Item 7. Management’s Discussion and Analysis
Item
7. 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 Annual Report. This discussion and analysis may contain
forward-looking statements based on assumptions about our future business. Our actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors, including but not limited to those set forth under
“Risk Factors” and elsewhere in this Annual Report.
Amounts
presented in the discussion below are in thousands, except share and per share amounts.
Results
of Operations
Overview
During
the year ended December 31, 2020, the Company fully utilized its expanded network of co-packers and implemented an upgraded
set of quality protocols. In addition to our traditional sales channels, the Company is utilizing its ecommerce platform
that includes their branded web sites and Amazon to offer its line of shots, ginger candy and drinks packaged in cans.
Two
public equity offerings which closed during the year ended December 31, 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.
33
COVID-19
Considerations
During
the year ended December 31, 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 follow the recommended actions of government and
health authorities to protect our employees. Since the inception of the COVID-19 pandemic and through the year ended December
31, 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
December 31, 2020, the COVID-19 pandemic has not negatively impacted the Company’s liquidity position as of such date. Net
sales for the year ended December 31, 2020 were up 23% from the prior year period. Through December 31, 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 I, Item 1A of this Form 10-K.
Results
of Operations – Year Ended December 31, 2020
The
following table sets forth key statistics for the years ended December 31, 2020 and 2019, in thousands:
Year
Ended December 31,
Pct.
2020
2019
Change
Gross
sales (A)
$ 46,801
$ 39,300
19 %
Less:
Promotional and other allowances (B)
5,186
5,480
-5 %
Net
sales
$ 41,615
$ 33,820
23 %
Cost
of goods produced (C)
28,849
25,635
13 %
%
of Gross sales
62 %
65 %
%
of Net sales
69 %
76 %
Cost
of goods sold – idle capacity (D)
-
309
-100 %
%
of Net sales
- %
1 %
Gross
profit
$ 12,766
$ 7,876
62 %
%
of Net sales
31 %
23 %
Expenses
Delivery
and handling
$ 6,856
$ 5,993
14 %
%
of Net sales
16 %
18 %
Dollar
per case ($)
2.76
2.83
Selling
and marketing
7,503
9,188
-18 %
%
of Net sales
18 %
27 %
General
and administrative
7,023
7,551
-7 %
%
of Net sales
17 %
22 %
Total
Operating expenses
21,382
22,732
-6 %
Loss
from operations
$ (8,616 )
$ (14,856 )
-42 %
Interest
expense and other expense
$ (1,561 )
$ (1,256 )
24 %
Net
loss
$ (10,177 )
$ (16,112 )
-37 %
Loss
per share – basic and diluted
$ (0.17 )
$ (0.46 )
-63 %
Weighted average
shares outstanding - basic & diluted
60,644,842
35,058,004
73 %
34
(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 of 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.
35
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 years ended
December 31, 2020.
Total
Total
Per
Case
Per
Case
2020
2019
vs
PY
2020
2019
vs
PY
Cases:
Reed’s
1,254
970
29 %
Virgil’s
1,204
1,083
11 %
Total
Core
2,458
2,053
20 %
Non
Core
2
33
-94 %
Candy
26
34
-24 %
Total
2,486
2,120
17 %
Gross
Sales:
Core
$ 45,324
$ 37,769
20 %
$ 18.4
$ 18.4
0 %
Non
Core
556
560
-1 %
278.0
16.9
1,548 %
Candy
921
971
-5 %
35.4
28.6
24 %
Total
$ 46,801
$ 39,300
19 %
18.8
18.5
2 %
Discounts:
Total
$ (5,186 )
$ (5,480 )
-5 %
$ (2.1 )
$ (2.6 )
-19 %
COGS:
Core
$ (28,139 )
$ (24,286 )
16 %
$ (11.4 )
$ (11.8 )
-3 %
Non
Core
(110 )
(678 )
-84 %
(55.0 )
$ (20.5 )
168 %
Candy
(600 )
(671 )
-11 %
(23.1 )
$ (19.8 )
16 %
Idle
Plant
-
(309 )
-100 %
-
(0.1 )
-100 %
Total
$ (28,849 )
$ (25,944 )
11 %
$ (11.6 )
$ (12.2 )
-5 %
Gross
Margin:
$ 12,766
$ 7,876
62 %
$ 5.1
$ 3.7
38 %
as
% Net Sales
31 %
23 %
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.
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 year ended December 31, 2020, represents
98% of all beverage volume.
Sales
Core
brand gross revenue increased by 20% to $45,324 compared to the same period last year, driven by Reed’s volume growth of
29%. The result is an increase in total gross revenue of 19%, to $46,801 in the year ended December 31, 2020, from $39,300
during the same period last year. Price on our core brands remained flat from the prior year, while volume grew 20% as compared
to the same period last year.
Discounts
as a percentage of gross sales decreased to 11% from 14% in the same period last year. As a result, net sales revenue grew 23%
in the year ended December 31, 2020 to $41,615, compared to $33,820 in the same period last year.
36
Cost
of Goods Sold and Produced
Cost
of goods sold increased $2,905 during the year ended December 31, 2020 as compared to the same period last year. As a percentage
of net sales, cost of goods sold in the year ended December 31, 2020 improved to 69% as compared to 77% for the same period last
year.
The
total cost of goods per case decreased to $11.60 per case in the year ended December 31, 2020 from $12.24 per case for the same
period last year. The cost of goods sold per case on core brands was $11.45 during the year ended December 31, 2020, compared
to $11.83 for the same period last year. Improvements in COGS have been driven by cost savings initiatives on core brands.
