REED'S, INC. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and the related notes appearing elsewhere in this report. This discussion and analysis may contain forward-looking statements based on assumptions about our future business. Overview During the third quarter of 2020, the Company fully utilized their expanded network of co-packers and implemented an upgraded set of quality protocols. In addition to our traditional sales channels, the Company is utilizing their ecommerce platform that includes their branded web sites and Amazon to offer its line of shots, ginger candy and drinks packaged in cans. A public equity offering, which closed on April 20, 2020, provided the Company with funds for working capital and general corporate purposes. These funds enabled us to initiate the implementation of our 2020 strategy that included driving growth while strategically reducing operating costs. The Company remains focused on driving sales growth and improving margin. The sales growth focus is on channel expansion, new product introduction and improved sales execution. The margin enhancement initiative is driven by co-packer upgrades, better leveraged purchasing and improved efficiency. Underpinning these initiatives is a focus on strategically reducing operating costs. COVID-19 Considerations In the quarter ended September 30, 2020, the COVID-19 pandemic did not have a material net impact on our operating results. In the future, the pandemic may cause reduced demand for our products if, for example, the pandemic results in a recessionary economic environment which negatively effects the consumers who purchase our products. Based on the recent increase in demand for our products, we believe that over the long term, there will continue to be strong demand for our products. Our ability to operate without significant negative operational impact from the COVID-19 pandemic will in part depend on our ability to protect our employees and our supply chain. The Company has endeavored to comply with the recommended actions of government and health authorities to protect our employees. For the six months ended September 30, 2020, we maintained the consistency of our operations during the onset of the COVID-19 pandemic. We will continue to innovate in managing our business, coordinating with our employees and suppliers to do our part in the infection prevention and remain flexible in responding to our customers and suppliers. However, the uncertainty resulting from the pandemic could result in an unforeseen disruption to our workforce and supply chain (for example an inability of a key supplier or transportation supplier to source and transport materials) that could negatively impact our operations. Through September 30, 2020, in part due to our innovative response to the COVID-19 pandemic, the COVID-19 pandemic has not negatively impacted the Company’s liquidity position as of such date. Shipments to customers in the third quarter were up 14% from the first quarter of the year and down slightly (2%) from the Second quarter of 2020, with fluctuations consistent with historical seasonal patterns. Through September 30, 2020, we continue to generate cash flows to meet our short-term liquidity needs, and we expect to maintain access to the capital markets. We have also not observed any material impairments of our assets or a significant change in the fair value of our assets due to the COVID-19 pandemic. For additional information on risk factors related to the pandemic or other risks that could impact our results, please refer to “Risk Factors” in Part II, Item 1A of this Form 10-Q. 1 Results of Operations – Three months ended September 30, 2020 The following table sets forth key statistics for the three months ended September 30, 2020 and 2019, respectively, in thousands. Three Months Ended September 30, Pct. 2020 2019 Change Gross sales (A) $ 11,897 $ 10,112 18 % Less: Promotional and other allowances (B) 1,335 1,372 -3 % Net sales $ 10,562 $ 8,740 21 % Cost of goods produced (C) 7,176 6,238 15 % % of Gross sales 60 % 62 % % of Net sales 68 % 71 % Gross profit $ 3,386 $ 2,502 35 % % of Net sales 32 % 29 % Expenses Delivery and handling $ 2,207 $ 1,902 16 % % of Net sales 21 % 22 % Dollar per case ($) 3.5 3.5 Selling and marketing 1,872 2,508 -25 % % of Net sales 18 % 29 % General and administrative 1,583 2,470 -36 % % of Net sales 15 % 28 % Total Operating expenses 5,662 6,880 -18 % Loss from operations $ (2,276 ) $ (4,378 ) -45 % Interest expense and other expense (314 ) (187 ) 68 % Net loss $ (2,590 ) $ (4,565 ) -43 % Loss per share – basic and diluted $ (0.04 ) $ (0.14 ) -70 % Weighted average shares outstanding - basic & diluted 62,940,091 33,716,359 87 % (A) Gross sales are used internally