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Edited Transcript of REED earnings conference call or presentation 14-May-18 8:30pm GMT

Thomson Reuters StreetEvents

Q1 2018 Reed's Inc Earnings Call

LOS ANGELES May 16, 2018 (Thomson StreetEvents) -- Edited Transcript of Reed's Inc earnings conference call or presentation Monday, May 14, 2018 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Daniel V. Miles

Reed's, Inc. - CFO

* Neal Cohane

Reed's, Inc. - SVP of Sales & Marketing

* Stefan Freeman

Reed's, Inc. - COO

* 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

* Paul Strigler

Esplanade Capital - Analyst

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Presentation

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Operator [1]

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Good afternoon, and welcome to Reed's First Quarter 2018 Earnings Conference Call for the period ending in March 31, 2018. My name is Mike, and I will be your conference call operator today.

Today's call is limited to 1 hour and will have prepared remarks of Val Stalowir, Reed's Chief Executive Officer; and also Dan Miles, Reed's Chief Financial Officer. (Operator Instructions)

Before we begin today's call, I have a safe harbor statement to read to our listeners. I would like to remind the listeners that during this call, management remarks may contain forward-looking statements that are subject to risks and uncertainties and that management may take additional forward-looking statements in response to your questions.

Additionally, please note that 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. Non-GAAP financial information is not meant as a substitute for GAAP results but is included solely for informational and comparative purposes. The company believes that the presentation of non-GAAP financial measures provides useful information to investors regarding the company's financial condition and results of operations. Therefore, the company claims the protection of the safe harbor for forward-looking statements that are contained in the Private Securities Litigation Reform Act of 1995.

Actual results may differ from those discussed today due to such risks but are not limited to risks relating to demand for the company's 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 the company's filings with the United States Securities and Exchange Commission.

In addition, any projections as to the company's future performance represent management's estimates as of today, May 14, 2018. Reed's, Inc. assumes no obligation to update these projections in the future as market conditions change.

I'll now turn the call over to Mr. Stalowir. Please go ahead.

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

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Thank you, and good afternoon, everyone. It is my pleasure to speak with you today to discuss our first quarter results and update you on the continued progress we are making with our transformation and value creation plan.

As I've said before, I'm confident that we have the right strategy, the right team, the right board and the right partners in place to capitalize on the substantial opportunity we have with our leading brands that are benefiting from large macro consumer trends and are in attractive and growing beverage categories. Our transformation is well underway, and we expect our new strategic focus to improve margins, allow us to invest in sales and marketing and deliver the financial results to enhance shareholder value.

I'll begin with a brief overview of the first quarter and then provide an update on the progress we've made since our last call in March. I'll then hand the call over to Dan to provide the financial details.

During the first quarter, net revenue was flat with last year at $8.3 million. We're pleased with our ability to hold net revenue flat despite the significant SKU rationalization we implemented last year and the reduced sales in trade spend we had during the quarter versus prior year. We'll begin to turn this marketing and sales and trade spend back on to support the launch of Virgil's Zero Sugar which is shipping to retailers as we speak.

The price increase taken in the third quarter of last year continued to lead to higher average selling prices, which offset lower case volume during the quarter. The price increase, in conjunction with the SKU rationalization and our new glass contract with Owens-Illinois, led to significant gross margin expansion during the first quarter.

Gross profit more than doubled year-over-year, and the gross margin percent increased to nearly 28% from 13% in the prior year, up 1,510 basis points. Gross margin was up 650 basis points sequentially from the fourth quarter last year, which primarily reflects the impact of the new OI glass contract. Note that this improvement in gross margin came despite continued idle plant charges during the quarter, and we continue to believe that our current efforts can deliver further enhancements to gross margin.

We generated a modified EBITDA loss of $700,000 in the quarter, nearly a 50% improvement from the loss of $1.3 million in the same period last year.

In summary, we're very pleased with the improved gross margin performance and the early enhancements to our financial performance as a result of our strategic efforts.

Let me walk you through the plan and our recent progress. As we've discussed in prior calls, there are 5 key components to our transformation and value creation plan. The first phase includes new leadership, new strategic focus, optimizing our business model, improving our capital structure. And the second phase of the plan will be investing in sales and brands to transform our great products and good brands to great brands and drive sales growth and increase brand value.

