Item
2.
Management’s Discussion and Analysis of Financial Condition and Results of
Operations
FORWARD
LOOKING STATEMENTS
Certain
statements in this Quarterly Report on Form 10-Q, or the Report, are
“forward-looking statements.” These forward-looking statements include, but are
not limited to, statements about the plans, objectives, expectations and
intentions of Reed’s, Inc., a Delaware corporation (referred to in this Report
as “we,” “us,” or “our””) and other statements contained in this Report that are
not historical facts. Forward-looking statements in this Report or hereafter
included in other publicly available documents filed with the Securities
and
Exchange Commission, or the Commission, reports to our stockholders and
other
publicly available statements issued or released by us involve known and
unknown
risks, uncertainties and other factors which could cause our actual results,
performance (financial or operating) or achievements to differ from the
future
results, performance (financial or operating) or achievements expressed
or
implied by such forward-looking statements. Such future results are based
upon
management's best estimates based upon current conditions and the most
recent
results of operations. When used in this Report, the words “expect,”
“anticipate,” “intend,” “plan,” “believe,” “seek,” “estimate” and similar
expressions are generally intended to identify forward-looking statements,
because these forward-looking statements involve risks and uncertainties.
There
are important factors that could cause actual results to differ materially
from
those expressed or implied by these forward-looking statements, including
our
plans, objectives, expectations and intentions and other factors that are
discussed under the section entitled “Risk Factors,” in our Annual Report on
Form 10-KSB for the year ended December 31, 2007.
The
following discussion and analysis of our financial condition and results
of
operations should be read in conjunction with our unaudited condensed financial
statements and the related notes appearing elsewhere in this Form
10-Q.
Overview
We
develop, manufacture, market, and sell natural non-alcoholic and “New Age”
beverages, candies and ice creams. “New Age Beverages” is a category that
includes natural soda, fruit juices and fruit drinks, ready-to-drink teas,
sports drinks, and water. We currently manufacture, market and sell six
unique
product lines:
|
·
|
Virgil’s
Root Beer, Real Cola, and Cream Sodas in regularly sweetened
and diet
versions,
|
|
·
|
Reed’s
Ginger Candies, and
|
|
·
|
Reed’s
Ginger Ice Creams
|
We
sell
most of our products in specialty gourmet and natural food stores, supermarket
chains, retail stores and restaurants in the United States and, to a lesser
degree, in Canada. We primarily sell our products through a network of
natural,
gourmet and independent distributors. We also maintain an organization
of
in-house sales managers who work mainly in the stores serviced by our natural,
gourmet and mainstream distributors and with our distributors. We also
work with
regional, independent sales representatives who maintain store and distributor
relationships in a specified territory. In Southern California, we have
our own
direct distribution system.
Trends,
Risks, Challenges, Opportunities That May or Are Currently Affecting Our
Business
Our
main
challenges, trends, risks, and opportunities that could affect or are affecting
our financial results include but are not limited to:
Slowing
Economy- The recent economic crisis could cause consumers to pull back
from high
end natural food products. So far the natural food industry has seen a
slow down
of growth but according to a recent news article by SPINS, the industry
scan
data providers, sales are up 10% over the same period last year for 4 week
of
October 2008. Never the less a more accelerated slow down would potentially
impact our core customers, the natural food consumer.
Fuel
Prices - As oil prices continue to increase, our packaging, production
and
ingredient costs will continue to rise. We have attempted to offset the
rising
freight costs from fuel price increases by creatively negotiating rates
and
managing freight. We will continue to pursue alternative production, packaging
and ingredient suppliers and options to help offset the affect of rising
fuel
prices on these expenses.
Low
Carbohydrate Diets and Obesity - Most of our products are not geared for
the low
carbohydrate market. Consumer trends have reflected higher demand for lower
carbohydrate products. We monitor these trends closely and have developing
low-carbohydrate versions of some of our beverages namely the whole Virgil’s
line.
Distribution
Consolidation - There has been a recent trend towards continued consolidation
of
the beverage distribution industry through mergers and acquisitions. This
consolidation results in a smaller number of distributors to market our
products
and potentially leaves us subject to the potential of our products either
being
dropped by these distributors or being marketed less aggressively by these
distributors. As a result, we have initiated our own direct distribution
to
mainstream supermarkets and natural and gourmet foods stores in Southern
California and to large national retailers. Consolidation among natural
foods
industry distributors has not had an adverse affect on our sales.
Consumers
Demanding More Natural Foods - The rapid growth of the natural foods industry
has been fueled by the growing consumer awareness of the potential health
problems due to the consumption of chemicals in the diet. Consumers are
reading
ingredient labels and choosing products based on them. We design products
with
these consumer concerns in mind. We feel this trend toward more natural
products
is one of the main trends behind our growth. Recently, this trend in drinks
has
not only shifted to products using natural ingredients, but also to products
with added ingredients possessing a perceived positive function like vitamins,
herbs and other nutrients. Our ginger-based products are designed with
this
consumer demand in mind.
Supermarket
and Natural Food Stores - More and more supermarkets, in order to compete
with
the growing natural food industry, have started including natural food
sections.
As a result of this trend, our products are now available in mainstream
supermarkets throughout the United States in natural food sections. Supermarkets
can require that we spend more advertising money and they sometimes require
slotting fees. We continue to work to keep these fees reasonable. Slotting
fees
in the natural food section of the supermarket are generally not as expensive
as
in other areas of the store.
Beverage
Packaging Changes - Beverage packaging has continued to innovate, particularly
for premium products. There is an increase in the sophistication with respect
to
beverage packaging design. While we feel that our current core brands still
compete on the level of packaging, we continue to experiment with new and
novel
packaging designs such as the 5-liter party keg and 750 ml. champagne style
bottles. We have further plans for other innovative packaging
designs.
Packaging
or Raw Material Price Increases - An increase in packaging or raw materials
has
caused our margins to suffer and has negatively impacted our cash flow
and
profitability. We continue to search for packaging and production alternatives
to reduce our cost of goods.
