Monster Beverage Corp

NASDAQ:MNST

Earnings Call Transcript 2018-Q1

[Operator]

Good day, ladies and gentlemen, and welcome to the Monster Beverage Corporation First Quarter 2018 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a Q-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Mr. Rodney Sacks, Chairman and CEO. Sir, you may begin.

[Rodney Cyril Sacks, Monster Beverage Corp.]

Hi. Good afternoon, ladies and gentlemen. Thank you for attending this call. I'm Rodney Sacks. Hilton Schlosberg, our Vice Chairman and President, is with me today; as is Tom Kelly, our Senior Vice President of Finance.

Before we begin, I would like to remind listeners that certain statements made during this call may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities and Exchange Act of 1934 as amended, and which are based on currently-available information regarding the expectations of management with respect to revenues, profitability, future business, future events, financial performance and trends. Management cautions that these segments are based on our current knowledge and expectations and are subject to certain risks and uncertainties, many of which are outside the control of the company that may cause actual results to differ materially from the forward-looking statements made during this call.

Please refer to our filings with the Securities and Exchange Commission, including our most recent Annual Report on Form 10-K filed on March 1, 2018, including the sections contained therein entitled Risk Factors and Forward-Looking Statements for discussion on specific risks and uncertainties that may affect our performance. The company assumes no obligation to update any forward-looking statements, whether as a result of new information, future events, or otherwise.

An explanation of the non-GAAP measure of gross sales and certain expenditures, which may be mentioned during the course of this call, is provided in the notes and designated with asterisks in the consolidated statements of income and other information attached to the earnings release dated May 8, 2018. A copy of this information is also available on our website at monsterbevcorp.com in the Financial Information section.

Growth in the beverage industry globally continues to be challenging. However, there has been recent positive momentum in the energy category.

Net sales for the 2018 first quarter were negatively impacted by $9.9 million due to the adoption of Accounting Standards Codification 606. Under ASC 606, commissions paid to The Coca-Cola Company based on our sales to certain of the company's customers which The Coca-Cola Company accounts for under the equity method, or consolidates are now included as a reduction to net sales whereas prior to January 1, 2018, commissions based on sales to those customers which Coca-Cola accounts for under the equity method were included in operating expenses.

In the first quarter, net sales were $850.9 million, up 14.7% from $742.1 million in the first quarter of 2017. Net sales in the first quarter were positively impacted by approximately $17.7 million of foreign currency movements. Without the adoption of ASC 606, the percentage increase in net sales would have been 16%. The company recorded first quarter gross sales of $990.6 million, up 17.2% from the $845.5 million in the first quarter of 2017. Gross sales in the first quarter were positively impacted by approximately $22.2 million of foreign currency movements.

Gross profit as a percentage of net sales for the first quarter was 60.6% as compared to 64.8% for the comparable 2017 first quarter and 62.1% for the 2017 fourth quarter. Without the adoption of ASC 606, the gross profit percentage would have been 61%. The decrease in gross profit as a percentage of net sales was primarily attributable to: increases in promotional allowances as a percentage of gross sales; the $9.9 million of commissions accounted for as a reduction of net sales due to the adoption of ASC 606; geographical sales mix, our foreign operations generally have lower gross profit margins; a change in domestic product sales mix principally a higher percentage of sales of Java Monster, Caffé Monster, Espresso Monster and Hydro; increases in certain import costs principally freight-in aluminum cans and sucralose; Hydro production issues in the U.S. and EMEA, and certain increases in other costs.

Distribution costs as a percentage of net sales were 3.9% for the 2018 first quarter as compared to 3.1% in the 2017 first quarter largely due to higher carrier contract rates in the U.S. and increased distribution inefficiencies due to longer haul distances for certain products.

Selling expenses as a percentage of net sales were 11.5% compared to 11.7% in the same quarter a year ago. General and administrative costs as a percentage of net sales were 12.3% as compared to 14.4% in the same quarter last year. Included in general and administrative costs was distributed termination expenses of $7 million for the 2018 first quarter as compared with $19.9 million in the comparable 2017 first quarter.

