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Q3 2017 Craft Brew Alliance Inc Earnings Call

PORTLAND Nov 9, 2017 (Thomson StreetEvents) — Edited Transcript of Craft Brew Alliance Inc earnings conference call or presentation Thursday, November 9, 2017 at 4:30:00pm GMT

Corporate Participants

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* Andrew J. Thomas

Craft Brew Alliance, Inc. – CEO

* Edwin A. Smith

Craft Brew Alliance, Inc. – Principal Accounting Officer and Corporate Controller

* J. Scott Mennen

Craft Brew Alliance, Inc. – COO and VP

* Joseph K. Vanderstelt

Craft Brew Alliance, Inc. – CFO, EVP and Treasurer

* Kenneth C. Kunze

Craft Brew Alliance, Inc. – CMO and VP

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Conference Call Participants

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* Francesco Pellegrino

Sidoti & Company, LLC – Research Analyst

* Pablo Ernesto Zuanic

Susquehanna Financial Group, LLLP, Research Division – Senior Analyst

* Vivien Nicole Azer

Cowen and Company, LLC, Research Division – MD and Senior Research Analyst

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Good day, ladies and gentlemen. And welcome to the Third Quarter 2017 Craft Brew Alliance Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to introduce your host for today’s conference, Mr. Andy Thomas, CEO. Sir, you may begin.

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Andrew J. Thomas, Craft Brew Alliance, Inc. – CEO [2]

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Thank you, Amanda. And good morning, everyone. It’s my pleasure to present the Craft Brew Alliance investor conference call to discuss our results for the third quarter of 2017. This morning, I’m again joined on this call by 3 other members of the CBA leadership team. Our CMO, Ken Kunze; our COO, Scott Mennen; and our CFO, Joe Vanderstelt. But before we begin, I’ll again ask Ed Smith, our Corporate Controller to read our safe harbor statement.

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Edwin A. Smith, Craft Brew Alliance, Inc. – Principal Accounting Officer and Corporate Controller [3]

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Thanks, Andy. As a reminder, this call may contain forward-looking statements. Forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from those described in any such forward-looking statements. The risk factor section in our most recent 10-K lists some of the factors that could cause Craft Brews actual results to differ materially from the forward-looking statements made on this call. Craft Brew undertakes no obligation to update publicly any forward-looking statements except as required by law. Andy?

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Andrew J. Thomas, Craft Brew Alliance, Inc. – CEO [4]

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Thanks, Ed. Q3 2017 was another solid quarter for CBA. It marks the third consecutive quarter that our results have largely been in line with our expectations. So despite the temptation to introduce a new metaphor to construct this call, I will keep with the overall theme of our Q1 and Q2 calls, parting clouds, sunny skies and a bright outlook for the future. Within the context of consistently stubborn industry trends something I’ll elaborate upon in a moment. Those parting clouds and sunnier skies that I referenced revealed the litany of wins for CBA and its stakeholders in Q3. They revealed Kona’s own brand Kona continuing to shine at home in Hawaii and across key geographies, not just on the mainland U.S., but around the globe. They revealed our Plus portfolio of own brands Widmer Brothers, Redhook and Omission maturing in their respective supporting roles with Widmer Brothers showing real progress in reclaiming its home market. They revealed an opportunity to focus on realizing the potential of existing partners. Appalachian Mountain Brewery, Cisco Brewers and Wynwood Brewing and Plus in adding additional partners. They revealed healthy revenue growth without panic discounting. They revealed significant progress in the rationalization of our brewery footprint, and perhaps more importantly, they revealed the most tangible evidence yet of our ability to operate that rationalized footprint more efficiently and more profitably without sacrificing quality or innovation. They revealed continued traction from our partnership with Anheuser-Busch, which is delivering more value for our shareholders than ever before. They revealed progress in pruning and shaping our underlying cost base, both in the ability to trim cost in our breweries and G&A, and in continuing to invest in our brands in top line. They revealed success in execution of capital projects both to fuel the top line with the opening of Redhook BrewLab and Redhook’s home market of Seattle and to support our improved brewery operations with new smaller batch capabilities and our most efficient own brewery Portland. But they also revealed that there are still clouds in the sky. As evidenced by emerging pressures in the performance of our brewpubs and the new challenges revealed in this dynamic marketplace. So before handing off to the team for more color in all of those areas, let me offer a few thoughts on those new challenges revealed in this dynamic marketplace.

Keeping with the theme of consistency, the beer market, I dare I say the social lubricant market remains a dynamic place experiencing swift and significant transformation imposing formidable challenges for participants of all varieties and sizes [from the line] big beer to upstart [weed dispensaries] to boutique distillers to the artists, formerly known as Craft Brewers. We’ve all heard the narrative that it’s a tough market out there. And we’ve all done our share of shaping that narrative to sue our specific circumstance or suggest that we have the right answers. But for a moment, let’s look at the fact shaping our marketplace. Specifically just how crowded things are getting and the impact of that clutter with respect to consumers and retailers. When we talk about how crowded the marketplace is getting, the narrative generally points to the fact that in 2017 there will be over 8,000 active brewery permits compared to less than 4,000 just 4 years ago, we’ve heard that. But also consider that in 2017 there will be over 2,300 active distillery permits compared to less than half of that 4 years ago, and that there will be nearly 13,000 active winery permits compared to less than 10,000, 4 years ago. In total, that’s over 23,000 active alcoholic beverage permits out there, an increase of nearly 50% compared to 2013. All competing and was increasingly becoming the same space. In all of that is without the unknown impact of weed. With respect to that same space from a consumer perspective, the facts also overwhelmingly suggest that while total alcoholic beverage consumption has been relatively flat over the same time period, more consumers are drinking across more categories more often leading to share losses for beer. And from the retailer perspective, it’s likely that we ain’t seen nothing yet, while we’ve already witnessed changes to our traditional channel view of the market, especially in the areas of on-premise. With the advent of online retailing in the scale of players like Amazon entering the space, our off-premise channel view is likely to experience even sharper and potentially more impactful changes in the short and mid-term. As consumer behavior changes, it’s not just that consumers are buying different things, it’s also that they’re buying things differently, and beer will not be immune to the impact. So as I hand-off to the team for some color to be clearer about why we feel so good about our results. It’s not just the absolute numbers, it’s also that in this market, we believe our performance from the strong growth of Kona to the [market leading] gross margins is even more distinctive. We feel that we’ve been choiceful in picking our battles, we feel that we’ve been resourceful in fighting those battles, and we feel the results year-to-date validate that we’re finally winning more of those battles. So let’s get some detail from the team beginning with Ken.

