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| REED > SEC Filings for REED > Form 10-K on 27-Mar-2009 | All Recent SEC Filings |
27-Mar-2009
Annual Report
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and the related notes appearing elsewhere in this Annual Report. This discussion and analysis may contain forward-looking statements based on assumptions about our future business. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including but not limited to those set forth under "Risk Factors" and elsewhere in this Annual Report.
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 five unique product lines:
? Reed's Ginger Brews,
? Virgil's Root Beer, Cream Sodas and Real Cola, including diet sodas
? China Colas,
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.
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:
Fuel Prices - Last year's fuel price increases caused increases in our packaging, production and ingredient costs. Fuel prices have abated; however we continue to pursue alternative production, packaging and ingredient suppliers and options to help offset the effect of last year's fuel price increases 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 developed low-carbohydrate versions of some of our beverages namely the 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 initiated our own direct distribution to mainstream supermarkets and natural and gourmet foods stores in Southern California and to large national retailers. However, we are in the process of discontinuing our direct distribution and redirecting our customers to local distributors. 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. We own trademarks that we consider material to our business. Three of our material trademarks are registered trademarks in the U.S. Patent and Trademark Office: Virgil's ®, Reed's Original Ginger Brew All-Natural Jamaican Style Ginger Ale ® and Tianfu China Natural Soda ®. Registrations for trademarks in the United States will last indefinitely as long as we continue to use and police the trademarks and renew filings with the applicable governmental offices. We have not been challenged in our right to use any of our material trademarks in the United States. We intend to obtain international registration of certain trademarks in foreign jurisdictions.
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 years ended December 31, 2008 or December 31, 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 years ended December 31, 2008 or December 31, 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.
Accounts Receivable. We evaluate the collectability 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.
Stock-Based Compensation. We periodically issue stock options and warrants to employees and non-employees in non-capital raising transactions for services and for financing costs. We adopted SFAS No. 123R, "Accounting for Stock-Based Compensation" effective January 1, 2006, and are using the modified prospective method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS No. 123R for all share-based payments granted after the effective date and (b) based on the requirements of SFAS No. 123R for all awards granted to employees prior to the effective date of SFAS No. 123R that remain unvested on the effective date. We account for stock option and warrant grants issued and vesting to non-employees in accordance with EITF No. 96-18: "Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services," and EITF 00-18 "Accounting Recognition for Certain Transactions involving Equity Instruments Granted to Other Than Employees" whereby the fair value of the stock compensation is based on the measurement date as determined at either a) the date at which a performance commitment is reached, or b) at the date at which the necessary performance to earn the equity instrument is complete.
We estimate the fair value of stock options pursuant to SFAS No. 123R using the Black-Scholes option-pricing model, which was developed for use in estimating the fair value of options that have no vesting restrictions and are fully transferable. This model requires the input of subjective assumptions, including the expected price volatility of the underlying stock and the expected life of stock options. Projected data related to the expected volatility of stock options is based on the historical volatility of the trading prices of the Company's common stock and the expected life of stock options is based upon the average term and vesting schedules of the options. Changes in these subjective assumptions can materially affect the fair value of the estimate, and therefore the existing valuation models do not provide a precise measure of the fair value of our employee stock options.
Results of Operations
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
Gross sales for the year ended December 31, 2008 increased to $15,277,000 from $13,059,000 during 2007, a net increase of $2,218,000, or 17%. Sales increased in both our Virgil's product line and our Reed's Ginger Brews line. We experienced increases in the volumes of sales, especially in our Virgil's product line; and increases in our prices, primarily on our Reed's Ginger Brew lines. Generally, over 90% of our sales are split evenly between our two most significant product lines, Reed's Ginger Brews and Virgil's sodas, during both 2008 and 2007. The increase in sales was primarily due to an increase in sales to newly introduced mainstream distributors and to an increase in our existing distribution channels of natural food distributors and retailers.
Cost of Goods Sold
Cost of goods sold consists primarily of the costs of our ingredients, packaging and production. Cost of goods sold increased by 8% to $11,891,000 during the year ended December 31, 2008 from $11,040,000 in 2007; as compared to the sales increase of 17% in the same comparable periods. Our costs of sales have been impacted by fuel and commodity price increases which have caused an increase in our costs of production from our co-packer. Fuel price increases in 2008 have increased our costs of delivery. The costs of glass vary, and the cost of ginger has increased by about 20% in 2008. In addition, we had increased costs of packaging. In late 2008, we negotiated reductions in our co-packing fees, which are anticipated to decrease our per-unit cost of goods sold in 2009. In 2009, we are experiencing lower freight costs due to the fall of fuel costs. We are also producing higher portions of our products at our own facility in Los Angeles, which is anticipated to lower our per-unit costs and improve our margins. We are also currently negotiating for significant reductions in glass costs.
Gross Profit
Our gross profit increased to $3,386,000 in the year ended December 31, 2008, from $2,019,000 in 2007, an increase of $1,367,000 or 68%. The gross profit as a percentage of sales improved to 22% in 2008, from 15% in 2007. This gross profit margin increase is primarily due to price increases in 2008, where we have raised prices on the Reed's Ginger Brew line by approximately 20% bringing it more in line with our competitors in the natural soda category. In addition, we have improved our systems to track and manage the approval and use of promotions and discounting, resulting in higher effective prices and net gross margins. Finally, we have renegotiated our production costs from our largest co-packer and we anticipate a further increase in gross margins of approximately 5% in 2009, with current pricing.