Cash
Flow
Requirements - Our growth will depend on the availability of additional
capital
infusions. We have a financial history of losses and are dependent on
non-banking sources of capital, which tend to be more expensive and charge
higher interest rates. Any increase in costs of goods will further increase
losses and will further tighten cash reserves.
Interest
Rates - We use lines of credit as a source of capital and are negatively
impacted as interest rates rise.
Critical
Accounting Policies
Our
financial statements are prepared in accordance with accounting principles
generally accepted in the United States of America, or GAAP. GAAP requires
us to
make estimates and assumptions that affect the reported amounts in our
financial
statements including various allowances and reserves for accounts receivable
and
inventories, the estimated lives of long-lived assets and trademarks and
trademark licenses, as well as claims and contingencies arising out of
litigation or other transactions that occur in the normal course of business.
The following summarize our most significant accounting and reporting policies
and practices:
Revenue
Recognition. Revenue is recognized on the sale of a product when the product
is
shipped, which is when the risk of loss transfers to our customers, and
collection of the receivable is reasonably assured. A product is not shipped
without an order from the customer and credit acceptance procedures performed.
The allowance for returns is regularly reviewed and adjusted by management
based
on historical trends of returned items. Amounts paid by customers for shipping
and handling costs are included in sales.
Trademark
License and Trademarks. Trademark license and trademarks primarily represent
the
costs we pay for exclusive ownership of the Reed’s® trademark in connection with
the manufacture, sale and distribution of beverages and water and non-beverage
products. We also own the Virgil’s® trademark and the China Cola® trademark. In
addition, we own a number of other trademarks in the United States as well
as in
a number of countries around the world. We account for these items in accordance
with SFAS No. 142, “Goodwill and Other Intangible Assets.” Under the
provisions of SFAS No. 142, we do not amortize indefinite-lived trademark
licenses and trademarks.
In
accordance with SFAS No. 142, we evaluate our non-amortizing trademark
license and trademarks quarterly for impairment. We measure impairment
by the
amount that the carrying value exceeds the estimated fair value of the
trademark
license and trademarks. The fair value is calculated by reviewing net sales
of
the various beverages and applying industry multiples. Based on our quarterly
impairment analysis the estimated fair values of trademark license and
trademarks exceeded the carrying value and no impairments were identified
during
the nine months ended September
30, 2008 or September
30, 2007.
Long-Lived
Assets. Our management regularly reviews property, equipment and other
long-lived assets, including identifiable amortizing intangibles, for possible
impairment. This review occurs quarterly or more frequently if events or
changes
in circumstances indicate the carrying amount of the asset may not be
recoverable. If there is indication of impairment of property and equipment
or
amortizable intangible assets, then management prepares an estimate of
future
cash flows (undiscounted and without interest charges) expected to result
from
the use of the asset and its eventual disposition. If these cash flows
are less
than the carrying amount of the asset, an impairment loss is recognized
to write
down the asset to its estimated fair value. The fair value is estimated
at the
present value of the future cash flows discounted at a rate commensurate
with
management’s estimates of the business risks. Quarterly, or earlier, if there is
indication of impairment of identified intangible assets not subject to
amortization, management compares the estimated fair value with the carrying
amount of the asset. An impairment loss is recognized to write down the
intangible asset to its fair value if it is less than the carrying amount.
Preparation of estimated expected future cash flows is inherently subjective
and
is based on management’s best estimate of assumptions concerning expected future
conditions. No impairments were identified during the nine months ended
September
30, 2008 or 2007.
Management
believes that the accounting estimate related to impairment of our long
lived
assets, including our trademark license and trademarks, is a “critical
accounting estimate” because: (1) it is highly susceptible to change from
period to period because it requires management to estimate fair value,
which is
based on assumptions about cash flows and discount rates; and (2) the
impact that recognizing an impairment would have on the assets reported
on our
balance sheet, as well as net income, could be material. Management’s
assumptions about cash flows and discount rates require significant judgment
because actual revenues and expenses have fluctuated in the past and we
expect
they will continue to do so.
In
estimating future revenues, we use internal budgets. Internal budgets are
developed based on recent revenue data for existing product lines and planned
timing of future introductions of new products and their impact on our
future
cash flows.
Advertising.
We account for advertising production costs by expensing such production
costs
the first time the related advertising is run.
Accounts
Receivable. We evaluate the collectibility of our trade accounts receivable
based on a number of factors. In circumstances where we become aware of
a
specific customer’s inability to meet its financial obligations to us, a
specific reserve for bad debts is estimated and recorded which reduces
the
recognized receivable to the estimated amount our management believes will
ultimately be collected. In addition to specific customer identification
of
potential bad debts, bad debt charges are recorded based on our historical
losses and an overall assessment of past due trade accounts receivable
outstanding.
Inventories.
Inventories are stated at the lower of cost to purchase and/or manufacture
the
inventory or the current estimated market value of the inventory. We regularly
review our inventory quantities on hand and record a provision for excess
and
obsolete inventory based primarily on our estimated forecast of product
demand
and/or our ability to sell the product(s) concerned and production requirements.
Demand for our products can fluctuate significantly. Factors that could
affect
demand for our products include unanticipated changes in consumer preferences,
general market conditions or other factors, which may result in cancellations
of
advance orders or a reduction in the rate of reorders placed by customers.
Additionally, our management’s estimates of future product demand may be
inaccurate, which could result in an understated or overstated provision
required for excess and obsolete inventory.
Income
Taxes. Current income tax expense is the amount of income taxes expected
to be
payable for the current year. A deferred income tax asset or liability
is
established for the expected future consequences of temporary differences
in the
financial reporting and tax bases of assets and liabilities. We consider
future
taxable income and ongoing, prudent, and feasible tax planning strategies,
in
assessing the value of our deferred tax assets. If our management determines
that it is more likely than not that these assets will not be realized,
we will
reduce the value of these assets to their expected realizable value, thereby
decreasing net income. Evaluating the value of these assets is necessarily
based
on our management’s judgment. If our management subsequently determined that the
deferred tax assets, which had been written down, would be realized in
the
future, the value of the deferred tax assets would be increased, thereby
increasing net income in the period when that determination was
made.
