily due to increases in in-market promotional spend and professional fees, partially offset by a gain of $0.5 million in the first quarter of 2018 related to the sale of the Woodinville brewing and bottling equipment and a decrease in general and administrative costs.

The increase in SG&A in 2017 compared to 2016 was primarily due to increased professional fees, technology related expenses and an impairment charge of $0.5 million related to the sale of our Woodinville Brewery, partially offset by a $1.0 million contract settlement fee received from Pabst, as well as a decrease in creative and media spend.

Interest Expense
Information regarding Interest expense was as follows (dollars in thousands):
 
 
Year Ended December 31,
 
Dollar
Change
 
% Change
 
 
2018
 
2017
 
Interest expense
 
$
614

 
$
715

 
$
(101
)
 
(14.1
)%
 
 
 
 
 
 
 
 
 
 
 
Year Ended December 31,
 
Dollar
Change
 
% Change
 
 
2017
 
2016
 
Interest expense
 
$
715

 
$
709

 
$
6

 
0.8
 %

 
 
Year Ended December 31,
 
 
2018
 
2017
 
2016
Average debt outstanding
 
$
18,664

 
$
27,189

 
$
27,548

Average interest rate
 
2.96
%
 
2.08
%
 
1.51
%

The decrease in Interest expense in 2018 compared to 2017 was primarily due to a decrease in our average debt outstanding, partially offset by an increase in our average interest rate. The decrease in our average debt outstanding was due to principal payments made on our term loan and the payoff of our revolving credit balance following the sale of our Woodinville, Washington brewery in January 2018.

The increase in Interest expense in 2017 compared to 2016 was primarily due to an increase in our average interest rate, partially offset by a decrease in our average debt outstanding. The decrease in our average debt outstanding was due to principal payments made on our term loan and a decrease in the average amount outstanding on our line of credit, which fluctuates with our operating capital needs.

Income Tax Provision (Benefit)
Our effective income tax rate was 23.7%, (135.7)% and 4.6% in 2018, 2017 and 2016, respectively. The effective income tax rates reflect the impact of non-deductible expenses (primarily meals and entertainment expenses), state and local taxes, tax credits, and for periods prior to 2018, income excluded from taxation under the domestic production activities exclusion.

Our effective income tax rate in 2018 reflects the benefit of tax legislation, which reduced our federal tax rate from 34% to 21% effective January 1, 2018.

In the second quarter of 2017, we recognized a tax credit of $164,000 for a biofuel project at our New Hampshire brewery. The tax credit was claimed on our 2016 tax return and is based upon a study completed in the second quarter of 2017.

33



In the fourth quarter of 2017, we recognized the impact of enacted tax legislation, which reduced our federal tax rate from 34% to 21% effective January 1, 2018. This reduction resulted in a $6.9 million decrease to our deferred tax liability, which was recognized as a reduction to our income tax provision in the fourth quarter of 2017, the period of enactment. Before consideration of the effects of tax reform, our income tax provision would have been $1.4 million, for an effective income tax rate of 34.9%. Our accounting for the income tax effects of the new tax legislation is complete, and we do not anticipate adjustments to such accounting in future periods.

Liquidity and Capital Resources

We have required capital primarily for the construction and development of our production breweries, to support our expansion and growth plans, including acquisitions, and to fund our working capital needs. Historically, we have financed our capital requirements through cash flows from operations, bank borrowings and the sale of common and preferred stock. We anticipate meeting our obligations for the twelve months beginning January 1, 2019, primarily from cash flows generated from operations and borrowing under our line of credit facility as the need arises. Capital resources available to us at December 31, 2018 included $0.7 million of Cash and cash equivalents and $7.9 million available under our line of credit facility.

We had $13.7 million and $38.0 million of working capital and our debt as a percentage of total capitalization (total debt and common shareholders’ equity) was 25.8% and 20.3% at December 31, 2018 and 2017, respectively.

A summary of our cash flow information was as follows (in thousands):
 
 
Year Ended December 31,
 
 
2018
 
2017
 
2016
Net cash provided by operating activities
 
$
13,241

 
$
16,778

 
$
7,444

Net cash used in investing activities
 
(27,124
)
 
(20,348
)
 
(16,572
)
Net cash provided by financing activities
 
14,504

 
3,707

 
8,659

Increase (decrease) in cash, cash equivalents and restricted cash
 
$
621

 
$
137

 
$
(469
)

Cash provided by operating activities of $13.2 million in 2018 resulted from our Net income of $4.1 million, net non-cash expenses of $11.5 million, and changes in our operating assets and liabilities as discussed in more detail below.

