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REED > SEC Filings for REED > Form 10-Q on 14-May-2013All Recent SEC Filings

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Form 10-Q for REEDS INC


14-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

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 report. This discussion and analysis may contain forward-looking statements based on assumptions about our future business.

Overview

Our first quarter results reflect our continued sales growth in all products and regions. Our kombucha rollout is gaining sales momentum and the product line is anticipated to become a material part of our overall sales mix during 2013. We are addressing the challenges of kombucha production, which has used an inordinate portion of our plant production schedule. We are currently placing a strong focus on increasing our Los Angeles plant capacity so that we can accommodate our private label production, our kombucha production, and meet the west coast requirements for our Reed's and Virgil's products. Increased capacity can greatly mitigate the increases in delivery costs that we are currently experiencing from cross-country delivery of our products to the western regions.

We are investing in promotions at a higher rate than last year and we feel that this has helped lift our sales volumes without margin erosion. Our promotions have generally been concentrated at retail grocer level, along with incentives for distributors to feature our brands and reduce retail price points to drive incremental revenues.

Results of Operations

Three months ended March 31, 2013 Compared to Three months ended March 31, 2012

Sales

Sales of $8,126,000 for the three months ended March 31, 2013 represented an increase of 24% from $6,539,000 in the prior year same period. Sales growth was driven primarily by continued increases in sales volume in our branded products as we expand our distribution networks. We have been steadily adding distributors and expanding our product offerings to existing customers. Private label sales also increased at approximately the same rate and comprised approximately 15% of overall sales in the both quarters ended March 31, 2013 and March 31, 2012. Kombucha sales comprised approximately 7% of case volume sales in the 2013 quarter, which were not a part of the 2012 sales.

Cost of Tangible Goods Sold

Cost of tangible goods sold consists of the costs of raw materials utilized in the manufacture of products, co-packing fees, repacking fees, in-bound freight charges, as well as certain internal transfer costs. As a percentage of net sales, our Cost of Tangible Goods Sold decreased to 60% in the three months ended March 31, 2013 as compared to 64% in the three months ended March 31, 2012. The decrease in these costs, compared to sales, is primarily due to improved margins on our private label sales in 2013. The costs of our branded 12-ounce soft drink sales remained constant, as a percentage of sales. While our costs to produce kombucha are higher on a per-unit basis, the costs are lower than our carbonated soft drinks as a percentage of sales, due to the higher price point on kombucha.

Cost of Goods Sold - Idle Capacity

Cost of goods sold - idle capacity consists of direct production costs of our Los Angeles plant in excess of charges allocated to our finished goods in production. Plant costs include labor costs, production supplies, repairs and maintenance, and inventory write-off. Our charges for labor and overhead allocated to our finished goods are determined on a market cost basis, which is lower than our actual costs incurred. Plant costs in excess of production allocations are expensed in the period incurred rather than added to the cost of finished goods produced. Idle capacity expenses increased to $686,000 in the three months ended March 31, 2013, from $369,000 in 2012. Our Los Angeles plant production has increased by over 20% in the first quarter, as compared to 2012. Plant costs, including labor, increased by approximately 50%. During the quarter, we continued to experience very slow overall copack rates on our Kombucha, due to filling and labeling methods. We are aggressively improving our methods and we believe that our plant capacity is increasing. As we refine our production methods, we feel that these costs will reduce in the future.

Gross Profit

Our gross profit of $2,535,000 in the three months ended March 31, 2013 represents an increase of $550,000, or 28% from 2012. As a percentage of sales, our gross profit increased to 31% in 2013 as compared to 30% in 2012. The improvement is primarily due to increased revenues and gross margin percentage on private label sales.

Delivery and Handling Expenses

Delivery and handling expenses consist of delivery costs to customers and warehouse costs incurred for handling our finished goods after production. Delivery costs increased by 89% in the three months ended March 31, 2013 to $906,000 from $479,000 in 2012. The increase is primarily due to a higher portion of our branded products being manufactured at our copacker in Pennsylvania for west coast customers, requiring additional freight costs for delivery. We also experienced stronger sales growth in the Pacific Northwest, the region of highest delivery freight cost. During the winter months, we are often required to use refrigerated shipping to prevent freezing in transit, causing higher freight rates. We anticipate that delivery costs will reduce in future quarters, as a percentage of sales, because we will only use refrigerated freight for our kombucha and because we are adding capacity to our plant, enabling more manufacturing of branded products on the west coast.

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 increased overall to $880,000 in the three months ended March 31, 2013 from $722,000 in 2012. The $158,000 increase is primarily due to increased compensation and travel costs of $55,000, increased stock option expense of $44,000, increased trade show promotion and advertising costs of $32,000, and increased delivery and facilities related costs of $23,000. Our sales staff has increased from 13 at March 31, 2012 to 19 at March 31, 2013. We believe that our sales staffing is adequate for our current business level; however, we will continue to add salespeople as our revenue base increases.

