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Edited Transcript of REED earnings conference call or presentation 13-Aug-18 8:30pm GMT

Q2 2018 Reed's Inc Earnings Call

LOS ANGELES Sep 14, 2018 (Thomson StreetEvents) -- Edited Transcript of Reed's Inc earnings conference call or presentation Monday, August 13, 2018 at 8:30:00pm 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 Second Quarter 2018 Earnings Conference Call for the period ending on June 30, 2018. My name is Jeremy, 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, level of activity, performance or 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 achievement. In addition, any projections as to the company's future performance represent management's estimates as of today, August 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 as 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 is my pleasure to speak with you today to discuss our second quarter performance. We delivered solid sales growth this quarter. We expanded gross margins beyond our 30% near-term target. We saw excellent retailer and consumer response to our Virgil's Zero Sugar launch, and we continue to make good progress on each aspect of our transformation plan.

I'll provide an update on our key milestones and accomplishments in a moment, but let me first introduce you to Iris Snyder, who has joined us as Chief Financial Officer.

Iris brings to Reed's significant leadership and financial experience across the food and beverage industry including her most recent role as CFO of Stoli Group North America. I look forward to working with Iris as we continue to improve the company's capabilities, performance and position the company for accelerated growth of our category-leading brands.

Now let me turn the floor over to Iris to discuss the second quarter financial results.

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

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Thank you very much, Val, and good afternoon, everyone. It's a privilege to speak with you today. I believe there is a significant opportunity at Reed's. We have leading on-trend products, have developed a strategy for improved financial performance and growth, and Val has assembled a strong leadership group. I'm excited to join the team and look forward to meeting and speaking with all of you in the future.

As Val mentioned, we delivered strong second quarter sales growth. Net sales grew 6% to $9.4 million compared to the prior year period of $8.9 million. This growth came despite the significant SKU rationalization that occurred in the third quarter of 2017. Growth was driven by our core brands and included both higher volume and average price per case.

Gross sales of our core brands increased 13%, driven by a 7% volume increase and 6% growth in price per case. The launch of Virgil's Zero Sugar was the primary driver of volume growth, while last year's price increase drove the higher selling price per case.

The combination of higher revenue per case and a 12% decline in cost of goods sold on a per-case basis contributed to an 81% increase in gross profit.

Gross margin as a percentage of net sales increased 1,340 basis points over the prior year to 32%, achieving our near-term target of 30% or better. We also generated 460 basis points of gross margin expansion on a sequential basis compared to the first quarter of 2018. The combination of higher average selling prices, the benefits of the new glass contract as well as reduced idle plant costs contributed to the gross margin expansion.

Delivery and handling costs increased 43% to $1.2 million or 350 basis points higher as a percentage of net sales compared to the prior year. This increase is due to transition charges to new warehouse partners and an industry-wide increase in freight rate.

Selling and marketing costs increased 66% to $1.2 million during the quarter. The 470 basis point increase as a percentage of net sales versus prior year was primarily driven by increased investments in sales and marketing personnel and support agencies and our new broker relationships. The increased investment in sales and marketing is consistent with the company's strategy to refresh and reaccelerate growth of the core brand.

General and administrative expenses increased to $3.4 million in the second quarter compared to $1.3 million in the prior year period. The second quarter G&A includes significant noncash accruals and stock option expense, bonus accruals and onetime severance expense associated with the recently announced plan to relocate our corporate offices to Norwalk, Connecticut.

The second quarter operating loss was $2.8 million compared to a $1.2 million loss in the prior year period. Interest expense decreased to $0.4 million in the second quarter compared to $1 million last year. Other financing costs were $0.1 million in the second quarter related to the change in fair value of warrant liability. This compares to a net benefit of $2.3 million from other financing items in the second quarter of 2017 related to a gain of $3.3 million due to the change in fair value of warrant liability partially offset by $1 million of financing and warrant modification costs.

