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Edited Transcript of REED earnings conference call or presentation 13-Nov-18 9:30pm GMT

Q3 2018 Reed's Inc Earnings Call

LOS ANGELES Nov 14, 2018 (Thomson StreetEvents) -- Edited Transcript of Reed's Inc earnings conference call or presentation Tuesday, November 13, 2018 at 9:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Iris Snyder

Reed's, Inc. - CFO

* Valentin M. Stalowir

Reed's, Inc. - CEO & Director

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Conference Call Participants

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* Anthony V. Vendetti

Maxim Group LLC, Research Division - Executive MD of Research & Senior Healthcare Analyst

* David Brian Bain

Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Good afternoon, and welcome to Reed's Third Quarter 2018 Earnings Conference Call for the period ending September 30, 2018. My name is David, and I will be your conference call operator today. (Operator Instructions) And we'll have prepared remarks from Val Stalowir, Reed's Chief Executive Officer; and Iris Snyder, Reed's Chief Financial Officer. Following management remarks, they will take your questions.

Before we begin today's call, I have a Safe Harbor statement to read to our listeners. I would like to remind our listeners that during this call, management's remarks may contain forward-looking statements and that management may make additional forward-looking statements in response to your questions.

Forward-looking statements are only current predictions and are subject to known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance of achievements to be materially different from those anticipated by such statements.

These factors include, but are not limited to, the company's ability to manage growth, manage debt and meet development goals, reduction in demand for our products, dependence on third-party manufacturers and distributors, changes in the competitive environment, access to capital and other information detailed from time to time in our filings with the United States Securities and Exchange Commission.

Although we believe that the expectations reflected in forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. In addition, any projections as to the company's future performance represent management's estimates as of today, November 13, 2018. We assume no obligation to update these projections in the future as market conditions change.

Additionally, please note non-GAAP financial measures referenced during this call are reconciled to their comparable GAAP financial measures in the press release and supplemental materials filed with the SEC and is posted on our website at www.reedsinc.com.

Non-GAAP financial information is not meant as a substitute for GAAP results, but is included solely for informational and comparative purposes. 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 core operating performance.

I will now turn the call over to Mr. Stalowir. Please go ahead, sir.

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [2]

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Thank you, and good afternoon, everyone. It's my pleasure to speak with you today to discuss our third quarter performance and update you on the progress we've made in our transformation efforts, which we have now substantially completed and only need to finish the last major remaining item, which is exiting our manufacturing operations in L.A.

During the third quarter, we finalized laying the groundwork for our sales and brand building activities. Having completed our brand refresh work for both Virgil's and Reed's and are preparing to bring new product news and innovation to the craft category. We have yet to fully turn on these investments to impact sales, but we'll begin to ship our refresh packaging and exciting new product offerings over the coming months.

During the third quarter, we again delivered core brand gross sales growth and generated normalized gross margins of 29%, as Iris will discuss. Gross margin this quarter also included 160 basis points of swatting cost to support the Virgil's Zero Sugar rollout. We expect further gross margin improvement and remain confident with our near-term target of margins in the mid-30s.

We continue to see excellent retailer and consumer response to our Virgil's Zero Sugar launch. We added 1,100 new doors during the quarter and are now gearing up for the launch of Reed's Zero Sugar in bottles and cans, which should begin to ship during the first quarter of 2019.

Before I dive into our sales, marketing and new product strategies, let me discuss our progress on our transformation plan. As I mentioned, we have just one item left to complete, which is the exit from our Los Angeles manufacturing facility. Exiting manufacturing will complete our transition to an asset-light sales and marketing organization and reduce our idle plant charges, which were $1.1 million this quarter. We're in the final stages of the process and expect to complete our transition by year-end.

As we've discussed over the past few calls, we've been diligently executing a business model optimization plan that will create a solid and scalable foundation from which to drive improved margin performance and sales growth. This new business platform will allow the company to invest increased capital in sales and brand-building resources and initiatives.

Our progress includes an updated leadership team across all functions and a highly experienced board. Our renewed strategic focus on our core brands and optimized business model upon completing the L.A. plan exit, an improved and flexible capital structure at lower rates and much reduced debt service, which was completed with the refinancing of our credit agreements last month. And we laid the groundwork for building brand equity and accelerating sales growth on both brands. We've begun to see the benefits of these investments on the Virgil's brand, which posted double-digit growth this quarter and will continue to ramp.

