Reed’s, Inc. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017; filed August 14, 2017. Financial statements are unaudited. Reed’s sells beverages and other products, including Reed’s and Virgil’s brands.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $8.864 million | $10.992 million | $17.159 million | $20.996 million |
| Gross profit | $1.683 million | $2.602 million | $2.768 million | $4.495 million |
| Gross margin | 19.0% | 23.7% | 16.1% | 21.4% |
| Operating loss | $(1.173) million | $(0.347) million | $(2.657) million | $(1.549) million |
| Net income (loss) | $0.153 million | $(0.763) million | $(1.840) million | $(2.343) million |
| Cash used in operations | Not separately provided for quarter | $(3.170) million | $(4.104) million |
Q2 net income attributable to common stockholders was $148,000 after preferred dividends. The quarter’s reported net income was not representative of operating performance: a $3.299 million noncash gain from revaluing warrant liabilities offset financing and interest costs. For the six months, the company reported modified EBITDA of $(1.526) million, versus $(0.770) million a year earlier; this is a non-GAAP measure.
Liquidity, debt and capital
- At June 30, cash was $251,000, working capital deficit was $2.041 million, and stockholders’ deficit was $3.179 million. Current liabilities were $13.222 million against current assets of $11.181 million.
- Six-month operating cash outflow was $3.170 million; investing cash outflow was $60,000. Financing activities provided $3.030 million, including $3.083 million net proceeds from the April convertible-note financing. Cash declined $200,000 from year-end.
- Debt and financing obligations included $4.589 million drawn on the revolving credit line, $7.318 million in bank notes, a $3.4 million convertible note principal, $1.514 million net long-term financing obligation and $531,000 in capital lease obligations. The line had only $250,000 of stated borrowing availability. PMC loans are secured by substantially all company assets and were amended to mature in October 2018.
- The April 21 convertible note bears 12% interest, compounds monthly, is secured behind PMC, matures in two years and cannot be prepaid. Conversion and warrant exercise rights begin after 180 days; the financing also included warrants with potential dilution.
Changes, outlook and risks
- Q2 net sales fell 19% year over year and six-month sales fell 18%. Management attributed much of the decline to reduced or discontinued non-core products; core-product gross revenue also declined. Q2 volume was down 16.3%, with Reed’s beverages down 7.5% and Virgil’s down 13.7%.
- Gross margin weakened as promotional allowances rose and plant utilization remained low. Q2 idle-capacity charges were $588,000; six-month charges were $1.376 million, up 44% from the prior-year period. Management also cited adverse product mix and higher per-unit production costs.
- Operating expenses fell 3% in Q2 and 10% for the six months, but general and administrative costs rose, including costs associated with management transition, directors and legal work. Interest expense rose substantially, in part from the convertible note and its debt-discount amortization.
- Management described a turnaround begun during Q2: concentrate on Reed’s and Virgil’s, discontinue non-core SKUs, improve plant utilization, strengthen sales and marketing, and evaluate an asset-light model. Further Los Angeles plant capital spending was on hold pending review. Management said results did not yet reflect expected improvements and gave no quantified financial guidance.
- Management believed liquidity was sufficient for at least the next 12 months, relying on sales goals, cost reductions, operating cash flow and refinancing or renegotiation of PMC debt. The filing cautions that refinancing is not assured and additional financing may not be available on acceptable terms. The company reported a going-concern basis, operating losses, cash burn and working-capital deficit.
- One customer represented 22% of six-month sales; one vendor represented 18% of purchases and 20% of accounts payable at June 30. These concentrations create customer and supplier exposure.
- After quarter-end, warrant agreements were repriced and certain exercise restrictions waived; the company reported $1.6 million gross proceeds from exercise of 1,093,750 warrant shares. Additional tranche warrants were issued or authorized. The company also agreed to seek stockholder approval for up to five million additional authorized common shares and certain future offerings. CEO Valentin Stalowir was appointed effective June 28; the company disclosed a potential 4% fully diluted equity stake in his compensation arrangements.
Important facts for investors to verify
- Whether the turnaround improves core-brand sales, gross margins and plant utilization, and reduces idle-plant costs.
- Actual cash burn, borrowing availability and the company’s ability to refinance PMC obligations before their amended maturities.
- The economic and dilution effects of the convertible note, repriced warrants, additional warrants and proposed share authorization.
- The size and timing of any future warrant-liability accounting effects; the Q2 earnings gain was noncash and management expected the liability treatment to change in Q3.
- Several six-month product-level figures in the MD&A tables appear internally inconsistent with the financial statements, including net-sales and cost-of-goods-sold entries. Use the financial statements’ reported six-month net sales of $17.159 million and cost of goods sold of $14.391 million, and verify detailed product data against the original filing.