REED’S, INC. — Q2 2016 Form 10-Q
Business context and reporting period. Reed’s, Inc. sells craft beverages and related products, including Reed’s Ginger Brew, Virgil’s, kombucha, private-label products and candy. This unaudited report covers the three and six months ended June 30, 2016; comparisons are with the corresponding 2015 periods.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $10.992 million | $12.178 million | $20.996 million | $22.850 million |
| Gross profit / margin | $2.602 million / 23.7% | $3.640 million / 29.9% | $4.495 million / 21.4% | $6.900 million / 30.2% |
| Operating loss | $347,000 | $493,000 | $1.549 million | $563,000 |
| Net loss | $763,000 | $686,000 | $2.343 million | $957,000 |
| Modified EBITDA, non-GAAP | $5,000 | $94,000 | ($770,000) | $450,000 |
- Q2 net sales fell 9.7% year over year; reported gross margin declined 6.2 percentage points. Management attributed margin pressure to product mix and discounting, higher production costs, and lower margins on discontinued private-label items.
- For the first half, net sales declined 8.1%, while cost of goods sold rose 6.4%. Management cited $743,000 of costs unallocated to specific SKUs, primarily inventory adjustments, as a significant contributor to margin deterioration.
- Operating expenses fell 28.6% in Q2 and 19.0% in the first half. Q2 operating loss improved, but higher interest expense drove net loss above the prior-year quarter. First-half operating and net losses widened substantially.
- First-half operating cash flow was negative $4.104 million, versus negative $1.844 million in 2015. Investing cash flow was negative $78,000; financing cash flow provided $3.335 million. Cash fell from $1.816 million at year-end to $969,000.
Financial position, debt and liquidity
- At June 30, 2016, total assets were $20.893 million, total liabilities $19.811 million, stockholders’ equity $1.082 million and working capital $1.216 million. Cash was $969,000; inventory was $7.723 million.
- Debt and financing obligations included a $5.657 million revolving line, $3.000 million of term loans, a $3.190 million capital-expansion loan, a $1.583 million net long-term financing obligation and $641,000 of capital lease obligations. The revolver had only $250,000 of maximum borrowing availability reported at quarter-end.
- PMC extended the maturity of its loans, including the line of credit, to October 1, 2017. The revolving line was $6 million, secured by substantially all company assets; its reported rate was 9% at quarter-end. Management said rates can increase based on trailing EBITDA, and the second term loan carried a stated 14.85% rate.
- The company raised $2.122 million net in a June private offering of common stock and warrants and received $117,000 from share sales to officers. The financing helped fund vendor payments and increased equity; the offering also resulted in dilution.
Changes, outlook and risks
- Management reported sequential growth in Q2 gross sales for Reed’s Ginger Brew (3.6%), Virgil’s (17.1%) and other Reed’s brands (61.3%). Private-label volume increased, partly due to liquidation of discontinued SKUs, which management said reduced Q2 gross margin by 1.9 percentage points. These sequential trends did not prevent year-over-year sales declines.
- The Los Angeles plant upgrade continued, with $1.444 million of capital equipment outlay in Q2 and $3.074 million of construction in progress at June 30. Management expects added capacity to reduce transportation costs and improve delivery, but gave no quantified guidance.
- A $261,000 impairment was recognized for equipment expected to be retired before the plant upgrade is complete. Candy sales were affected by a California lawsuit concerning sourcing locations; the company said all candy SKUs began shipping again during Q2. The filing reports no legal proceedings requiring disclosure in the legal-proceedings item.
- Management said current working capital should support operations through year-end and elsewhere expressed confidence it could support existing operations until loan maturities; it expects to renew the line of credit but cautioned there is no assurance. Profitability, operating cash generation and acceptable additional financing remain uncertain. The filing warns that failure to achieve sales and profitability goals could require operating-cost cuts or constrain growth plans.
- Revenue and receivables were concentrated: one customer represented 26% of first-half sales and 23% of receivables at June 30. One vendor represented 27% of first-half purchases and 20% of accounts payable. The company also disclosed cash deposits above the $250,000 FDIC insurance limit.
- Management concluded disclosure controls were effective at June 30, 2016 and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Reconcile the six-month loss per share: the financial statements report $(0.18), while the MD&A comparison table reports $(0.17).
- Track gross-margin recovery and the nature and recurrence of the $743,000 first-half unallocated production costs and inventory adjustments.
- Assess cash burn, borrowing availability, covenant or rate conditions, and the company’s ability to refinance or repay obligations due October 1, 2017.
- Monitor plant-upgrade spending, commissioning, capacity utilization and whether expected cost and delivery benefits materialize.
- Evaluate customer and supplier concentration, candy-related legal exposure, and the potential dilution from issued and outstanding warrants and other securities.