We expect to see a similar impact on Reed's brand once the new brand refresh, the new Zero Sugar offerings and can packages begin to hit shelves in 2019. We are very pleased to have most of our transformation efforts behind us, so we can now fully focus on the second phase of our value creation plan, which is to invest in sales and brand-building activities in order to expand our leadership position in 2 of the fastest growing categories in beverage.

The most recent 52-week period showed Ginger Beer growing at 12% and the better-for-you segment of the craft specialty soda category up 27%. We are very proud of the work we've completed to transform the Reed's business model. We now have the focus, the resources, the tools and the viable gross margins to achieve our goals of capitalizing on the significant growth upside in these fast-growing categories.

Let me turn now to our recent gains for Virgil's and then discuss our plans for the Reed's brand. As I've already noted, we continue to gain distribution for Virgil's Zero Sugar. We add 1,100 doors this quarter, including regional chains, such as Stop & Shop, Market Basket, Tops, Big Y, [King Co] in the Northeast, national chains, such as Wegmans and Giant-Carlisle and several natural food accounts, including Earth Fare.

These gains add to our second quarter distribution gains, including Target and Kroger, where Virgil's Zero Sugar is doing well with volumes continuing to build and measured velocity is approaching similar levels as some of our more established SKUs. We'll continue to invest in trade programs to drive further awareness, trial and repeat purchase on our Virgil's Zero Sugar line.

During the third quarter, we also ran a successful mix and match roadshow program featuring Virgil's Zero Sugar products in our western Costco region, and our goal is to expand this roadshow program to additional regions in 2019. Our launch of Virgil's in cans and next year's introduction of Reed's in cans will be a compelling new addition to this program and the club channel in general.

Turning to Reed's. We've completed our brand refresh work and development of Reed's Zero Sugar offerings and have begun the selling process to major retailers. The Reed's Zero features the same great tasting all-natural zero-calorie formula used in our Virgil Zero line and will be the only all-natural Zero Sugar Ginger Beer on the market made from fresh organic ginger. Now consumers can enjoy America's #1 Ginger Beer without any sugar or calories.

The Reed's brand refresh includes new high-impact graphics and packaging on our 4-pack bottled 4 packs, and our plans also include launching Reed's in 4-pack cans. We expect to be shipping the refreshed bottles, cans and Zero Sugar line in the first quarter of 2019 with product on shelf by the second quarter.

During the third quarter, we also continued to add sales, broker and distributor resources. We've partnered with Advanced Solutions to enter the convenience store channel and are already launching our first regional C-store test. For the on-premise channel, we partnered with Young's Market, a leading distributor of wine and spirits with reach into 10 Western markets.

We're initially launching in California and already have our first orders in the fourth quarter. Success in California will be followed by expansion to additional markets and regions. In parallel, we've had productive conversations with similar sized wine and spirit distributors in major markets and initial reactions have been very positive. Interest is especially high on the Reed's can product offerings.

We are also making solid progress in adding new bar and liquor store accounts daily in the 3 major test markets where we've invested in experienced on-premise field sales personnel. We remain excited about our opportunity to disrupt and elevate the multibillion-dollar Ginger Beer category as well as upgrading consumers to natural craft offerings from the $80 billion mainstream soda category. We are confident that we have the right business model, the right team and the right products, packages and branding to deliver on our goal of becoming the Sam Adams of natural craft beverage.

As we near the final stage of our transformation with the resources in place to accelerate our investments in sales and our brands, we're excited for the opportunity ahead. I remain very proud of what we have been able to accomplish in a short amount of time. We've made good progress to date, and there are significant opportunities for us to capture moving forward.

We look forward to updating you each quarter on our progress and continuing to improve financial results and shareholder value.

Now let me turn the call over to Iris.

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Iris Snyder, Reed's, Inc. - CFO [3]

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Thank you very much, Val, and good afternoon, everyone. As Val mentioned, we continue to make good progress on our key initiatives. Let me run through the financial results.

Net sales decreased 1% to $10.8 million during the third quarter, while our core brands generated 3% of growth. The net sales decline reflects last year's SKUs reduction, a sales shift of private label this year from Q3 to Q4 as well as the impact of our slotting investments for Virgil's Zero Sugar, which are netted against sales.

The combination of higher revenue per case and a 9% decline in cost of goods sold on a per-case basis contributed to a 30% increase in gross profit.

Gross margin as a percentage of net sales increased 590 basis points over the prior year to 25%. Excluding approximately $500,000 of discrete accruals and inventory reevaluation related to the planned exit of the company's manufacturing operations, the gross margin would have been 29% this quarter.