As we highlighted last quarter, we have successfully built out the leadership team and enhanced the board. We have also completed our plans for a new strategic focus, directing 100% of our resources to growing the Reed's and Virgil's brands.

During the first quarter, core brands accounted for 97% of total beverage revenue. And thus far in 2018, our top 5 SKUs accounted for 73% of total sales, up from 31% in 2016. Our focus will continue to be on core brands and higher-margin products and packages.

We made additional progress in optimizing our business model over the last couple of months, and the results of our Owens-Illinois glass contract was evident in the first quarter gross margin. The strategy is to transform from a capital-intensive self-production model to an asset-light sales and marketing-driven enterprise.

During our fourth quarter call, we announced the receipt of a letter of intent to purchase our Los Angeles manufacturing facility, related assets and the private-label business. We now have a signed LOI with the buyers and are developing and negotiating definitive documents. We remain hopeful for a completion of the transaction this summer. We also continue to progress with the expansion of our strategic co-packing partnerships on both coasts for both bottles and cans and continuing to identify and negotiate improved supplier relationships to further lower our cost of goods.

The fourth pillar of our plan is to improve our capital structure. During the first quarter, we utilized proceeds from our rights offering to pay down stretched payables and are now in commercial terms with all of our key vendor partners. During the first quarter, we also paid down to 0 the high interest rate balance on our line of credit and launched the search for more favorable debt alternatives. We are now in the late stages of finalizing new debt agreements that we expect will lead to better terms and market rates on our asset-based working capital line and will significantly reduce the cash outflow for debt service, which we then plan to redirect toward increased investment in sales and marketing initiatives.

The second phase and fifth pillar of our transformation plan is where Reed's, really for the first time, invests significant levels of capital to drive accelerated revenue growth as well as increased brand awareness, trial and value. We've already added marketing and sales resources, including new broker relations, and soon begin to enhance support of our brands, which will transition us into the second phase of our value creation plan.

The second phase -- in the second phase, we will develop and execute sales-driving, brand-building programs; open new retailer accounts and new doors, including increased investment in slotting and in-store trade programs; drive increased sell-through velocity using public relations, a digital pull campaign and in-store programs such as product sampling and shippers.

Launch -- we're also launching a brand refresh on both Reed's and Virgil's this year, including packaging, website and social media enhancements. The Virgil's refresh is nearly complete, and the Reed's refresh process is well underway.

And finally, we plan to add to our licensed distributor network in order to expand our presence in the on-premise and liquor distribution channels.

We'll begin to see an increase in sales, marketing and promotional spend to support the launch of Virgil's Zero Sugar in order to drive awareness, trial and pull off the shelf. As I noted, we have started shipping product now and have seen a universally favorable response from the trade. More specifically, we're pleased to announce that we have secured national launch commitments from 2 of the largest retail chains in the country, Kroger and Target stores, and we expect to be on shelf before the end of June.

We're also processing orders from our 2 largest distributors that service the natural and specialty retail channels, UNFI and KeHE, as well as numerous regional DSD distributor partners throughout the country. We're in the process of rolling out into several regional chains, such as Harris Teeter, Lowe's Supermarkets, Albertsons Southwest Division and Woodman's. Further launch initiatives include independent and natural supermarket chains, such as Natural Grocers, Mother's Market, New Seasons, Lazy Acres and Bristol Farms. So far, we are very pleased with our sell-in efforts to date and expect to continue to gain new shelf placement in additional retail chains across the various channel categories as the year progresses.

Our tagline, Believe the Unbelievable, is the perfect description of the responses we are getting when partners, retailers, consumers and even investors have the opportunity to taste our product. We believe our Virgil's Zero Sugar innovation is pure genius and has the opportunity to be a major disruptive force in the massive CSD category that has never been able to combine natural, 0 calories and great taste until now.

I have to point out that in this day and age, there is no reason why consumers should still be drinking products with artificial colors, artificial flavors, artificial sweeteners, high-fructose corn syrup and chemical preservatives. And now with the Virgil's Zero Sugar offering, they can avoid everything artificial as well as calories and sugar, all naturally without having to sacrifice the taste.

The same opportunity for significant category disruption exists for our flagship Reed's Ginger Beer line. That is all natural and is made from fresh organic ginger root. Similar to Virgil's, we'll be refreshing all the branding, packaging and digital elements for the Reed's brand. And later this year, we'll be launching a new Reed's Zero Sugar line using the same proprietary natural sweetener system that we're utilizing for Virgil's.

