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.
In
addition to our GAAP results, the following discussion includes Modified EBITDA as a supplemental measure of our performance. 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 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,
legal settlement, and one-time restructuring-related costs including employee severance and asset impairment.
The
following discussion also includes the use of gross billing, a key performance indicator and metric. Gross billing represents invoiced
amounts to distributors and retailers, excluding sales adjustments. Gross billing may include deductions from MSRP or “list price”,
where applicable, and excludes promotional costs of generating such sales. Management utilizes gross billing to monitor operating performance
of products and salespersons, which performance can be masked by the effect of promotional or other allowances. Management believes that
the presentation of gross billing provides a useful measure of Reed’s operating performance.
33
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, 2022, the Company continued to strengthen its supply chain, implement gross margin enhancement initiatives,
drive efficiencies in transportation and warehouse costs and reduce operating expenses. In addition, it continues to build its innovation
pipeline with sustained growth in Reed’s Real Ginger Ale and Reed’s Classic Mule. At the end of the first quarter, the Company
shipped its rebranded Virgil’s zero sugar line in 12 oz. sleek cans and produced its new line of Reed’s Hard Ginger Ale.
The
Company remains focused on driving sales growth, improving gross margin, and reducing freight costs. The sales growth focus is on channel
expansion, increase in store placements, new product introduction and improved sales execution. The margin enhancement initiative is
driven by packaging savings, co-packer upgrades, and better leveraged purchasing and improved efficiency. Underpinning these initiatives
is a focus on strategically reducing operating costs particularly delivery and handling expenses.
Recent
Trends – Market Conditions
During
the year ended December 31, 2022, the COVID-19 pandemic continued to impact our operating results and the Company anticipates a residual
effect for the balance of the year. In addition, the pandemic could 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.
Although
the U.S. economy continued to grow during the first quarter of 2022, the continuing impact of the COVID-19 pandemic, higher inflation,
the actions by the Federal Reserve to address inflation, and rising energy prices create uncertainty about the future economic environment
which will continue to evolve and may impact our business in future periods. We have experienced supply chain challenges, including increased
lead times, as well as inflation of raw materials, logistics and labor costs due to availability constraints and high demand. Although
we regularly monitor companies in our supply chain, and use alternative suppliers when necessary and available, supply chain constraints
could cause a disruption in our ability to obtain raw materials required to manufacture our products and adversely affect our operations.
We expect the inflationary trends and supply chain pressures to continue throughout 2023.
During
the year ended December 31, 2022, the Company experienced moderation from elevated freight costs. While the average cost of shipping
and handling for the year ended December 31, 2022, was $3.95 per case, which is the same as the $3.95 per case for the year ended December
31, 2021, it was significantly higher during the first half of the year, however, was significantly reduced during the second half of
the year. The Company believes these challenges will continue 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 have been 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 2023.
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 protect 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, 2022, 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 to be responsible to our employees and business partners 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.
34
We
have 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.
During
the year ended December 31, 2022, the Ukraine conflict did not have a direct material impact on our financial position, results of operations
and liquidity.
Results
of Operations – Year Ended December 31, 2022
The
following table sets forth key statistics for the years ended December 31, 2022, and 2021, in thousands:
Year Ended December 31,
Pct.
2022
2021
Change
Gross billing (A)
$
59,464
$
54,658
9
%
Less: Promotional and other allowances (B)
6,423
5,059
27
%
Net sales
$
53,041
$
49,599
7
%
Cost of goods sold
40,929
36,001
14
%
% of Gross billing
69
%
66
%
% of Net sales
77
%
73
%
Gross profit
$
12,112
$
13,598
-11
%
% of Net sales
23
%
27
%
Expenses
Delivery and handling
$
11,603
$
11,939
-3
%
% of Net sales
22
%
24
%
Dollar per case ($)
3.95
3.95
Selling and marketing
7,316
9,665
-24
%
% of Net sales
14
%
19
%
General and administrative
7,489
7,965
-6
%
% of Net sales
14
%
16
%
Provision for receivable with former related party
538
-
-
% of Net sales
1
%
0
%
Total Operating expenses
26,946
29,569
-9
%
Loss from operations
$
(14,834
)
$
(15,971
)
-7
%
Interest expense and other expense
$
(5,223
)
$
(431
)
1,112
%
Net loss
$
(20,057
)
$
(16,402
)
22
%
Loss per share – basic and diluted
$
(9.07
)
$
(8.99
)
1
%
Weighted average shares outstanding - basic & diluted
2,211,319
1,824,688
21
%
35
(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.