Results
of Operations
Three
Months Ended September 30, 2007 Compared to Three Months Ended September
30,
2008
Gross
sales increased by $573,168, or 13.5%, from $4,236,429 in the three months
ended
September 30, 2007 to $4,809,597 in the three months ended September 30,
2008. The three months ended September 30, 2007 included $251,401 in Costco
Roadshows which are promotional sales that we decided against in 2008.
In
calculating our core business growth, we would exclude these sales.
Product
discounting increased by $222,651, or 62.6%, from $355,491 in the three
months
ended September 30, 2007 to $578,142 in the three months ended September
30,
2008. As a percentage of gross sales the product discounting increased
from 8.4%
in the first three months ended September 30, 2007 to 12.0% in the first
three
months ended September 30, 2008.The increase was due to greater promotional
activity of the brands in the marketplace.
Net
sales
increased by $351,858, or 9.0%, from $3,881,328 in the three months ended
September 30, 2007 to $4,233,186 in the three months ended September 30,
2008.
The increase in net sales was primarily due to an increase in our Virgil’s
product line and our Reed’s Ginger Brews line. The increase in sales was also
primarily due to an increase in net sales due to newly introduced mainstream
distributors and an increase in our existing distribution channels of natural
food distributors and retailers.
The
Virgil’s brand, which includes Root Beer, Real Cola, Cream Soda and Black Cherry
Cream soda, Diet Root Beer, Diet Real Cola, Diet Cream Soda and Diet Black
Cherry Cream Soda, realized an increase in net sales of $151,000, or 8%
to
$1,983,000 in the three months ended September 30, 2008 from $1,832,000
in the
three months ended September 30, 2007. The increase was the result of increased
sales in 12 ounce Root Beer of $86,000 or 9% from $1,003,000 in the three
months
ended September 30, 2007 to $1,089,000 in the three months ended September
30,
2008, increased sales in Cream Soda of $49,000 or 18% from $271,000 in
the three
months ended September 30, 2007 to $320,000 in the three months ended September
30, 2008, and decreased sales in Black Cherry Cream Soda of $20,000 or
12% from
$163,000 in the three months ended September 30, 2007 to $143,000 in the
three
months ended September 30, 2008. Also, the Virgil’s Root Beer five-liter party
kegs decreased $150,000 or 66%, from $228,000 in the three months ended
September 30, 2007 to $78,000 in the three months ended September 30, 2008.
In
addition, the increase in sales in the Virgil’s Brand was the result of launch
of Virgil’s Real Cola in 2008 which realized net sales of $127,000 in the three
months ended September 30, 2008. Virgil’s diet sodas, the new stevia sweetened
versions, sales increased $47,000 or 61% from $77,000 in the three months
ended
September 30, 2007 to $124,000 in the three months ended September 30,
2008.
The
Reeds
Ginger Brew Line increased $433,000 or 24% to $2,223,000 in the three months
ended September 30, 2008 from $1,790,000 in the three months ended September
30,
2007.
Net
sales
of candy increased $25,000, or 11% to $261,000 in the three months ended
September 30, 2008 from $236,000 in the three months ended September 30,
2007.
The
product mix for our two most significant product lines, Reed’s Ginger Brews and
Virgil’s sodas was 48.6% and 43.3%, respectively of net sales in the three
months ended September 30, 2008 and was 45.1% and 46.2%, respectively of
net
sales in the three months ended September 30, 2007.
Cost
of
sales decreased by $145,368, or 4.7%, to $2,937,687 in the three months
ended
September 30, 2008 from $3,083,055 in the three months ended September
30, 2007.
As a percentage of net sales, cost of sales decreased to 69.3% in the three
months ended September 30, 2008 from 79.4% in the three months ended September
30, 2007. Cost of sales as a percentage of net sales decreased by 10.1%,
primarily as a result of the price increase on April 1, 2008 for the Reed’s
Ginger Brew line of beverages offset by fuel and commodity price increases
which
have caused an increase in our costs of production from our co-packer.
Fuel
price increases have also increased our costs of delivery. In addition,
we had
increased costs of packaging. If fuel and commodity prices continue to
increase,
we will have more pressure on our margins.
Gross
profit increased $497,226 or 62.3% to $1,295,499 in the three months ended
September 30, 2008 from $798,273 in the three months ended September 30,
2007.
As a percentage of net sales, gross profit increased to 30.7% in the first
three
months of 2008 from 20.6% in the first three months of 2007.
To
improve gross margins in 2008, we have raised prices on the Reed’s Ginger Brew
line by 20% bringing it more in line with our competitors in the natural
soda
category. In addition, we are implementing systems to track and manage
the
approval and use of promotions and discounting to maintain a higher net
gross
margin. Finally, we have renegotiated our production costs from our largest
co-packer and expect an increase in gross margins between 5-6% as we move
through our current inventory. The contract is effective November 1,
2008.
Operating
expenses decreased by $941,267, or 40.7%, to $1,377,456 in the three months
ended September 30, 2008 from $2,318,723 in the three months ended September
30,
2007 and decreased as a percentage of net sales to 32.5% in the three months
ended September 30, 2008 from 59.8% in the three months ended September
30,
2007. The decrease was primary the result of decreased selling and general
and
administrative expenses. In March of 2008, we reduced our staff by 17 employees,
mostly from the sales staff.
During
the first quarter of 2008, we implemented a cost reduction strategy to
reduce
unnecessary expenses and revised our budget for 2008. We reduced selling
expenses by reducing our work force by 17 employees. We expect to save
approximately $2,000,000 in annual expense with this sales force reduction.
Operating expenses decreased by $743,640 or 30.3%, to $1,710,634 in the
three
months ended June 30, 2008 from $2,454,274 in the three months ended March
31,
2008. Operating expenses decreased by $333,178 or 19.5%, to $1,377,456
in the
three months ended September 30, 2008 from $1,710,634 in the three months
ended
June 30, 2008. We expect to stabilize at this level of operating expense
for the
next few quarters and increase in 2009 in later quarters due to increased
gross
profits expected in 2009.