Reed's will also be made available for the first time in cans to help drive increased penetration of the club, convenience store and on-premise channels. We expect these efforts, combined with increased consumer communication in support of the Reed's brand, will change the way consumers view and experience products that sell themselves as ginger beverages, featuring the word ginger on the front of the package but containing no actual ginger in the package or on the ingredient list.

As I hope you can tell, we are very excited here at Reed's by our mission to disrupt and elevate the sparkling beverage category. At the same time, we are also eager to grow our business and enhance shareholder value through the successful execution of our transformation plan. We have made very good progress to date, and we see significant opportunities moving forward. We look forward to updating you each quarter on our progress and continue to deliver improved financial results and shareholder value.

Now let me turn the call over to Dan to run through the first quarter financials.

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Daniel V. Miles, Reed's, Inc. - CFO [3]

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Thank you, Val. Good afternoon, everyone. I'm very pleased to give you these financial results.

During the first quarter of 2018, net sales were consistent with the prior year at $8.3 million, driven by higher revenue per case that was offset by lower case volume. The combination of the higher revenue per case and the 9.6 decline in cost of goods sold on a per-case basis contributed to a more than doubling of gross profit and a significant increase in the gross margin. Gross profit increased 118% to $2.3 million and $1.1 million last year. And gross margin increased, 27.8% from 12.7% in the prior year period.

As Val discussed, our new glass contract delivered a significant margin benefit, driving approximately 900 basis points of the year-over-year improvement and was the primary driver of the 650 basis point improvement in gross margin when compared to the fourth quarter of last year.

Delivery and handling costs increased 28.7% to $1 million or a 250 basis point percentage of sales, reflecting onetime transitioning costs to accommodate new transportation and logistics contracts and generally higher freight costs that have impacted the entire freight industry.

Selling and marketing costs increased 28.6% to $1 million during the quarter. The increase was driven by marketing costs, reflecting a buildout of our new marketing department and support agencies. Selling expenses were flat over year-over-year, and as Val mentioned, we are planning increased investment in selling and marketing to support the launch and ramp-up of Virgil's sugar line beginning in the second quarter.

General and administrative expenses increased 31% to $1.5 million from $1.1 million in the prior year period. The increase was largely due to a higher noncash equity compensation and shareholder-related activities. Therefore, in the first quarter, the operating loss improved to $1.1 million as compared to $1.6 million loss in the prior year period. The interest expense increased 11% to $500,000. We continue to make progress on our restructuring of our asset-based credit agreement and are targeting the midyear completion. Once in place, we expect the average interest rate and lower interest cost moving forward.

The net loss narrowed to $1.6 million or $0.06 in the first quarter of 2018 from a loss of $2 million or $0.14 per share in the first quarter of 2017. Modified EBITDA was a loss of $700,000 in the first quarter, nearly a 50% improvement from a loss of $1.3 million in the prior year and a sequential improvement from a loss of $1.2 million in the fourth quarter of last year.

Moving to the balance sheet and cash flows. We ended up the first quarter with $3.4 million in cash and cash equivalents and a $4.4 million in undrawn credit line availability. During the first quarter, we used in operating activities $4.6 million. And as we indicated in our December rights offering, we used the cash proceeds to reduce the stretched payables by $2.9 million, which enabled us to return to commercial terms with all of our key suppliers. We further reduced $3.3 million to a drawdown on the outstanding balance on our high interest rate of revolving credit line to near 0. The result of the deployment of cash was to reduce the operating costs and position the company to obtain more favorable terms for the net debt that remains.

With that, I'd like to open it up for questions. And so operator, can you take it from here? Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from the line of Anthony Vendetti with Maxim Group.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research & Senior Healthcare Analyst [2]

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I just wanted to start out with Virgil's. I know the launch called the no sugar launch was supposed to be in April. Can you just give us an update on how that launch went and where are we with that launch right at this moment?

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

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Yes. I think last quarter, we said we'd be producing products in April and launching and starting shipment this month, and that's what we've done. And so we're very happy with the initial orders. Like I've walked through a number of major retailer chains that have accepted it for national distribution. So I couldn't be happier with the progress that we've made. And every single buyer meeting we go in, we're leaving with a yes.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research & Senior Healthcare Analyst [4]

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Okay. So you're batting 1,000 then, I guess, on meetings with the 0 -- the no-sugar Virgil's?