Net loss was $3.4 million or $0.13 per share in the second quarter of 2018. This is compared to net income of $0.2 million or $0.01 per share in the same period last year, which reflected the benefit of the significant gain related to the change in fair value of warrant liability.

Modified EBITDA was a loss of $1.1 million in the second quarter of 2018 compared to a loss of $0.8 million in the prior year period. A reconciliation of net income to modified EBITDA is included in today's press release. You can access the press release on our website in the Investors section at www.reedsinc.com.

Moving to the balance sheet and cash flows. We ended the second quarter with $1.8 million in cash and cash equivalents and $2 million in undrawn credit line availability. I am pleased to announce that we have executed a term sheet for a new revolving line of credit that is sufficient to repay all of our existing credit agreements at improved terms and reduced annual debt service with the flexibility to provide additional working capital if needed. We expect to enter into a definitive agreement and close on this new credit facility in the near term.

During the first half of 2018, we used cash in operating activities of $10.4 million compared to $3.2 million in the prior year period. The increase primarily relates to payment of stretched payables earlier in the year and investments in inventory during the second quarter. The added inventory is in place to support the planned transition of our L.A. manufacturing operations and to support the launch of Virgil's Zero Sugar. Additionally, given the strong shipments of Zero Sugar late in the second quarter, we also saw higher accounts receivable at the end of June 2018.

Now let me turn the call back to Val to discuss recent business developments and the transformation plan. Val?

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [4]

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Thank you, Iris. As you can see, we're very pleased with the second quarter results. We're delivering growth despite eliminating over 100 SKUs last year. We generated dollar revenue growth for both core brands during the quarter for the first time in the last 2 years. And our top 5 SKUs accounted for 70% of sales, up from 31% in 2016. Our enhanced focus on our core brands positions us to continue driving growth of our category-leading brands.

I'm pleased to report that our sales and marketing efforts are starting to ramp up. We're beginning to see a positive impact from our new broker relationships in terms of expanding our distribution footprint in the natural, specialty, grocery and club channels. This quarter, we anticipate launching a new broker partnership that currently serves over 5,000 convenience store doors in the U.S., which has generally been whitespace for the company.

The launch of the Virgil's Zero Sugar line in May has gone very well with a strong positive response from both retailers and consumers. So far, every retailer that we have sampled and presented to has taken on the product line and we are now authorized in over 5,000 retail doors.

The majority of our distributor network now carries the line, including UNFI and KeHE. We are currently in select Target and Kroger stores across the country, and this month, we've kicked off our roadshow effort at Costco in San Diego. We have also landed strong regional grocery banners such as Stop & Shop, Harris Teeter, H-E-B, Giant-Landover, Wegmans and Market Basket, to name a few.

The Virgil's brand refresh is now complete. The website and social media platforms are up and running, and we're excited to add Jeopardy! champion, Austin Rogers, as our first genius brand ambassador for Virgil's. We have some fun upcoming events planned for Austin and a digital campaign slated to launch later this quarter.

The brand refresh, the new Zero product news and marketing support initiatives will continue to build momentum and drive increased sales and distribution for the Virgil's brand.

The refresh of the flagship Reed's brand is also well underway and the design portion of the process is nearly complete. We're targeting to launch new cans and refreshed bottles by the end of the year.

Additionally, we have completed the formulation work on a Zero Sugar line of Reed's Ginger Beer, which will transform the Ginger Beer category just as we are now transforming the all-natural Zero Sugar Craft Soda category. We are targeting to launch the new Zero Sugar line also by year-end.

The launch will represent a true category breakthrough by offering the only all-natural, Zero Sugar Ginger Beer made with fresh organic ginger root. The new packages and Zero Sugar line are expected to be a key driver of Reed's brand growth in 2019.

Now I'd like to update you on our accomplishments and milestones related to the 5 key components of our transformation plan. The first phase includes new leadership, a new strategic focus, optimizing our business model and improving our capital structure. The second phase of the plan and the fifth key transformation component, which I just gave you a brief update on, is investing in sales and brands in order to drive accelerated growth and increase brand value.