by management as an indicator of and to monitor operating performance, including sales performance of particular products, salesperson performance, product growth or declines and overall Company performance. The use of gross sales allows evaluation of sales performance before the effect of any promotional items, which can mask certain performance issues. We therefore believe that the presentation of gross sales provides a useful measure of our operating performance. Gross sales are not a measure that is recognized under GAAP and should not be considered as an alternative to net sales, which is determined in accordance with GAAP, and should not be used alone as an indicator of operating performance in place of net sales. Additionally, gross sales may not be comparable to similarly titled measures used by other companies, as gross sales have been defined by our internal reporting practices. In addition, gross sales may not be realized in the form of cash receipts as promotional payments and allowances may be deducted from payments received from certain customers. (B) Although the expenditures described in this line item are determined in accordance with GAAP and meet GAAP requirements, the disclosure thereof does not conform to GAAP presentation requirements. Additionally, our definition of promotional and other allowances may not be comparable to similar items presented by other companies. Promotional and other allowances primarily include consideration given to the Company’s distributors or retail customers including, but not limited to the following: (i) reimbursements given to the Company’s distributors for agreed portions of their promotional spend with retailers, including slotting, shelf space allowances and other fees for both new and existing products; (ii) the Company’s agreed share of fees given to distributors and/or directly to retailers for in-store marketing and promotional activities; (iii) the Company’s agreed share of slotting, shelf space allowances and other fees given directly to retailers; (iv) incentives given to the Company’s distributors and/or retailers for achieving or exceeding certain predetermined sales goals; and (v) discounted or free products. The presentation of promotional and other allowances facilitates an evaluation of their impact on the determination of net sales and the spending levels incurred or correlated with such sales. Promotional and other allowances constitute a material portion of our marketing activities. The Company’s promotional allowance programs with its numerous distributors and/or retailers are executed through separate agreements in the ordinary course of business. These agreements generally provide for one or more of the arrangements described above and are of varying durations, ranging from one week to one year. 2 (C) Cost of goods produced: Cost of goods produced consists of the costs of raw materials and packaging utilized in the manufacture of products, co-packing fees, repacking fees, in-bound freight charges, inventory adjustments, as well as certain internal transfer costs. Cost of goods produced is used internally by management to measure the direct costs of goods sold, aside from unallocated plant costs. Cost of goods produced is not a measure that is recognized under GAAP and should not be considered as an alternative to cost of goods sold, which is determined in accordance with GAAP, and should not be used alone as an indicator of operating performance in place of cost of goods sold. Sales, Cost of Sales, and Gross Margins The following chart sets forth key statistics for the transition of the Company’s top line activity through the third quarter of 2020 and 2019. 2020 2019 Q3 Per Case Sept YTD Per Case Q1 Q2 Q3 YTD Q3 vs PY YTD vs PY Q1 Q2 Q3 YTD 2020 2019 vs PY 2020 2019 vs PY Cases: Reed’s 288 335 314 937 32 % 24 % 238 281 238 757 Virgil’s 262 308 319 889 6 % 4 % 257 296 302 855 Total Core 550 643 633 1,826 17 % 13 % 495 577 540 1,612 Non Core 2 - - 2 -95 % -92 % 20 2 4 26 Candy 8 8 5 21 -10 % -11 % 9 9 6 24 Total 560 651 639 1,850 16 % 11 % 524 588 550 1,662 Gross Sales: Core $ 10,175 $ 11,940 $ 11,622 $ 33,737 18 % 15 % $ 9,098 $ 10,455 $ 9,809 $ 29,362 $ 18.4 $ 18.2 1 % $ 18.5 $ 18.2 1 % Non Core 102 33 74 209 -44 % -39 % 181 29 131 341 $ 350.1 $ 32.8 969 % 94.4 13.1 619 % Candy 274 256 201 731 17 % 6 % 241 274 172 687 $ 37.3 $ 28.7 30 % 34.2 28.6 19 % Total $ 10,551 $ 12,229 $ 11,897 $ 34,677 18 % 14 % $ 9,520 $ 10,758 $ 10,112 $ 30,390 $ 18.6 $ 18.4 1 % 18.7 18.3 3 % Discounts: Total $ (1,028 ) $ (1,376 ) $ (1,335 ) $ (3,739 ) -3 % 0 % $ (1,071 ) $ (1,278 ) $ (1,372 ) $ (3,721 ) $ (2.1 ) $ (2.5 ) -16 % $ (2.0 ) $ (2.2 ) -10 % COGS: Core $ (6,414 ) $ (7,674 ) $ (7,031 ) $ (21,119 ) 15 % 15 % $ (5,469 ) $ (6,843 ) $ (6,094 ) $ (18,406 ) $ (11.1 ) $ (11.3 ) -2 % $ (11.6 ) $ (11.1 ) 4 % Non Core (59 ) (15 ) (15 ) (89 ) -59 % -62 % (167 ) (28 ) (38 ) (233 ) (73.2 ) (9.5 ) 672 % (40.4 ) (9.0 ) 351 % Candy (180 ) (176 ) (129 ) (485 ) 22 % 10 % (159 ) (177 ) (106 ) (442 ) (24.0 ) (17.6 ) 36 % (22.7 ) (18.4 ) 23 % Idle Plant - -- - - -100 % (150 ) (159 ) - (309 ) - - 0 % - (0.2 ) -100 % Total $ (6,653 ) $ (7,865 ) $ (7,176 ) $ (21,694 ) 15 % 12 % $ (5,945 ) $ (7,207 ) $ (6,238 ) $ (19,390 ) $ (11.2 ) $ (11.3 ) -2 % $ (11.7 ) $ (11.7 ) 0 % Gross Margin: $ 2,870 $ 2,988 $ 3,386 $ 9,244 35 % 27 % $ 2,504 $ 2,273 $ 2,502 $ 7,279 $ 5.3 $ 4.5 17 % $ 5.0 $ 4.4 15 % as % Net Sales 30 % 28 % 32 % 30 % 30 % 24 % 29 % 27 % As part of the Company’s ongoing initiative to simplify and streamline operations by reducing the number of SKUs, the Company has identified core products on which to place its strategic focus. These core products consist of Reed’s and Virgil’s branded beverages. Beginning in 2020, our Wellness Shots are captured in Non-core products. Non-core products for 2019 consist primarily of slower selling discontinued Reed’s and Virgil’s SKUs. Sales As a result of our decision to focus on the core Reed’s and Virgil’s beverage brands and simplify operations by reducing the overall number of SKUs that we offer, the Company’s core beverage volume for the quarter ended September 30, 2020, represents 98% of all beverage volume. Core brand gross revenue increased by 18% to $11,622 compared to the same period last year, driven by Reed’s volume growth of 32%. The result is an increase in total gross revenue of 18%, to $11,896 from $10,112 during the same period last year. Price on our core brands increased $0.19 per case or 1% year over year, while volume grew 17% as compared to the same period last year. 3 Discounts as a percentage of gross sales decreased to 11% in the third quarter of 2020 from 14% in the same period last year. As a result, net sales revenue grew 21% in the third quarter of 2020 to $10,562, compared to $8,740 in the same period last year. Cost of Goods Sold and Produced Cost of goods sold increased $938 during the third quarter of 2020 as compared to the same period last year. As a percentage of net sales, cost of goods sold in the third quarter of 2020 improved to 68% as compared to 71% for the same period last year. The total cost of goods per case decreased to $11.24 per case in the third quarter of 2020 from $11.34 per case for the same period last year. The cost of goods sold per case on core brands was $11.11 during the third quarter of 2020, compared to $11.29 and the third quarter of 2019. Gross Margin Gross margin increased to 32% for the third quarter of 2020, compared to 29% during the same period last year. Operating Expenses Delivery and Handling Expenses Delivery and handling expenses consist of delivery costs to customers and warehousing costs incurred for handling our finished goods after production. Delivery and handling expenses increased by $306 in the third quarter of 2020 to $2,207 from $1,902 in the same period last year, driven by increased volumes. Delivery costs in the third quarter of 2020 were 21% of net sales and $3.45 per case, compared to 22% of net sales and $3.46 per case during the same period last year. Selling and Marketing Expenses Marketing expenses consist of direct marketing, marketing labor, and marketing support costs. Selling expenses consist of all other selling-related expenses including personnel and contractor support. Total selling and marketing expenses were $1,872 during the third quarter of 2020, compared to $2,508 during the same period last year. As a percentage of net sales, selling and marketing costs decreased to 18% during the third quarter of 2020, as compared to 29% during the same period last year. The decrease represents a lapping of the “Fooled Your Mom” campaign in the third quarter of 2019 and a lower level of digital advertising, event sampling and agency fees. In addition, personnel and travel related costs declined. General and Administrative Expenses General and administrative expenses consist primarily of the cost of executive, administrative, and finance personnel, as well as professional fees. General and administrative expenses decreased in the third quarter of 2020 to $1,583 from $2,470, a decrease of $887 over the same period last year. Decrease was driven by a $643 decrease in severance expense, $214 decrease in stock option expense, and a $74 decrease in professional and consulting fees, partially offset by a $44 increase in other general and administrative expenses. Loss from Operations The loss from operations was $2,276 for the third quarter of 2020, as compared to a loss of $4,378 in the same period last year driven by increase gross profit and reductions in operating expenses discussed above. 