Business context and reporting period
Reed’s, Inc. filed this Form 10-K for the fiscal year ended December 31, 2013, with 2012 as the comparable period. The company develops, manufactures and sells premium natural beverages—including Reed’s ginger brews, Virgil’s sodas and Culture Club Kombucha—as well as candies and ice creams. It sells primarily in U.S. natural-food and mainstream supermarkets through distributors and direct accounts. Kombucha, introduced in 2012, had grown to approximately 10% of net revenue.
Financial performance and liquidity
| Metric | 2013 | 2012 |
|---|---|---|
| Gross sales, before promotional allowances | $42.242 million | $32.946 million |
| Promotional and other allowances | $4.961 million | $2.939 million |
| Net sales | $37.281 million | $30.007 million |
| Cost of goods sold | $26.487 million | $20.863 million |
| Gross profit / margin | $10.794 million / 29% | $9.144 million / 30% |
| Operating income (loss) | $(0.869) million | $0.136 million |
| Net loss | $(1.520) million | $(0.524) million |
| Net loss per common share, basic and diluted | $(0.12) | $(0.05) |
| Cash from (used in) operating activities | $(1.193) million | $1.177 million |
Net sales rose 24%; gross sales rose 28%. Promotional allowances increased 69%, reflecting kombucha launch and broader promotional activity. Gross profit grew 18%, but margin fell one percentage point. Delivery and handling costs rose 51% to $3.977 million, and selling and marketing expense rose to $4.180 million. Management attributed operating losses to higher promotional spending and production costs not absorbed into finished goods.
Cash was $1.104 million at year-end, versus $1.163 million in 2012. Working capital declined to $1.347 million from $2.298 million; stockholders’ equity fell to $3.387 million from $4.098 million. Investing cash outflow was $0.602 million, mainly for plant improvements. Financing activities provided $1.736 million, including a $1.501 million net draw on the revolving credit line. Management reported modified EBITDA of $13,000 in 2013 versus $1.004 million in 2012; this is a company-defined non-GAAP measure.
At December 31, 2013, the balance sheet included a $4.524 million revolving-credit balance, a $0.647 million term loan, a $2.258 million net long-term financing obligation and $0.185 million in capital-lease obligations. The revolver’s stated rate was 7%; the term loan rate was 14.85%. The revolver matures November 8, 2014, and the term loan matures April 20, 2017.
Material changes and unusual items
- Branded-product sales increased approximately $6.260 million, or 25%; kombucha expansion was a significant contributor.
- Promotional allowances increased by $2.022 million. A one-time $412,000 loss on a private-label contract was recorded in the second quarter.
- Freight expense rose substantially, partly because more product for West Coast customers was made at the Pennsylvania co-packer and the company offered delivered terms to new customers. Added cold-storage needs also increased warehouse costs.
- Operating cash flow swung from positive $1.177 million to negative $1.193 million, while the revolver balance increased by approximately $1.501 million.
- The company was in default of two credit-agreement covenants at year-end: revolver availability was below $100,000 and 2013 capital spending exceeded the $500,000 limit. The lender waived the defaults on March 19, 2014.
- Series B preferred shares were converted into common shares during 2013; common shares outstanding increased to 12.923 million from 12.085 million at year-end 2012.
- After year-end, the former CFO and COO resigned. The company accelerated vesting of 37,500 options, expecting to record $151,000 of related expense in first-quarter 2014.
Outlook, risks and contingencies
Management said available working capital was sufficient to support existing operations for at least the next 12 months and identified positive operating cash flow as its primary capital source. It provided no quantified revenue, earnings or margin guidance. Management cautioned that failure to meet sales goals could require cost reductions or additional financing, which might not be available on acceptable terms.
Key risks include continued losses and cash consumption; reliance on the revolving credit facility and its 2014 maturity; promotional intensity and price pressure; higher freight and production costs; dependence on a single contract packer for a majority of beverage production; and concentration among customers and suppliers. Two customers represented approximately 32% and 10% of 2013 sales, and one vendor represented approximately 29% of purchases. The company also disclosed potential liability relating to certain 2005–2006 share issuances that may have been subject to rescission; it said the ultimate outcome could not be predicted. Distributor agreements may require termination fees if ended early or not renewed. Management reported no other material litigation and no recognized asset impairment in 2013.
The independent auditor issued an unqualified opinion on the financial statements. Management concluded disclosure controls and internal control over financial reporting were effective at year-end; the auditor did not attest to internal-control effectiveness.
Important facts for investors to verify
- Whether the company generated positive operating cash flow after 2013 and how it refinanced or repaid the revolving credit balance at maturity.
- Whether promotional spending and the one-time contract loss affected subsequent gross margins, and whether kombucha growth translated into profitable sales.
- Current borrowing-base availability, covenant compliance, lender waivers and any amendments to credit terms.
- Developments in customer, supplier and co-packer concentration, including continuity of production and delivery costs.
- Any resolution, claims or updated exposure concerning the legacy securities rescission matter.
- Actual dilution from options, warrants and preferred-stock conversions, and the costs associated with post-year-end executive departures.