In the quarter, payroll expenses were up $8.8 million compared to the same period last year primarily due to head count growth both domestically and internationally including to support the launches in China and other countries.

Legal expenses related to regulatory matters and litigation concerning the advertising, marketing, promotion, ingredients, usage, safety and sale of the company's products were $1.7 million in the 2018 first quarter as compared to $1.9 million in the 2017 first quarter.

Operating income was adversely affected by losses in China and India. The losses in India were due to establishment costs in advance of the launch which has continued to take longer than anticipated for regulatory reasons as well as due to inventory reserves.

Our effective tax rates decreased from 32.8% in the 2017 first quarter to 23.3% in the 2018 first quarter. The decrease in the effective tax rate was primarily due to the Tax Reform Act signed into law on December 22, 2017. The decrease was partially offset by the elimination of certain deductions, specifically the domestic production deduction and decrease in stock-based compensation tax deduction.

Net income was $216.1 million in the 2018 first quarter compared to net income of $178 million in the 2017 first quarter, an increase of 21.4%. The weighted average number of diluted shares outstanding decreased from 582 million for the first quarter of 2017 to 574.1 million for the first quarter of 2018 as a result of share repurchases, which I will cover later in this call.

Diluted earnings per share for the 2018 first quarter increased 23.1% to $0.38 from $0.31 in the first quarter of 2017. Distributed terminations were $7 million in this quarter or approximately $0.01 per diluted share after-tax.

We continue to make good progress in the implementation of our strategic alignment with Coca-Cola bottlers globally. We're also making good progress in the U.S. in nontraditional channels including foodservice, accounts and e-commerce. In the first quarter of 2018, in the U.S., we have now fully transitioned the state of Minnesota.

In EMEA, launches are planned in the second and third quarters of 2018 in Azerbaijan, Belarus, Egypt, Saudi Arabia and Tanzania. We plan to launch Predator in 2018 as an affordable energy brand in selected Eastern European and African markets.

During the first quarter of 2018, we launched Monster in Argentina and are planning to launch Monster in Ecuador and Uruguay later this year.

In China, we continue to focus our efforts towards establishing Monster around the country, with an emphasis on distribution in the top 40 cities and to key accounts, targeting the younger and more affluent consumer demographic. We have commenced shipments of Monster to Coca-Cola India where we launched Monster in April in a lead market. We plan to expand the distribution and sales of Monster in India more extensively later this year.

Mutant, one of our affordable energy brand that is positioned differently than in the U.S., was recently launched in Pakistan and Cambodia and is planned to be launched in Vietnam and Myanmar later this year.

According to the Nielsen reports, for the 13 weeks through March 31, 2018, all outlets combined, namely, convenience, grocery, drug, mass merchandisers, sales in dollars in the energy drink category including Energy Shots increased by 4.8% versus the same period a year ago. Sales of Monster grew 13.7% in the 13-week period, while sales of NOS increased 6.1% and sales of Full Throttle decreased 1.2%, sales of Red Bull increased 1.3%, sales of Rockstar decreased by 2.6%, sales of 5-Hour decreased 6.6%, and sales of Amp decreased 19.6%.

According to Nielsen, for the five weeks ended March 31, 2018, sales in the convenience and gas channel including Energy Shots in dollars increased 5.6% over the same period last year. Sales of Monster increased by 14.7% over the same period last year, while NOS was up 5.9% and Full Throttle was up 0.8%. Sales of Red Bull were up 2.6%, Rockstar was down 5.6%, 5-Hour was down 6.6%, and Amp was down 21.8%.

According to Nielsen, for the five weeks ended March 31, 2018 Monster's market share of the energy drink category in the convenience and gas channel including energy shots in dollars increased by 3 points over the same period last year to 37.8%. NOS's share remained the same at 4.2%, and Full Throttle's share remained the same at 1%. Red Bull's share decreased 1 point to 35%, Rockstar's share was down 0.8 of a point to 7.1%, 5-Hour's share was lower by 0.9 points at 6.7%, and Amp's share decreased by 0.3 of 1 point to 0.9%.