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Kenneth C. Kunze, Craft Brew Alliance, Inc. – CMO and VP [5]

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Thank you, Andy. Good morning, everyone. CBA’s third quarter was again led by strong depletion performance for Kona Brewing Company, which is up plus 9% in Q3 and up plus 10% year-to-date. As highlighted in previous quarters CBA’s overall depletion performances followed a consistent pattern with Kona’s strong performance supported by incremental new partner volume and offset by declines in legacy owned brands as we refocused those brands on geographies closer to home. This pattern continued in Q3, with CBA’s overall depletion’s down 2% in Q3, and down 1% year-to-date despite Kona’s robust growth. As highlighted last quarter, CBA’s performance was achieved in spite of rather dramatic slowing of the craft market in 2017. To our total portfolio performance in perspective, Q3 was one of the tougher quarters in recent memory for industry depletion’s. Based on Beer Institute depletion data total beer and craft depletion’s in Q3 were both down 3.4% overall. Down 5.3% and 5.5% respectively in the on-premise and down 3% and 2.3% in the off-premise respectively. On-premise volume maybe more difficult than even these numbers imply due to the number of craft brewers already over 5,500 actively competing for limited drafting handles and due to more tap rooms competing for more craft occasions. Tap rooms have had the hurt on traditional bar tavern and restaurant performance, which saw craft volumes decline minus 6% and down 8% respectively in the quarter. As highlighted last quarter at a state level, California, Oregon and Washington are some of the most highly developed craft markets, some of CBA’s most developed markets from a share perspective and combined remain a significant percentage of the total business of close to 45% of CBA volume. The craft segment has slowed even more significantly in these 3 states, which are declining in volume and share of total beer, while craft segment performance improved modestly in Q3, craft segment volume year-to-date remains down with California down 3.9%, Washington down 2.8%, and Oregon down 1.7%, as measured by Nielsen xAOC through October 7, on a volume basis. In spite of this, CBA maintained its national share position in Q3 and year-to-date and continue to drive share gains in key markets. Kona grew share of craft in Hawaii by 220 basis points, and in Florida by 110 basis points. Widmer Brothers grew share in both Oregon and Washington by 60 and 30 basis points respectively, while continuing to work to stabilize on-premise volumes.

Appalachian Mountain Brewery grew dollars by plus 70% and share by 40 basis points in North Carolina to become the #5 local craft brand, while Cisco in New England grew dollars plus 31% and share by 20 basis points. Two critical markets where CBA underperformed were California, where Kona lost 30 basis points this year, and Washington, where Redhook saw an erosion of 120 basis points of share, all measured in dollars in Nielsen xAOC year-to-date through October 7.

Let me again address Washington and California this quarter. Redhook’s performance in Washington reflects the ongoing repositioning of Redhook in its home market. In Q3, BrewLab, Redhook’s new Capitol Hill brewpub in downtown Seattle opened a schedule on August 17 to strong reviews and crowds. In addition, we continue to see positive traction behind new beers like Big Ballard Imperial IPA and Bicoastal IPA and expanded chain commitments to both brands in Washington in upcoming resets.

Big Ballard IPA recently became the #1 new item in Washington, as measured by Nielsen. Redhook’s marketing efforts moving forward in Seattle with center around BrewLab, and the new beers developed and tested in BrewLab by the innovation team. The last 2 weeks of September also saw the largest trade factor in Washington, implement our suggested price to consumer, a price that better reflects Redhook’s value in the marketplace.

In Washington, we’ve begun to see a moderation of the declining trends in the off-premise, while the impact of new beers in the BrewLab have not yet materialized in slowing Redhook’s on-premise decline. In regards to Kona in California, we continue to execute aggressive plans to secure incremental retail activity, improved wholesaler execution and build the brand with consumers. Our investment in [media] and sampling over the summer drove a significant increase in awareness, past month — 3-month usage and trial in Southern California, albeit, off a small base, marking significant progress, it was not enough to turn the trend in Q3, given competitive and market structural issues in California. Q3 became the first full quarter to include Wynwood Brewery out of Miami, with the equity agreement completed in July. Wynwood rounds out our national footprint of breweries, expanding in our Eastern Seaboard business partnerships, focused in New England, North Carolina and Florida. Q3 saw the 3 partners Cisco Brewers, Appalachian Mountain Brewery and Wynwood Brewery go double-digits and achieved 6% of total portfolio volume.

And finally, Kona’s growth was again driven by flagship brand, Big Wave Golden Ale with plus 25% depletion growth year-to-date, and by the launch of Hanalei Island IPA in Q1, which is now our top 10 new craft item nationally year-to-date in 2017. Kona continued to post double-digit growth plus 10% through the first 3 quarters. International volume was up plus 49% in Q3, driven by Kona’s continued penetration of our top 4 markets in Asia and Europe via our partner Craft Can Travel. Further international distribution expansion through ABI is being ceded in a deliberate and thoughtful way. We remain optimistic on the international opportunity for Kona.

