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 report.
18
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, tax expense, depreciation and amortization,
stock-based compensation, changes in fair value of warrant expense, legal and insurance settlements, inventory write-offs associated
with exited categories and major packaging and formula changes, one-time changes in policy, impact of changes to accounting methodology
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.
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, 2023, 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, Virgil’s Zero Sugar handcrafted sodas, Reed’s Classic and
Stormy Mule, and 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. In addition, the Company continues
to augment its co-packer network to drive further efficiencies and build proper levels of inventory at the appropriate location to maximize
delivery metrics.
Recent
Trends – Market Conditions
Although
the U.S. economy continued to grow throughout 2023, the 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.
During
the year ended December 31, 2023, the Company experienced moderation from the elevated freight costs experienced in 2022. The average
cost of shipping and handling for year ended December 31, 2023, was $3.07 per case, as compared to $3.95 per case for the year ended
December 31, 2022. Although the Company has experienced decreases in freight costs over the last three quarters, in the Company’s
opinion there remains a volatile environment and the Company will continue to monitor pricing and availability in transportation. Mitigation
plans have been implemented to manage this risk. The Company has been 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. The Company
has experienced moderation in inflation and anticipates this to continue throughout 2024.
19
Through
December 31, 2023, we continued to generate cash flows to meet our short-term liquidity needs, and we expected to maintain access to
the capital markets.
Results
of Operations – Year Ended December 31, 2023
The
following table sets forth key statistics for the years ended December 31, 2023, and 2022, in thousands:
Year
Ended December 31,
Pct.
2023
2022
Change
Gross
billing (A)
$ 50,689
$ 59,464
-15 %
Less:
Promotional and other allowances (B)
5,978
6,423
-7 %
Net
sales
$ 44,711
$ 53,041
-16 %
Cost
of goods sold
31,884
40,929
-22 %
%
of Gross billing
63 %
69 %
%
of Net sales
71 %
77 %
Product quality hold write-down
1,848
-
-22 %
% of Gross billing
4 %
0 %
% of Net sales
4 %
0 %
Provision for product hold
1,267
-
%
of Gross billing
3 %
0 %
%
of Net sales
3 %
0 %
Gross
profit
$ 9,712
$ 12,112
-20 %
%
of Net sales
22 %
23 %
Expenses
Delivery
and handling
$ 7,561
$ 11,603
-35 %
%
of Net sales
17 %
22 %
Dollar
per case ($)
3.07
3.95
Selling
and marketing
4,865
7,316
-34 %
%
of Net sales
11 %
14 %
General
and administrative
6,118
7,489
-18 %
%
of Net sales
14 %
14 %
Provision
for receivable with former related party
585
538
9 %
%
of Net sales
1 %
1 %
Total
Operating expenses
19,129
26,946
-29 %
Loss
from operations
$ (9,417 )
$ (14,834 )
-37 %
Interest
expense and other expense
$ (6,106 )
$ (5,223 )
17 %
Net
loss
$ (15,523 )
$ (20,057 )
-23 %
Loss
per share – basic and diluted
$ (4.39 )
$ (9.07 )
-52 %
Weighted
average shares outstanding – basic & diluted
3,537,882
2,211,319
60 %
20
(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, 2023.
Total
Total
Per Case
Per Case
2023
2022
vs PY
2023
2022
vs PY
Cases:
Reed’s
1,530
1,582
-3 %
Virgil’s
870
1,209
-28 %
Total Core
2,400
2,791
-14 %
Non-Core
60
149
-60 %
Total
2,460
2,940
-16 %
Gross Billing:
Core
$ 48,778
$ 54,613
-11 %
$ 20.32
$ 19.57
4 %
Non-Core
1,911
4,851
-61 %
31.85
32.56
-2 %
Total
$ 50,689
$ 59,464
-15 %
20.61
20.23
2 %
Discounts: Total
$ (5,978 )
$ (6,423 )
-7 %
$ (2.4 3)
$ (2.18 )
11 %
COGS:
Core
$ (30,777 )
$ (37,931 )
-19 %
$ (12.82 )
$ (13.59 )
-6 %
Non-Core
(4,222 )
(2,998 )
-41 %
(70.46 )
$ (20.12 )
250 %
Total
$ (34,999 )
$ (40,929 )
-14 %
$ (14.22 )
$ (13.92 )
2 %
Gross Margin:
$ 9,712
$ 12,112
-1 9 %
$ 3.95
$
4.1 2
-4 %
as % Net Sales
22 %
23 %
21
Sales,
Cost of Sales, and Gross Margins
Sales
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 Private Label, Wellness Shots, candy and slower selling discontinued Reed’s and Virgil’s SKUs.
During
2023, the Company licensed its candy business to Rootstock Trading, a company founded and owned by our former Chief Sales Officer, Neal
Cohane. As part of this agreement, Rootstock agrees to pay a royalty on a percentage of its net sales of licensed products. The royalty
fees are 0% for 2023, 2% for 2024, 4% for 2025, and 5% thereafter.
Core
beverage volume for the year ended December 31, 2023, represents 98% of all beverage volume.
Core
brand gross billing decreased by 11% to $48,778 compared to $54,613 during the same period last year, driven by a Reed’s volume
decline of 3% and Virgil’s volume decline of 28%. The result is a decrease in total gross billing of 15%, to $50,689 during the
year ended December 31, 2023, from $59,464 in the same period last year. Price on our core brands increased 4% to $20.32 per case. The
decrease was a result of volume declines that have impacted the CSD segment as a result of price increases coupled with the Company’s
inability to produce sufficient levels of inventory to meet current demand as a result of tighter credit terms from suppliers.