Selling
expenses decreased by $787,576 or 49.0%, to $819,362 in the three months
ended
September 30, 2008 from $1,606,938 in the three months ended September
30, 2007.
The decrease in selling expenses is due to our decreased sales force size
and
reduced promotions at Costco which caused sales salaries, sales contractors,
hiring expenses, road show, demos and travel expenses to reduce partially
offset
by increased commissions to outside sales organizations as we outsourced
some of
our sales efforts. Sales salaries expenses decreased $238,398 or 44.5%
to
$297,490 in the three months ended September 30, 2008 from $535,888 in
the three
months ended September 30, 2007. This decrease was due to the reduction
of the
sales force. Contract and Hiring expenses decreased $124,986 or 96.8% to
$4,172
in the three months ended September 30, 2008 from $129,158 in the three
months
ended September 30, 2007. The decrease in contract and hiring expenses
was due
to the reduction of sales staff. Road show expenses decreased $153,592
or
100.0%, to $0 in the three months ended September 30, 2008 from $153,592
in the
three months ended September 30, 2007. We did not run any road shows in
the
three months ended September 30, 2008 . Travel expenses decreased $148,343
or
73.6%, to $53,198 in the three months ended September 30, 2008 from $201,541
in
the three months ended September 30, 2007. The decrease in travel expenses
was
due to decreased sales force. Brokerage commission expenses increased $57,354
or
75.8%, to $133,000 in the three months ended September 30, 2008 from $75,646
in
the three months ended September 30, 2007. The increase in brokerage commission
expenses was due to increased use of outside food brokers to represent
us to the
supermarket trade. Demo expenses decreased $224,636 or 113.8% to ($27,218)
in the three months ended September 30, 2008 from $197,418 in the three
months
ended September 30, 2007. This decrease is due to the reduction of use
of demos
and a credit due to prior over charging by a demo company. In March 2008,
we
announced our new strategic direction in sales, whereby our focus is to
strengthen our product placements in our estimated 10,500 supermarkets
nationwide. This strategy replaces our strategy in the three months ended
September 30, 2007 that focused on both the supermarkets and a direct store
delivery (DSD) effort. Since March 2008, our sales organization has been
reduced
by 16 compared to the level we had at December 31, 2007. We have found
that the
most effective sales efforts are to grocery stores. We have our products
in more
than 10,500 supermarket stores across the country and our new direction
for 2008
is to remain focused on these accounts while opening new business with
other
grocery stores leveraging our brand equity. We feel that the trend in grocery
stores to offer their customers natural products can be served with our
products. Our sales personnel are leveraging our success at natural food
grocery
stores to establish new relationships with mainstream grocery
stores.
General
and administrative expenses decreased by $153,691 or 21.6% to $558,094
in the
three months ended September 30, 2008 from $711,785 in the first three
months
ended September 30, 2007. The decrease in general and administrative expenses
is
due to decreased legal, accounting and investor relations expenses, officer
salaries, and travel expenses. Legal, accounting and investor relations
expenses decreased $114,866 or 54.7% to $95,030 in the three months ended
September 30, 2008 from $209,896 in the three months ended September 30,
2007.
The decrease in legal, accounting and investor relation expenses was due
to
decreased legal and accounting costs mostly related to the decreased costs
of
reporting and compliance with the Securities and Exchange Commission and
NASDAQ
as we changed firms and renegotiated fees. Officer salaries decreased by
$26,251
or 27.3% to $69,982 in the three months ended September 30, 2008 from $96,233
in
the three months ended September 30, 2007. The decrease was due to the
leaving
of a Chief Operating Officer in April 2008. Travel expenses decreased by
$21,513
or 100% to $0 in the three months ended September 30, 2008 from $21,513
in the
three months ended September 30, 2007. The decrease was due to non traveling
of
office personnel during the three months ended September 30, 2008.
Interest
expense was $92,201 in the three months ended September 30, 2008, compared
to
interest expense of $51,407 in the three months ended September 30, 2007.
Interest income dropped to $-0- in the three months ended September 30,
2008,
compared to interest income of $45,898 in the three months ended September
30,
2007.
Interest
income decreased because of our overall decrease in cash and corresponding
decrease in interest bearing cash accounts. Interest expenses will probably
increase due to the increased reliance of the Company to finance operations
with
its $3,000,000 inventory and accounts receivable line of credit with First
Capital LLC.
Nine
Months Ended September 30, 2007 Compared to Nine Months Ended September
30,
2008
Gross
sales increased by $2,261,779, or 19.9%, from $11,359,958 in the three
months
ended September 30, 2007 to $13,621,737 in the three months ended September
30,
2008.
Product
discounting increased by $260,056, or 26.2%, from $993,579 in the three
months
ended September 30, 2007 to $1,253,635 in the three months ended September
30,
2008. As a percentage of gross sales the product discounting increased
from 8.7%
in the first nine months ended September 30, 2007 to 9.2% in the first
nine
months ended September 30, 2008. The increase was due to greater promotional
activity of the brands in the marketplace.
Net
sales
increased by $2,001,724, or 19.3%, from $10,366,378 in the first nine months
ended September 30, 2007 to $12,368,102 in the first nine months ended
September
30, 2008. The increase in net sales was primarily due to an increase in
our
Virgil’s product line and our Reed’s Ginger Brews line. The increase in sales
was also primarily due to an increase in net sales due to newly introduced
mainstream distributors and an increase in our existing distribution channels
of
natural food distributors and retailers.
