REED’S, INC. — Q3 2014 Form 10-Q
Business context and period: Beverage maker Reed’s reported unaudited results for the three and nine months ended September 30, 2014, compared with the same 2013 periods. Management cited growth in Reed’s and Virgil’s branded products and Culture Club Kombucha. The filing was signed November 13, 2014.
Financial results
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $12.319 million | $10.076 million | $32.456 million | $27.721 million |
| Gross profit | $3.885 million | $3.176 million | $10.494 million | $8.168 million |
| Gross margin | 32% | 32% | 32% | 29% |
| Operating income (loss) | $246,000 | $214,000 | $1.029 million | $(394,000) |
| Interest expense | $195,000 | $180,000 | $560,000 | $469,000 |
| Net income (loss) | $48,000 | $34,000 | $466,000 | $(863,000) |
| Modified EBITDA, non-GAAP | $477,000 | $372,000 | $1.880 million | $255,000 |
- Q3 net sales rose 22%; nine-month sales rose 17%. Management reported gross sales growth of 18% and 15%, respectively, before promotional and other allowances.
- For the nine months, operating results improved from a loss to income; management attributed much of the year-over-year gross-profit comparison to a $412,000 private-label contract loss in 2013. Kombucha sales rose 51% year over year for the nine-month period and represented about 13% of net revenue.
- Nine-month operating cash flow was $1.557 million, versus cash used of $1.035 million in 2013. Investing cash use was $355,000; financing cash use was $601,000. Cash increased $601,000 to $1.705 million.
- At September 30, 2014, working capital was $1.999 million, stockholders’ equity $4.197 million, and total liabilities $13.442 million. Current assets were $12.524 million against current liabilities of $10.525 million.
- Debt and financing balances included a $4.159 million revolving line, a $525,000 term loan, a $2.215 million net long-term financing obligation, and $608,000 of capital lease obligations. The revolver carried a 7% rate and had approximately $236,000 of availability, per management.
Changes, outlook, and risks
- Management said production at the Los Angeles plant increased about 25% in 2014, with improved production efficiency and lower idle-capacity costs. It planned additional equipment purchases in Q4 2014 and the first half of 2015, expecting higher line speed, lower labor and freight costs, and reduced idle capacity. A new Kombucha coffee flavor was planned for Q4 2014.
- The company shifted some promotional spending toward national advertising, including its first national cable commercials; Q3 advertising expense included $407,000 for those commercials. Management said it expected to reduce total borrowing costs by more than 50% in 2015, but provided no formal earnings or revenue guidance.
- Management believed working capital was sufficient for at least the next 12 months, primarily relying on positive operating cash flow. It also warned that weaker-than-planned sales, future losses, or unavailable financing on acceptable terms could constrain operations and expansion.
- The $4.8 million revolving facility, including a $500,000 over-advance, was extended to December 31, 2014. Its borrowing base depends on eligible receivables and inventory; it is secured by substantially all company assets. A separate term loan carries a minimum 14.85% interest rate.
- Customer and supplier concentration is notable: two customers accounted for 44% of Q3 sales and 47% of nine-month sales; one vendor represented 26% of purchases for both periods. Two customers made up 41% of receivables at quarter-end, and one vendor accounted for 30% of payables.
- In October 2014, the company issued 200,000 five-year warrants at $5.60 per share, valued at $584,000, in connection with releasing brewery equipment from lease collateral and obtaining release of the CEO’s $150,000 personal guarantee. In November, it financed $493,506 of brewery equipment under a 60-month lease.
Important facts for investors to verify
- Confirm the December 31, 2014 revolver maturity extension and available borrowing capacity, given the limited reported availability and working-capital dependence on the borrowing base.
- Assess whether planned plant upgrades deliver the anticipated capacity, labor, freight, and idle-capacity savings, and whether they require additional financing.
- Review customer and vendor concentration, receivable collection, inventory quality, and the increase in accounts payable to $5.788 million from $3.612 million at year-end.
- Reconcile the filing’s tax disclosures: the statements show $3,000 of income tax expense for 2014, while the income-tax note says no provision was recorded because of net operating loss carryforwards.
- Check the nine-month interest discussion: the MD&A calls the change a “decrease,” although reported interest expense increased to $560,000 from $469,000.
- Consider dilution from employee options and warrants, as well as the 200,000 warrants issued after quarter-end. The filing also contains inconsistent effective-date references for the lease amendment; the notes and subsequent-events discussion identify October 1, 2014.