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, 2021, the Company expanded its retail footprint outside of grocery and natural channels that
historically represent the majority of our products sold. The Company continued to expand growth in its 12-ounce can product line
led by Ginger Ale and Ginger Beer growth, fully utilizing its expanded network of co-packers to support this
growth. 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.
A
public equity offering which closed during the year ended December 31, 2021, provided the Company with funds for working capital and
general corporate purposes. These funds enabled us to initiate the implementation of our 2021 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.
28
COVID-19
Considerations
During
the year ended December 31, 2021, the COVID-19 pandemic has impacted our operating results and the Company anticipates a continued impact
for the balance of the year. In addition, 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.
Through
December 31, 2021, the Company has experienced higher transportation expenses as the capacity in the freight market has not kept up with
demand. The Company believes that costs will continue to increase throughout the year. In addition, the Company experienced increases
in the pricing of several of its raw materials and delays in procuring several of these items. However, mitigation plans are being implemented
to manage this risk. Additionally, the Company was negatively impacted by supply chain challenges impacting our ability to benefit from
strong demand for and increased sales of our product. The disruption caused by labor shortages, significant raw material cost inflation,
logistics issues and increased freight costs, and ongoing port congestion, resulted in suppressed margins and net income. The Company
anticipates a continued impact throughout 2022.
Our
ability to operate without significant incremental 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 December 31, 2021, 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.
Net
sales for the year ended December 31, 2021, were up 19% from the prior year period. Through December 31, 2021, 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.
29
Results
of Operations – Year Ended December 31, 2021
The
following table sets forth key statistics for the years ended December 31, 2021 and 2020, in thousands:
Year Ended December 31,
Pct.
2021
2020
Change
Gross billing (A)
$ 54,658
$ 46,801
17 %
Less: Promotional and other allowances (B)
5,059
5,186
-2 %
Net sales
$ 49,599
$ 41,615
19 %
Cost of goods sold
36,001
28,849
25 %
% of Gross billing
66 %
62 %
% of Net sales
73 %
69 %
Gross profit
$ 13,598
$ 12,766
7 %
% of Net sales
27 %
31 %
Expenses
Delivery and handling
$ 11,939
$ 6,856
74 %
% of Net sales
24 %
16 %
Dollar per case ($)
3.95
2.76
Selling and marketing
9,665
7,503
29 %
% of Net sales
19 %
18 %
General and administrative
7,965
7,023
13 %
% of Net sales
16 %
17 %
Total Operating expenses
29,569
21,382
38 %
Loss from operations
$ (15,971 )
$ (8,616 )
85 %
Interest expense and other expense
$ (431 )
$ (1,561 )
-72 %
Net loss
$ (16,402 )
$ (10,177 )
61 %
Loss per share – basic and diluted
$ (0.18 )
$ (0.17 )
7 %
Weighted average shares outstanding - basic & diluted
91,234,406
60,644,842
50 %
(A)
We define gross billing as the total sales for the Company unadjusted for costs related to generating those sales. Management utilizes
gross billing as an indicator of and to monitor operating performance of products and salespersons before the effect of any promotional
or other allowances, which are determined in accordance with GAAP, and can mask certain performance issues. We believe that the presentation
of gross billing provides a useful measure of our operating performance. Additionally, gross billing may not be comparable to similarly
titled measures used by other companies, as gross billing has been defined by our internal reporting practices .
(B)
We define promotional and other allowances as costs deducted from gross billing which are associated with generating those sales. Management
utilizes promotional and other allowances as an indicator of and to monitor operating performance of products, salespersons, and customer
agreements. We believe that the presentation of promotional and other allowances provides a useful measure of our operating performance.
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. 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. 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.
30
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, 2021.
Total
Total
Per Case
Per Case
2021
2020
vs PY
2021
2020
vs PY
Cases:
Reed’s
1,605
1,254
28 %
Virgil’s
1,388
1,204
15 %
Total Core
2,993
2,458
22 %
Non Core
2
2
0 %
Candy
28
26
8 %
Total
3,023
2,486
22 %
Gross Billing:
Core
$ 53,263
$ 45,324
18 %
$ 17.8
$ 18.4
-3 %
Non Core
362
556
-35 %
181.0
278.0
-35 %
Candy
1,033
921
12 %
36.9
35.4
4 %
Total
$ 54,658
$ 46,801
17 %
18.1
18.8
-4 %
Discounts: Total
$ (5,059 )
$ (5,186 )
-2 %
$ (1.7 )
$ (2.1 )
-20 %
COGS:
Core
$ (34,804 )
$ (28,139 )
24 %
$ (11.6 )
$ (11.4 )
2 %
Non Core
(304 )
(110 )
176 %
(152.0 )
$ (55.0 )
176 %
Candy
(893 )
(600 )
49 %
(31.9 )
$ (23.1 )
38 %
Total
$ (36,001 )
$ (28,849 )
25 %
$ (11.9 )
$ (11.6 )
3 %
Gross Margin:
$ 13,598
$ 12,766
7 %
$ 4.5
$ 5.1
-12 %
as % Net Sales
27 %
31 %
Sales,
Cost of Sales, and Gross Margins
As
part of the Company’s ongoing initiative to simplify and streamline operations 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. Non-core products consist
primarily of Wellness Shots, candy and slower selling discontinued Reed’s and Virgil’s SKUs.
Core
beverage volume for the year ended December 31, 2021, represents 99% of all beverage volume.