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

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Yes. Neal, do you want to jump in? I don't think we've gotten a no yet in terms of every retailer that we have offered and sampled the new Virgil's Zero line with. Neal, want to jump in?

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Neal Cohane, Reed's, Inc. - SVP of Sales & Marketing [6]

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Yes. Thanks. So Anthony, right now, when you say batting 1,000, there is not one person, not one buyer that we walked into that said, "We don't want this." It's now a matter of -- it's a rollout, right? So we will be rolling with our 2 largest -- one of our 2 largest customers out there, our 2 largest national retailers. They will lead the way and carve the path. And then there's going to be a lot of regional chains that you're going to start seeing come on board over the course of the year. It'll start rolling this month, and it will be a continuous roll as we get into -- because each retailer has a different planogram schedule. And as their planogram schedule comes to pass, we will enter into the stores. And we will start sending out press releases letting everybody know the success and the rollout schedule.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research & Senior Healthcare Analyst [7]

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Okay. So it sounds like everything is on target. You were producing it, getting it ready in April. You're going to start shipping it out and rolling it out to some of the stores in May and then throughout the year continue to ramp the production and shipment out to these. A, start with the 2 large national chains and then go from there, is that about accurate?

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Neal Cohane, Reed's, Inc. - SVP of Sales & Marketing [8]

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Yes, that's accurate.

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

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Okay. And then on the core brands, Val, I think you mentioned -- I just want to make sure I got the percent right, so the top 5 SKUs accounted for 73% of sales, but the core brands accounted for 97%. Did you say that? Is that right?

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [10]

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Yes, that's correct. The top 5 SKUs accounted for 73% of total sales. That's year-to-date, and as opposed to 97% was talking about Q1 only.

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

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Q1 only, okay. And then what -- if you're just talking about the core brands, what was the growth 1Q '18 over 1Q '17 for those core brands?

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

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It was flat.

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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, so it's similar to -- okay, similar to Q4.

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [14]

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Q3 -- Q4, exactly. Well, we -- look, we raised capital at the end of December, and it's very difficult to program anything in Q1. Everything has lead times in terms of retailer execution. So our actual investment in trade spending went down in Q1 in anticipation of putting it really against -- in support of the Virgil's Zero Sugar launch. So we had lower -- we had a higher price on our retails because of our price increase last year, and we had a little bit lower volumes. So it netted out to a flat year-on-year comparison on the core beverage.

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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. And then just 2 last questions. One on sales. I know you had hired a couple of brokers. But can you talk about the sales team or the sales strategy with those brokers? And have you hired any other new salespeople to help with these rollouts? And then just an update on the candy business.

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [16]

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Hey, Neal, you want to take the sales strategy moving forward?

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Neal Cohane, Reed's, Inc. - SVP of Sales & Marketing [17]

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Yes, absolutely. So the sales strategy right now is we have a national broker. We started and tested with our national broker starting January 15. We gave them the East -- we'll call it East of Texas territory. We were extremely pleased with results that we're seeing, so we have now expanded their responsibility to the entire country. That is for -- primarily for supermarket chains and natural food stores throughout the country. The progress is going well. We are aligning our sales team with their sales team. So we'll have a small sales team, literally using the new broker as an extension of our sales force. So that's number one. Number two is we're just bringing on board a new broker that will help us enter into the world of Costco and club stores. And that is in works and almost done. So we'll start seeing our brands open up in some of the Costco regions. In other words, we're in the beginning phases of working with a broker right now for our -- the C-store end of the business, which will help us with the national C-store footprint. We'll start getting our Zero Sugar -- Virgil's Zero Sugar cans into the national C-stores.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research & Senior Healthcare Analyst [18]

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Okay. So this new broker is also on the C-store as well as the clubs. And then you -- when you said the national broker you're working with is going to be parallel with the Reed's team, approximately how many salespeople from the national broker are working on the Reed's strategy with you? And then I know your team is relatively small. But you can -- just give us a number of people that are working on it from the national broker side and then your side as well.