I'm happy to report that we've had -- we've made good progress on each aspect of the business model optimization plan points during the second quarter.

In terms of new leadership, I'm pleased by the organizational improvements happening across the company. We recently announced several significant additions to our senior management team that are already having a positive impact on the organization. Our goal is to add new leadership capabilities and develop new processes and systems across each functional area to drive increased efficiency and effectiveness and improve overall company performance.

In addition to Iris, we recently added the appointment of Phil -- we announced the appointments of Phil Trotman as Director of Marketing; Beth Brown as Director of Supply Chain and Procurement. And I would now also like to welcome and announce the addition of Tilde Zimmerman as our new Director of Logistics.

Phil spent his career in marketing and advertising for high-growth consumer brands. He managed large blue-chip brands at Colgate-Palmolive and then supported the growth and development of smaller CPG brands as practice leader at Diadem Partners.

Beth was most recently Senior Supply Chain Manager at ZWILLING Henckels, and has considerable supply chain experience in the beverage industry having served in multiple operational management positions at Diageo America and at Pepsi Beverage Company, with a focus on systems and continuous process improvement.

Tilde was most recently Director of Transportation for Children's Place and brings considerable logistics leadership experience in the food and beverage industry from her management positions at PepsiCo, The Dannon Company and Heineken USA.

I also want to take this opportunity to give a special thanks to Dan Miles for his contributions to Reed's and all of his hard work and dedication during our transformation effort. Dan has been a great partner and an important asset to Reed's for several years and we really appreciate his continued commitment to support a smooth CFO transition.

In terms of benefits from the company's new strategic focus on the core beverage brands, the second quarter results delivered continued gross margin improvement and a reacceleration of core brand sales growth. All of our resources are now deployed against our 2 core brands and a more focused number of top-selling, higher-velocity SKUs. This will allow us to achieve greater returns on the investments we make from innovation to marketing to sales support.

In terms of optimizing our business model, improving our margins and profitability and lowering our need for CapEx investments, we're committed to exiting our L.A. manufacturing plant by year-end and completing our transition to an asset-light sales and marketing company.

We are well along the preparation process for transitioning manufacturing, including bicoastal co-packing relationships and building additional inventory in preparation of exiting the plant.

Concurrent with exiting the plant, the next evolution of our transition to an asset-light sales and marketing-focused model is to relocate our corporate operations to Norwalk, Connecticut. The team we have and are adding to is East Coast-based and the new location provides us with access to high-level agency support resources and a significant talent base as is evident by our recent leadership additions.

In terms of our capital structure, as Iris mentioned, we executed a term sheet for a new revolving credit line that is sufficient to refinance all of our outstanding credit agreements, reduce our annual debt service at improved terms and provide additional working capital, if needed. We went through a broad process looking at numerous potential structures and lenders and are pleased to be wrapping up these efforts in the near term. The improved financial terms and reduced debt service will allow us to fund incremental investments in sales and marketing, driving improved growth and financing performance.

As I hope you can tell, we're very excited here at Reed's by our mission to disrupt and elevate the ginger beverage and Craft Soda categories en route to becoming the Sam Adams of natural craft beverage. At the same time, we're also eager to grow our business and enhance shareholder value through the successful execution of our optimization plan.

I'd like to take this opportunity to say that it's been an honor and a pleasure leading Reed's this past year. And I want to thank the entire team for their continued support, their passionate belief in our mission and their tireless dedication to drive significant change and improvement at the company.

I'm very proud of what we've been able to accomplish in a very short amount of time. We have 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 in continuing to deliver improved financial results and shareholder value.

With that, we would like to open the lines for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of David Bain from Roth Capital.