Accounts receivable, net, increased $2.2 million to $30.0 million at December 31, 2018, compared to $27.8 million at December 31, 2017. This increase was primarily due to a $3.3 million increase in our receivable from A-B to a total of $23.9 million at December 31, 2018, primarily due to the $6.0 million international distribution agreement fee from ABWI outstanding at December 31, 2018, which was received in January 2019, compared to the $5.0 million fee outstanding at December 31, 2017. Historically, we have not had collection problems related to our accounts receivable.

Inventories increased $3.4 million to $17.2 million at December 31, 2018, compared to $13.8 million at December 31, 2017. The increase was primarily due to an increase in raw materials as we purchased hops under raw material contracts.

Accounts payable increased $3.3 million to $17.6 million at December 31, 2018, compared to $14.3 million at December 31, 2017, primarily due to the timing of payments for capital projects. The portion of our payable to A-B that is included in our Accounts payable totaled $5.1 million at December 31, 2018, which is slightly higher than the balance at December 31, 2017, primarily due to the timing of payments related to our contract brewing relationship with ABCS.

As of December 31, 2018 we had the following net operating loss carryforwards (“NOLs”) and federal credit carry forwards available to offset payment of future income taxes:

state NOLs of $10,000, tax-effected; and
federal alternative minimum tax (“AMT”) credit carry forwards of $170,000.

The AMT credit carryforward is refundable over the next four years  As such, the carryforward is recognized as a tax receivable on our Consolidated Balance Sheets at December 31, 2018. 

Capital expenditures of $12.8 million in 2018 were primarily directed to beer production capacity and efficiency improvements and Brewpubs remodeling. As of December 31, 2018, we had an additional $3.1 million of expenditures recorded in Accounts payable on our Consolidated Balance Sheets, compared to $0.5 million at December 31, 2017. Beginning in 2015, we invested

34


approximately $10 million in our Oregon Brewery to expand capacity; the project was completed in the fourth quarter of 2017. Also beginning in 2015 through expected completion in 2019, we are investing approximately $20 million in a new Hawaiian Brewery. We anticipate capital expenditures of approximately $15 million to $19 million in 2019, primarily for our new Kona brewery.


35


Loan Agreement

On October 10, 2018, we executed a First Amendment (the "Amendment") to our Amended and Restated Credit Agreement with Bank of America, N.A. dated November 30, 2015 (as amended, the "Credit Agreement"). The Credit Agreement provides for a revolving line of credit (“Line of Credit”), including provisions for cash borrowings and up to $2.5 million notional amount of letters of credit, and a $10.8 million term loan (“Term Loan”). The primary changes effected by the Amendment were to increase the maximum amount available under the line of credit from $40.0 million to $45.0 million and to extend the maturity date of the line of credit from November 30, 2020 to September 30, 2023, which is also the maturity date of the term loan. The maximum amount of the line of credit is subject to loan commitment reductions in the amount of $750,000 each quarter beginning March 31, 2020. The Amendment also increased the limit on the total amount of investments that we may make in other craft brewers, other than the acquisition of all or substantially all of the assets or controlling ownership interests, from $5.0 million to $10.0 million. We may draw upon the Line of Credit for working capital and general corporate purposes. At December 31, 2018, we had $37.1 million of borrowings outstanding under the Line of Credit and $8.8 million outstanding under the Term Loan.

As discussed in Note 21 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this report, we completed the sale of our Woodinville, Washington brewery on January 12, 2018 for a total selling price of $24.5 million. We used proceeds from the sale to fully pay down our Line of Credit effective January 26, 2018. In the fourth quarter of 2018, we borrowed on the Line of Credit primarily to fund the asset purchase and acquisitions as discussed in Note 5.

Under the Loan Agreement, interest accrues at an annual rate based on the London Inter-Bank Offered Rate (“LIBOR”) Daily Floating Rate plus a marginal rate. The marginal rate varies from 0.75% to 1.75% for the Line of Credit and Term Loan based on our funded debt ratio. At December 31, 2018, our marginal rate was 1.25% resulting in an annual interest rate of 3.23%.

Accrued interest for the Term Loan is due and payable monthly. Principal payments on the Term Loan are due monthly in accordance with an agreed-upon schedule set forth in the Loan Agreement, with any unpaid principal balance and unpaid accrued interest due and payable on September 30, 2023.

The Loan Agreement authorizes acquisitions within the same line of business as long as we remain in compliance with the financial covenants of the Loan Agreement and there is at least $5.0 million of availability remaining on the Line of Credit following the acquisition.