According to Nielsen, for the five weeks ended March 31, 2018, sales of Energy Plus Coffee drinks, which now includes Caffé Monster and Espresso Monster in dollars in the convenience and gas channel increased 19.3% over the same period last year. Sales of our Java Monster alone were 26.1% higher than in the same period last year, while sales of Starbucks Doubleshot Energy was 6.2% lower.

Our shares of coffee + energy category which we define as including Java Monster, Caffé Monster, Espresso Monster, Starbucks Doubleshot and Rockstar Roasted for the five weeks ended March 31, 2018 was 56.6%, up 11.7 points. Java Monster's share alone for the five weeks ended March 31, 2018 was 47.6%, up 2.6 points, while Starbucks Doubleshot Energy's share was 43.1%, down 11.7 points.

The production capacity shortages that we experienced in the second half of 2016 for both Java Monster and Muscle Monster were largely worked through by the fourth quarter of 2017. Both Java Monster and Muscle Monster came up for allocation by the end of that quarter.

Together with our bottling partners, we are currently focused on regaining lost shelf space for these products. According to Nielsen in the convenience and gas channel in Canada for the 12 weeks ended March 31, 2018, the Energy Drink category increased 6% in dollars. Monster sales increased 15% versus a year ago. Monster's market share increased 2.5 share points to 33%. NOS's sales increased 8% and its market share increased 0.1 of a share point to 2.9%.

Full Throttle's sales increased 22% and its market share increased by 0.2 of a point to 1.6%. Red Bull sales increased 5% and its market share decreased 0.4 of a point to 35.5%. Rockstar's sales decreased 4% and its market share decreased 1.8 points to 17.6%.

According to Nielsen for all outlets combined in Mexico, the energy drink category grew 17.6% during the month of March 2018. Monster sales increased 20.7%. Our market share in value increased 0.7 points to 29% against the comparable period last year.

Sales of Burn decreased 13.8%. Burn's market share decreased 0.7 points to 2%. Red Bull sales increased 5.9% and its market share decreased by 1.3 points to 11.4%. Vive 100 sales increased 12.7% and its market share decreased 1.6 points to 37.2%, while Boost's market share decreased 0.3 of a point to 8.3%.

The Nielsen statistics for Mexico cover single months, which is a short period that may often be materially influenced, positively and/or negatively, by sales in the OXXO Convenience chain which dominates the market. Sales in the OXXO Convenience chain in turn can be materially influenced by promotions that may be undertaken in that chain by one or more energy drink brands during a particular month. Consequently, such activities put a very significant impact on the monthly Nielsen statistics for Mexico.

I'd like to point out that the Nielsen numbers in EMEA should only be used as a guide because the channels read by Nielsen in EMEA vary from country to country. According to Nielsen in the 13-week period ending March 2018, Monster's retail market share in value, as compared to the same period last year, grew from 10.5% to 11.5% in Belgium, from 11.8% to 12% in Czech Republic, from 23.7% to 27.1% in France, from 15.6% to 18.7% in Great Britain, from 31.2% to 31.8% in Greece, from 10% to 14.1% in Italy, from 5.2% to 7% in the Netherlands, from 11.6% to 16.2% in Norway, from 6.5% to 8.3% in Poland, from 26.4% to 29.1% in Spain, and from 10.6% to 11.8% in Sweden.

According to Nielsen in the 13-week period ending February 2018, Monster's retail market share in value as compared to the same period last year increased from 10.3% to 13.7% in Ireland. For the 13-week period ended March 2018, Monster's retail market share in value decreased, however, from 16.1% to 16% in Germany, and from 16.8% to 15.3% in South Africa, although sales were up in both countries.

According to Nielsen for the month of March 2018 in Chile, Monster's retail market share in value increased from 28.4% to 34.4% compared to the same period last year, and Monster's market share in value in Brazil for the month of March 2018 increased from 7.4% to 14.9% as compared to the same period last year.

According to IRI in Australia, Monster's market share in value grew from 7.1% to 9.1% in March 2018, as compared to the same period last year. According to IRI in New Zealand, Monster's market share in value for the last four weeks ended March 18, 2018 grew from 5.7% to 6.4% as compared to the same period last year.