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

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Congratulations on the quarter. First, I was going to ask you about the plant sale with regarding just the timing. You remain in negotiations, I believe, it said. And I guess the question is, are those negotiation specifics -- are those hurdles that you believe could put the timing of the sale at risk? Or are these less material items?

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

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Yes, the negotiations -- the deal is fairly complex with a lot of different parties and contracts, and we're still in parts of negotiations in terms of documentation as well as terms. So I mean, I anticipate kind of wrapping up the sale process and having more of a definitive position in terms of a go/no go in the following few weeks.

We're -- at the very least, we're committed to exiting the L.A. plant one way or another by the end of the year. So we're working hard to land the sale, but we're also prepared to execute against a different strategy if that sale doesn't materialize. But in any case, Dave, we're absolutely planning on exiting the plant by the end of the year.

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

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Got it. Okay. And then, Iris, I didn't see the Q come out yet, and I was hoping to get a case volume breakout for Reed's, and in particular Virgil's for 2Q.

And then, Val, with respect to Virgil's, are there any, like, anecdotes or feedback from customers that you can give us to kind of gauge sell-through at this point and any color intra-quarter on the Virgil's 3Q case volume trends relative to 2Q?

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

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He said a few in there.

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Iris Snyder, Reed's, Inc. - CFO [6]

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This is Iris. So the Q will be coming out at 5:00, so in about 10 minutes. And we will be updating the table that's been there in the past so by quarter and we'll have 2018 Q1 and Q2 sales price and cost of goods per case and Reed's and Virgil's volumes. So that will be noted in there.

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David Brian Bain, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [7]

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Okay.

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [8]

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Yes. And in terms of response, yes it's been -- we probably started hitting shelves the end of June, beginning of July. So it's really too early to start measuring, let's say, repeat orders. Retailers are just figuring out what the velocities are.

Anecdotally, yes, I see a lot of half-shopped shelves at Kroger and Ralphs and at Target. So we're very happy with the rate and the percentage of acceptance of getting on-shelf. And so far, from what we see inside -- in the field, we're seeing good sell-through but I can't really give you specific metrics. It's just too early to call.

And even if we give you metrics on the first sort of purchase pattern, it really matters to go through a couple of cycles to see what the repeat is. I mean, a lot of people will try something new. The magic is if you've really hooked them as a loyal user. So we will provide any -- the feedback as we get it, once we feel that there's a stable story to tell.

But so far, anecdotally, it's been very positive. I just came from a roadshow that we launched in -- at Costco and we sampled hundreds of people with a lot of smiling faces and a lot of sold products. So, so far so good on sort of the retailer and consumer acceptance of the Zero Sugar line.

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David Brian Bain, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [9]

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Very good. And then one more, if I could, just on the new Ginger Beer product launch. At this point, just from a modeling standpoint, I mean, when you look out, do you expect sort of a similar cadence of adoption for this product that we are seeing so far with the Virgil's new product rollout? Or is there any reason to believe that, that would change in terms of the rollout?

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

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Yes, that's a good question. I mean, I think Reed's has a little bit better footprint in general in the market and selling in a Zero Sugar product in a glass -- we'll be offering glass and cans.

So it's pretty close in, in terms of you've got a full sugar version. We have a Zero Sugar version and it's a little bit less of a complex sales story. With Virgil's, it was really the first time we were in cans and we're -- and given that Virgil is a little bit less widely distributed, there was more sort of new territory that we were trying to carve out.

So I would think that the Reed's Zero Sugar should follow the same cadence, if not a little bit better. But definitely at the very least, the same sort of momentum.

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Operator [11]

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Our next question comes from the line of Anthony Vendetti from Maxim Group.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research & Senior Healthcare Analyst [12]

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So on the expense side, just wanted to focus on a couple things. Shipping expense seems to be increasing across the industry. Any other factors there? Or is this just the industry trends and something we should expect to see as an increased cost going forward?