The
Virgil’s brand, which includes Root Beer, Real Cola, Cream Soda and Black Cherry
Cream soda, Diet Root Beer, Diet Real Cola, Diet Cream Soda and Diet Black
Cherry Cream Soda, realized an increase in net sales of $1231,000, or 27%
to
$5,791,000 in first nine months ended September 30, 2008 from $4,560,000
in
first nine months ended September 30, 2007. The increase was the result
of
increased sales in 12 ounce Root Beer of $305,000 or 12% from $2,570,000
in
first nine months ended September 30, 2007 to $2,875,000 in first nine
months
ended September 30, 2008, increased sales in Cream Soda of $176,000 or
28% from
$625,000 in the first nine months of 2007 to $801,000 in the first nine
months
of 2008, and increased sales in Black Cherry Cream Soda of $25,000 or 7%
from
$359,000 in the first nine months of 2007 to $384,000 in the first nine
months
of 2008. Also, the Virgil’s Root Beer five-liter party kegs increased $381,000
or 61%, from $620,000 in first nine months ended September 30, 2007 to
$1,001,000 in first nine months ended September 30, 2008. In addition,
the
increase in sales in the Virgil’s Brand was the result of launch of Virgil’s
Real Cola in 2008 which realized net sales of $228,000 in the first nine
months
ended September 30, 2008. Virgil’s diet sodas, the new stevia sweetened
versions, sales increased $103,000 or 60.6% from $170,000 in the nine
months ended September 30, 2007 to $273,000 in the nine months ended September
30, 2008.
The
Reeds
Ginger Brew Line increased $1,173,000 or 24% to $6,110,000 in first nine
months
ended September 30, 2008 from $4,937,000 in first nine months ended September
30, 2007.
Net
sales
of candy increased $69,000, or 10% to $746,000 in first nine months ended
September 30, 2008 from $677,000 in first nine months ended September 30,
2007.
The
product mix for our two most significant product lines, Reed’s Ginger Brews and
Virgil’s sodas was 47.2% and 44.7%, respectively of net sales in first nine
months ended September 30, 2008 and was 49.6% and 43.3%, respectively of
net
sales in first nine months ended September 30, 2007.
Cost
of
sales increased by $935,405, or 11.2%, to $9,283,460 in first nine months
ended
September 30, 2008 from $8,348,055 in first nine months ended September
30,
2007. As a percentage of net sales, cost of sales decreased to 75.1% in
first
nine months ended September 30, 2008 from 80.5% in first nine months ended
September 30, 2007. Cost of sales as a percentage of net sales decreased
by
5.4%, primarily
as a result of the price increase on April 1, 2008 for the Reed’s Ginger Brew
line of beverages offset by fuel and commodity price increases which have
caused
an increase in our costs of production from our co-packer. Fuel price increases
have also increased our costs of delivery. In addition, we had increased
costs
of packaging. If fuel and commodity prices continue to increase, we will
have
more pressure on our margins.
Gross
profit increased $1,066,319 or 52.8% to $3,084,642 in first nine months
ended
September 30, 2008 from $2,018,323 in first nine months ended September
30,
2007. As a percentage of net sales, gross profit increased to 24.9% in
the first
nine months of 2008 from 19.5% in the first nine months of 2007.
To
improve gross margins in 2008, we have raised prices on the Reed’s Ginger Brew
line by 20% on April 1, 2008 bringing it more in line with our competitors
in
the natural soda category. In addition, we are implementing systems to
track and
manage the approval and use of promotions and discounting to maintain a
higher
net gross margin. Finally, we have renegotiated our production costs from
our
largest co-packer and expect an increase in gross margins between 5-6%
as we
move through our current inventory. The contract is effective November
1,
2008.
Operating
expenses increased by $881,851 or 18.9%, to $5,542,334 in first nine months
ended September 30, 2008 from $4,660,483 in first nine months ended September
30, 2007 and decreased as a percentage of net sales to
44.8%
in first nine months ended September 30, 2008 from 44.9% in first nine
months
ended September 30, 2007. The increase was primary the result of increased
selling and general and administrative expenses. In March of 2008, we reduced
our staff by 17 employees, mostly from the sales staff. During the first
quarter
of 2008, we implemented a cost reduction strategy to reduce unnecessary
expenses
and revised its budget for 2008. We reduced selling expenses by reducing
our
work force by 17 employees. We expect to save approximately $2,000,000
in annual
expense with this reduction. During the last nine months ending September
30,
2008 we had an average monthly operating expense of $615,650. During the
three
months ended September 30, 2008 we had an average monthly operating expense
of
$459,044. We believe we are reaching operating expense levels that allow
for
good growth while maintaining a lean environment.
Selling
expenses decreased by $54,709 or 1.8%, to $2,994,498 in first nine months
ended
September 30, 2008 from $3,049,207 in first nine months ended September
30,
2007. The decrease in selling expenses is due to decreased road show, demo,
stock option, contract services, and auto expenses offset by increased
salary, promotion, trade show, travel, broker commission and telephone
expenses.
Road show expenses decreased $134,473 or 97.1% to $4,308 in first nine
months
ended September 30, 2008 from $138,781 in first nine months ended September
30,
2007. This decrease was due to not running as many Costco road shows in
2008.
Demo expenses decreased $196,821 or 71.8% to $76,767 in first nine months
ended
September 30, 2008 from $273,588 in first nine months ended September 30,
2007.