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, 2022.
Total
Total
Per
Case
Per
Case
2022
2021
vs
PY
2022
2021
vs
PY
Cases:
Reed’s
1,582
1,605
-1
%
Virgil’s
1,209
1,388
-13
%
Total
Core
2,791
2,993
-7
%
Non-Core
131
2
6432
%
Candy
18
28
-36
%
Total
2,940
3,023
-3
%
Gross
Billing:
Core
$
54,613
$
53,263
3
%
$
19.6
$
17.8
10
%
Non-Core
4,032
362
1014
%
30.9
181.0
-83
%
Candy
819
1,033
-21
%
45.3
36.9
23
%
Total
$
59,464
$
54,658
9
%
20.2
18.1
12
%
Discounts:
Total
$
(6,423
)
$
(5,059
)
27
%
$
(2.2
)
$
(1.7
)
31
%
COGS:
Core
$
(37,931
)
$
(34,804
)
9
%
$
(13.6
)
$
(11.6
)
17
%
Non-Core
(2,568
)
(304
)
745
%
(19.7
)
$
(152.0
)
-87
%
Candy
(430
)
(893
)
-52
%
(23.8
)
$
(31.9
)
-25
%
Total
$
(40,929
)
$
(36,001
)
14
%
$
(13.9
)
$
(11.9
)
17
%
Gross
Margin:
$
12,112
$
13,598
-11
%
$
4.1
$
4.5
-8
%
as
% Net Sales
23
%
27
%
36
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, 2022, represents 95% of all beverage volume.
Core
brand gross billing increased by 3% to $54,613 compared to the same period last year, driven by Reed’s volume decline of 1% and
Virgil’s volume decline of 13%. The result is an increase in total gross billing of 9%, to $59,464 in the year ended December 31,
2022, from $54,658 during the year ended December 31, 2021. Price on our core brands increased 10.0% to $19.57 per case due to a shift
in mix to lower priced, higher margin products.
Discounts
as a percentage of gross billing increased to 11% from 9% in the same period last year. As a result, net sales revenue grew 7% in the
year ended December 31, 2022, to $53,041, compared to $49,599 in the same period last year.
Cost
of Goods Sold
Cost
of goods sold increased $4,928 during the year ended December 31, 2022, as compared to the same period last year. As a percentage of
net sales, cost of goods sold for the year ended December 31, 2022, was 77% as compared to 73% for the same period last year.
The
total cost of goods per case increased to $13.92 per case in the year ended December 31, 2022, from $11.91 per case for the same period
last year. The cost of goods sold per case on core brands was $13.59 during the year ended December 31, 2022, compared to $11.63 for
the same period last year.
Gross
Margin
Gross
margin was 23% for the year ended December 31, 2022, compared to 27% for 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 expense decreased by $336 in the years ended December 31, 2022, to $11,603 from $11,939 in the same period last
year, driven by decreased volumes, ecommerce fulfilment costs, and decreasing freight rates due to market conditions. Delivery costs
in the year ended December 31, 2022, were 22% of net sales and $3.95 per case, compared to 24% of net sales and $3.95 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 decreased $2,349 to $7,316 during the year ended December 31, 2022, compared to $9,665 during
the same period last year. As a percentage of net sales, selling and marketing costs decreased to 14% during the year ended December 31,
2022, as compared to 19% during the same period last year. The decrease was driven by lower employee related costs, stock compensation,
distributor buyouts and reduced sampling and marketing spend partially offset by higher broker fees.
37
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
decreased in the year ended December 31, 2022, to $7,489 from $7,965, a decrease of $476 over the same period last year. As a percentage
of net sales, general and administrative expenses decreased to 14% during the year ended December 31, 2022, as compared to 16% during
the same period last year. The decrease was driven by lower legal settlements, stock compensation and employee related costs, and bad
debt expense, partially offset by higher public company costs and co-packer downtime charges.