4 Interest and Other Expense Interest and other expense for the third quarter of 2020, consisted of $322 of interest expense offset by the change in fair value of our warrant liability of $8. During the same period last year, interest and other expense consisted of $318 of interest expense offset by the change in fair value of our warrant liability of $131. Modified EBITDA In addition to our GAAP results, we present Modified EBITDA as a supplemental measure of our performance. However, Modified EBITDA is not a recognized measurement under GAAP and should not be considered as an alternative to net income, income from operations or any other performance measure derived in accordance with GAAP, or as an alternative to cash flow from operating activities as a measure of liquidity. We define Modified EBITDA as net income (loss), plus interest expense, depreciation and amortization, stock-based compensation, changes in fair value of warrant expense, and one-time restructuring-related costs including employee severance and asset impairment. Management considers our core operating performance to be that which our managers can affect in any particular period through their management of the resources that affect our underlying revenue and profit generating operations during that period. Non-GAAP adjustments to our results prepared in accordance with GAAP are itemized below. You are encouraged to evaluate these adjustments and the reasons we consider them appropriate for supplemental analysis. In evaluating Modified EBITDA, you should be aware that in the future we may incur expenses that are the same as or similar to some of the adjustments in this presentation. Our presentation of Modified EBITDA should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items. Set forth below is a reconciliation of net loss to Modified EBITDA for the three months ended September 30, 2020 and 2019 (unaudited; in thousands): Three Months Ended September 30, 2020 2019 Net loss $ (2,590 ) $ (4,565 ) Modified EBITDA adjustments: Depreciation and amortization 59 38 Interest expense 322 318 Stock option and other noncash compensation 263 368 Change in fair value of warrant liability (8 ) (131 ) Severance - 643 Total EBITDA adjustments $ 636 $ 1,236 Modified EBITDA $ (1,954 ) $ (3,329 ) We present Modified EBITDA because we believe it assists investors and analysts in comparing our performance across reporting periods on a consistent basis by excluding items that we do not believe are indicative of our core operating performance. In addition, we use Modified EBITDA in developing our internal budgets, forecasts and strategic plan; in analyzing the effectiveness of our business strategies in evaluating potential acquisitions; making compensation decisions; and in communications with our board of directors concerning our financial performance. Modified EBITDA has limitations as an analytical tool, which includes, among others, the following: ● Modified EBITDA does not reflect our cash expenditures, or future requirements, for capital expenditures or contractual commitments; ● Modified EBITDA does not reflect changes in, or cash requirements for, our working capital needs; ● Modified EBITDA does not reflect future interest expense, or the cash requirements necessary to service interest or principal payments, on our debts; and ● Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and Modified EBITDA does not reflect any cash requirements for such replacements. 5 Results of Operations – Nine months ended September 30, 2020 The following table sets forth key statistics for the nine months ended September 30, 2020 and 2019, respectively, in thousands. Nine Months Ended September 30, Pct. 2020 2019 Change Gross sales (A) $ 34,677 $ 30,391 14 % Less: Promotional and other allowances (B) 3,739 3,721 - % Net sales $ 30,938 $ 26,669 16 % Cost of goods produced (C) 21,694 19,081 14 % % of Gross sales 63 % 63 % % of Net sales 70 % 72 % Cost of goods sold – idle capacity (D) - 309 -100 % % of Net sales - % 1 % Gross profit $ 9,244 $ 7,279 27 % % of Net sales 30 % 27 % Expenses Delivery and handling $ 4,950 $ 4,369 13 % % of Net sales 16 % 16 % Dollar per case ($) 2.7 2.6 Selling and marketing 5,382 7,718 -30 % % of Net sales 17 % 29 % General and administrative 4,872 6,557 -26 % % of Net sales 16 % 25 % Total Operating expenses 15,204 18,644 -18 % Loss from operations $ (5,960 ) $ (11,365 ) -48 % Interest expense and other expense (960 ) (924 ) 4 % Net loss $ (6,920 ) $ (12,289 ) -44 % Loss per share – basic and diluted $ (0.12 ) $ (0.38 ) -68 % Weighted average shares outstanding - basic & diluted 56,706,141 32,179,119 76 % 6 (A) Gross sales are used internally by management as an indicator of and to monitor operating performance, including sales performance of particular products, salesperson performance, product growth or declines and overall Company performance. The use of gross sales allows evaluation of sales performance before the effect of any promotional items, which can mask certain performance issues. We therefore believe that the presentation of gross sales provides a useful measure of our operating performance. Gross sales are not a measure that is recognized under GAAP and should not be considered as an alternative to net sales, which is determined in accordance with GAAP, and should not be used alone as an indicator of operating performance in place of net sales. Additionally, gross sales may not be comparable to similarly titled measures used by other companies, as gross sales have been defined by our internal reporting practices. In addition, gross sales may not be realized in the form of cash receipts as promotional payments and allowances may be deducted from payments received from certain customers. (B) Although the expenditures described in this line item are determined in accordance with GAAP and meet GAAP requirements, the disclosure thereof does not conform to GAAP presentation requirements. Additionally, our definition of promotional and other allowances may not be comparable to similar items presented by other companies. Promotional and other allowances primarily include consideration given to the Company’s distributors or retail customers including, but not limited to the following: (i) reimbursements given to the Company’s distributors for agreed portions of their promotional spend with retailers, including slotting, shelf space allowances and other fees for both new and existing products; (ii) the Company’s agreed share of fees given to distributors and/or directly to retailers for in-store marketing and promotional activities; (iii) the Company’s agreed share of slotting, shelf space allowances and other fees given directly to retailers; (iv) incentives given to the Company’s distributors and/or retailers for achieving or exceeding certain predetermined sales goals; and (v) discounted or free products. The presentation of promotional and other allowances facilitates an evaluation of their impact on the determination of net sales and the spending levels incurred or correlated with such sales. Promotional and other allowances constitute a material portion of our marketing activities. The Company’s promotional allowance programs with its numerous distributors and/or retailers are executed through separate agreements in the ordinary course of business. These agreements generally provide for one or more of the arrangements described above and are of varying durations, ranging from one week to one year. (C) Cost of goods produced: Cost of goods produced consists of the costs of raw materials and packaging utilized in the manufacture of products, co-packing fees, repacking fees, in-bound freight charges, inventory adjustments, as well as certain internal transfer costs. Cost of goods produced is used internally by management to measure the direct costs of goods sold, aside from unallocated plant costs. Cost of goods produced is not a measure that is recognized under GAAP and should not be considered as an alternative to cost of goods sold, which is determined in accordance with GAAP, and should not be used alone as an indicator of operating performance in place of cost of goods sold. (D) Cost of goods sold – idle capacity: Cost of goods sold – idle capacity consists of direct production costs in excess of charges allocated to our finished goods in production. Plant costs in excess of production allocations are expensed in the period incurred rather than added to the cost of finished goods produced. Plant costs include labor costs, production supplies, repairs and maintenance, and inventory write-off. Our charges for labor and overhead allocated to our finished goods are determined on a market cost basis, which is lower than our actual costs incurred. Cost goods sold – idle capacity is not a measure that is recognized under GAAP and should not be considered as an alternative to cost of goods sold, which is determined in accordance with GAAP, and should not be used alone as an indicator of operating performance in place of cost of goods sold. Sales, Cost of Sales, and Gross Margins As part of the Company’s ongoing initiative to simplify and streamline operations by reducing the number of SKUs, the Company has identified core products on which to place its strategic focus. These core products consist of Reed’s and Virgil’s branded beverages. Beginning in 2020, our Wellness Shots are