The decrease in demo expenses was due to decreased use of demoing in our
marketing in 2008. Stock option expenses decreased $146,817 or 101.0%,
to
($1,522) in first nine months ended September 30, 2008 from $145,295 in
first
nine months ended September 30, 2007. This decrease was due to the stock
options
that were forfeited. Contract services expenses decreased $112,131 or 75.2%,
to
$37,727 in first nine months ended September 30, 2008 from $149,858 in
first
nine months ended September 30, 2007. The decrease in contract services
expenses
was due to reduced useage of contract services. Hiring expenses decreased
$61,788 or 98.7%, to $825 in first nine months ended September 30, 2008
from
$62,613 in first nine months ended September 30, 2007. The decrease in
hiring
expenses was due to inactivity in hiring for sales in 2008. Auto expenses
decreased $105,527 or 44.5%, to $131,459 in first nine months ended September
30, 2008 from $236,986 in first nine months ended September 30, 2007. The
decrease in auto expenses was due the reduction in the sales force in March
of
2008. These decreases were offset by increases in the following expenses.
Salary
expense increased $229,927 or 22.8% to $1,234,667 in first nine months
ended
September 30, 2008 from $1,004,740 in first nine months ended September
30,
2007. This decrease is due to the build up of sales employees in late 2007.
Promotional expense increased $186,518 or 432.5% to $229,952 in first nine
months ended September 30, 2008 from $43,434 in first nine months ended
September 30, 2007. This increase is due to increased promotionally spending
with supermarkets as we implement increased marketing programs with our
supermarket partners. Trade show expenses increased $43,896 or 68.8% to
$107,718
in first nine months ended September 30, 2008 from $63,822 in first nine
months
ended September 30, 2007. This increase is due to a increase in the number
of
trade shows we are attending including first time showings at the drug
store
chain national trade show in 2008. Travel expenses increased $21,826 or
8.2% to
$282,089 in first nine months ended September 30, 2008 from $260,263 in
first
nine months ended September 30, 2007. This increase is due to a increase
in the
sales force in the earlier part of 2008. Brokerage commission expenses
increased
$180,163 or 96.7% to $366,396 in first nine months ended September 30,
2008 from
$186,233 in first nine months ended September 30, 2007. This increase is
due to
a increase use of brokerage firms to help penetrate and manage our supermarket
busines in 2008. Telephone and postage expenses increased $29,554 or 69.1%
to
$72,314 in first nine months ended September 30, 2008 from $42,760 in first
nine
months ended September 30, 2007. This increase is due to a increase in
the
number of sales people toward the end of 2007 and also the increase in
samples
and mailing due to aggressive telemarketing. In March 2008, we announced
our new
strategic direction in sales, whereby our focus is to strengthen our product
placements in our estimated 10,500 supermarkets nationwide. This strategy
replaces our strategy in first nine months ended September 30, 2007 that
focused
on both the supermarkets and a direct store delivery (DSD) effort. Since
March
2008, our sales organization has been reduced by 16 compared to the level
we had
at December 31, 2007. We have found that the most effective sales efforts
are to
grocery stores. We have our products in more than 10,500 supermarket stores
across the country and our new direction for 2008 is to remain focused
on these
accounts while opening new business with other grocery stores leveraging
our
brand equity. We feel that the trend in grocery stores to offer their customers
natural products can be served with our products. Our sales personnel are
leveraging our success at natural food grocery stores to establish new
relationships with mainstream grocery stores.
General
and administrative expenses increased by $936,560 or 58.0% to $2,547,836
in
first nine months ended September 30, 2008 from $1,611,276 in the first
nine
months of 2007. The increase in general and administrative expenses is
due to
increased legal, accounting and investor relations expenses, officer salaries,
general liability insurance, stock options, and one time expenses of our
First
Capital line of credit set up expense. Legal, accounting and investor relations
expenses increased $623,027 or 168.2% to $993,338 in first nine months
ended
September 30, 2008 from $370,311 in first nine months ended September 30,
2007.
The increase in legal, accounting and investor relation expenses was due
to
increased legal and accounting costs mostly related to the increased costs
of
reporting and compliance with the Securities and Exchange Commission and
NASDAQ,
in addition, we had a one-time non cash expense of $320,762 for consulting
services, for which we issued stock. Officer salaries increased by $168,236
or
86.6% to $362,412 in first nine months ended September 30, 2008 from $194,176
in
first nine months ended September 30, 2007 The increase was due to the
hiring of
a Chief Operating Officer in May 2007 and a Chief Financial Officer in
October
2007. Liability insurance expenses increased $84,539 or 209.9% to $124,820
in
first nine months ended September 30, 2008 from $40,281 in first nine months
ended September 30, 2007. This increase was mainly due to increased sales
and
coverage. Stock option expenses increased $32,500 or 125.0% to $58,500
in first
nine months ended September 30, 2008 from $26,000 in first nine months
ended
September 30, 2007. This increase was due to the hiring of a Chief Operating
Officer in May 2007 and a Chief Financial Officer in October 2007. We had
one
time expenses with the new line of credit with First Capital in first nine
months ended September 30, 2008 of $30,122.
Interest
expense was $198,629 in the nine months ended September 30, 2008, compared
to
interest expense of $163,290 in the nine months ended September 30, 2007.
Interest income dropped to $975 in the nine months ended September 30,
2008,
compared to interest income of $98,498 in the nine months ended September
30,
2007.
Interest
income decreased because of our overall decrease in cash and corresponding
decrease in interest bearing cash accounts. Interest expenses will probably
increase due to the increased reliance of the company to finance operations
with
its $3,000,000 inventory accounts receivable line of credit with First
Capital
LLC.
Historically,
we have financed our operations primarily through private sales of common
stock,
preferred stock, convertible debt, a line of credit from a financial
institution, and cash generated from operations. On December 12, 2006,
we
completed the sale of 2,000,000 shares of our common stock at an offering
price
of $4.00 per share in our initial public offering. The public offering
resulted
in gross proceeds of $8,000,000 to us. In connection with the public offering,
we paid aggregate commissions, concessions and non-accountable expenses
to the
underwriters of $800,000, resulting in net proceeds of $7,200,000, excluding
other expenses of the public offering. In addition, we issued, to the
underwriters, warrants to purchase up to approximately an additional 200,000
shares of common stock at an exercise price of $6.60 per share (165% of
the
public offering price per share), at a purchase price of $0.001 per warrant.
The
underwriters’ warrants are exercisable for a period of five years commencing on
the final closing date of the public offering. From August 3, 2005 through
April
7, 2006, we had issued 333,156 shares of our common stock in connection
with the
public offering. We sold the balance of the 2,000,000 shares in connection
with
the public offering (1,666,844 shares) following October 11, 2006.
