REED's, INC. annual report, FY2016

REED’S, INC. — 2016 Form 10-K Summary

Reporting period: Fiscal year ended December 31, 2016; comparison with fiscal 2015. Reed’s develops, manufactures and sells premium natural beverages, including Reed’s ginger brews, Virgil’s sodas and Culture Club Kombucha, as well as private-label products and ginger candy. Products are sold primarily in the United States through distributors and directly to retailers.

Financial performance and liquidity

Metric	2016	2015
Net sales	$42.472 million	$45.948 million
Gross profit / gross margin	$8.982 million / 21.1%	$11.605 million / 25.3%
Operating loss	$3.053 million	$2.730 million
Net loss	$5.009 million	$3.961 million
Loss per share, basic and diluted	$0.37	$0.30
Cash used in operating activities	$2.533 million	$1.348 million
Cash and cash equivalents at year-end	$451,000	$1.816 million

Net sales fell approximately 8%; gross profit declined 23%. The gross margin contracted 4.2 percentage points.
Modified EBITDA, a company-defined non-GAAP measure, was a loss of $1.254 million, versus a loss of $2.150 million in 2015.
Year-end working capital was negative $1.563 million, compared with positive working capital of $730,000 a year earlier. Stockholders’ equity moved from positive $785,000 to a deficit of $1.657 million.
Year-end current liabilities were $11.884 million against current assets of $10.321 million. The company reported no availability under its $6 million revolving credit line at December 31, 2016.
Debt-related balances included $4.384 million drawn on the line of credit, $6.872 million in net bank notes, $1.553 million in net long-term financing obligations and $621,000 in capital leases. Borrowing costs were high; the company reported an effective year-end revolving-line rate of 9.5% and a 14.85% current rate on Term Loan B in its discussion.

Material changes versus 2015

Overall beverage volume declined 5%. Reed’s ginger-based beverage volume increased 0.5%, while Virgil’s fell 10.4% and Kombucha fell 54.3%. Private-label beverage volume increased 0.5%.
Management attributed broad channel weakness to consumer preferences moving away from sugar-sweetened sodas, including beverages using natural sugars. Candy and other non-beverage gross sales declined 31%, with candy affected by a California lawsuit that required the company to find alternative suppliers.
Cost of goods sold fell only 2.5%, less than the sales decline. Management cited $2.376 million of additional production-cost pressure relative to a volume-based reduction, including inventory write-offs, packaging and ingredient cost increases.
Delivery and handling expense fell 23%, selling and marketing expense fell 24%, and general and administrative expense fell 4%, partially offsetting reduced gross profit.
Interest expense rose to $1.724 million from $1.231 million, reflecting additional borrowing and amended loan terms. A $224,000 China Cola brand impairment and a $232,000 loss from the change in warrant-liability fair value also affected 2016 results.

Outlook, management commentary and risks

Management said ingredient-use and packaging-price initiatives were on track to improve full-year margins by more than 200 basis points, and expected the Los Angeles plant upgrade to provide an additional 350 basis points of annualized savings. These are management expectations, not formal earnings guidance.
The Los Angeles facility upgrade was expected to enter production in May 2017. Management also expected to complete market testing of a reduced-calorie beverage offering and begin distribution of an all-natural fountain product later in 2017. A Kombucha relaunch was planned, with management seeking to regain lost shelf space.
The company reported a $197,000 cash balance and $191,000 of available line borrowing as of March 31, 2017. A subsequent April 2017 financing provided approximately $3.240 million in net proceeds through a $3.4 million, 12% convertible subordinated note due in two years, with warrants and potential dilution. Management stated it expected liquidity to support operations for at least 12 months, while also disclosing ongoing losses and uncertainty about future financing and profitability.
In April 2017, founder Christopher Reed resigned as CEO and became Chief Innovation Officer; director Stefan Freeman was appointed interim CEO.
Key risks include continued cash burn, restricted borrowing availability, high-cost secured debt, dependence on successful cost savings and sales recovery, changing consumer preferences, competition and pricing pressure, customer and supplier concentration, and reliance on co-packers. Two customers represented approximately 22% and 12% of 2016 sales; one vendor represented about 26% of purchases.
The filing describes ordinary-course legal claims and a California lawsuit affecting candy supply; management said there were no material litigation matters at the filing date. The independent auditor gave an unqualified opinion on the financial statements. Management reported effective disclosure controls and internal control over financial reporting; the auditor did not provide an internal-control attestation.

Most important facts for investors to verify

Whether the April 2017 note proceeds, subsequent cash balances and borrowing availability are sufficient to fund operations, and the impact of the note’s interest, security and conversion terms.
Whether sales stabilize—especially Virgil’s and Kombucha—and whether the planned product launches and shelf-space recovery deliver measurable growth.
Whether the promised plant and cost-reduction savings are realized, and whether gross margin improves from 21.1%.
Debt maturities, interest-rate terms, covenant or borrowing-base conditions, and the company’s ability to generate positive operating cash flow.
Potential dilution from outstanding options and warrants, the 2016 financing warrants and the 2017 convertible note and warrants.
Customer, supplier and co-packer concentration, as well as the financial and operational effects of the candy supply disruption.