captured in Non-core products. Non-core products for 2019 consist primarily of slower selling discontinued Reed’s and Virgil’s SKUs. 7 Sales As a result of our decision to focus on the core Reed’s and Virgil’s beverage brands and simplify operations by reducing the overall number of SKUs that we offer, the Company’s core beverage volume for the first nine months of 2020, represents 98% of all beverage volume. Core brand gross revenue increased by 15% to $33,737 compared to the same period last year, driven by Reed’s volume growth of 24%. The result is an increase in total gross revenue of 14%, to $34,677 from $30,391 during the same period last year. Price on our core brands increased $0.26 per case or 1% year over year, while volume grew 13% as compared to the same period last year. Discounts as a percentage of gross sales decreased to 11% in the first nine months of 2020 from 12% in the same period last year. The decrease in our promotions was driven by lower promotional activity primarily due to the impacts of COVID-19 as promotional execution became a lower priority at retail. As a result, net sales revenue grew 16% in the first nine months of 2020 to $30,938, compared to $26,669 in the same period last year. Cost of Goods Sold and Produced Cost of goods sold increased $2,304 during the first nine months of 2020 as compared to the same period last year. As a percentage of net sales, cost of goods sold in the first nine months of 2020 improved to 70% as compared to 73% for the same period last year. The total cost of goods per case increased to $11.73 per case in the first nine months of 2020 from $11.67 per case in the same period last year. The increase is driven by utilization of higher costed inventory remaining from 2019 in the first quarter and a $198 reserve recorded related to packaging material from transition to the FDA mandated nutritional fact requirements disclosure. The cost of goods sold per case on core brands increased to $11.57 during the first nine months of 2020, from the $11.42 for the same period last year. We are continuing to work with suppliers and co-packers to improve our processes and maximize cost efficiencies. Gross Margin Gross margin increased to 30% for the first nine months of 2020, compared to 27% during the same period last year. Operating Expenses Delivery and Handling Expenses Delivery and handling expenses consist of delivery costs to customers and warehousing costs incurred for handling our finished goods after production. Delivery and handling expenses increased by $581 in the first nine months of 2020 to $4,950 from $4,369 in the same period last year, driven by increased volumes. Delivery costs in the nine months of 2020 were 16% of net sales and $2.68 per case, compared to 16% of net sales and $2.63 per case during the same period last year. The per case rate increase was driven by market forces impacted by COVID-19. Selling and Marketing Expenses Marketing expenses consist of direct marketing, marketing labor, and marketing support costs. Selling expenses consist of all other selling-related expenses including personnel and contractor support. Total selling and marketing expenses were $5,382 during the first nine months of 2020, compared to $7,718 during the same period last year. As a percentage of net sales, selling and marketing costs decreased to 17% during the first nine months of 2020, as compared to 29% during the same period last year. The decrease represents a lapping of the “Fooled Your Mom” campaign which ran in the second quarter of 2019 as well as the Catalina retail register coupon program, which has yet to be used in 2020 and a lower level of digital advertising, event sampling and agency fees. In addition, personnel and travel related costs declined. 8 General and Administrative Expenses General and administrative expenses consist primarily of the cost of executive, administrative, and finance personnel, as well as professional fees. General and administrative expenses decreased in the first nine months of 2020 to $4,872 from $6,557, a decrease of $1,685 over the same period last year. The decrease was driven by lower severance of $682, forfeiture/expiration of options in the amount of $580, the lapping of a $220 one-time final transition cost incurred in 2019 related to our plant sale and a reduction professional fees and consultants of $70, and lower personnel and travel related costs. Loss from Operations The loss from operations was $5,960 for the first nine months of 2020, as compared to a loss of $11,365 in the same period last year driven by increase gross profit and reductions in operating expenses discussed above. Interest and Other Expense Interest and other expense for the first nine months of 2020, consisted