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

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Form 10-Q for REEDS INC


14-Nov-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

The results for our third quarter of 2013 reflect continuing strong growth in sales volume among all of our products. Our gross sales (see below) increased by 33% in the 2013 third quarter, as compared to 2012, and 29% for the nine month period as compared to 2012. Our promotional spending outpaced the sales increases, as we have invested heavily in our Culture Club Kombucha rollout and added additional promotions on our Reed's and Virgil's branded product sales in 2013. We believe that our increased promotional spending is producing a good return on investment, in the form of increased market penetration and a higher floor of recurring business.

Since promotional and other allowances are handled as a direct reduction of sales, increasing the spending at a rate higher than sales growth has the effect of reducing our sales and gross margin percentage, as reflected in the nine month 2013 period as compared to 2012. Our direct cost of tangible goods sold, however, remained constant in those periods, as a percentage of gross sales, and improved by 2% to 56% in the third fiscal quarter, as compared to 2012, indicating higher margins based on sales prices.

We have placed a high focus on upgrading our Los Angeles plant equipment in 2013 and on increasing its capacity. Our plant production has increased by approximately 25% in 2013, and we anticipate further improvements in future quarters. As we increase production volume of our branded products in our Los Angeles plant, we will also reduce the cross-country freight that we are currently incurring to move products to west coast customers. As our sales base grows, our excess plant costs become a smaller portion of our overall cost of sales and we anticipate that this cost will reduce as plant production increases further.

We have gained a solid #2 position in sales of kombucha nationally. We believe that there is a strong opportunity to gain additional market share and expand this product line with both our existing and new customers. As we expand, we are improving our production techniques and we have plans for additional flavors and improved packaging in 2014.

While our promotional costs have increased at a rate that exceeds our sales growth, we have reached a breakeven net income in the 3rd quarter on $10 million in net revenues. Our plan is to continue to refine our promotional programs so that we can continue to experience high growth in sales while also increasing the margin contribution at the same pace as our sales increases.

Results of Operations



The following table sets forth key statistics for the three and nine months
ended September 30, 2013 and 2012, respectively.



                                       Three Months Ended              Nine Months Ended
                                         September 30,       Pct.        September 30,       Pct.
                                        2013        2012    Change     2013         2012    Change
Gross sales, net of discounts &
returns *                            11,501,000   8,628,000   33%   31,290,000   24,278,000   29%
Less: Promotional and other
allowances**                          1,425,000     740,000   93%    3,569,000    2,020,000   77%
Net sales                            10,076,000   7,888,000   28%   27,721,000   22,258,000   25%
Cost of tangible goods sold           6,399,000   4,975,000   29%   18,028,000   13,993,000   29%
As a percentage of:
Gross sales                                 56%         58%                58%          58%
Net sales                                   64%         63%                65%          63%
Cost of goods sold - idle capacity      501,000     456,000   10%    1,525,000    1,126,000   35%
As a percentage of net sales                 5%          6%                 6%           5%
Gross profit                          3,176,000   2,457,000   29%    8,168,000    7,139,000   14%
Gross profit margin as a
percentage of net sales                     32%         31%                29%          32%

* Gross sales is used internally by management as an indicator of and to monitor operating performance, including sales performance of particular products, salesperson performance, product growth or declines and overall Company performance. The use of gross sales allows evaluation of sales performance before the effect of any promotional items, which can mask certain performance issues. We therefore believe that the presentation of gross sales provides a useful measure of our operating performance. Gross sales is not a measure that is recognized under GAAP and should not be considered as an alternative to net sales, which is determined in accordance with GAAP, and should not be used alone as an indicator of operating performance in place of net sales. Additionally, gross sales may not be comparable to similarly titled measures used by other companies, as gross sales has been defined by our internal reporting practices. In addition, gross sales may not be realized in the form of cash receipts as promotional payments and allowances may be deducted from payments received from certain customers.

** Although the expenditures described in this line item are determined in accordance with GAAP and meet GAAP requirements, the disclosure thereof does not conform with GAAP presentation requirements. Additionally, our definition of promotional and other allowances may not be comparable to similar items presented by other companies. Promotional and other allowances primarily include consideration given to the Company's distributors or retail customers including, but not limited to the following: (i) reimbursements given to the Company's distributors for agreed portions of their promotional spend with retailers, including slotting, shelf space allowances and other fees for both new and existing products; (ii) the Company's agreed share of fees given to distributors and/or directly to retailers for in-store marketing and promotional activities;
(iii) the Company's agreed share of slotting, shelf space allowances and other fees given directly to retailers; (iv) incentives given to the Company's distributors and/or retailers for achieving or exceeding certain predetermined sales goals; and (v) discounted or free products. The presentation of promotional and other allowances facilitates an evaluation of their impact on the determination of net sales and the spending levels incurred or correlated with such sales. Promotional and other allowances constitute a material portion of our marketing activities. The Company's promotional allowance programs with its numerous distributors and/or retailers are executed through separate agreements in the ordinary course of business. These agreements generally provide for one or more of the arrangements described above and are of varying durations, ranging from one week to one year.