From
May
25, 2007 through June 15, 2007, we completed a private placement to accredited
investors only, on subscriptions for the sale of 1,500,000 shares of common
stock and warrants to purchase up to 749,995 shares of common stock, resulting
in an aggregate of $9,000,000 of gross proceeds to us. We sold the shares
at a
purchase price of $6.00 per share. The warrants issued in the private placement
have a five-year term and an exercise price of $7.50 per share. We paid
cash
commissions of $900,000 to the placement agent for the private placement
and
issued warrants to the placement agent to purchase up to 150,000 shares
of
common stock with an exercise price of $6.60 per share. We also issued
additional warrants to purchase up to 15,000 shares of common stock with
an
exercise price of $6.60 per share and paid an additional $60,000 in cash
to the
placement agent as an investment banking fee. Total proceeds received,
net of
underwriting commissions and the investment banking fee and excluding other
expenses of the private placement, was $8,040,000.
As
of
September 30, 2008, we had an accumulated deficit of $13,760,048 and we
had
working capital of $1,656,096, compared to an accumulated deficit of $11,081,141
and working capital of $2,942,909 as of December 31, 2007. Cash and cash
equivalents were $83,091 as of September 30, 2008, as compared to $742,719
as of
December 31, 2007. This decrease in our working capital and cash position
was
primarily attributable to our net loss for the nine months ended September
30,
2008. In addition to our cash position on September 30,2008, we had availability
under our line of credit of approximately $273,000.
Net
cash
used in operating activities during the nine months ended September 30,
2008 was
$2,737,415 which was due primarily to our net loss of $2,655,346. In the
nine
months ended September 30, 2008, we used $186,313 of cash in investing
activities, which was due primarily to the purchase of various equipment
to
support business growth.
Net
cash
provided by financing activities during the nine months ended September
30, 2008
was $2,264,100. The primary components of that were the net proceeds from
the
refinancing of our land and buildings and our obtaining of a line of credit.
As
of
September 30, 2008, we had outstanding borrowings of $1,290,082 under our
line
of credit agreement. Our line of credit lender is a privately held, Senior
Secured Commercial Lender. Our lender has communicated to us that they
are not a
bank and are not subject to banking regulations. They have also communicated
to
us that they have over $1billion dollars in assets and has approximately
20% of
equity capital. They communicated that they have adequate lines of credits
in
place with banks to achieve their business goals. They communicated that
there
are no requirements in place for them to repurchase any of their outstanding
stock. Based on these communications, we believe that our lending source
will be
able to fund the full extent of our line of credit, should we meet the
requirements for such funding.
We
recognize that operating losses negatively impact liquidity and we are
working
on decreasing operating losses, while focusing on increasing net sales.
We are
currently borrowing near the maximum on our line of credit. We have
approximately $500,000 to $1,000,000 in excess inventory over our normal
inventory levels. We believe the operations of the company are running
at
approximately breakeven, after adjusting for non-cash expenses . Between
the
reduction of our inventory to more normal levels and our current breakeven
operating status, we believe that our current cash position and lines of
credit
will be sufficient to enable us to meet our cash needs through at least
the end
of 2008. We
believe that if the need arises we can raise money through the equity
markets.
We
may
not generate sufficient revenues from product sales in the future to achieve
profitable operations. If we are not able to achieve profitable operations
at
some point in the future, we eventually may have insufficient working capital
to
maintain our operations as we presently intend to conduct them or to fund
our
expansion and marketing and product development plans. In addition, our
losses
may increase in the future as we expand our manufacturing capabilities
and fund
our marketing plans and product development. These losses, among other
things,
have had and will continue to have an adverse effect on our working capital,
total assets and stockholders’ equity. If we are unable to achieve
profitability, the market value of our common stock will decline and there
would
be a material adverse effect on our financial condition.
If
we
continue to suffer losses from operations, the proceeds from our public
offering
and private placement may be insufficient to support our ability to expand
our
business operations as rapidly as we would deem necessary at any time,
unless we
are able to obtain additional financing. There can be no assurance that
we will
be able to obtain such financing on acceptable terms, or at all. If adequate
funds are not available or are not available on acceptable terms, we may
not be
able to pursue our business objectives and would be required to reduce
our level
of operations, including reducing infrastructure, promotions, personnel
and
other operating expenses. These events could adversely affect our business,
results of operations and financial condition.
In
addition, some or all of the elements of our expansion plan may have to
be
curtailed or delayed unless we are able to find alternative external sources
of
working capital. We would need to raise additional funds to respond to
business
contingencies, which may include the need to:
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fund
more rapid expansion,
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fund
additional marketing expenditures,
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enhance
our operating infrastructure,
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respond
to competitive pressures, and
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acquire
other businesses.
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We
cannot
assure you that additional financing will be available on terms favorable
to us,
or at all. If adequate funds are not available or if they are not available
on
acceptable terms, our ability to fund the growth of our operations, take
advantage of opportunities, develop products or services or otherwise respond
to
competitive pressures, could be significantly limited.
Recent
Accounting Pronouncements
References
to the “FASB”, and “SFAS” herein refer to the “Financial Accounting Standards
Board”, and “Statement of Financial Accounting Standards”,
respectively.
In
December 2007, the FASB issued FASB Statement No. 141 (R), “Business
Combinations” (FAS 141(R)), which establishes accounting principles and
disclosure requirements for all transactions in which a company obtains
control
over another business. Statement 141(R) applies prospectively to business
combinations for which the acquisition date is on or after the beginning
of the
first annual reporting period beginning on or after December 15, 2008.
Earlier
adoption is prohibited.