of $961 of interest expense offset by the change in fair value of our warrant liability of $1. During the same period last year, interest and other expense consisted of $947 of interest expense offset by the change in fair value of our warrant liability of $23. Modified EBITDA In addition to our GAAP results, we present Modified EBITDA as a supplemental measure of our performance. However, Modified EBITDA is not a recognized measurement under GAAP and should not be considered as an alternative to net income, income from operations or any other performance measure derived in accordance with GAAP, or as an alternative to cash flow from operating activities as a measure of liquidity. We define Modified EBITDA as net income (loss), plus interest expense, depreciation and amortization, stock-based compensation, changes in fair value of warrant expense, and one-time restructuring-related costs including employee severance and asset impairment. Management considers our core operating performance to be that which our managers can affect in any particular period through their management of the resources that affect our underlying revenue and profit generating operations during that period. Non-GAAP adjustments to our results prepared in accordance with GAAP are itemized below. You are encouraged to evaluate these adjustments and the reasons we consider them appropriate for supplemental analysis. In evaluating Modified EBITDA, you should be aware that in the future we may incur expenses that are the same as or similar to some of the adjustments in this presentation. Our presentation of Modified EBITDA should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items. Set forth below is a reconciliation of net loss to Modified EBITDA for the nine months ended September 30, 2020 and 2019 (unaudited; in thousands): Nine Months Ended September 30, 2020 2019 Net loss $ (6,920 ) $ (12,289 ) Modified EBITDA adjustments: Depreciation and amortization 145 108 Interest expense 961 947 Stock option and other noncash compensation 1,007 1,597 Change in fair value of warrant liability (1 ) (23 ) Severance - 682 Total EBITDA adjustments $ 2,112 $ 3,311 Modified EBITDA $ (4,808 ) $ (8,978 ) 9 We present Modified EBITDA because we believe it assists investors and analysts in comparing our performance across reporting periods on a consistent basis by excluding items that we do not believe are indicative of our core operating performance. In addition, we use Modified EBITDA in developing our internal budgets, forecasts and strategic plan; in analyzing the effectiveness of our business strategies in evaluating potential acquisitions; making compensation decisions; and in communications with our board of directors concerning our financial performance. Modified EBITDA has limitations as an analytical tool, which includes, among others, the following: ● Modified EBITDA does not reflect our cash expenditures, or future requirements, for capital expenditures or contractual commitments; ● Modified EBITDA does not reflect changes in, or cash requirements for, our working capital needs; ● Modified EBITDA does not reflect future interest expense, or the cash requirements necessary to service interest or principal payments, on our debts; and ● Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and Modified EBITDA does not reflect any cash requirements for such replacements. Liquidity and Capital Resources The accompanying financial statements have been prepared under the assumption that the Company will continue as a going concern. Such assumption contemplates the realization of assets and satisfaction of liabilities in the normal course of business. For the nine months ended September 30, 2020, the Company recorded a net loss of $6,920 and used cash in operations of $6,768. As of September 30, 2020, we had a cash balance of $875 with borrowing capacity of $3,037, a stockholder’s equity of $558 and a negative working capital of $207, compared to a cash balance of $913 with borrowing capacity of $3,235, stockholders’ equity of $1,147 and a working capital of $4,885 at December 31, 2019. In April 2020, the Company conducted a public offering of 15,333,334 shares of its common stock at $0.375 per share, resulting in net proceeds to the Company of $5,310. On April 20, 2020, the Company received loan proceeds in the amount of $770 pursuant to the Paycheck Protection Program under the Coronavirus Aid, Relief and Economic Security Act (the “Cares Act”) (see Note 8). The PPP loan agreement is dated April 20, 2020, matures on April 20, 2022, bears interest at a rate of 1% per annum, with the first six months of interest deferred, is payable monthly commencing on November 2020, and is unsecured and guaranteed by the U.S. Small