Discounts
as a percentage of gross sales were 12% compared to 11% in the same period last year. As a result, net sales revenue decreased 16% for
the year ended December 31, 2023, to $44,711, compared to $53,041 in the same period last year.
In
December 2023, the Company made a one-time change in policy for discounts which resulted in an additional $756 of deductions in
2023. Excluding this adjustment, discounts as a percentage of sales would have been 10%.
Cost
of Goods Sold
Cost
of goods sold decreased $9,045 during the year ended December 31, 2023, as compared to the same period last year. As a percentage of
net sales, cost of goods sold for the year ended December 31, 2023, was 71% as compared to 77% for the same period last year. The decrease
was primarily driven by lower supply chain and input costs.
In
December 2023, the Company wrote off $1,848 of inventory comprised of $1,452 of packaging and ingredients related to major changes
in packaging and formulations, and $396 of candy as a result of exiting this line of business. These write-offs represented 4% of
net sales.
During the three months ended December 31,
2023, the Company was made aware of a closure failure in our seasonal swing-lid products which resulted in a product quality hold
write-down. The Company recorded expense of $1,267 related to costs associated with the product quality hold write-down. An
insurance claim is pending.
The
total cost of goods per case decreased to $14.22 per case for the year ended December 31, 2023, from $13.92 per case for the same period
last year. The cost of goods sold per case on core brands was $12.82 during the year ended December 31, 2023, compared to $13.59 for
the same period last year. Excluding the write-offs and provision for product quality hold write-down., total cost of goods sold per case would have been $12.96.
Gross
Margin
Gross
margin decreased to 22% for the year ended December 31, 2023, compared to 23% for the same period last year. Excluding the one-time adjustments
related to discounts, inventory write-offs, and provision for product quality hold write-down. discussed above, gross margin would have been 30% for the year ended December 31, 2023.
22
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 decreased by $4,042 in the year ended December 31, 2023, to $7,561 from $11,603 in the same period last
year, driven by our efforts to mitigate inflationary costs. Delivery costs in the year ended December 31, 2023, were 17% of net sales
and $3.07 per case, compared to 22% 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 were $4,865 during the year ended December
31, 2023, compared to $7,316 during the same period last year. As a percentage of net sales, selling and marketing were 11% of net sales
during the year ended December 31, 2023, as compared to 14% of net sales during the same period last year. The decrease was driven by
lower marketing related expenditures, headcount, broker commissions, information technology charges, travel and entertainment expenses
partially offset by stock compensation and trade show expenses.
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, 2023, to $6,118 from $7,489, a decrease of $1,371
over the same period last year. The decrease was driven by lower stock compensation, bad debt expense, co-packer and customer penalties,
information technology charges, consulting fees, and investor relation charges partially offset by higher franchise tax expense.
Loss
from Operations
The
loss from operations was $9,417 for the year ended December 31, 2023, as compared to a loss of $14,834 in the same period last year driven
by decreased gross profit and decreases in operating expenses discussed above.
Interest
Expense
Interest
expense for the year ended December 31, 2023, consisted of $6,106 of interest expense. During the same period last year, interest expense
consisted of $5,223 of interest expense.
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, tax expense, depreciation and amortization,
stock-based compensation, changes in fair value of warrant expense, legal and insurance settlements, inventory write-offs associated
with exited categories and major packaging and formula changes, one-time changes in policy, impact of changes to accounting
methodology and one-time restructuring-related costs including employee severance and asset impairment.
23
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, 2023, and 2022 (in thousands):
Year
Ended December 31,
2023
2022
Net
loss
$ (15,523 )
$ (20,057 )
Modified
EBITDA adjustments:
Depreciation
and amortization
281
225
Interest
expense
6,106
5,223
Tax
expense
251
-
Stock
option and other noncash compensation
493
859
Provision
for receivable with former related party
585
538
Product quality hold write-down
1,267
-
Inventory
write-offs associated with exited categories and major packaging and formula changes
1,848
One-time change in policy for discounts
756
-
Legal
settlement
12
-
Severance
costs
256
66
Total
EBITDA adjustments
$ 11,855
$ 6,911
Modified
EBITDA
$ (3,668 )
$ (13,146 )
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.
24
Liquidity
For
the year ended December 31, 2023, the Company recorded a net loss of $15,523 and used cash in operations of $4,266. In accordance with
Accounting Standards Codification (“ASC”) 205-40, Going Concern , the Company’s management has evaluated whether
there are conditions and events, considered in the aggregate, that raise substantial doubt about the Company’s ability to continue
as a going concern within one year after the date the accompanying financial statements were issued. As of the issuance date of these
financial statements, management expects that the Company’s existing cash of $603, plus $4,100 of additional cash received subsequent
to December 31, 2023, from investments with significant stockholders (See Note 15), will be sufficient to fund the Company’s current
operating plan for at least twelve months from the date of issuance of these financial statements. The financial statements do not include
any adjustments that might be necessary if the Company is unable to continue as a going concern.
Management’s
assessment whether there is sufficient cash on hand, together with expected capital raises, to assure operations for a period of at least
twelve months from the date these financial statements are issued, is based on conditions that are known and reasonably knowable to management,
considering various scenarios, projections, and estimates and certain key assumptions. These assumptions include, among other factors,
management’s ability to raise additional capital, and the expected timing and nature of the Company’s forecasted cash expenditures.
Historically,
the Company has financed its operations through public and private sales of common stock, convertible debt instruments, credit lines
from financial institutions, and cash generated from operations. 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.
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, 2022, 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.
25