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [13]

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Yes. I'll try to answer that, and then I'll have Stefan Freeman, who's the COO, jump in if I don't cover it. The -- there is definitely a significant increase in terms of freight rates given the new requirement -- limit on driver hours and fuel.

There is also a portion of the increase, driven by our transition from our old logistics provider to our new logistics provider. And that transition, there were -- it wasn't as smooth as we'd hoped it would be. I think now we're fully up to speed in terms of transitioning to the new provider.

And I have to say, one of the things I'm looking forward to and why I mentioned Tilde Zimmerman coming on is we're really bringing in the right talent to wrestle that entire portion of our P&L down. She comes with deep experience from Heineken and Pepsi, and I really anticipate her making an immediate impact, a positive impact on our whole process in that area and hopefully wring out some of the inefficiencies that we still have in terms of selling, distributing and warehousing.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research & Senior Healthcare Analyst [14]

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So it's possible then -- and maybe, Stefan, you can answer this if Val can't and Iris is -- can jump in as well. But as a percent of revenue, do you think shipping expense will start to moderate as a percent of revenue? Plateau? And then with the new logistics in place, could -- when do you expect it to actually, as a percent of revenue, decrease?

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [15]

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Hey, Stefan? You're probably on mute. Anyways, do you want to? Or?

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

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Go ahead.

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [17]

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Yes. So from that standpoint, Anthony, we're thinking that we're kind of peaking right now in terms of inefficiencies, our transition and current sort of industry increases. We hope that it's going to stabilize and moderate. And then over time, we expect it to come down. I'm not sure if we're going to hit historical levels, but I think we're absolutely going to move as a percentage of net sales lower than where we are today.

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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, great. And then with -- you've brought on, obviously, a highly experienced new team. G&A went up this quarter, so that's probably a good segue to that. But -- and then there were some severance payments that's, obviously, primarily onetime.

But how should we think about G&A going forward, other than taking out that -- those severance payments? Should we think about this as the new normalized G&A as we move forward?

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Iris Snyder, Reed's, Inc. - CFO [19]

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Yes. So well, that's a great question. Let me talk to a little bit about that. A lot of what's in the G&A is, as you said, onetime. So the onetime severance was about $640,000.

We also had a bonus accrual in there. So at the beginning of the year and in Q1, we did not make a bonus accrual. But this quarter, as we're starting to perform and meeting our numbers, we put in an accrual assuming 100% payout. We will evaluate that over time.

And so really, this quarter was a catch-up. We accrued for Q1 and for Q2. So going forward, that will normalize and go down. So those 2 items combined are well over -- are over $1 million right there.

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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 on the move to Connecticut. Val, can you talk a little bit about how much space you need there? Obviously, you're transitioning out of the L.A. plant by the end of the year. How much space have you leased out? And how many people will be based there at the Norwalk facility?

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

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Right. So we've got a negotiated lease. It's a sublease actually. I can't get into too many details because they haven't signed their portion yet. They need to get landlord approval. It should be any day now once we consummate that and we can announce it and 8-K that.

But the office space is really a -- it's an A building and an A space. We've got about 8,600 square feet, and we've negotiated to only pay for 4,600 of that for the first 3 years. So it anticipates all of our needs in terms of growing over time. We'll probably have less than 20 people to start. I don't see us growing beyond 30.

So we can absolutely -- I can see us really just being in the same space for many, many years to come. So we're excited to be there. It's got everything that we want in terms of convenience and on the metro lines for the tri-state area. And so it's definitely more than we need today, but our plans are to grow into that over time.

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Operator [22]

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Ladies and gentlemen, there are currently no more questions at this time.

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Valentin M. Stalowir, Reed's, Inc. - CEO & Director [23]

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Great. Well, thank you, again, for your support and for participating on today's call. We're encouraged by the progress we're making and we're excited for the next chapter of Reed's. We look forward to updating you on further progress on our next call. Please don't hesitate to call with any additional questions or comments, and have a great day. Thank you.

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Operator [24]

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