Core
brand gross billing increased by 18% to $53,263 compared to the same period last year, driven by Reed’s volume growth of
28% and Virgil’s volume growth of 15%. The result is an increase in total gross billing of 17%, to $54,658 in the year ended
December 31, 2021, from $46,801 during the year ended December 31, 2020. Price on our core brands decreased 3% to $17.80 per case due
to a shift in mix to lower priced, higher margin products.
Discounts
as a percentage of gross billing decreased to 9% from 11% in the same period last year. As a result, net sales revenue grew 19% in the
year ended December 31, 2021, to $49,599, compared to $41,615 in the same period last year.
Cost
of Goods Sold
Cost
of goods sold increased $7,152 during the year ended December 31, 2021, as compared to the same period last year. As a percentage of
net sales, cost of goods sold for the year ended December 31, 2021, was 73% as compared to 69% for the same period last year.
The
total cost of goods per case increased to $11.91 per case in the year ended December 31, 2021, from $11.60 per case for the same period
last year. The cost of goods sold per case on core brands was $11.63 during the year ended December 31, 2021, compared to $11.45 for
the same period last year.
Gross
Margin
Gross
margin was 27% for the year ended December 31, 2021, compared to 31% for the same period last year.
31
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 $5,083 in the years ended December 31, 2021, to $11,939 from $6,856 in the
same period last year, driven by increased volumes, ecommerce fulfilment costs, and increasing freight rates due to market conditions.
Delivery costs in the year ended December 31, 2021, were 24% of net sales and $3.95 per case, compared to 16% of net sales and $2.76
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 increased $2,162 to $9,665 during the year
ended December 31, 2021, compared to $7,503 during the same period last year. As a percentage of net sales, selling and marketing costs
increased to 19% during the year ended December 31, 2021, as compared to 18% during the same period last year. The increase was driven
by staffing costs, stock compensation, and distributor buyout.
General
and Administrative Expenses
General
and administrative expenses consist primarily of the cost of executive, administrative, operations and finance personnel, as well
as professional fees. General and administrative expenses increased in the year ended December 31, 2021, to $7,965 from $7,023
an increase of $942 over the same period last year. The increase was driven by higher legal settlements, liquor licensing fees,
loss on sale of assets, recycling fees, postage, public company costs, travel expenses, depreciation, and bad debt, partially
offset by lower stock compensation.
Loss
from Operations
The
loss from operations was $15,971 for the year ended December 31, 2021, as compared to a loss of $8,616 in the same period last
year driven by increased gross profit offset by increases in operating expenses discussed above.
Interest
and Other Income (Expense)
Interest
and other income for the year ended December 31, 2021, consisted of $1,201 of interest expense offset by $770 gain on forgiveness of
debt. During the same period last year, interest and other expense consisted of $1,307 of interest expense, loss on extinguishment of
debt of $262, offset by the change in fair value of our warrant liability of $8.
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.
32
Set
forth below is a reconciliation of net loss to Modified EBITDA for the year ended December 31, 2021 and 2020 (in thousands):
Year Ended December 31,
2021
2020
Net loss
$ (16,402 )
$ (10,177 )
Modified EBITDA adjustments:
Depreciation and amortization
243
204
Interest expense
1,201
1,307
Stock option and other noncash compensation
1,927
1,592
Gain on extinguishment of debt
(770 )
-
Legal settlement
292
-
Loss on extinguishment of debt
-
262
Change in fair value of warrant liability
-
(8 )
Impairment and severance costs
-
5
Total EBITDA adjustments
$ 2,893
$ 3,362
Modified EBITDA
$ (13,509 )
$ (6,815 )
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,
Capital Resources and Going Concern
The
accompanying financial statements have been prepared under the assumption that the Company will continue as a going concern for one
year from the date these financial statements are issued. Such assumption contemplates the realization of assets and
satisfaction of liabilities in the normal course of business.
For the year ended December 31, 2021, the
Company recorded a net loss of $16,402 and used cash in operations of $17,589. These conditions raise substantial doubt
regarding our ability to continue as a going concern for a period of at least one year from the date of issuance of these financial
statements. In addition the Company’s independent registered public accounting firm, in their report on the Company’s December 31, 2021,
audited financial statements, raised substantial doubt about the Company’s ability to continue as a going concern.
During
2021, the Company conducted public offerings and sold 6.7 million of its common shares and received net proceeds of $7,327.
On March 10, 2022, the
Company entered into a Securities Purchase Agreement (“Purchase Agreement”) with certain institutional and accredited investors
(the “Purchasers”) pursuant to which the Purchasers agreed to purchase, and the Company agreed to issue and sell to the Purchasers
in a private placement, an aggregate of 18,594,571 shares (“Shares”) of the Company’s common stock, $0.0001 par value
(“Common Stock”), and warrants (“Warrants”) to purchase an aggregate of 9,297,289 shares of Common Stock (the
“Private Placement”). The purchase price per share of common stock and associated warrant was $0.28 for the investors (other
than officers and directors of the Company) and $0.3502 for the officers and directors of the Company in compliance with the rules of
the Nasdaq Stock Market. Each whole warrant entitles the holder to purchase one share of common stock at an exercise price of $0.2877
per share. The warrants are exercisable at a per share exercise price of $0.2877 for a period of five years commencing six months from
the closing date. Officers and directors of the Company purchased approximately $1.1 million of the securities in the offering.
The gross proceeds to the Company, after deducting placement agent fees and other offering expenses, are approximately $5.1 million.
33
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. Management
is currently evaluating various funding alternatives and may seek to raise additional funds through the issuance of equity,
mezzanine or debt securities, through arrangements with strategic partners or through obtaining credit from financial
institutions. In addition, 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.
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.
34