Additionally, investments in slotting this quarter reduced the gross margin by approximately 160 basis points compared to minimal slotting expense in the prior quarter. On an adjusted basis, adding back the discrete items and adjusting for slotting, the gross margin would have improved 1,200 basis points year-over-year, primarily driven by the benefits of the new glass supplier contract with Owens-Illinois, higher average selling prices and the benefits of SKU rationalization.

As Val mentioned, we remain confident with our gross margin trajectory and opportunity for incremental improvement.

Delivery and handling costs increased 25% to $1.4 million or 260 basis points higher as a percentage of net sales compared to the prior year. This increase reflects an industry-wide increase in freight rate, transition charges from and to new warehouse partners and the effects of the initial ramp up of can production on the East Coast.

Selling and marketing costs increased 66% to $1.4 million during the quarter. The 520 basis point increase as a percentage of net sales versus prior year reflects the company's strategy to enhance brand value and reaccelerate growth of the core brand. The investments focus on marketing infrastructure, brand refresh work and support of new product launches.

General and administrative expenses increased to $2 million in the third quarter compared to $1.1 million in the prior year period. The third quarter G&A increase reflects noncash stock option expense of approximately $400,000, transition expenses associated with our headquarter relocation to Norwalk, Connecticut of approximately $300,000 and another $100,000 of cost associated with bonus accruals.

The third quarter operating loss narrowed to $2.1 million from $3 million in the prior year and was negatively impacted by the $500,000 of discrete accruals and inventory reevaluation related to the planned facility exit and the $300,000 of relocation expense, both of which are nonrecurring.

Interest expense decreased $0.6 million in the third quarter compared to $0.8 million last year. Warrant cost this quarter were de minimis as compared to $1.9 million of warrant modification and expenses associated with the change in fair value of warrant liability in the prior year period.

Net loss is $2.7 million or $0.10 per share in the third quarter of 2018. This is compared to a net loss of $5.6 million or $0.37 per share in the same period last year.

Moving to the balance sheet and cash flows. We ended the third quarter with $0.2 million in cash and cash equivalents. While we had approximately $3 million of availability on our credit facility on September 30, we were managing our cash position to limit our borrowings on our previous credit facility prior to refinancing, which occurred shortly after the quarter ended.

As we announced last month on October 4, we successfully refinanced our credit facilities with Rosenthal & Rosenthal, strengthening our financial profile and significantly reducing debt service and borrowing costs. The $30 million asset-based loan replaced our previous credit agreement with PMC. Based on current interest rates, our annual debt service is expected to be reduced by approximately $1.5 million.

During the first 9 months of 2018, we used cash in operating activities of $10.5 million compared to $4.7 million in the prior period. As we noted on prior calls, the increase primarily relates to payment of stretched payables during the first quarter of 2018 and investments in inventory during the second quarter. The added inventory had been put into place to support the planned transition of our L.A. manufacturing operations as well as supporting the recent launch of Virgil's Zero Sugar.

Now let me turn the call back to the operator to begin the question-and-answer session. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from David Bain from Roth Capital Partners.

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David Brian Bain, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [2]

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Congrats on the refi and continued Virgil's traction. My first question is if you could give us a little bit more color on sell-through versus sell-in with the Zero line. I know you mentioned velocities are approaching levels of your more established SKUs. I assume that means it's selling faster than nonmature SKUs. How should be view that in terms of consumer acceptance from the investor or a modeling standpoint?

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [3]

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Yes. There's 2 things that we're looking at. One is sort of our traction in our big retailers and sort of where there minimums are. And in the few months that we're in, we're approaching closer and closer to sort of their minimum threshold is, which I think is pretty good in terms of how short that's been. And we've only started promoting in September in terms of couponing and sort of poll activity. So we're really happy with what we've set out in terms of targets and developments in the large retailers, like Target and Kroger. And then on the other major sort of guide that we have is syndicated data. And unfortunately, that percentage of ACV, of which is a measurement of distribution, is still quite small compared to our more established brands. We're comparing sort of Virgil's Zero to virtual root beer and black cherry, which have been on shelf and been selling through for a number of years. So it's -- I caution to interpret too much because the ACV is 1/5 the size of where our established is. But on a sales per point of distribution, the Zeroes are doing as well as our regular flavors on a sales per point. So that tells me the velocities in a short amount of time are in the ballpark of brands that have been on the shelf for a lot of years. So that, to me, is encouraging. The question is going to be are those rates going to continue as the ACV for Zero continues to grow, which is our plan. I mean, right now, we're probably in the mid-teens and sort of the best or most widely distributed Zero. Whereas we're probably in the 40s or 50s, at least in grocery, in terms of the more established.