Contractual Commitments and Obligations
 
The following is a summary of our contractual commitments and obligations as of December 31, 2018 (in thousands):
 
 
Payments Due By Period
Contractual Obligations
 
Total
 
2019
 
2020 and 2021
 
2022 and 2023
 
2024 and beyond
Term loan
 
$
8,823

 
$
442

 
$
936

 
$
7,445

 
$

Interest on term loan(1)
 
420

 
97

 
179

 
144

 

Line of credit
 
37,092

 

 

 
37,092

 

Operating leases
 
43,712

 
11,208

 
3,800

 
3,258

 
25,446

Capital leases
 
1,725

 
529

 
599

 
398

 
199

Purchase commitments
 
27,794

 
7,278

 
14,641

 
5,875

 

Sponsorship obligations
 
4,168

 
1,830

 
1,745

 
593

 

Interest rate swap(2)
 
780

 
180

 
332

 
268

 

 
 
$
124,514

 
$
21,564

 
$
22,232

 
$
55,073

 
$
25,645


(1)
The variable interest rate on our Term Loan and Line of Credit was 3.23% at December 31, 2018.
(2)
The fixed rate on our interest rate swap was 2.86%. We pay interest at the fixed rate and receive interest at the Benchmark Rate, which was 2.46% at December 31, 2018.

See Notes 9 and 18 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this report for additional information.

Inflation

We believe that the impact of inflation was minimal on our business in 2018, 2017 and 2016.

Critical Accounting Policies and Estimates

Our financial statements are based upon the selection and application of significant accounting policies that require management to make significant estimates and assumptions. Judgments and uncertainties affecting the application of these policies may result in materially different amounts being reported under different conditions or using different assumptions. Our estimates are based upon historical experience, market trends and financial forecasts and projections, and upon various other assumptions that management believes to be reasonable under the circumstances at various points in time. Actual results may differ, potentially significantly, from these estimates.

Goodwill and Other Indefinite-Lived Intangible Assets
We test goodwill and other indefinite-lived intangible assets for impairment on an annual basis, or as indicators of impairment are present. We have an option to first assess certain qualitative factors for indications of impairment in order to determine whether it is necessary to perform the quantitative, two-step impairment test. If we choose not to first perform the qualitative test, or we determine that it is more likely than not that the fair value of the reporting unit is less than the carrying amount, we perform the quantitative two-step impairment test.

Our goodwill and other indefinite-lived intangible assets impairment loss calculations contain uncertainties because they require management to make assumptions in the qualitative assessment of relevant events and circumstances and to estimate the fair value of our reporting units and indefinite-lived intangible assets, including estimating future cash flows. These calculations contain uncertainties because they require management to make assumptions and apply judgment to estimate economic factors and the profitability of future business operations and, if necessary, the fair value of a reporting unit’s assets and liabilities. Further, our ability to realize the future cash flows used in our fair value calculations is affected by changes in such factors as our operating performance, our business strategies, our industry and economic conditions.

We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to test for impairment losses on goodwill. Based on the results of our annual impairment test for goodwill and other indefinite-lived intangible assets, no impairment was recorded. We believe, based on our assessment discussed above, that our goodwill and other indefinite-lived intangible assets are not at risk of impairment. However, if actual results are not consistent with our estimates or assumptions or there are significant changes in any of these estimates, projections or assumptions, the fair value of these assets in future measurement periods could be materially affected, resulting in an impairment that could have a material adverse effect on our results of operations.

Refundable Deposits on Kegs
We distribute our draft beer in kegs that are owned by us and are reflected as a component of Property, equipment and leasehold improvements in our Consolidated Balance Sheets at cost and are depreciated over the estimated useful life of the keg. When draft beer is shipped to the wholesaler, we collect a refundable deposit, reflected as a current liability in our Consolidated Balance Sheets. Upon return of the keg to us, the deposit is refunded to the wholesaler. When a wholesaler cannot account for some of our kegs for which it is responsible, it pays us a fixed fee and forfeits its deposit for each keg determined to be lost. We have experienced some loss of kegs and anticipate that some loss will occur in future periods due to the significant volume of kegs handled by each wholesaler and retailer, the similarities between kegs owned by most brewers, and the relatively low deposit collected on each keg when compared with the market value of the keg. We believe that this is an industry-wide issue and our loss experience is typical of the industry. In order to estimate forfeited deposits attributable to lost kegs, we periodically use internal records, A-B records, other third-party records, and historical information to estimate the physical count of kegs held by wholesalers and A-B.

These estimates affect the amount recorded as brewery equipment and refundable deposits as of the date of the consolidated financial statements. The actual liability for refundable deposits could differ from estimates.

Revenue Recognition
We recognize revenue from product sales, net of excise taxes, discounts and certain fees we must pay in connection with sales to a member of the A-B wholesale distributor network, when the products are delivered to the member. A member of the A-B wholesale distributor network may be a branch of A-B or an independent wholesale distributor.

We recognize revenue on contract brewing sales when the product is shipped to our contract brewing customer.


