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Edited Transcript of REED earnings conference call or presentation 24-Apr-17 5:30pm GMT

Thomson Reuters StreetEvents

Q4 2016 Reed's Inc Earnings Call

LOS ANGELES Apr 26, 2017 (Thomson StreetEvents) -- Edited Transcript of Reed's Inc earnings conference call or presentation Monday, April 24, 2017 at 5:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Daniel V. Miles

Reed's, Inc. - CFO

* John J. Bello

Reed's, Inc. - Chairman of the Board

* Stefan Freeman

Reed's, Inc. - Interim CEO and Director

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Conference Call Participants

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* Anthony V. Vendetti

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

* Mitchell Brad Pinheiro

Wunderlich Securities Inc., Research Division - SVP and Senior Consumer Research Analyst

* William S. Smith

Wm Smith & Co. - President

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Presentation

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Operator [1]

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Good morning, and welcome to the Reed's 2016 Earnings Conference Call for the period ending December 31, 2016. My name is Kathy, and I will be your conference call operator today. Today's call is limited to 1 hour, and we'll start with the prepared remarks of Dan Miles, Reed's' Chief Financial Officer. Also on the call today, we have John Bello, Reed's Chairman of the Board; and Stefan Freeman, Reed's Interim Chief Executive Officer. Following management remarks, they will take your questions. As a reminder, this call is being recorded April 24, 2017.

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 remarks may contain forward-looking statements that are subject to risks and uncertainties, and that management may make additional forward-looking statements in response to your questions. 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. Non-GAAP financial information is not meant as a substitute for GAAP result, but is included solely for informational and comparative purposes. The company believes that the presentation of the 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 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, April 24, 2017. Reed's Inc. assumes no obligation to update these projections in the future as market conditions change.

I will now turn the call over to Mr. Miles who'll begin with the prepared remarks.

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Daniel V. Miles, Reed's, Inc. - CFO [2]

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Thank you, Kathy. This is Dan Miles, Chief Financial Officer for Reed's Inc. Today, the company issued 3 press releases. One announced the transition of Chris Reed to the new role of Founder and Chief Innovation Officer of Reed's and named Stefan Freeman, our operations-focused board member, to the role of Interim CEO. Our second release announced a $3.4 million financing transaction. And the third press release announced our financial results that we'll discuss.

On today's call joining me, we have John Bello, the Chairman of the Board of Reed's Inc.; and Stefan Freeman, our new Interim Chief Executive Officer. Chris Reed wanted to announce directly to you his new role, but he is on a flight to Europe for a conference, where Chris will be presenting as a speaker and a panelist. Chris will represent Reed's at the 13th annual InnoBev Global Conference Congress in Frankfurt, Germany. Chris looks forward to seeing you at the future trade shows and other beverage industry events. Please stop by and say hello.

I'm now going to turn the call over to John and Stefan. When they conclude, I'll go over the 2016 results, at which point, we'll take your questions.

John, I'm going to turn the call over to you now.

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John J. Bello, Reed's, Inc. - Chairman of the Board [3]

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Thank you, Dan. Hello, all. It's an honor and pleasure to introduce myself to Reed's shareholders and investing partners. Let me start by saluting the past before looking to the future. Chris Reed is a legend, and his brands are iconic in the beverage industry. He has pioneered the way nonalcoholic beverages are produced. He was a man ahead of his time in creating all-natural healthier beverages almost 30 years ago, well before the shift to wellness and better-for-you trends became a reality. But those trends are reality today. The product lines that Chris has created and refined in Reed's Ginger Brews, Virgil's Natural Lines and carbonated soft drinks will fill the voids created by the decline in sugared, preserved sodas offered by the major players Coke, Pepsi and Dr. Pepper. The future of the nonalcoholic beverage industry belongs to Reed's.

