REED

REED's, INC. - 10-Q Summary (Period Ended September 30, 2010)

Business Context and Reporting Period

This is a Quarterly Report (Form 10-Q) for REED's, INC., a smaller reporting company incorporated in Delaware. The report covers the three and nine-month periods ended September 30, 2010. The company manufactures and sells branded and private label beverages, including Reed's and Virgil's brands. As of November 5, 2010, there were 10,400,247 shares of Common Stock outstanding.

Key Financial Metrics

Note: Total Debt includes Line of Credit ($1,518,000), Long-term financing obligation ($2,322,000), Capital leases ($195,000), and Notes payable ($97,000).

Material Changes vs. Prior Period

• Revenue Growth: Sales increased 23% year-over-year for the nine-month period, driven by a 16% increase in branded product sales and the introduction of private label sales ($848,000), which were non-existent in the prior year.
• Margin Compression: Gross margin decreased from 25% to 23%. Management attributes this to lower-margin initial private label contracts, higher ingredient costs, and increased freight delivery costs (up 40% year-over-year).
• Operating Loss Reduction: Operating loss improved significantly to $(400,000) from $(1,454,000) in the prior year. This improvement is largely due to increased sales and the absence of a $641,000 asset impairment charge recorded in 2009.
• Expense Trends: Selling and marketing expenses decreased 12% due to reduced advertising and stock option expenses. General and administrative expenses increased 9% due to higher compensation and amortization costs.
• Interest Expense: Interest expense increased 32% to $421,000 due to higher long-term debt balances and increased utilization of the line of credit.

Guidance, Outlook, and Risks

• Outlook: Management anticipates continued sales increases for the remainder of 2010. The fourth quarter is expected to reflect further growth in private label sales and the contribution of a new diet line to the Virgil's brand. Management expects significant margin improvements in 2011 as contract terms for private label sales improve.
• Liquidity: The company believes it has sufficient working capital to support operations through September 2011. Primary capital sources are cash flow from operations and a $3,000,000 line of credit (with $187,000 availability as of Sep 30, 2010).
• Risks: The company faces risks related to achieving profitability. If sales goals are not met, the company may need to reduce operations, infrastructure, and personnel. Continued operating losses could adversely affect working capital and stock value. The line of credit bears a high interest rate of 18% per annum.
• Unusual Items: No asset impairments were recorded in the current period, unlike the $641,000 charge in 2009. The company issued stock for services and bonuses totaling $261,000 in value during the nine-month period.

Investor Verification Checklist

• Private Label Margins: Verify the timeline and magnitude of margin improvement on private label contracts as projected for 2011.
• Debt Service: Review the terms of the $3,000,000 line of credit (18% interest) and the long-term financing obligation (9.9% implicit rate) to assess cash flow impact.
• Customer Concentration: Note that two customers accounted for approximately 44% of sales in the nine-month period (12% and 32% respectively).
• Inventory Levels: Inventory increased by $1,073,000 during the period; verify that this buildup aligns with sales forecasts to avoid obsolescence risks.
• Equity Dilution: Monitor the conversion of Series B Preferred Stock and the exercise of warrants, which could dilute common shareholders.