Three months ended September 30, 2013 Compared to Three months ended September 30, 2012

Sales

Sales of $10,076,000 for the three months ended September 30, 2013 represented an increase of 28% from $7,888,000 in the prior year same period. Sales growth was driven primarily by a 31% increase in sales of our branded products, including kombucha, as well as a 19% increase in private label product revenues. Kombucha sales began in the 2012 third quarter and have increased to become approximately 11% of our total net revenues.

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, inventory adjustments, as well as certain internal transfer costs. Our costs of tangible goods sold of $6,399,000 for the three months ended September 30, 2013 represents an increase of 29% from the same period in 2012. The increase is primarily due to the 28% increase in sales. Additionally, the costs to produce our 12-ounce branded natural sodas increased by approximately 5% in 2013 over the prior year period.

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 depreciation. 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 $501,000 in the three months ended September 30, 2013, from $456,000 in 2012. The 10% increase is primarily due to approximately two weeks of downtime during the 2013 quarter for repairs and upgrades. As a percentage of sales, the idle capacity costs decreased to 5% in the 2013 nine-month period, from 6% in 2012.

Gross Profit

Our gross profit of $3,176,000 in the three months ended September 30, 2013 represents an increase of $719,000, or 29% from 2012. As a percentage of sales, our gross profit increased to 32% in 2013 as compared to 31% in 2012. The increase is primarily due to a higher portion of our overall sales being branded products in 2013, as compared to private label sales, since our branded products have slightly higher margins on net 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 and handling costs increased by 36% to $1,040,000 in the three months ended September 30, 2013 compared to 2012. The $277,000 increase, or 36%, is primarily due to freight cost increases of $207,000 and warehouse cost increases of $70,000. The freight cost increases are 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. Also, we have offered delivered terms to several new significant customers. The warehouse cost increases are primarily due to increased volume and the addition of several new cold-storage facilities for our kombucha.

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 $1,159,000 in the three months ended September 30, 2013 from $818,000 in 2012. The $341,000 increase (42%) is primarily due to an increase in trade show and advertising costs of $179,000, increased compensation and travel costs of $78,000, increased stock option expense of $22,000, increased brokerage commissions of $29,000, and an increase in supplies and sample costs of $32,000. Our sales staff increased to 18 members at September 30, 2013, from 15 at September 30, 2012.

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 $763,000 during the three months ended September 30, 2013 from $693,000 in the same period of 2012, an increase of $70,000. Compensation costs increased by $36,000, stock option expense increased by $20,000, and professional, legal and consulting costs increased by $16,000.

Income/Loss from Operations

Our income from operations was $214,000 in the three months ended September 30, 2013, as compared to $183,000 in the same period of 2012. The increase is primarily due to the increase in gross profit contribution of $719,000, or 29%, in the 2013 third quarter as compared to 2012.

Interest Expense

Interest expense increased to $180,000 in the three months ended September 30, 2013, compared to interest expense of $161,000 in the same period of 2012. The increase is primarily due to increased borrowing on our revolving line of credit.

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 September 30,
                                               2013                   2012
Net income (loss)                        $         34,000       $         22,000

Modified EBITDA adjustments:
Depreciation and amortization                      89,000                184,000
Interest expense                                  180,000                161,000
Stock option compensation                          69,000                 26,000
Other stock compensation for services                   -                  2,000
Total EBITDA adjustments                          338,000                373,000

Modified EBITDA income from operations   $        372,000       $        395,000

Nine months ended September 30, 2013 Compared to Nine months ended September 30, 2012

Sales

Sales of $27,721,000 for the nine months ended September 30, 2013 represented an increase of 25% from $22,258,000 in the prior year same period. Sales growth was driven primarily by increased sales of our branded products of $5,001,000, or 26%. Kombucha sales began in the 2012 third quarter and have increased to become approximately 9% of our total net revenues.

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, inventory adjustments, as well as certain internal transfer costs. Our costs of tangible goods sold of $18,028,000 for the nine months ended September 30, 2013 represents an increase of 29% from the same period in 2012. The increase was primarily due to net revenue increases of 25%. Additionally, a one-time loss on a private label contract in the amount of $412,000 was recorded during the second fiscal quarter. Generally, our per-unit costs have not increased materially in 2013 as compared to 2012.