Moving forward into 2018, and as an outgrowth of our enhanced agreements and partnership with ABI, we anticipate an ongoing benefit through greater commercial alignment than ever before, with both Anheuser-Busch and the Anheuser-Busch wholesaler network in planning, executing and delivering targets overall and in key markets. From a depletion standpoint, Kona continues to deliver strong performance, plus 10% depletion’s year-to-date with significant [room] remain in both domestically and internationally. Overall, total depletion’s were solid for the first 3 quarters of 2017, despite the current competitive market environment and one less selling day for the quarter and year-to-date. While Q3 saw some slippage due to our decision not to add an additional new partner, that reflected stronger revenue management and net pricing performance in the quarter, as a result, we’ll tighten and slightly lower our full year depletion guidance, which Joe will address shortly. We remain confident and committed to leveraging our Kona Plus strategy to deliver results.

With that, I’d like to turn it over to Scott Mennen, CBA’s Chief Operating Officer.

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J. Scott Mennen, Craft Brew Alliance, Inc. – COO and VP [6]

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Thank you, Ken, and good morning, everyone. Before getting into my remarks, I would like to recognize the continued great work our brewers are doing. At the recent Great American Beer Festival, our brewers were awarded a silver medal for Kona Longboard Lager, it’s fourth GABF medal. AMB’s Boone Creek Blonde, a beer brewed in our Portsmouth brewery in partnership with [AB] took home a gold medal. What sets these winning beers apart is that they are available year round and consumers can find them in their local markets.

In addition, as Ken discussed, in Q3, we opened Redhook’s BrewLab in Seattle. It’s part of the brewpub, our brewer started up a new 10 hectoliter of small batch brewing system, which will enable our Redhook Brewmaster Nick Crandall to create amazing new and innovative beers for the public.

Now onto the results. As Andy stated in his opening, Q3 was a solid quarter for CBA. Prior to getting into the numbers, I want to remind you of the fundamental changes we have made in involving our brew footprint, which help deliver reductions in our beer cost of goods sold and drive gross margin improvement. Those changes included, the startup of our contract brewing operation with Anheuser-Busch. The production with AB is now fully online and we expect to ship approximately 150,000 barrels of beer out of Fort Collins in 2017, with the cost savings of $10 per barrel. With this move to Fort Collins, we have ceased production of Memphis. In addition, the Woodinville brewery is now completely shutdown and the facility is being actively marketed for sale. Our brewery footprint evolution is complete for now, and we have reached our new normal brewing in Portland, Portsmouth, Kona, and AB’s Fort Collins brewery. But we are already looking at what tomorrow will look like, as we bring on the new Kona brewery in the first half of 2019.

The evolution of our brewery footprint in conjunction with our ongoing efficiencies being gained with our industry leading continuous improvement program, world class craft, which was highlighted at the Master Brewers Association of Americas conference in Atlanta last month, and the redesign of our supply chain planning process came together to deliver solid results in Q3.

Now onto the numbers. Capacity utilization for Q3 was 63% compared to 71% in Q3 of last year. This reduction in capacity utilization reflects the changes in our brewery footprint with more beer produced in Fort Collins and the Woodinville brewery out of the mix. Year-to-date, capacity utilization was 62% compared to 69% last year. Q3 beer gross margin was a strong 38%, 460 basis points ahead of Q3 last year. The improved gross margin a result of improvements in our beer cost of goods sold, which reflect improved efficiencies in our breweries and logistics operations, improved losses, production out of Fort Collins. In addition, the work being done, the balance production on our own breweries and the rightsizing of our cost base helped offset the impact of lower capacity utilization. Overall, CBA’s gross margin for the third quarter was 34.2%, 350 basis points better than Q3 of 2016. Year-to-date, beer gross margin was 34.6%, 260 basis points ahead of last year, reflecting improvements in our brewery and logistics costs, Fort Collins production, partly offset by lower capacity utilization and lower fixed cost absorption. Year-to-date, CBA’s gross margin was 31.2%, a 170 basis points better than 2016.

Moving into Q4. The team will continue to be aggressive on rightsizing our cost structure, while balancing production between our own breweries in Fort Collins, leveraging our improved supply chain planning process, and focusing on continuous improvement and innovation with our world class craft program to improve operating efficiencies. Giving our Q3 and year-to-date performance, we expect CBA’s full year gross margin to be at the mid to upper end of our guidance of 30.5% to 32.5%.

Now onto Joe for more insight into our results.

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Joseph K. Vanderstelt, Craft Brew Alliance, Inc. – CFO, EVP and Treasurer [7]

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Thank you, Scott, and good morning, everyone. During my remarks, I will share our Q3 2017 financial results, updates on our cost reduction initiatives and provide an update on our balance of your outlook. You’ll see continued top line growth from Kona and our partner brands, improved gross margins on a quarterly and year-to-date basis, continued investment behind our brands, and significant improvements in overall profitability.

During the third quarter, net sales were $56.6 million, up 3% versus the same period last year. Gross profit for the quarter increased 14% to $19.4 million versus Q3 2016. Our gross margin increased 350 basis points to 34.2%. Net income for the quarter was $1.8 million or $0.09 per diluted share compared to $0.03 in Q3, 2016. Increased net income and EPS as a result of higher net revenue per barrel and lower cost per barrel, partially offset by increased SG&A expenses and lower gross profits. Q3 2017 net sales were favorable versus same period last year, primarily due to increased price, lower discounting and mix. Net sales per barrel increased 4.4% versus same time last year, reflects a continued development of our revenue management capabilities. Net sales in our brewpubs declined 6% due to lower traffic and I’ll share further details on the performance of our Plus (inaudible). Shipments for the quarter were down 20 basis points versus Q3 2016, due to declines in the Redhook Brewery, Widmer Brothers brewing and contract production, mostly offset by shipments for Kona, Wynwood brewing company and Appalachian Mountain Brewery. Third quarter cost of goods sold per barrel decreased 2.7% versus same period last year, primarily as a result of lower cost or maybe for [Kona’s] Brewery and lower material cost. As stated earlier, gross margin increased 350 basis points to 34.2%, which is favorably impacted by lower cost per barrel, as well as increased price, mix and [part of our fees]. Beer gross margin for the quarter was 38.1% or 460 basis points higher versus same period last year. These gains were partially offset by a 500 basis point decline in our pub gross margins during the quarter.