According to Nielsen in South Korea, Monster's market share in value in all outlets combined grew from 25.1% to 30.9% in the first quarter of 2018 versus the same period last year.

According to INTAGE, Monster's market share value in the convenience store channel in Japan grew from 44.9% to 45.9% in the first quarter of 2018 versus the same period last year. We, again, point out that certain market statistics that cover single months may often be materially influenced positively and/or negatively by promotions or other trading factors during those months.

Net sales for the Monster Energy Drinks segment for the first quarter of 2018 increased 16.7% from $668.6 million to $780.5 million from the comparable period last year. Net sales for the Monster Energy Drinks segment in the 2018 first quarter were negatively impacted by $3.9 million due to the adoption of ASC 606. Without the adoption of ASC 606, the percentage increase in net sales for the Monster Energy Drinks segment would have been 17.3%. Net sales for the Monster Energy Drinks segment in the first quarter of 2018 were positively impacted by approximately $15.4 million of foreign currency movements.

Net sales for the Strategic Brand segment was $65.8 million for the first quarter as compared to $68 million in the same quarter last year. Net sales for the Strategic Brand segment for the first quarter of 2018 were negatively impacted by $6 million due to the adoption of ASC 606. Without the adoption of ASC 606, the percentage increase in sales for the Strategic Brand segment would have been 5.6%.

Net sales for the company's Strategic Brand segment in the first quarter of 2018 were positively impacted by approximately $2.3 million of foreign currency movements in the quarter.

Net sales for the other segment, which includes third-party sales made by AFF, were $4.7 million in the first quarter, as compared to $5.5 million in the same quarter last year. Net sales to customers outside the U.S. were $242.1 million in the 2018 first quarter, compared to $190.9 million in the corresponding quarter in 2017. Foreign exchange had the effect of increasing net sales in U.S. dollars by approximately $17.7 million.

(00:20:15) reported geographic sales or our sales to the company's military customers, which are delivered in the U.S. and transshipped to the military and their customers overseas.

In Europe, the Middle East and Africa, net sales in the first quarter increased 30.5% in dollars and 16.6% in local currencies, as the same period last year. Without the adoption of ASC 606, the percentage increase would have been 37.2% in net sales and 23.2% in local currencies.

Gross profit in this region, as a percentage of net sales for the quarter, was 44.5%, compared to 50.3% in the same quarter last year and 47.5% in the fourth quarter of 2017. Without the adoption of ASC 606, gross profit as a percentage of net sales would have been 47.2% for the first quarter. Gross profit in the region was also impacted by a higher percentage of Monster sales.

We're pleased with the rollout of additional SKUs in the Ultra range in EMEA markets. In the first quarter of 2018, we introduced Ultra Citron in the Netherlands and Ultra Violet in the United Kingdom and Ireland. Various SKUs in the Ultra line are now sold in 38 EMEA markets. We are also pleased that Monster continues to perform well and gained market share in Belgium, Czech Republic, France, Great Britain, Greece, Ireland, Italy, the Netherlands, Norway, Poland, Spain and Sweden.

In Asia-Pacific, net sales in the first quarter increased 18.9% in dollars and 14.2% in local currencies over the same period last year. Without the adoption of ASC 606, the percentage increase would have been 21.3% in dollars and 16.6% in local currencies.

Gross profit in this region as a percentage of net sales was 42.8% versus 47.7% over the same period last year. Without the adoption of ASC 606, gross profit as a percentage of net sales would have been 44%.

The decrease in gross profit percentage was also impacted by a higher percentage of Monster sales. In Japan, net sales in the quarter increased 54.6% or 49.3% in local currency as compared to the same quarter last year.

In South Korea, net sales increased 22.9%, or 13.5% in local currency as compared to the same quarter last year. In Oceania, which includes Australia, New Zealand, Tahiti, French Polynesia, New Caledonia, Papua New Guinea and Guam, net sales increased 5.5% or 1% in local currencies as compared to the same quarter last year.

In Latin America, including Mexico and the Caribbean, net sales in the first quarter increased 37.7% in dollars and 34.5% in local currencies over the same period last year. Without the adoption of ASC 606, the percentage increase would have been 39.4% in dollars and 36.2% in local currencies.