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David Brian Bain, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [4]

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Okay, great. Very helpful. Okay. And then can you get a little bit more granular with the plant plans and -- so is the potential sale, is there -- it looks like there's probably not going to be a deal with potential buyers. What exactly happens if there's not before year-end when you exit? How does that work?

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [5]

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Yes, that's a good question. So it's something that we've always been working on for a long time. Now we have a competitive process. We have more than one bidder, and we're coming down for the final strokes. We have draft, definitive documents. And we expect to sign something more definitive this week and then drive to close in short order before the end of the year. And the terms are similar to what we had reflected in the 2017 financials. And there's even upside in terms of toll fees being more attractive than what we had thought in terms of the first round. So what's taken us long is when we went down the road pretty deep with the first bidder and then the terms changed pretty significantly, we kind of regrouped and started over and attracted different competitive sets. So that is why it's taken as long as it has. It's a little -- it's definitely a complex process because there's a discrete amount of potential interested buyers in what this facility is. And we're also trying to attract the right partner to be a solid and dependable co-packer for our core brand on the West Coast. Now the good news is we are adding another co-packer on West Coast, which we'll announce fairly shortly. So we won't be 100% dependent on the L.A. plant producing everything we need. But we'd still like to give all of our employees there the best chance of transitioning to a good partner to produce -- continue to produce our product. So we're pretty confident we're going to get a deal done this year. If we don't get a deal done, the good news is the -- we have an option to buy the plant, and the plant's value has actually appreciated. And so we've hired a commercial firm to do an appraisal and right now, there is a good chance that we could buy and sell this property without a lot of out-of-pocket investment in getting that done and extinguish the lease obligation. And then we would sell all the new equipment and everything else to bring in cash. Again, it would be in the range of what we would expect to bring in versus selling the facility, selling the beverage business. So from that standpoint, Plan B is not that bad, it's just more work. But obviously, the preferred option is to find a partner and exit to them, which, right now, I'm pretty confident that's going to happen.

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David Brian Bain, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [6]

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Okay, great. And then just final one, if I may, because this comes up with certain investors. Can you give us any insight as to how you look at the potential for CBD within the context of your future offering, if at all?

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [7]

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Look, you're not the first to ask. So we are an all-natural craft soda. We have 30,000 distribution doors. So we have an infrastructure that's pretty rare in the industry. And so -- and we are looking at functional beverages. Ginger is a superfood. It's a functional beverage. It's all natural. It has sort of a counterculture brand image. And so, of course, we're looking at all fast-growing new breakthrough ingredients. And so we are looking at all that space. We're looking in learning in that space in general. So from that standpoint, we're doing the good diligence that a management team should be doing in beverage and evaluating sort of breakthrough ingredients and/or offerings. So that's the way I would answer that. The other piece here, David -- I'm so sorry, David. The other piece is when you take a look at some of our major retailers, they're not going to distribute anything that is still federally illegal. CBD, right now, until the farm bill passes as is, that's when CBD will no longer be considered illegal substance. There's no way Whole Foods or any of the other major retailer partners that we have would bring anything on that is still officially federally illegal to carry.

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Operator [8]

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Operator Instructions) Our next question is from Anthony Vendetti with Maxim Group.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research & Senior Healthcare Analyst [9]

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The third quarter revenue from your core brands, from Reed's and Virgil's, made up how much of total revenue?

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Iris Snyder, Reed's, Inc. - CFO [10]

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It grew by 3% -- oh, 80% of our total revenue.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research & Senior Healthcare Analyst [11]

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It grew by 3% and it was 80%? Okay.

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [12]

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Yes. We have private label that hits third and fourth quarter. There were some timing issues where our large private label customers ordered later this year that impacted sort of revenues. So from that standpoint, you'll see little margin depression and sales from -- into Q3, into Q4 for our private label business.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research & Senior Healthcare Analyst [13]

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Okay. And then idle manufacturing costs were $1.1 million this quarter. Is all of that in cost of goods sold?