Chris' decision to step aside from day-to-day operations at Reed's was discussed when Chris and I spoke about me joining the Reed's board last year. At that time, we talked about its development pipeline and I was beyond impressed. He had concepts in the works that were big, timely and relevant to current consumer consumption trends. The beverage industry is a designer industry. Its mojo is dependent on product concepts that are exciting, new and different. Snapple, AriZona and my own SoBe that was sold to Pepsi for $370 million reflect that trend. Chris' development portfolio is a treasure trove of exciting new and different ideas that must be cultivated and nurtured. Product development takes time, and Chris realizes that it wasn't practical or possible for him to do it all. We are at a transitional time in the soft drink industry, and I hesitate to call it soda because Reed's products are so much more than sodas. But now it's more important than ever to get new products to market quickly and efficiently and of course, profitably. This brings us to today's announcement and the naming of Chris as Chief Innovation Officer where he will spend time, energy and his considerable talent devoted to new products and R&D projects. We, Chris and the board together agree that now was a time to unleash Chris' enormous creativity that he should devote himself full time to bringing his concept and vision to fruition in his new role. In that capacity, Chris will be working to add to his legacy as a beverage innovator and pioneer. He and I will work together to find a full-time CEO replacement who will add dimension and scope to the management team and the Board of Directors. This process has already begun. We will be working with a search firm to accomplish this.

Now on to the future. I have hinted in the above comments about Reed's' future. We are committed to getting Reed's back on track and taking the company to the next level and beyond. The supply outage of 2015 impacted Reed's retail presence, allowing inferior and higher-priced ginger products to gain shelf space and traction at our expense. We are in the process of reclaiming that space, but it will take some time and we are working off a new volume base. While we do this, we must improve margins dramatically to generate positive cash flow, which we plan to reinvest in marketing and sales to drive growth. To succeed, Reed's need to transition into a focused sales and marketing company. With that initiative and the new financing announced today, we are moving ahead into the future and into a new era for Reed's that is focused on strong profitability, growing cash flow and enhanced shareholder value while keeping the brand fresh with innovation and excitement. I know my way around the beverage space. I will be working with the sales organization to open doors at new channels such as up and down the street accounts like 7-Eleven and liquor stores and on-premise restaurant and bar accounts to take advantage of the explosion in popularity of mixed drinks like Moscow Mules and Dark 'n' Stormy, which use ginger beer as its base. We should own that space, along with the healthy refreshment category in natural and in broad market. We have the best craft product and a great sales force, which we will unleash with programs and resources and a steady stream of product news.

The brand continues to sell, but the equation is simple. It must sell profitably. We are working to improve margins with pricing. As a market leader with premium ingredients and broad consumer awareness, Reed's reach should be leading pricing not lagging competition by up to $2 a 4-pack on the shelf. This is an easy fix and it's already under way. We make the best product in a growing category. We use superior real ingredients, yet we are generally the lowest price bottled craft soda. This doesn't make any sense from a branding perspective, and certainly doesn't reflect the quality of our product offering.

Premium products deserve premium pricing, and we believe as a top volume seller that we can support this strategic initiative without impacting sales or velocity. Improved cash flow will allow for more marketing spend to expand our consumer base, insulate Reed's from competition and in turn, drive more sell through for our retail partners.

The other side of the margin equation is cost of goods, which is a function of efficiency and supply chain and operation. We are fortunate to have Stefan Freeman available to step in as interim CEO with a focus on fixing operations and improving cost of goods. Stefan's life work in beverage has been in operations. As a board member, he is aware of the supply issues that have impacted Reed's. He has some immediate ideas on how to moderate and reduce cost, and that process has already begun.

In closing, I want to thank you, our shareholders and colleagues and the investment community as well as our suppliers and retail partners. Lastly, I want to reinforce that your Board of Directors will be tireless in making Reed's a world-class organization, making Reed's a marketing sales juggernaut and making Reed's the leader in the emerging health refreshment category and in the lifestyle category fueled by Reed's Moscow Mules. And most importantly, driving shareholder value as is our utmost priority.