As we turn to our pub performance, restaurants and the (inaudible) channel in general have seen the challenging business environment this year and our pubs are no exception. We’re seeing lower foot traffic in our pubs, higher labor costs and the short-term impact of executing our strategy in our Woodinville, Washington and Portsmouth and Hampshire locations. The Woodinville pub has been affected by the closure of the adjacent brewery, while our Portsmouth location has been affected by the pull back of Redhook to its home market of Washington. On the other hand, we are revisiting our pub strategy on multiple fronts and expect improved financial performance in 2018. In addition, our new Redhook BrewLab in Seattle has been open for just 12 weeks and we are definitely seeing early success.

Third quarter SG&A costs increased 3% versus Q3 2017, primarily due to end market promotional expenses and IT restructuring costs, partially offset by lower general and administrative expenses. As a percentage of net sales, SG&A costs were 28.8% similar to the same period last year. Pulling it altogether on a year-to-date basis, the depletion’s were minus 1%, shipments minus 3%, net sales plus 3%, gross profits plus 9%, gross margin plus 170 basis points, and EPS plus $0.11 versus same period last year.

Before updating everyone on 2017 guidance, I’d like to revisit the plan we announced at this time last year to reduce your cost base. At that time, we said that we’re targeting $5 million to $7 million in cost savings to ensure a sustainable investment against our brands and improve overall business performance. As part of those efforts, we reduced our nonpub related workforce in the fourth quarter of 2016, generating $4.3 million in annual savings heading into 2017. Since then, we closed our Woodinville Washington Brewery, generating $1.5 million in savings for 2017, and another $2 million once the brewery is sold. Earlier this fall, we also took action of rightsize our Portsmouth, Hampshire, Portland, Oregon breweries, as we work to rebalance our real footprint. We’ve definitely made progress here and we’ll share our plans for 2018 in the coming months.

Based on our third quarter and year-to-date results, we are revising our [end] tightening certain aspects of our 2017 guidance to provide more clarity on our expectations for the full year. First, we expect to deliver full year net revenue growth of plus 3.5% to plus 5%, supported by healthy increases in pricing and mix, as well as recurring ABI international distribution fees and a onetime past contract brewing fee. Depletion’s are now expected to range between minus 2% and flat compared to last year. Shipments are forecasted to range between minus 4% and minus 2%, primarily as a result of the pause of new partners as outlined by Andy. Average price increases of plus 1% to plus 2% remain the same, excluding recurring ABI international distribution fees and onetime contract brewing fees.

Total gross margin remains the same at 30.5% to 32.5% and we expect to be at the mid to high end of the range. SG&A expense guidance remains the same at $61 million to $63 million, although full year results are expected to be at the low end of the range. Capital expenditures are expected to be $18 million to $20 million, which reflects a narrowing of the previous range of $16 million to $20 million.

In summary, third quarter and year-to-date financial results are showing continued traction in improving the financial fundamentals of the business. We have further work to do and look forward to sharing our 2018 plans in the coming months.

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

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Andrew J. Thomas, Craft Brew Alliance, Inc. – CEO [8]

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Thanks, Joe. As you’ve heard, we again believe that both Q3 and the first 9 months of 2017 have brought solid performance both strategically and operationally are in line with our expectations and bode well for the future. Taking a quick check against the 3 commitments we continually reference in these calls; to strengthen the topline, to improve the core health of our business model and to actualize the future. Firstly, as per strengthening the topline, another quarter with the solid check mark, continued strong growth for Kona, solid volume and share performance on the Plus portfolio and favorable pricing. Secondly, in terms of improving the core health of our business model, another check mark, new personal best for CBA and beer gross margin delivery and continued solid cost management. And lastly, as for actualizing the future, a check mark again, continued improvements in leveraging the partnership with ABI, a renewed focus in building upon our existing foundations of brands and breweries and an honest appreciation of the challenges ahead.

Before I close, since our next call will include not only a wrap on 2017, but a preview of 2018. A few words on that honest appreciation of the challenges ahead. At the beginning of this call, I offered some sobering facts about the state of our industry. And on a recent occasion, addressing the Annual Meeting of the Master Brewers Association of the Americas in Atlanta, after sharing many of those same facts with the attendees, I pose the following 3 questions. One, do we know what a healthy beer industry looks like in today’s world? Two, do we really know who or what the competition is? And three, are we brewing and packaging beer for today’s marketplace or yesterday’s?

To all of our stakeholders, you can be assured that as we look to the future, these are the questions that I’m confident and this team will continue to answer. To our increasingly proven Kona Plus strategy, leveraging the unique lifestyle relevance of the Kona brand, the local relevance of our Plus portfolio, our enhanced commercial alignment in the Anheuser-Busch wholesaler network and our improved operational and cost management capabilities.

In closing, I’d like to again say thank you to all of you, to our investors, to those analysts who cover us, to our interested parties and importantly to our hardworking, passionate and engaged employees and partners, be it at our own locations in New Hampshire, Oregon, Washington, California and Hawaii and our partners in North Carolina, Massachusetts and Florida are working remotely somewhere between.

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

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Questions and Answers

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Operator [1]

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Thank you. (Operator Instructions) And our first question is from the line of Vivien Azer of Cowen. Your line is open.

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Vivien Nicole Azer, Cowen and Company, LLC, Research Division – MD and Senior Research Analyst [2]

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So, I wanted to start off with Kona. Andy, really impressive depletion’s in light of what was particularly challenging in third quarter. As we kind of think about the growth trajectory, can you just give us a sense of where you are from a distribution standpoint, what’s the composition of underlying velocity in terms of — turnover versus incremental distribution, how much runway is there? Thanks.