Gross profit in this region as a percentage of net sales was 46.5% versus 48.8% over the same period last year and 47.1% in the 2017 fourth quarter. Without the adoption of ASC 606, gross profit as a percentage of net sales would have been 47.2%. Net sales increased in Brazil by 86.1% in dollars and 88.2% in local currency largely due to the continued performance of Monster Energy drinks. Net sales in Chile increased 27.9% in dollars and 20% in local currency.

Turning to the balance sheet. Cash and cash equivalents amounted to $511.4 million compared to $528.6 million at December 31, 2017. Short-term investments were $585.2 million compared to $672.9 million at December 31, 2017. Long-term investments were $33.5 million compared to $2.4 million at December 31, 2017.

Accounts receivable increased to $525.5 million at March 31, 2018, from $449.5 million at December 31, 2017. Days outstanding for accounts receivable were 48.1 days compared to 43.8 days at December 31, 2017. Inventories increased to $268.6 million from $255.7 million at December 31, 2017. Average days of inventory was 71.7 days at March 31, 2018, compared to 75 days at December 31, 2017.

In the first quarter of 2018, we launched Caffé Monster, a ready to drink energy coffee in 13.7-ounce glass bottles in three flavors, relaunched Muscle Monster in a 15-ounce plastic bottle in two flavors and launched Rehab White Dragon Tea. We rebranded our two Monster Extra Strength SKUs into the Monster MAXX line and added an additional SKU. We also expanded Monster Hydro into a resealable 25.4-ounce bottle with three new flavors.

In Canada in the first quarter of 2018, we launched Monster Energy Ultra Violet and Monster Hydro in a 550-mL PET bottle in three flavors as well as Full Throttle orange in 16-ounce cans. In EMEA we launched Monster Hydro in 550-mL PET bottles in Sweden in January 2018 and in Germany in March 2018. In the first quarter of 2018, we launched Monster Mango Loco in the United Kingdom and Sweden along with Monster Pipeline Punch in the United Kingdom and Belgium.

We also recently launched Mutant as an affordable energy brand in Pakistan and Cambodia. We launched Ultra White in Hong Kong and Macau in the first quarter of 2018. In the second quarter of 2018, we will launch Monster Ultra Citron in Korea along with Cuba Libre in Japan. We launched the Lewis Hamilton signature Monster Energy Drink in Australia and New Zealand in the 2018 first quarter.

We estimate April 2018 gross sales to be approximately 18.9% higher than in April of 2017. On a foreign exchange adjusted basis, we estimate April 2018 gross sales will be approximately 16.1% higher than in April 2017. Please note that the impact of ASC 606 has not been included in determining these figures. April had one extra selling day. In this regard, we caution again that sales over a short period are often disproportionately impacted by various factors, such as, for example, selling days, days of the week in which holidays fall, timing of new product launches and the timing of price increases and promotions in retail stores, distributor incentives, as well as shifts in the timing of production.

In some instances where our bottles are responsible for production and unilaterally determined their production schedules, which affects the dates in which we invoice as bottlers, as well as inventory levels maintained by our distribution partners, which they alter unilaterally for their own business reasons. We reiterate that sales over a short period such as a single month or even two months should not be necessarily imputed to or regarded as indicative of results for the full quarter or any future period.

During the 2018 first quarter, the company purchased approximately 4.3 million shares of common stock at an average purchase price of $57.74 per share for a total of $249.9 million, excluding broker commissions. In February 2018, the company's board of directors authorized a new share repurchase program for the purchase of up to $250 million of the company's outstanding common stock. No shares have been repurchased pursuant to the February 2018 repurchase program.

In conclusion, I would like to summarize some recent positive points. The company continued to achieve record market shares in the U.S. and many countries. Retail sales statistics from many countries around the world demonstrate that the energy category is continuing to grow and that Monster is generally growing ahead of the category in line with earlier periods. New additions to the Monster family continue to add to the company's sales. We're excited about the prospects for our new product launches. We are pleased with our performance in our international markets and reiterate the growth potential for us in China and India despite operating losses recorded during the quarter for China and India of approximately $2.8 million. We are continuing to launch Monster Energy Drinks with Coca-Cola bottlers in certain markets.