36


We recognize revenue on retail sales at the time of sale and we recognize revenue from events at the time of the event.

We recognize revenue related to non-refundable payments to be received on specified dates throughout a contract term on a straight-line basis over the life of the related contract or contracts.

Deferred Taxes
Deferred tax assets arise from the tax benefit of amounts expensed for financial reporting purposes but not yet deducted for tax purposes and from unutilized tax credits and net operating loss carry forwards. We evaluate our deferred tax assets on a regular basis to determine if a valuation allowance is required. To the extent it is determined the recoverability of the deferred tax assets is not more likely than not, we will record a valuation allowance against deferred tax assets. If we are unable to generate adequate taxable income in future periods or our assessment that it is more likely than not that certain deferred tax assets will be realized is otherwise not accurate, we may incur charges in future periods to record a valuation allowance on our gross deferred tax assets.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources.

Recent Accounting Pronouncements

See Note 3 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this report.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk
We have assessed our vulnerability to certain market risks, including interest rate risk associated with financial instruments included in Cash and cash equivalents and Long-term debt. To mitigate this risk, on January 23, 2014, we entered into an $8.0 million notional amount interest rate swap agreement, which expires September 30, 2023, to hedge the variability of interest payments associated with our variable-rate borrowings on our term loan. On November 25, 2015, we entered into a $9.1 million notional amount interest rate swap agreement effective January 4, 2016, which was set to expire January 1, 2019, to hedge the variability of interest payments associated with our variable-rate borrowings on our line of credit. This swap agreement was terminated effective January 18, 2018 as we paid off our line of credit, and we received interest of $27,000. The notional amount fluctuates based on a predefined schedule based on our anticipated borrowings. Since the interest rate swap hedges the variability of interest payments on variable rate debt with similar terms, it qualifies for cash flow hedge accounting treatment. The interest rate swap hedges 75% of our total term loan outstanding and reduces our overall interest rate risk. As of December 31, 2018, we had unhedged variable-rate debt outstanding of $2.2 million on our term loan and $37.1 million on our line of credit. A 10% increase or decrease in the interest rate on our variable-rate debt would not have a material effect on our financial position, results of operations or cash flows.

Due to the nature of our highly liquid Cash and cash equivalents, an increase or decrease in interest rates would not materially affect the fair value of our cash or the related interest income.


37


Item 8. Financial Statements and Supplementary Data
 
Unaudited quarterly financial data for each of the eight quarters in the two-year period ended December 31, 2018 is as follows:
2018 (In thousands, except per share data)
 
1st Quarter
 
2nd Quarter
 
3rd Quarter
 
4th Quarter
Net sales
 
$
47,487

 
$
61,823

 
$
52,889

 
$
43,987

Cost of sales
 
32,416

 
39,696

 
36,190

 
29,561

Gross profit
 
15,071

 
22,127

 
16,699

 
14,426

Selling, general and administrative expenses(1)
 
14,748

 
15,857

 
16,712

 
15,255

Operating income (loss)
 
323

 
6,270

 
(13
)
 
(829
)
Interest expense and Other expense, net
 
(100
)
 
(86
)
 
(120
)
 
(16
)
Income (loss) before income taxes
 
223

 
6,184

 
(133
)
 
(845
)
Income tax provision (benefit)
 
62

 
1,732

 
(194
)
 
(313
)
Net income (loss)
 
$
161

 
$
4,452

 
$
61

 
$
(532
)
Basic and diluted net income (loss) per share(5)
 
$
0.01

 
$
0.23

 
$

 
$
(0.03
)
Shares used in basic per share calculation
 
19,310

 
19,334

 
19,370

 
19,382

Shares used in diluted per share calculation
 
19,488

 
19,517

 
19,545

 
19,382


2017 (In thousands, except per share data)
 
1st Quarter
 
2nd Quarter
 
3rd Quarter
 
4th Quarter(5)
Net sales(2)
 
$
44,302

 
$
60,550

 
$
56,638

 
$
45,966

Cost of sales
 
31,633

 
42,221

 
37,254

 
31,090

Gross profit
 
12,669

 
18,329

 
19,384

 
14,876

Selling, general and administrative expenses(3)
 
15,469

 
15,560

 
16,328

 
13,106

Operating income (loss)
 
(2,800
)
 
2,769

 
3,056

 
1,770

Interest expense and Other expense, net
 
(178
)
 
(163
)
 
(238
)
 
(175
)
Income (loss) before income taxes
 
(2,978
)
 
2,606

 
2,818

 
1,595

Income tax provision (benefit)(4)
 
(1,191
)
 
882

 
1,067

 
(6,240
)
Net income (loss)
 
$
(1,787
)
 
$
1,724

 
$
1,751

 
$
7,835

Income (loss) per share:(5)