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Andrew J. Thomas, Craft Brew Alliance, Inc. – CEO [3]

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Thanks, Vivien. So, appreciate the call. We feel really good about kind of the way Kona is performing. And as Ken talked about, the share gains in Hawaii and Florida make us feel really good even with the headwinds in California. So with that as kind of the backdrop. I think most of the gains we’re seeing, Vivien, and I might ask Ken to provide a little bit of color here, it’s not just through distribution, we’re seeing healthy velocity trends on the brand, particularly on Big Wave, where we’re seeing kind of a 1, 2 punch between some new distribution and some good velocity. We have picked up some distribution obviously, as Ken referenced on Hanalei Island IPA, and that’s all relatively new volume for us, as that brand kind of got introduced this year and entered the top 10 already of new items nationally this year. And on Longboard, I would say that’s where we’re probably suffering from a little bit of the most velocity softness, I’ll say on the brand, just given the kind of state of the marketplace. So if I kind of pull that together and look at the trajectory of the brand, I would say we have a lot of run room left on distribution in a couple of ways, one in terms of overall breadth of distribution, our (inaudible) coverage is still relatively low at a national level in the on-premise, certainly in depth of distribution, as we talk about, it’s not just whether you’re in distribution as how many packages or brands you’ve got in distribution and we believe there is run room there as well. So distribution, we think there is room in both areas, more places carrying Kona and more places carrying more Kona. And with respect to velocity, I would say we feel really good about the underlying velocity trends we’re seeing with the caveat that Longboard is one that has probably the most competitive positioning given the number of other competitive lagers out there. And that’s kind of an aggregate level. And now Ken, do you want to add anything to that.

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Kenneth C. Kunze, Craft Brew Alliance, Inc. – CMO and VP [4]

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Vivien, I think — it would be kind of this Hawaii eastward, again the answer is different depending upon like the brand development. And so, Hawaii, we’re extremely well developed and even in Hawaii from a breadth and depth and channel perspective, we still have distribution to fill out the entire portfolio from a distribution standpoint. Velocity in Hawaii is really strong and is the primary driver of volume growth in Hawaii. As you move east, the distribution opportunity is greater from just a pure kind of blocking and tackling basic 6 pack distribution, 12 pack opportunity is significant on the eastern half of the country. So C-store channel, we’re still really underdeveloped, so there is a ton of run room within C-store. And I think the mix between velocity and distribution, the further east you go it’s probably a little bit more heavily reliant on just new distribution that we’re gaining with velocity that come along and follow. California is really the only place where we’d like to see growth, be a little bit stronger.

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Vivien Nicole Azer, Cowen and Company, LLC, Research Division – MD and Senior Research Analyst [5]

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Just touching on your partner brand strategy, I guess, do we perfectly candid, I don’t know that I fully appreciate it that incremental partnerships were embedded in your guidance. So kind of is that, as I think about it then it is part of your kind of formal planning process. How are you thinking about the evolution of that contribution from partner brands overtime? Thanks.

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Andrew J. Thomas, Craft Brew Alliance, Inc. – CEO [6]

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So it’s a great color, Vivien. I think just to remind everybody, if you take a look at our partner strategy and where we’ve executed it, it has largely been part and parcel of our ability to pull back some of our legacy pioneering brands to home markets. So as we retreated if you will from the east that left volume for susceptible, left relationships that needed to be nurtured predominantly in 3 main areas on the Eastcoast and that would be New England, the Carolina’s and kind of Mid Atlantic and Florida. So it’s no accident that our partner brands Cisco, Appalachian Mountain and Wynwood kind of fit into that geography. So as we look at what was going on there as we’ve kind of been tracking with the way the market shape, and the importance of local and the ability to scale those brands in a healthy way for them just still remain relevant in their local market and not go too far too fast. We’re kind of always throttling if you will, do we need to add another partner or do we have enough. And candidly, we kind of came to the assessment in the middle of the third quarter. If you look at the traction Cisco is getting in New England and some of the numbers Ken talked about despite softening markets being able to gain share there and filling a lot of the Redhook volume pool there, we felt really good about that. If you look at AMB in North Carolina, from a standing start basically getting to the fifth largest local brand in the off-premise there makes us feel really good about AMB’s traction in the Carolina’s, which is formally a big profit pull for Redhook. And Wynwood started from it’s infancy, but the kind of 1, 2 punch of Wynwood and Kona in Florida kind of gave us pause to stop and take a look and say, do we need to add increasing complexity, because as you followed the story, Vivien, and a lot of others on the call. We are always in this balancing act between making it sure we’re not fragmenting our resource spend and we’re not basically opening up too many [flanks]. So in order to put a (inaudible) on it, if you take a look at why we enter the partner strategy, a lot of it was because of the retreat of our legacy brands. We feel those 3 partners collectively doing a great job plugging the former space held by the Redhook brand and even the Wynwood Brothers brand. If you look at the geographies it enables us to compete more effectively in New England, the Carolina’s and Florida, the geographies we’d want to play in. And if you take a look at kind of where we’ve been in the momentum, Scott’s teams gotten on the [COGS] size in the breweries whether or not we needed to add another brand in the kind of disruption that would cause and the distraction that would cause, with something we feel we really needed to do in the face of how the Kona brand was continuing to perform. A word on Wynwood Brothers, even though the volumes don’t look fantastic the share gains on Wynwood Brothers in Oregon to me make me feel fantastic about the home market strategy that we’ve got, so collectively Kona Plus feel really good about Kona, feel that the Plus portfolio of Cisco, AMB and Wynwood in Florida surrounded by Redhook and Wynwood Brothers in the Northwest and Omission makes us feel like we are pretty well suited to kind of enter ’18 and beyond. So hopefully that helps.

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Operator [7]

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Thank you. (Operator Instructions) Our next question is from the line of Francesco Pellegrino of Sidoti & Company. Your line is open.