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Iris Snyder, Reed's, Inc. - CFO [14]

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It is included in the cost of goods sold, correct. And the reason why, that idle cost includes the $500,000 of the discrete accrual and inventory reevaluation that both Val and I discussed.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research & Senior Healthcare Analyst [15]

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Okay. So it's all in there. Okay, good.

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Iris Snyder, Reed's, Inc. - CFO [16]

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Yes.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research & Senior Healthcare Analyst [17]

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And then you have a $13 million line of credit. Have you accessed any of it at this point? Or how much of it is still available?

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Iris Snyder, Reed's, Inc. - CFO [18]

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We closed and funded on October 4. So moving our -- all of our lines from PMC over to this asset based line of credit with Rosenthal & Rosenthal.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research & Senior Healthcare Analyst [19]

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Okay. And have you used any of it other than moving it all over there?

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Iris Snyder, Reed's, Inc. - CFO [20]

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Yes, we're using it as our working capital line of credit at the moment. Yes.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research & Senior Healthcare Analyst [21]

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Okay. And then, Val, maybe you could just talk about -- I know you're adding doors and so forth. But any major wins you can talk about this quarter? Or is this not the quarter for that in terms of restocking or -- what can you mention about that?

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [22]

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Yes. No, I mentioned we had some good hits for Virgil's in the Northeast with Stop & Shop, Big Y, et cetera, Wegmans more nationally, Giant-Carlisle. So we had some nice grocery hits. We won't be -- there is new news that we're working on, which we can't talk about right now that are pretty large opportunities for us. But that's what hit in the third quarter.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research & Senior Healthcare Analyst [23]

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Okay. And then the old Virgil's packaging, that should cycle through by the end of this year?

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [24]

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We'll start cycling actually the first of the year. So all the packaging, in terms of the 4 packs and the labels and all that, should be -- that production should start up in the first of January, like the first part of January. And so it's cycling through the first quarter.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research & Senior Healthcare Analyst [25]

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So cycling through for the first quarter. Okay, great.

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [26]

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Yes. We haven't seen the benefit of any of the redesigns really on shelf. I mean, the cans launched early, so there was sort of the new branding treatment on the cans. But neither the Reed's nor the Virgil's have the benefit of the new improved packaging on shelf.

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Operator [27]

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Next, we have a follow-up question from David Bain with Roth Capital.

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David Brian Bain, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [28]

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I'm wondering if we could just take a step back and speak to the CSD competitive space a bit. I mean, you mentioned the CSD growth number. Industry followers see that as well. And I'm wondering if it's leading to new entrants of note that you're viewing out there? Or since you put in your new products with Virgil's, have you seen any sort of defense coming out of your competitors in terms of discounting or anything else?

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [29]

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That's a good question. So in the Ginger Beer category, the playing field is pretty set. There's been no significant entrants in that space. All of them are kind of growing and Bundaberg -- I'd say Bundaberg, Fever-Tree, Gosling's are still the major players there and continue to be. So there's no real new entrants there. And some of them have actually slowed down in their growth and ACV expansion, and we feel pretty confident in our ability to compete given our product superiority in terms of organic ginger root and our formulas and the content in the flavors that we use. In terms of the craft soda space, that also has been kind of a quiet category. Zevia is doing very well. That's really the star of that category. It's growing both ACV and sales. And we have what we believe is the 2.0 in terms of taste on Zevia because we're using a proprietary blend of natural sweeteners as opposed to stevia alone. And so that is the major, let's say, competitor that we're looking at. And they have taken steps in terms of discounting more aggressively. They know we're coming. They're at our next booth over and over again last -- earlier this year. And so I think that's going to be sort of the fight for the consumer who really wants all natural and great taste. We believe we're the natural evolution of that offering, and we're excited to get on shelves and have that comparison made. There are a couple of other players. I think, DRY Soda is also starting to get their tail in this space as well, but I can't say that there's any major new entrants in this space. The sort of full sugar category is still dominated by sort of ingredient-challenged products like IBC and Stewart's. So there's no -- like the 27% growth coming from what I define as better-for-you craft specialty, that was really the Zero Sugars and that primarily has been driven by Zevia.

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Operator [30]

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Ladies and gentlemen, we have reached the end of the question-and-answer session. I would like to turn the call back to Val Stalowir for closing remarks.

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [31]

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I'd like to thank everyone for their continued support and for participating on today's call. Also, please note that we're launching a new Investor Relations website this week. Please visit www.reedsinc.com over the coming days to view our improved online investor support. Thanks again, and have a great day.

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Operator [32]

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This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.