I'd like to open the floor to questions about the quarter. Thank you.

[Operator]

Thank you. Our first question comes from the line of Vivien Azer from Cowen. Your line is now open.

[Vivien Azer, Cowen & Co. LLC]

Hi. Good afternoon.

[Rodney Cyril Sacks, Monster Beverage Corp.]

Hi. Afternoon.

[Vivien Azer, Cowen & Co. LLC]

So, Hilton, I know you say you don't give guidance, but you did offer some kind of personal color on the fourth quarter call around expectations for gross margin where I think – where you guys settled out in the first quarter did fall short of that and I think will prove to be disappointing to investors. So can you just help talk us through where, relative to your fourth quarter commentary, gross margin missed your personal expectations? Thank you.

[Hilton Hiller Schlosberg, Monster Beverage Corp.]

Sure, sure. In the last conference call, I did give my personal views on percentage gross margins going forward. I said that while the company does not give guidance, my personal view was to use the gross margin for the 2017 fourth quarter of 62.1% going forward. There are, of course, many factors that go into gross margin, some of which are one-off costs and some of which may well be ongoing as we experienced in Q1.

Looking forward, again, the company does not give guidance. But it is important to bear in mind what's happening with aluminum, which can fluctuate significantly even within a day. The Midwest, premium, freights, fuel issues, promotional allowances, geographic sales mix, domestic product sales mix, continuing investments in China and India, and so it's extremely difficult to talk about a sustainable gross profit margin percentage when there are many non-controllable factors. So we really are not in a position to give any further guidance on gross margins. On the other hand, we are continuing to progress production efficiencies and we continue to review pricing on an ongoing basis.

[Operator]

Thanks. And our next question comes from the line of Dara Mohsenian from Morgan Stanley. Your line is now open.

[Dara W. Mohsenian, Morgan Stanley & Co. LLC]

Hey. Good afternoon, gentlemen.

[Rodney Cyril Sacks, Monster Beverage Corp.]

Hi, Dara.

[Dara W. Mohsenian, Morgan Stanley & Co. LLC]

So, Hilton, following up on that comment on pricing, I guess we've seen price increases in this category during times of margin pressure in the past. And given the significant gross margin depression the last couple quarters and the continued commodity cost runoff, do you think you might look to take price increases in the U.S. at some point? And how do you guys think through the puts and takes of taking price increases? Thanks.

[Hilton Hiller Schlosberg, Monster Beverage Corp.]

What I said was we continue to review pricing on an ongoing basis, and we do this irrespective of margin pressures. Obviously, when we do have margin pressures, it's something that surfaces again, and it's something that we are continually reviewing. And more than that, I just don't want to say at this time.

[Dara W. Mohsenian, Morgan Stanley & Co. LLC]

Okay. And then could you guys talk about the health of the energy drink category in the U.S.? You mentioned weak beverage growth trends in general across the sector, but seemed more positive on the energy category. So where do things stand there and any worries about the potential impact on gas, convenience from the rising gas prices?

[Rodney Cyril Sacks, Monster Beverage Corp.]

Last year, sort of, I think the whole industry was at a bit of a loss to understand why the convenience category had been growing, which had historically grown ahead of all markets, had sort of changed and started to slow down. What we're starting to see now is that the convenience category has really come back and is now growing ahead of the all measured channels. And so I think that we are starting to see this trend, which is quite encouraging. So I think we referred to some of the numbers. I'm just trying to think. The convenience was up 4.6% in the last 13 weeks, and I think it was up a little higher in the last five weeks.

[Hilton Hiller Schlosberg, Monster Beverage Corp.]

5.6%.

[Rodney Cyril Sacks, Monster Beverage Corp.]

5.6%. So it certainly is moving in the right direction and starting to solidify and gain traction again.

[Operator]

And our next question comes from the line of from Andrea Teixeira from JPMorgan. Your line is now open.