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Francesco Pellegrino, Sidoti & Company, LLC – Research Analyst [8]

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So while everything is so impressive with what you’re doing with Kona, I guess almost 2017 year-to-date just matching up the decline in shipments, the decline in the (inaudible) for Widmer Brothers and Redhook has been very impressive, because they’re almost enjoying this like nice [PEG] ratio to each other, that we’re not getting this imbalance that we’ve got, maybe a year or 2 years ago. And I guess my question for you is what percentage of Widmer Brothers volumes are currently outside of the California, Oregon and Washington markets, and then I guess I’d ask the same question about Redhook, because right now while you’re doing a nice job balancing this shipment decline with the [pleasing] decline, it’s still like catching up falling knife?

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Andrew J. Thomas, Craft Brew Alliance, Inc. – CEO [9]

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Francesco, that’s really insightful question, I appreciate it. So if you take a look and I link it back to the answer I gave to Vivien, part of the pegging is something that we have followed pretty closely. It is one of the reasons why we felt like we are stabilizing and we need to have new partners join that battle, so to speak to keep the pegging. So that’s a great observation. In case of the question, specifically, on Widmer Brothers, there is negligible volume now outside of Oregon, California and a couple of Northwest market. So I probably [hazard] to say it’s under 10% now, maybe under 5%. Part of the problem in California is, California remains a tough market and we still have some volume there. So when we look at some of the volume softness in aggregate in Widmer Brothers and try to reconcile that to share gains in the off-premise in Oregon, California is part of that explanation. On Redhook, I can’t answer as buoyantly as that, as you know about half of Redhook volume probably still lives outside of the state of Washington. So when we see 20% and 30% declines on the Redhook brand it is painful as hell for everybody, but it’s part of the strategic consequence of where we’re headed and getting back and that again helps you to connect the dots on why do we had partners, why do we had the partners in the geographies we did, and why do we feel like we don’t need to add any more as we kind of get under that 50-50 mark on Redhook. And when we get to the 90% plus mark on Widmer brothers and its home market. So to answer your question the vast majority, I’d say less than 10% of Widmer Brothers volume is outside the states you identified and probably about half of Redhook volume is outside of its home state of Washington.

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Francesco Pellegrino, Sidoti & Company, LLC – Research Analyst [10]

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But even though you’ve highlighted that there are bigger problems for Redhook, it’s still a smaller volume basis compared to Widmer Brother. So while we look at it on a percentage basis, the volume number is a lot smaller than Widmer Brother?

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Andrew J. Thomas, Craft Brew Alliance, Inc. – CEO [11]

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Yes. I think just on that connect that dot too, if you take a look Redhook had a little bit further to fall after kind of its hey day years with the work we did with Buffalo Wild Wings’ and Game Changer, you saw Redhook volumes grow pretty dramatically 4 or 5 years ago and that was volume that is kind of shedding as well. So yes, your assessment is exactly right.

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Francesco Pellegrino, Sidoti & Company, LLC – Research Analyst [12]

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I know, maybe touched on the impressive partnership brand strategy. But I think something that’s almost get lost in translation, is what Craft Can Travel is bringing to the table in regards to — I guess non-AB international sales. Something that has been — they’ve been in charge for — 2 years now, a little bit over 2 years. The volume growth is really impressive, and I would just think that some of the market that they’re targeting, there are small international distributor, I guess? Could you just give us a little bit of color or maybe where you see that volume business going on their end. Is that new distributors that they are penetrating, is that new markets, is it just follow-up orders, because I would think that using Craft Can Travel!, the impressive volume gains that they’re getting might be a little bit of a read through into what AB (inaudible) brewing to the table possibly in 2018, but only — but obviously on a much larger scale?

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Andrew J. Thomas, Craft Brew Alliance, Inc. – CEO [13]

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Yes. That’s a great question. And I think — maybe to take a little bit of a step back before getting into the specific question. If you take a look at the world, it’s a big place, right? That’s kind of an obvious thing to say, and not all markets are created equally, not just because of the consumer dynamics in that market or the development of the beer market in the segments there, but also because of the distribution channels, and the channel profiles, and the characteristics of the market. So if you take a look at where would a company like CCT excel relative that Craft Can Travel CCT, relative to ABI where would they excel. Craft Can Travel can usually excel in markets where there isn’t say one big dominant national player or there isn’t a market that’s dominated by 1 or 2 or 3 big brewers, and where the distribution is more fragmented, and where there are more niches and where the segments are more developed. And when you think about places like that, you think of some countries in Europe, you think of some countries in Scandinavia, you think of some countries in Asia like Japan and South Korea and places along those lines. So with that 1, 2 approach, when we look at the ABI business, there is a method to the madness of saying, we’re going to look at markets like Brazil, we’re going to look at markets like Mexico, we’re going to look at markets like Chile, markets which are dominated by 1, 2 or 3 large brewers who have very strong distribution systems, and where the markets at an infancy in terms of international brand development. In the contrast to that to get to the core of your question with markets like the U.K. or markets like Japan and South Korea, or markets like Scandinavia or Australia where there is a more fragmented distribution base in that country and there is more segment development, and that’s where CCT is excelled, is through the ability to tap into international experience and international importer network, which can basically penetrate markets like that a little bit quicker and with some good effectiveness relative to what a big brewer would be able to do in that same market. So we continue to throttle, I use that word a couple of times on this call, kind of between ABI and CCT in terms of growing the overall CBA international portfolio kind of led by Kona, and we think some of the decisions we go through are — which partner is better suited given the market characteristics, as we look at those markets for the future Francesco.