Business Administration. The loan term may be extended to April 20, 2025, if mutually agreed to by the Company and lender. We applied ASC 470, Debt , to account for the PPP loan. The PPP loan may be prepaid at any time prior to maturity with no prepayment penalties. Funds from the PPP loan may only be used for qualifying expenses as described in the CARES Act, including qualifying payroll costs, qualifying group health care benefits, qualifying rent and debt obligations, and qualifying utilities. The Company intends to use the entire loan amount for qualifying expenses. Under the terms of the PPP, certain amounts of the loan may be forgiven if they are used for qualifying expenses. The Company intends to apply for forgiveness of the PPP loan with respect to these qualifying expenses, however, we cannot assure that such forgiveness of any portion of the PPP loan will occur. As for the potential loan forgiveness, once the PPP loan is, in part or wholly, forgiven and a legal release is received, the liability would be reduced by the amount forgiven and a gain on extinguishment would be recorded. The terms of the PPP loan provide for customary events of default including, among other things, payment defaults, breach of representations and warranties, and insolvency events. The Company was in compliance with the terms of the PPP loan as of September 30, 2020. Historically, we have financed our operations through public and private sales of common stock, issuance of preferred and common stock, convertible debt instruments, term loans and credit lines from financial institutions, and cash generated from operations. We have taken decisive action to improve our margins, including fully outsourcing our manufacturing process, streamlining our product portfolio, negotiating improved vendor contracts and restructuring our selling prices. 10 Critical Accounting Policies and Estimates Use of estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Those estimates and assumptions include estimates for reserves of uncollectible accounts, inventory obsolescence, depreciable lives of property and equipment, analysis of impairments of recorded long-term tangible and intangible assets, realization of deferred tax assets, accruals for potential liabilities and assumptions made in valuing stock instruments issued for services. Revenue Recognition The Company recognizes revenue in accordance with Accounting Standards Codification (ASC) 606, Revenue from Contracts with Customers (“ASC 606”). The underlying principle of ASC 606 is to recognize revenue to depict the transfer of goods or services to customers at the amount expected to be collected. ASC 606 creates a five-step model that requires entities to exercise judgment when considering the terms of contract(s), which include (1) identifying the contract or agreement with a customer, (2) identifying our performance obligations in the contract or agreement, (3) determining the transaction price, (4) allocating the transaction price to the separate performance obligations, and (5) recognizing revenue as each performance obligation is satisfied. The Company does not have any significant contracts with customers requiring performance beyond delivery, and contracts with customers contain no incentives or discounts that could cause revenue to be allocated or adjusted over time. Shipping and handling activities are performed before the customer obtains control of the goods and therefore represent a fulfillment activity rather than a promised service to the customer. Revenue and costs of sales are recognized when control of the products transfers to our customer, which generally occurs upon shipment from our facilities. The Company’s performance obligations are satisfied at that time. All of the Company’s products are offered for sale as finished goods only, and there are no performance obligations required post-shipment for customers to derive the expected value from them. The Company does not allow for returns, except for damaged products when the damage occurred pre-fulfillment. Damaged product returns have historically been insignificant. Because of this, the stand-alone nature of our products, and our assessment of performance obligations and transaction pricing for our sales contracts, we do not currently maintain a contract asset or liability balance for obligations. We assess our contracts and the reasonableness of our conclusions on a quarterly basis. Recent Accounting Pronouncements See Note 2 of the Notes to Condensed Financial Statements for a discussion of recent accounting pronouncements. Item 3. Quantitative and Qualitative Disclosures About Market Risk. A smaller reporting company is not required to provide the information required by this Item.