In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51”. SFAS No. 160
establishes accounting and reporting standards that require that the ownership
interests in subsidiaries held by parties other than the parent be clearly
identified, labeled, and presented in the consolidated statement of financial
position within equity, but separate from the parent’s equity; the amount of
consolidated net income attributable to the parent and to the noncontrolling
interest be clearly identified and presented on the face of the consolidated
statement of income; and changes in a parent’s ownership interest while the
parent retains its controlling financial interest in its subsidiary be
accounted
for consistently. SFAS No. 160 also requires that any retained noncontrolling
equity investment in the former subsidiary be initially measured at fair
value
when a subsidiary is deconsolidated. SFAS No. 160 also sets forth the disclosure
requirements to identify and distinguish between the interests of the parent
and
the interests of the noncontrolling owners. SFAS No. 160 applies to all
entities
that prepare consolidated financial statements, except not-for-profit
organizations, but will affect only those entities that have an outstanding
noncontrolling interest in one or more subsidiaries or that deconsolidate
a
subsidiary. SFAS No. 160 is effective for fiscal years, and interim periods
within those fiscal years, beginning on or after December 15, 2008. Earlier
adoption is prohibited. SFAS No. 160 must be applied prospectively as of
the
beginning of the fiscal year in which it is initially applied, except for
the
presentation and disclosure requirements. The presentation and disclosure
requirements are applied retrospectively for all periods presented.
In
March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities - an amendment of FASB Statement No. 133” (“SFAS No.
161”). SFAS No. 161 amends and expands the disclosure requirements of SFAS
No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS
No. 133”). The objective of SFAS No. 161 is to provide users of financial
statements with an enhanced understanding of how and why an entity uses
derivative instruments, how derivative instruments and related hedged items
are
accounted for under SFAS No. 133 and its related interpretations, and how
derivative instruments and related hedged items affect an entity’s financial
position, financial performance, and cash flows. SFAS No. 161 requires
qualitative disclosures about objectives and strategies for using derivatives,
quantitative disclosures about fair value amounts of and gains and losses
on
derivative instruments, and disclosures about credit-risk-related contingent
features in derivative agreements. SFAS No. 161 applies to all derivative
financial instruments, including bifurcated derivative instruments (and
nonderivative instruments that are designed and qualify as hedging instruments
pursuant to paragraphs 37 and 42 of SFAS No. 133) and related hedged items
accounted for under SFAS No. 133 and its related interpretations. SFAS No.
161 also amends certain provisions of SFAS No. 131. SFAS No. 161 is effective
for financial statements issued for fiscal years and interim periods beginning
after November 15, 2008, with early application encouraged. SFAS No. 161
encourages, but does not require, comparative disclosures for earlier periods
at
initial adoption.
The
Company does not believe the adoption of the above recent pronouncements,
will
have a material effect on the Company’s results of operations, financial
position, or cash flows.
Inflation
Although
management expects that our operations will be influenced by general economic
conditions, we do not believe that inflation has a material effect on our
results of operations.
Item
3. QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As
a
smaller reporting company, the Company is not required to provide disclosure
under this Part I, Item 3.
Item
4.
CONTROLS AND PROCEDURES
(a)
Management's Evaluation of Disclosure Controls and Procedures.
As
of
September 30, 2008, we carried out an evaluation, under the supervision
and with
the participation of our management, including our Chief Executive Officer
and
Chief Financial Officer, of the effectiveness of the design and operation
of our
“disclosure controls and procedures,” as such term is defined under Exchange Act
Rules 13a-15(e) and 15d-15(e).
Our
Chief
Executive Officer and Chief Financial Officer concluded that, as of September
30, 2008, our disclosure controls and procedures were effective to ensure
that information required to be disclosed by us in the reports we file
or submit
under the Exchange Act is recorded, processed, summarized and reported
within
the time periods specified in the rules and forms of the SEC, and accumulated
and communicated to our management, including our Chief Executive Officer
and
Chief Financial Officer, as appropriate to allow timely decisions regarding
required disclosure.
(b)
Changes in Internal Control Over Financial Reporting.
There
were no changes in our internal control over financial reporting during
the
quarter ended September 30, 2008 that materially affected, or are reasonably
likely to materially affect, our internal control over financial
reporting.
Part
II
Item
1.
Legal Proceedings
There
has
been no change to our disclosure regarding legal proceeding as set forth
in our
Annual Report on Form 10-KSB for the year ended December 31, 2007.
Except
as
set forth in such disclosure, we believe that there are no material litigation
matters at the current time. Although the results of such litigation
matters and
claims cannot be predicted with certainty, we believe that the final
outcome of
such claims and proceedings will not have a material adverse impact on
our
financial position, liquidity, or results of operations.
Item
1A. RISK FACTORS
As
a
smaller reporting company, the Company is not required to provide disclosure
under this Item 1A.
Item
2.
Unregistered Sales of Equity Securities and Use of Proceeds
For
the
nine months ended September 30, 2008, the following stock transactions
occurred:
The
Company issued 161,960 shares of common stock in exchange for consulting
services. The value of the stock was based on the closing price of
the stock on
the issuance date. The total value of $335,455 was charged to consulting
expenses.
The
Company issued 10,910 shares of common stock valued at $23,561 to its
preferred
stockholders, in accordance with the dividend provision of the preferred
stock
agreement.
The
Company issued 4,000 of common stock, resulting from the conversion
of 1,000
shares of preferred stock.
The
issuance of these securities was exempt from registration under Section
4(2) of
the Securities Act. The purchasers were either (a) “accredited investors” within
the meaning of Rule 501 of Regulation D promulgated under the Securities
Act or
(c) had a pre-existing or personal relationship with the Company. There
was
no advertising or public solicitation in connection with these transactions
bythe Company or anyone acting on the Company’s behalf.]
Item
3.
Defaults Upon Senior Securities
Item
4.
Submission of Matters to a Vote of Security Holders
Not
applicable
Item
5.
Other Information
Not
applicable
Item
6.
Exhibits
Exhibit
Number
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Description of Document
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31.1
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Officer's
Certification pursuant to Section 302 of the Sarbanes-Oxley
Act of
2002
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32.1
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Officer's
Certification pursuant to Section 906 of the Sarbanes-Oxley
Act of
2002
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SIGNATURE
In
accordance with requirements of the Exchange Act, the Registrant caused
this
report to be signed on its behalf by the undersigned thereunto duly
authorized.
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Reeds,
Inc.
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By:
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/s/
Christopher Reed
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Chief
Executive Officer, President
and
Chief Financial Officer
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November
11, 2008
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