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Francesco Pellegrino, Sidoti & Company, LLC – Research Analyst [14]

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I want to touch on the AB international distribution agreement, because a lot of the investors that I speak to, it’s like, when are you guys going to pull the lever, and what could potentially be this very lucrative opportunity. And when I think back about the second quarter conference call, there seems as if there was a tone of a lot of behind the scenes planning. I don’t want to say there was a lot of behind the scenes heavy lifting, I think it was a lot of strategic thinking that was occurring. Where do we currently stand right now in the third quarter and possibly going into the fourth quarter, because come to 2018, that’s when the royalty structure or stream comes then I would think you’d want to hit the grounds running?

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Andrew J. Thomas, Craft Brew Alliance, Inc. – CEO [15]

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Yes. It’s — you’re connecting the dots well Francesco. I think, if I go back to when we announced the enhanced agreements with ABI, we talked about the fact that the first 2, 3 years, we’re going to be a lot of strategic thinking and heavy lifting to pay off once the royalty stream kind of got in place on a per barrel or per case basis. So that’s the right assessment there, kind of what we’ve been doing, I think, I wish it were as easy as a lot of folks suggest that it is, that is just a matter of flipping the dial, because I can guarantee you that a company like ABI, if we were as simple as flipping the dial to get international growth going, they’d have done it already. It’s a little bit of a process where you’ve got to be patient, you’ve got to be deliberate, you’ve got to pick your battles and you can’t get overly aggressive I would say in terms of seeding brands and what not. So with that as a backdrop to answer your specific question, we are still kind of in strategy mode planning markets and entry strategies. We announced that part of the success of Q3 was — we’ll call it a successful pilot in Brazil. Pilot’s are tough to see the — tough to move the dial with, if you will, because by their very nature, they’re meant to help you get in there and learn and see what you want to do when you launch on a broader scale. So the work in Q2 led to the successful pilot in Q3, and based on that successful pilot in Brazil in Q3, we’ll go to kind of the next phase with ABI and we’ll start to say, hey, what have we learned and how can we scale that, starting with the markets that we’ve already disclosed, Brazil, Mexico and Chile and that’s kind of what we’re up to with ABI as we continue to look at harvesting some of the value that we’ve got from the work CCT is doing.

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Francesco Pellegrino, Sidoti & Company, LLC – Research Analyst [16]

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And just my last question is, maybe this is for Joe, because he brought it up. Joe provided us with some commentary that you guys are reviewing your pub segment performance. And obviously this is not a core business, it’s probably not even a complementary business, it’s just a nice business that attached to the breweries, you probably can’t divest it, because you can’t physically remove the pub from the brewery. I understand that there’s probably no rent expense associated with this business. But at the end of the day, you guys have sort of said that you’re looking into strategic alternatives or reassessing the business, it’s a huge margin drag for the overall company. And when I think about where Craft Brew Alliance is going to be 2, 3, 4 years from now, and the investments that are being made from some — from (inaudible), I don’t think that they’re investing a new based upon your pub business. And I just wonder if that’s more of a distraction right now, as compared to some of the bigger picture items that’s really going to drive growth over the long term?

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Andrew J. Thomas, Craft Brew Alliance, Inc. – CEO [17]

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So Francesco, well, Joe picks himself up off the floor. I’ll offer some — maybe color and then maybe give it to Joe to fill in some of the blanks. So I think, I would challenge a couple of the comments, we do think that the complementary nature of the business, because we do help — we think it helps to reinforce localness of some brands. So when somebody can walk into Capitol Hill and try and experiments a Redhook beer, it kind of connects them to what’s going on in that market and helps them to understand the brand better. And in the case of Redhook BrewLab, which I think is our best foot forward right now candidly, it’s our most current expression of pub strategy. So it should be our best foot forward right now. But for example, when we launched in August, pretty successfully as Ken referenced, we had 11 [Scott] collaboration beers on with other Seattle Brewers, which gave us the opportunity to have everybody kind of look at Redhook little bit differently again, remind everybody that Redhook was from Seattle, and remind everybody that Redhook can crank out some great beers and works with a lot of the local heroes, they’re in Seattle. So with that kind of is the [poster child] for — we do think there is a lot of complementarity there.

In terms of the points you made, it is a margin drain. There is no 2 ways about it, the restaurant business is tough, [Craft brewing] business is tough. But I think as we take a look, I can’t give you exactly where we’re headed yet, and that will be part of probably more of the guidance, we give in ’18, but I can share with you some of the factors that we’re considering and some of the principles, and then I might ask Joe to chime in. I think in terms of the factors we’re considering is in what places can we find a strategic complementary role for a pub relative to the brand, that the pub basically represents, and how do we scale the financial model in such a way that, that’s accretive either to the brand development or the margin into the bottom line of the company, so that can garner and generate some funds for us to reinvest in brand activity. And when we look at that, we look at the importance of everything ranging from local presence to location to what kind of beers we pour in there. I think last year I’m going to hazard this [guest] and as it going to jump across the table for me, but there will be [not material] that I promise. I think we brewed, import somewhere between 35 and 50 different beers in the Widmer Brothers pub last year. And the vast majority of those were commercially available outside of the pub. So what does that do back to the share numbers I can’t talked about and back to the reclaiming the romance for the Widmer Brothers brand in Oregon, we’d suggest to you that helps to reinforce that Widmer Brothers is a vibrant craft brewer here in Oregon that we’re doing a lot of really interesting things. And when people come into the tap room and try one of those beers, they’re basically able to kind of get a taste (inaudible) of the Widmer Brothers brand. They really get just by ordering a great pint of Hefe over a Providence Park, when the Timbers were playing. So strategically, we’re looking at what the role is, financially we’re trying to ensure that role is not dilutive, but that we can — we have a story for you guys, so we can demonstrate why it’s accretive to the brand performance or to the bottom line of the company. Joe, anything to add there?