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, and repairs and maintenance. 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 $1,525,000 in the nine months ended September 30, 2013, from $1,126,000 in 2012. The 35% increase was primarily due to inefficiencies in producing our kombucha during the first and second fiscal quarters. Our kombucha production runs have become much more efficient during our third fiscal quarter and we anticipate reductions in our cost of goods sold
- idle capacity in the future.

Gross Profit

Our gross profit of $8,168,000 in the nine months ended September 30, 2013 represents an increase of $1,029,000, or 14% from 2012. As a percentage of sales, our gross profit decreased to 29% in 2013 as compared to 32% in 2012. As discussed above, our gross profit was negatively impacted by a loss of $412,000 on a private label contract. The gross profit percentage decrease is also impacted by an increase in promotional discount costs. Since such costs are a deduction from sales, the gross margin percentage is negatively impacted by increased promotional costs. We have been granting substantial discounts on our kombucha, as we expand this product line into new distribution channels and customers, and we have also increased our promotional programs for other branded products. We believe that our promotional investments are effective and are accelerating sales growth.

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 and handling costs increased by 59% to $2,900,000 in the nine months ended September 30, 2013 compared to 2012. The $1,073,000 increase is primarily due to freight cost increases of $929,000 and warehouse cost increases of $144,000. The freight cost increases are 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. Also, we have offered delivered terms to several new significant customers. The Warehouse cost increases are primarily due to increased volume and the addition of several new cold-storage facilities for our kombucha.

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 $2,999,000 in the nine months ended September 30, 2013 from $2,239,000 in 2012. The $760,000 increase is primarily due to increased compensation and travel costs of $268,000, increased advertising costs of $267,000, increased brokerage commissions of $122,000, and increased stock option expense of $86,000. Our sales staff increased to 18 members at September 30, 2013, from 15 at September 30, 2012.

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 $2,663,000 during the nine months ended September 30, 2013 from $2,238,000 in the same period of 2012, in increase of $425,000. Compensation costs increased by $135,000, professional, legal and consulting costs increased by $112,000, stock option expense increased by $90,000, and accounts receivable reserve allowance increased by $88,000.

Income/Loss from Operations

Our loss from operations was $394,000 in the nine months ended September 30, 2013, as compared to income of $835,000 in the same period of 2012. The loss is primarily a result of the one-time loss on a private label contract in the amount of $412,000, as well as losses from other operations during the first two fiscal quarters of 2013.

Interest Expense

Interest expense decreased to $469,000 in the nine months ended September 30, 2013, compared to interest expense of $493,000 in the same period of 2012. The decrease is primarily due to a reversal of over-accrued interest on a long-term liability, as determined when the liability was paid in full.

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



                                             Nine Months Ended September 30,
                                               2013                   2012
Net (loss) income                        $       (863,000 )     $        342,000

Modified EBITDA adjustments:
Depreciation and amortization                     387,000                556,000
Interest expense                                  469,000                493,000
Stock option compensation                         257,000                 81,000
Other stock compensation for services               5,000                 23,000
Total EBITDA adjustments                        1,118,000              1,153,000

Modified EBITDA income from operations   $        255,000       $      1,495,000

Liquidity and Capital Resources

As of September 30, 2013, we had stockholders equity of $3,676,000 and we had working capital of $1,782,000, 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 $516,000 was primarily a result of net losses and pay downs on our long-term debt.

Our decrease in cash and cash equivalents to $1,046,000 at September 30, 2013 compared to $1,163,000 at December 31, 2012, a decrease of $117,000, was primarily a result of cash used by operating activities of $1,035,000, costs of plant improvements of $447,000, and principal payments on debt of $247,000; which was offset primarily by net drawdown on our revolving line of credit of $1,290,000, an increased advance on our term loan of $217,000, and proceeds from the exercise of stock options and warrants of $105,000. In addition to our cash position on September 30, 2013, we had availability under our line of credit of approximately $365,000.

Our Loan and Security Agreement with PMC Financial Services Group, LLC provides a $4.5 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 September 30, 2013). 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. On May 1, 2013 the term loan was increased back to the original balance of $750,000 under the same terms as the existing term loan. The Company was granted an over advance on its revolving line of credit of $500,000 and a temporary increase in the line amount to $4,800,000, both for a six month period ending February 28, 2014. At September 30, 2013, our term loan balance was $684,000.

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.

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. Raw materials account for the largest portion of the cost of sales. Raw materials include cans, bottles, other containers, ingredients and packaging materials.

Cost of goods sold - Idle Capacity - Cost of goods sold - idle capacity consists of direct production costs in excess of charges allocated to finished goods. Our charges for labor and overhead allocated to our finished goods are determined on a cost basis. Plant costs include labor costs, production supplies, and repairs and maintenance. Plant costs in excess of production allocations are expensed in the period incurred.

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 . . .

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