Gross
Margin
Gross
margin increased to 31% for the year ended December 31, 2020, compared to 23% for the same period last year. The improvements
in gross margin have been driven by reduced discount spend and cost savings initiatives.
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 $863 in the year ended December 31, 2020 to $6,856 from $5,993 in the
same period last year, driven by increased volumes. Delivery costs in the year ended December 31, 2020 were 16% of net sales and
$2.76 per case, compared to 18% of net sales and $2.83 per case during the same period last year. The improvement was driven
by a reduction in cross country shipments but this savings was negatively impacted by increasing freight rates due to 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 $7,503 during the year ended December 31, 2020, compared to $9,188 during the same period
last year. As a percentage of net sales, selling and marketing costs decreased to 18% during the year ended December 31, 2020,
as compared to 27% during the same period last year. The decrease was driven by the lapping of the “Fooled Your Mom”
campaign from 2019, and reduced expenditures on trade shows and sponsorships, partially offset by an increase in stock
compensation and market research.
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 year ended December 31, 2020 to $7,023 from $7,551, a decrease of $528
over the same period last year. The decrease was driven by a $638 decrease in severance expense, and a $147 decrease in professional
and consulting fees, partially offset by a $76 increase in stock option expense and $181 increase in other general and administrative
expenses.
Loss
from Operations
The
loss from operations was $8,616 for the year ended December 31, 2020, as compared to a loss of $14,856 in the same period last
year driven by increased gross profit and reductions in operating expenses discussed above.
Interest
and Other Expense
Interest
and other expense for the year ended December 31, 2020, consisted of $262 loss on extinguishment of debt, $1,307 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 $1,286 of interest expense offset by the change in fair value of our warrant liability of $30.
37
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 year ended December 31, 2020 and 2019 (in thousands):
Year
Ended December 31,
2020
2019
Net loss
$
(10,177
)
$
(16,112
)
Modified EBITDA adjustments:
Depreciation and amortization
204
152
Interest expense
1,307
1,286
Stock option and other noncash compensation
1,592
1,296
Loss on extinguishment of debt
262
-
Change in fair value of warrant liability
(8
)
(30
)
Impairment and
severance costs
5
643
Total
EBITDA adjustments
$
3,362
$
3,347
Modified EBITDA
$
(6,815
)
$
(12,765
)
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.
38
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 year ended December 31, 2020, the Company recorded a net loss of $10,177 and used cash in operations of $9,496. As
of December 31, 2020, we had a cash balance of $595 with borrowing capacity of $5,166, stockholders’ equity of $10,404
and a working capital of $9,528, compared to a cash balance of $913, stockholders’ equity of $1,147 and working
capital of $4,885 at December 31, 2019. Notwithstanding the loss for 2020, management projects adequate cash from operations and
available line of credit in 2021 to ensure continuation of the Company as a going concern.
In
April 2020, the Company conducted a public offering of 15,333,334 shares of its common shares at a public offering price of $0.375
per share. The net proceeds to the Company from this offering are $5,310, after deducting underwriting discounts and commissions
and other offering expenses.
In
November 2020, the Company conducted a public offering of 21,562,500 shares of its common shares at a public offering price of
$0.523 per share. The net proceeds to the Company from this offering are $11,254, after deducting underwriting discounts and commissions
and other offering expenses.
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.
Critical
Accounting Policies and Estimates
Use
of Estimates and Assumptions. 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 receivables, assumptions used in valuing inventories at net realizable value, impairment
testing of recorded long-term tangible and intangible assets, the valuation allowance for deferred tax assets, accruals for potential
liabilities, assumptions made in valuing stock instruments issued for services, and assumptions used in valuing warrant liabilities,
and assumptions used in the determination of the Company’s liquidity.
Accounts
Receivable. Accounts receivable are recorded at the invoiced amounts. The Company evaluates the collectability of its
trade accounts receivable based on a number of factors. In circumstances where the Company becomes aware of a specific customer’s
inability to meet its financial obligations to the Company, a specific reserve for bad debts is estimated and recorded, which
reduces the recognized receivable to the estimated amount the Company believes will ultimately be collected. In addition to specific
customer identification of potential bad debts, bad debt charges are recorded based on the Company’s historical losses and
an overall assessment of past due trade accounts receivable outstanding.
39
Inventory.
Inventory is stated at the lower of cost or net realizable value. We regularly review our inventory quantities on hand
and record a provision for excess and obsolete inventory based primarily on our estimated forecast of product demand and our ability
to sell the product(s) concerned. Demand for our products can fluctuate significantly. Factors that could affect demand for our
products include unanticipated changes in consumer preferences, general market conditions or other factors, which may result in
cancellations of advance orders or a reduction in the rate of reorders placed by customers. Additionally, our management’s
estimates of future product demand may be inaccurate, which could result in an understated or overstated provision required for
excess and obsolete inventory.
Revenue
Recognition . 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. 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.
Stock
Compensation Expense . The Company periodically issues stock options and restricted stock awards to employees and non-employees
in non-capital raising transactions for services and for financing costs. The Company accounts for such grants issued and vesting
based on ASC 718, Compensation-Stock Compensation whereby the value of the award is measured on the date of grant and recognized
as compensation expense on the straight-line basis over the vesting period. The Company recognizes the fair value of stock-based
compensation within its Statements of Operations with classification depending on the nature of the services rendered.
Recent
Accounting Pronouncements
See
Note 2 of the financial statements for a discussion of recent accounting pronouncements.
Item
7A. Quantitative and Qualitative Disclosures about Market Risk
As
a smaller reporting company, Reed’s is not required to provide the information required by this Item 7A.
40