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Joseph K. Vanderstelt, Craft Brew Alliance, Inc. – CFO, EVP and Treasurer [18]

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Just one small piece, Andy, I think at the end of the day, we still believe that there is a strategic role like Andy said. The question becomes, can you do it at a level of margin that’s acceptable based on the [assets] that you have dedicated to the pubs. And I’m not convinced that we can’t do that. I feel like, yes, we’ve had lower traffic, but with lower traffic you should be able to flex your labor. And when we look at our labor cost, we’ve been affected one by — there is a certain level of overhead that you have to carry in order to ensure that your guest have a good or great experience with your beers, otherwise you wouldn’t be doing it. But beyond that, it’s a very mobile workforce. More now, I think that we faced as long as I’ve been here, which is caused significant amount of turnover, you pay more overtime to staff up the restaurants and the pubs, and so at the end of the day we’re looking really hard that how do we manage the labor tightly, and (inaudible) position where we can flex it based on traffic and your business conditions, while still being able to get our guest a really good experience.

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Francesco Pellegrino, Sidoti & Company, LLC – Research Analyst [19]

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So what I’m hearing from you guys is that it solidifies customer loyalty, which does make sense?

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Andrew J. Thomas, Craft Brew Alliance, Inc. – CEO [20]

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Yes.

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Operator [21]

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Thank you. Your next question is from the line of Pablo Zuanic of SIG. Your line is open.

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Pablo Ernesto Zuanic, Susquehanna Financial Group, LLLP, Research Division – Senior Analyst [22]

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Look, just 3 very quick questions. One, when you’re in the press release when you say that Kona is going to be part of a distributed planning distribution system, with Anheuser-Busch wholesaler network. What does that really mean in practice compared to the way that Kona is being handled by that distribution network right now? I just want to understand in practice, what difference, how impactful that would be. That’s #1. #2, can you remind me if I think of a — in Washington Redhook versus Elysian, and in Oregon, Widmer versus (inaudible). Just remind us about the scale in each of those days within the brands, and how are you doing versus say within Washington, how is Redhook doing versus Elysian at scale and also performance. And the third question, I mean, from my point of view the guidance side and the depletion side was quite significant. But I think you attributed most of that your plan partner brands and some of those agreements were delayed, I guess. But in terms of what was the planning or depletion’s for Redhook, Widmer and Kona, how did that change if at anyway or your outlook for those that hasn’t changed? Thank you very much.

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Andrew J. Thomas, Craft Brew Alliance, Inc. – CEO [23]

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Thanks, Pablo. And thanks for the question. So I’ll start off from the first one. If you think about an organization that’s just (inaudible) Anheuser-Busch wholesaler network is and the management around that. What’s different next year than was this year, Pablo, was by the time we signed the enhanced agreements in the early fall or late summer of last year, we kind of missed the planning cycle in the new ways like we caught it this year. So without getting into a lot of gory detail, because it’s complex Anheuser-Busch and their wholesalers do some really robust planning is what we believe makes the AB wholesaler network such a competitive advantage for those of us who are fortunate enough to be aligned with it. So their overall planning process kicks off kind of early kind of in the summer and then goes through the fall and we missed that planning last year. So we’re kind of playing catch up a lot and trying to fill in the plugs and trying to make sure that we had some kind of basically plugs in there, if you will. And so to answer your question specifically, this year, what’s different and how significant can it be is that as AB wholesalers basically look at their 2018 plans will be in those plans from the beginning, as opposed to kind of getting plugged into those plans along the way. So how do you quantify that there’s probably a benefit to it. I think as we get into ’18 guidance, we’ll be able to share a little bit more on that. But that’s what’s behind that. If I take a look at kind of publicly available data on Washington, I’m taking a look at some Nielsen numbers right now. If we look at the Redhook brand relative to Elysian, Redhook is slightly smaller than Elysian, but that’s kind of because of the trends. So you can say that even with the Redhook trends in Washington, its probably 80%, 90% the size of the Elysian brand and that’s something that I think to answer your second question in terms of how big is Elysian relative to Redhook in Washington. In Oregon, if I take a look at 10 barrel relative to Widmer Brothers, Widmer Brothers is much larger and again I’m using publicly available data in that Nielsen data. So a brand like Widmer Brothers will be more skewed to the off-premise. So there is a bias in there, but to give you kind of an order of magnitude, if I look on a year-to-date basis, Widmer Brothers is probably twice the size if not 2.5x the size of 10 barrel in the state of Oregon. So I think that was your second question. And with respect to the third question, I think it was related to — you’re absolutely right we attributed most of the adjustment in our guidance to our partner strategy, so as far as underlying kind of what was going on, [Ken I might ask that you’d] maybe talk about if there were any major surprises in the third quarter beyond what you said in the script relative to kind of core brands in the portfolio.

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Kenneth C. Kunze, Craft Brew Alliance, Inc. – CMO and VP [24]

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I don’t think major surprises, Andy. I think California continues to be the most difficult market for us relative to what we had planned to do. And just given the significant volume base there that just has a more of a magnitude in terms of the overall performance numbers when California falters a little bit.

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Andrew J. Thomas, Craft Brew Alliance, Inc. – CEO [25]

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And Pablo just to kind of put a final note on that without saying we wouldn’t have adjusted guidance without the partner strategy, I think it’s fair for you to say, I’ll say this our own portfolio kind of perform the way we would have expected on a year-to-date basis relative to our guidance to be more succinct about it. And I’d be remiss if I didn’t welcome you to the call, Pablo. So thanks for the interest, thanks for picking up coverage and thanks for the engagement on this call. It’s well appreciated, and it certainly recognized by this team.

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Operator [26]

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Thank you, and at this time I’m showing no further questions, I’d like to turn the conference back over to Mr. Andy Thomas, CEO for closing remarks.

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Andrew J. Thomas, Craft Brew Alliance, Inc. – CEO [27]

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I appreciate everyone’s continuing support of CBA and being available for this call. We look forward to discussing the results of the fourth quarter of 2017 with you soon. Thank you, and have a great day.

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Operator [28]

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Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program. You may now disconnect. Everyone have a great day.

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