[Andrea F. Teixeira, JPMorgan Securities LLC]

Thanks. Good afternoon.

[Rodney Cyril Sacks, Monster Beverage Corp.]

Afternoon.

[Andrea F. Teixeira, JPMorgan Securities LLC]

Hi. So could I go to the international? Can you speak about international growth? Because if you exclude the 2% inventory benefit that you highlighted in the January sales, it seems that your underlying sales internationally could have decelerated again to the high-single digit range. Is that what we should expect for a normalized rate of growth going forward?

[Rodney Cyril Sacks, Monster Beverage Corp.]

Well, I don't think it's gone down to the high-single digits, and I think we did explain and drew the distinction in the markets to some of the geographic sales mix which also affected sales. If you look at the figures we gave you for Strategic Brands, which was down in dollars and marginally up, that has had a drag on our sales. The Monster sales internationally are still continuing to grow on quite a healthy basis.

[Operator]

And our next question comes from the line of Pablo Zuanic from SIG. Your line is now open.

[Pablo Zuanic, Susquehanna Financial Group LLLP]

Thank you. Hilton and Rodney, look, I just want some big picture comments in terms of gross margins. I mean, a number of companies in the industry are facing what they call cyclical gross margin issues with aluminum lags and increasing prices. In your case, it seems to me that you face secular issues also going from single cans to pack sizes in the U.S., growing faster overseas than domestically. I mean, in China, your prices are much lower. So I don't know if it's possible, but if you could just help us understand in terms of these declining gross margins we're seeing, how much could we consider cyclical and how much will be secular?

And the second question which is related to this. Other companies like, say, Buffalo, their gross margin story will be that they will bring in a lot of production in-house from third-party manufacturers. In your case, I've never really understood if there is such a story. I mean as you move distribution to the Coke system, is there an opportunity there to also shift production, or those bottlers were already producing your products? So just help us understand how much leeway or opportunity you have there in terms of structural changes that could help profitability and gross margins. And the very last one on the same topic...

[Rodney Cyril Sacks, Monster Beverage Corp.]

Wait. Wait. Wait. You're now going on to the third question. We've lost track of the first one.

[Pablo Zuanic, Susquehanna Financial Group LLLP]

(37:19).

[Rodney Cyril Sacks, Monster Beverage Corp.]

No, no, go on. We're supposed to have one question at a time. Okay. So let's just – let me just start with production. All of our products of Coke PET we have a finished product model that's not going to change. What will change is as we continue to align ourselves with the Coke bottlers, we will continue to increase production sites with those Coke bottlers in their countries and in their markets, which will have the effect of reducing costs, of reducing freight, reducing import duties, and so that will benefit and continue to improve. There isn't any plan to change that.

In the Strategic Brands, they are already being manufactured by Coke because the model for the Strategic Brands segment is pretty much a concentrate model. Where there are some products in the Strategic Brands where the Coke bottlers can't manufacture them; for example, a 24-ounce cap can for NOS in the U.S., we then are selling that product on a finished product basis. And that accounts for a little bit lower product of gross margin for us because we're obviously in the one case selling concentrate at a higher margin and in the other case we are selling a finished product which does have a lower gross margin just because of the economics and the law of numbers.

So that's on the margin side. So we will continue to achieve production efficiencies. We will lower costs by improving our production and increasing the number of plants. That is also particularly so with regard to the newer products like Hydro. As you know, we experienced some production increases in coffee product because we were having to import product. We are still importing Espresso Monster, but we are looking to convert that to local production, which will again – which will assist in costs.

And as we start ramping up with Caffé Monster and others, we are looking to improve efficiencies in Hydro, which is really manufactured in the Northeast now. We're looking to – in bottles and in Carolina for the cans, we are looking to increase facilities coming on board which will reduce costs.

Could you take the first question, Hilton?

[Hilton Hiller Schlosberg, Monster Beverage Corp.]

I'm not...

[Rodney Cyril Sacks, Monster Beverage Corp.]

You don't know what the first question was. Do you want to repeat your first question? Hello?

[Operator]

Our next question comes from the line of Judy Hong from Goldman Sachs. Your line is now open.