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Neal Cohane, Reed's, Inc. - SVP of Sales & Marketing [19]

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Yes. So if you have -- the broker has a large footprint. So we're tapping into a network of about 125-plus sales folks that will be reaching out to every one of the retailers out there. They're in the process of doing that now. And when I said they align with our team, we have a small team of 6 people, and each one is aligned with their regions. So they are there to hold them accountable, to measure results, to make sure that every customer is called on. And it's a very aggressive plan that we have going right now. And as we build and we build revenue, we will continue to add internal sales folks to our team.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research & Senior Healthcare Analyst [20]

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Okay, okay. And then just a quick follow-up. You decided to keep the candy business. Can you just give us a quick update on how that's going?

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [21]

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Yes. We haven't turned a lot of focus on that yet. It's flat Q1 to this year to Q1 last year. Some of the magic will be when we can rebrand, refresh the whole Reed's line. And the second opportunity there is really just putting a person on. Now we actually have a brand manager working on that business. Before, it was an orphan, and they are putting together a strategic plan on how to reenergize the growth. And part of the opportunity is really giving the new brokers that we've brought on board the opportunity to sell this in. And we really currently are selling through our 2 major distributors, KeHE and UNFI. And we've not really offered that up to the broker system as of yet, but we do plan to. So you can imagine now 125 sales reps from our major natural specialty and grocery broker now having a list to be able to offer and sell. We're anticipating some new doors and added distribution by taking advantage of that relationship, but we're really going to start seeing that later in the year.

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Operator [22]

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(Operator Instructions) We now have a question from the line of Paul Strigler with Esplanade.

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Paul Strigler, Esplanade Capital - Analyst [23]

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Congrats on the gross margin progress. In terms of the logistics contract, Q1 looks like it was a glass story. When can we expect to see the contribution from logistics? And how do we think about the logistics contract and how it might help you accelerate the rollout of both Virgil's and the Reed's relaunch, the relaunched product in the cans?

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

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Thanks, Paul. I'll have Stefan, our COO, who's down in those trenches. He can give you an update on that.

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Stefan Freeman, Reed's, Inc. - COO [25]

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Yes. So I would tell you that the one thing that we've been focusing on more than anything else right now is specifically around making sure that we've got the right partner. And so we've got contracts with our East and West Coast partners right now, and we've been focusing in on making sure that they have a logistics portion. So we're doing some 3PL work where we actually have brick-and-mortar warehousing that can actually work with a lot of our customers to do pickups and things like that where they can direct-ship. So some of our customers pick up. And for those customers that pick up, they can actually go in and tender loads directly with the 3PL. And we try and -- so we're working really hard to get that synergy pushed through. And through that, we're able to go in and start negotiating on trying to get the best attractive pricing and make sure that we move our inventory to the customer and get them the service that they deserve and get our products out there and get them out to the marketplace as fast as possible and in an efficient manner.

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

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Yes. I mean, it always takes some time to transition from an old provider to a new provider. And that's sort of -- Q1 has been sort of going up that transition and learning curve. And we hope to start seeing some of the benefits of a more efficient partner in the second quarter.

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Paul Strigler, Esplanade Capital - Analyst [27]

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Great. And in terms of the plant sale, I don't know if I missed it on the call, is there any sort of update on timing of when that may close? I heard signed LOI, but I didn't hear much beyond that.

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [28]

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Yes. We said and we hope to close in the summer, and that's still the plan. We're in negotiations of definitive documents. So we're making good progress, but negotiations are ongoing. And like I said, we had said summer, and we still believe it's going to be completed by the summer.

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Paul Strigler, Esplanade Capital - Analyst [29]

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And can we expect you to net cash on that transaction? I know you can't disclose a specific amount, but will it be a -- will there be cash coming in to Reed's from this transaction at currently sort of...

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [30]

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Dan, why don't you take that one?

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Daniel V. Miles, Reed's, Inc. - CFO [31]

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Yes, Paul. We announced in the K and we're updating again that we do have a cash offer and a release of a financing agreement for the building and the equipment that was here in 2009. So the entire compensation package is in the bound to $2.75 million.

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Operator [32]

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There are no more questions at this time. I'll now turn the call back to Mr. Stalowir. Please go ahead.

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [33]

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Thank you again for your support and for participating on today's call. We're making very good progress with our transformation plan and are looking forward to moving into Phase 2 of value creation strategy later this summer, following the expected sale of our beverage manufacturing facility, which we just talked about, and restructuring our credit line and term loan. We look forward to updating you on further progress on our next call. Please don't hesitate to call with any additional questions. And have a great day. Thanks.

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Operator [34]

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Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.