Provision for Receivable with Former Related
Party
At December 31, 2022, the Company had a receivable
due from California Custom Beverage, LLC’s (“CCB”), an entity owned by Christopher J. Reed, a former related party.
At December 31, 2022, CCB disputes that it owes $1,043 recorded as receivable
by the Company. The Company believes that it will prevail in this dispute, however, as of December 31, 2022, due to the uncertainty about
the ultimate amount that will be settled, the Company has provided a reserve for $538 based on management’s estimate.
Loss from Operations
The loss from operations was $14,834 for the year
ended December 31, 2022, as compared to a loss of $15,971 in the same period last year driven by decreased gross profit partially offset
by decreases in operating expenses discussed above.
Interest
and Other Income (Expense)
Interest
and other income for the year ended December 31, 2022, consisted of $5,223 of interest expense. During the same period last year, interest
and other expense consisted of consisted of $1,201 of interest expense offset by $770 gain on forgiveness of debt.
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, legal settlement,
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.
38
Set
forth below is a reconciliation of net loss to Modified EBITDA for the year ended December 31, 2022, and 2021 (in thousands):
Year Ended December 31,
2022
2021
Net loss
$
(20,057
)
$
(16,402
)
Modified EBITDA adjustments:
Depreciation and amortization
225
243
Interest expense
5,223
1,201
Stock option and other noncash compensation
859
1,927
Provision for receivable with former related party
538
-
Gain on extinguishment of debt
-
(770
)
Legal settlement
-
292
Severance costs
66
-
Total EBITDA adjustments
$
6,911
$
2,893
Modified EBITDA
$
(13,146
)
$
(13,509
)
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, 2022, the Company recorded a net loss of $20,057 and used cash in operations of $15,530. As of December 31,
2022, we had a cash balance of $533, with $110 of current availability, and $1,633 of additional borrowing capacity, a stockholder’s
deficit of $8,470 and negative working capital of $1,563, compared to a cash balance of $49 with
borrowing capacity of $109, stockholders’ equity of $4,203 and working capital of $2,981 at December 31, 2021 .
During
the year ended December 31, 2022, the Company entered into a note purchase agreement with Whitebox Advisors, LLC and agreed to issue
$13,750 of secured convertible promissory notes (the “Notes”). The net proceeds from the issuance of the Notes, after deducting
placement agent fees and other debt issuance costs, was approximately $12,430.
39
The
Notes will mature on May 9, 2025, bear interest at a rate of 10% per annum (with 5% per annum payable in cash and 5% per annum payable
“in kind” by adding such accrued interest to the principal amount of the Notes). The Notes are secured by substantially all
of the Company’s assets (including all of its intellectual property) and are subject to a collateral sharing agreement with ACS,
the Company’s existing secured lender (see Note 5). During the year ended December 31, 2022, principal payments of $800 were made,
and accrued interest of $1,052 was added to the principal balance, leaving a balance owed of $11,502 at December 31, 2022.
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. To alleviate these conditions,
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. As
we seek additional sources of financing, there can be no assurance that such financing would be available to us on favorable terms or
at all. Our ability to obtain additional financing in the debt and equity capital markets is subject to several factors, including market
and economic conditions, our performance and investor sentiment with respect to us and our industry.
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
The
preparation of the Company’s financial statements in conformity with generally accepted accounting principles in the United States
(“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities
at the date of the financial statements and the reported amounts of expenses during the reporting period. Some of those judgments can
be subjective and complex, and therefore, actual results could differ materially from those estimates under different assumptions or
conditions. Management bases its estimates on historical experience and on various assumptions that are believed to be reasonable in
relation to the financial statements taken as a whole under the circumstances, the results of which form the basis for making judgments
about the carrying values of assets and liabilities that are not readily apparent from other sources. Management regularly evaluates
the key factors and assumptions used to develop the estimates utilizing currently available information, changes in facts and circumstances,
historical experience and reasonable assumptions. After such evaluations, if deemed appropriate, those estimates are adjusted accordingly.
Actual results could differ from those estimates. Significant estimates include those related to assumptions used in 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. There were no changes to our critical accounting policies described in the consolidated financial
statements included in this Annual Report on Form 10-K for the fiscal year ended December 31, 2021, that impacted our condensed consolidated
financial statements and related notes included herein.
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