Selling and marketing expenses
Selling and marketing expenses consist primarily of direct charges for staff compensation costs, advertising, sales promotion, marketing and trade shows. Selling and marketing costs decreased to $3,817,000 in the year ended December 31, 2008 from $4,587,000 in 2007, a net decrease of $770,000 or 17%. The decrease is primarily due to decreases in compensation and travel costs of $1,011,000 and a decrease in trade show costs of $333,000. Such decreases were offset by an increase in advertising in promotion of $229,000, an increase in broker commissions of $229,000, and an increase in office and equipment costs of $59,000.
Our strategic direction in sales is to focus on our product placements in our estimated 10,500 supermarkets nationwide. This strategy replaces our strategy in 2007 that focused on both the supermarkets and a direct store delivery (DSD) effort. As a result, 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 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.
Our decrease in trade show costs in 2008 was due to non-recurring promotions that occurred with one customer in 2007. Promotional expense increased in 2008 due to increased promotionally spending with supermarkets as we implement increased marketing programs with our supermarket partners. Brokerage commission expenses increased due to an increased use of brokerage firms to help penetrate and manage our supermarket business in 2008.
General and Administrative Expenses
General and administrative expense consists primarily of the cost of executive, administrative, and finance personnel, as well as professional fees. General and administrative expenses increased to $3,140,000 during the year ended December 31, 2008 from $2,621,000 in 2007, a net increase of $519,000 or 20%. The increase in 2008 is primarily due to an increase in professional fees expense of $444,000 and an increase in insurance and operating costs of $74,000. The increase in professional fees, including 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 Sarbanes-Oxley legislation. In addition, we had a one-time non cash expense of approximately $300,000 for professional consulting services, for which we issued stock.
We believe that our existing executive and administrative staffing levels are sufficient to allow for moderate growth without the need to add personnel and related costs for the foreseeable future.
Loss from Operations
Our loss from operations decreased to $3,571,000 in the year ended December 31, 2008 from $5,489,000 in 2007. The improvement of $1,918,000 was due to increased sales, increased margins and lower costs of marketing. We have implemented cost-cutting measures throughout our business during 2008 and believe that this will result in over $2 million lower costs for the 2009 year.
Interest Expense
Interest expense increased to $244,000 in the year ended December 31, 2008, compared to interest expense of $182,000 in 2007. The increase is due to the increased borrowing under a long-term mortgage, secured by our buildings; and under a line of credit agreement with First Capital LLC, secured primarily by our inventory and accounts receivable.
Liquidity and Capital Resources
As of December 31, 2008, we had an accumulated deficit of $14,919,000 and we had working capital of $636,000, compared to an accumulated deficit of $11,081,000 and working capital of $2,943,000 at December 31, 2007. Cash and cash equivalents were $229,000 as of December 31, 2008, as compared to $743,000 at December 31, 2007. This decrease in our working capital and cash position was primarily attributable to our net loss. In addition to our cash position on December 31, 2008, we had availability under our line of credit of approximately $33,000.
Our decrease in cash and cash equivalents to $229,000 at December 31, 2008 compared to $743,000 at December 31, 2007 was the result of $2,468,000 used in operating activities and $191,000 used in investing activities; offset by $2,145,000 provided by financing activities.
The measures that we have taken in late 2008 to lower our cost of goods are yielding current improvements in gross margins of approximately 5% that we believe will extend throughout 2009. We also have initiatives underway to improve our glass costs as well as our ginger costs. Our completed operating cost reductions will lower operating expenses by over $2 million in 2009, as compared to 2008. At the current sales run rates and prices, we believe that our Company will operate at profitable levels in 2009.
We believe that the Company has a number of options for gaining the necessary working capital in 2009; needed to fund our seasonality, product launches and other growth plans. Our primary capital source will be cash flow from operations. We are also investigating improved working capital loans that more fully value our assets for collateral. We may raise a limited amount of funds through a combination of equity and debt; however, we'd prefer to wait until our stock has a better market value so that we minimize dilution. We believe that the Company can become leaner if our sales goals do not materialize, and that our costs can be managed to produce profitable operations.
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. In 2007, we completed a private placement to accredited investors, 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 total proceeds received, net of underwriting commissions and the investment banking fee, of $8,040,000.
Net cash used in operations during 2008 was $2,468,000 compared with $5,806,000 used in operations during 2007. Cash used in operations during 2008 was primarily due to the net loss in period and to an increase in accounts receivable collections, as compared to the same prior year period.
Net cash used in investing activities of $191,000 during 2008 compared with $2,951,000 during 2007 is primarily the result of equipment purchases during 2008 of $191,000 as compared to $2,651,000 in 2007.
Net cash provided by financing activities of $2,145,000 during 2008 was primarily due to net proceeds from the refinancing of our land and buildings of $1,770,000 and our obtaining of a line of credit of $1,354,000; offset by debt payoffs of $800,000. As of December 31, 2008, we had outstanding borrowings of $1,354,000 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 financially secure and have over $1 billion dollars in assets with 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.
Our operating losses have negatively impacted our liquidity and we are continuing to work on decreasing operating losses, while focusing on increasing net sales. We are currently borrowing near the maximum on our line of credit. At December 31, 2008, we had approximately $500,000 to $1,000,000 in excess inventory over our normal inventory levels, which is being used to fuel sales in the first quarter of 2009. We believe the operations of the company are currently 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 2009. 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. We cannot . . .
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