General and Administrative Expenses

General and administrative expenses consist primarily of the cost of executive, administrative, and finance personnel, as well as professional fees. General and administrative expenses increased to $988,000 during the three months ended March 31, 2013 from $740,000 in the same period of 2012. Compensation and related costs increased by $105,000, primarily due to an increase of one staff member and payment of bonuses in the first quarter of 2013. Stock option expense increased by $44,000, and professional and legal costs increased by $56,000 and bad debt costs increased by $40,000.

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.

Income/Loss from Operations

Our loss from operations was $239,000 in the three months ended March 31, 2013 as compared to income from operations of $44,000 in the same period of 2012. The loss was primarily a result of increases in delivery costs and idle plant capacity costs described above.

Interest Expense

Interest expense decreased to $164,000 in the three months ended March 31, 2013, compared to interest expense of $168,000 in the same period of 2012.

Modified EBITDA

The Company defines modified EBITDA (a non-GAAP measurement) as net loss before interest, taxes, depreciation and amortization, and non-cash expense for securities. Other companies may calculate modified EBITDA differently. Management believes that the presentation of modified EBITDA provides a measure of performance that approximates cash flow before interest expense, and is meaningful to investors.

                            MODIFIED EBITDA SCHEDULE

                                            Three Months Ended March 31,
                                               2013               2012
Net loss                                 $     (403,000 )     $  (124,000 )

Modified EBITDA adjustments:
Depreciation and amortization                   145,000           183,000
Interest expense                                164,000           168,000
Stock option compensation                       119,000            26,000
Other stock compensation for services                 -            15,000
Total EBITDA adjustments                        428,000           392,000

Modified EBITDA income from operations   $       25,000       $   268,000

Liquidity and Capital Resources

As of March 31, 2013, we had stockholders equity of $3,923,000 and we had working capital of $2,076,000, compared to stockholders equity of $4,098,000 and working capital of $2,298,000 at December 31, 2012. The decrease in our working capital of $22,000 was primarily a result of net losses and pay downs on our long-term debt.

Our decrease in cash and cash equivalents to $726,000 at March 31, 2013 compared to $1,163,000 at December 31, 2012 was primarily a result of cash used by operating activities of $932,000, costs of plant improvements of $98,000, and principal payments on debt of $79,000. Such cash used by operations was offset primarily by net drawdown on our revolving line of credit of $642,000 and proceeds from the exercise of stock options and warrants of $30,000. In addition to our cash position on March 31, 2013, we had availability under our line of credit of $211,000.

Our Loan and Security Agreement with PMC Financial Services Group, LLC provides a $4 million revolving line of credit and a $750,000 term loan. The revolving line of credit is based on 85% of eligible accounts receivable and 50% of eligible inventory. The interest rate on the revolving line of credit is at the prime rate plus 3.75% (7% at December 31, 2012). The term loan is for $750,000 and bears interest at the prime rate plus 11.6%, which shall not be below 14.85%, is secured by all of the unencumbered assets of the Company, and is to be repaid in 48 equal installments of principal and interest of $21,000. At March 31, 2013, out term loan balance was $533,000. On May 1, 2013 the term loan was increased to $750,000 under the same terms as the existing term loan. The Company was also granted an over advance on its revolving line of credit of $200,000.

We believe that the Company currently has the necessary working capital to support existing operations for at least the next 12 months. Our primary capital source will be positive cash flow from operations. If our sales goals do not materialize as planned, we believe that the Company can reduce its operating costs and can be managed to maintain positive cash flow from 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.

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 may 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 would decline and there would be a material adverse effect on our financial condition.

If we suffer losses from operations, our working capital 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. 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.

Critical Accounting Policies and Estimates

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. The Company reimburses its wholesalers and retailers for promotional discounts, samples and certain advertising and promotional activities used in the promotion of the Company's products. The accounting treatment for the reimbursements for samples and discounts to wholesalers results in a reduction in the net revenue line item. Reimbursements to wholesalers and retailers for certain advertising activities are included in selling and marketing expenses.

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 FASB guidance; we do not amortize indefinite-lived trademark licenses and trademarks.

In accordance with FASB guidance, 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 year ended December 31, 2012.

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 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 year ended December 31, 2012.

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. The Company accounts for stock option and warrant grants issued and vesting to employees based on FASB ASC Topic 718, "Compensation - Stock Compensation", whereas the award is measured at its fair value at the date of grant and is amortized ratably over the vesting period. We account for stock option and warrant grants issued and vesting to non-employees in accordance with ASC Topic 718 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 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.

We believe there have been no significant changes, during the year ended December 31, 2012, to the items disclosed as critical accounting policies and estimates in Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

Recent Accounting Pronouncements

There were recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA, and the Securities Exchange Commission (the "SEC"), such pronouncements are not believed by management to have a material impact on the Company's present or future financial statements.

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