[Freda Zhuo, Goldman Sachs & Co. LLC]

Hi. This is actually Freda Zhuo on for Judy. Thanks so much for taking my questions.

[Rodney Cyril Sacks, Monster Beverage Corp.]

Hi.

[Freda Zhuo, Goldman Sachs & Co. LLC]

So my question is actually on China. So I think if you look at some of the channel data, it seems as though category growth has kind of taken a step down in 2018 closer to the 10% range. Can you talk about what you're seeing on the ground in terms of what might be driving some of that slower category growth? And then I caught a comment that you guys were repositioning or perhaps targeting some of the younger, more affluent demographics. So is that impacting the price point that you're placing Monster at in the market? Thanks.

[Hilton Hiller Schlosberg, Monster Beverage Corp.]

Okay. No, we're continuing with our price strategy, which was to remain competitive with Red Bull Gold, the Thai Red Bull. So that strategy is continuing. Our strategy is to maintain our products adjacent to Red Bull and to have what we call 3P execution, which is pricing competitive with Red Bull, point-of-sale, and position on shelf. So that is the target that we have set our bottlers, and we're moving forward in those accounts where we believe that we can achieve good sustainable sales.

And our bottlers – I've just come back from China – have set themselves an objective of focusing and trying to achieve what we have succeeded and what we succeeded initially in the U.S. is to develop an energy shelf so that Chinese consumers can go to a shelf and select an energy drink. When our product is placed in a Coca-Cola cooler adjacent to a Coke and a Sprite, it doesn't help the consumer understand what the product is.

So we are proceeding down our strategy, which we are supporting with a range of marketing media and social media. We've got a major computer game program that we are tying in with called Battleground, which is a significant property. We're moving forward on that strategy this year. So we always said that China would be a long-term development, and we're just staying the course.

[Rodney Cyril Sacks, Monster Beverage Corp.]

Yeah. Just to – perhaps, if I would just add to that. Obviously, one of the challenges we're still having is the level of execution or quality of execution from the bottlers to execute the 3P that Hilton just alluded to, and that continues to be an ongoing challenge. We have seconded some of our key staff from the U.S. to really try and educate them and actually be able to really direct them and show them what we need to do. And we're confident that we will get it done, but it's a longer and harder road, and it will be achieved, and we will get there.

With regard to the demographic, while we talk about the younger and more affluent, there hasn't been a change. In China, we have our product. It's carbonated. Our researchers indicated that younger consumers do prefer a carbonated product, and we've distinguished ourselves from Red Bull, which is a still product Thai Red Bull in China, and we believe that we're continuing with that strategy. The pricing is premium in that it's not as premium as our product in the rest of the world and it is aligned with Red Bull China, but that is at a premium to some of the other energy drinks and certainly soft drinks.

So that just will continue and that continues to be our strategy. There's been no change in our strategy. The challenge is just again getting the recognition for Monster in China that is at a lower level because of the social media fact that you don't have as much access to – the consumer doesn't have access to Facebook and YouTube that they have around the rest of the world. And we are improving and, obviously, taking steps to start getting the consumer more familiar with us through the local social media companies that have the equivalent channels and programs in China.

[Operator]

And this ends the Q&A portion of the call. I would now like to turn it back to Rodney Sacks for any further remarks.

[Rodney Cyril Sacks, Monster Beverage Corp.]

Thank you. On behalf of Monster, I'd like to thank everyone for their continued interest in the company. We continue to believe in the company and our growth strategy and remain committed to continuing to develop, differentiate our brand, and to expand the company both at home and abroad, and in particular, to expand distribution of our products through the Coca-Cola bottling system internationally.

We are also particularly excited about the new opportunities that we have going forward with the portfolio of energy drink products throughout the world comprised of our Monster Energy brand together with the Strategic Brands, as well as Hydro and Mutant. I hope to see you all at the Annual Stockholders Meeting in Corona on June 7, 2018, at 2:00 PM. Thank you very much for your attendance.

[Operator]

Ladies and gentlemen, thank you for your participation in today's conference call. This concludes today's program, and you may all disconnect. Everyone, have a great day.