I would like now to hand the call over to our Interim CEO, Stefan Freeman.

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Stefan Freeman, Reed's, Inc. - Interim CEO and Director [4]

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Hey, thanks, John. Good morning, and thank you for joining us today. Today is a transitional day for Reed's and I'm very excited to have the opportunity to work with a company that truly brews the best craft beverages in North America.

As John said before, Reed's has great potential and is positioned to build on its craft brewing heritage to become the leader in the beverage industry and the craft brewing arena once again.

As John mentioned, I joined the board of Reed’s late last year and have already started evaluation of the supply chain operations and the opportunities that drive better margins through improved efficiency. This has been my area of expertise in the beverage industry for the last 20 years, where I've worked for Pepsi, Dr. Pepper, and most recently as the regional Vice President of Manufacturing for Coca-Cola where I oversaw 8 manufacturing facilities located throughout the West Coast. With those facilities, I was accountable for producing 231 million cases and revenue generation of more than $500 million annually. I will take advantage of my past experience in this area to support sales operations, manufacturing, distribution, warehousing, procurement and transportation to drive those efficiencies in the supply chain which will free up cash for sales and marketing.

Now turning on my focus to Reed's. Our first step to turning things around is for management and the board to complete our deep assessment of strengths, opportunities and challenges to deliver strategies and tactics focused on sales, marketing and margins to revive the Reed's brand. I will be working out of the corporate headquarters at the L.A. plant which allows hands-on assessment of our current situation, and being in the office will give me additional insight into the day-to-day operations that are now visible at -- that are not visible at the board level. I look forward to working with the great team at Reed's, and as we realign the company culture around teamwork, transparency and innovation. Our employees are our greatest asset and has excellent ideas to building the brand and the business, and I look forward to exploring that further with them. The findings that we have will be utilized to rebuild our presence in our current retail channel and to target new shelf space in the convenience and gas channels, where we have very limited exposure and see significant growth opportunities.

By leveraging our people and existing company assets teamed with our co-manufacturing partners, we can produce our brands closer to the customer, reduce overall supply chain cost and increase service levels. We believe that more efficient supply chain strategies coupled with product innovation, which includes new low-calorie sodas and beverages, we could focus our specific product offerings that will take Reed's to new heights.

In the coming quarters, I will be announcing our marketing plans in conjunction with the release of our new low-calorie craft sodas. If you ask how we can do this, we will enhance our profitability and cash generation through price optimization and greater supply chain efficiencies that will allow us to reinvest in marketing and sales. Dan earlier talked about the fact that we just received a $3.4 million investment, which we received today from Harbor Venture Capital. Harbor Venture Capital strengthens our financial position and helps us on the path to sales growth, better margins and enhanced shareholder value. The investment from Harbor is smart money for us and they are looking to help us drive growth through the use of their network and experience. I'm excited to work with this strategic group who we believe will be good partners for the company and generate real shareholder value. I believe, as does the rest of the Board of Directors and leadership team at Reed's, that a revolution is about to take place within the national beverages market and our partners and shareholders are going to benefit from being a part of this revolution.

I will now turn the call over to Dan, who will discuss our financials. These are exciting times for not only myself, but for Reed's, and I look forward to updating you on our progress.

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Daniel V. Miles, Reed's, Inc. - CFO [5]

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Thanks, Stefan. We'll talk about the financials here and then get to your questions. I'm sure you've got many. So feel free to hold those until I get done with the financials. And then we'll take your questions.

Gross sales for all of Reed's products decreased 7% to $46 million for the year ended December 31, 2016 from $50 million the prior year. As in the past, we've used the 8-ounce serving size to keep beverage information uniform. Our total sales volume for all beverages decreased 5%. The Reed's ginger-based beverages increased 0.5%. Reed's variety beverages were up 4%. And net private label beverages were up 0.5%. Virgil's decreased 10%, and Reed's Kombucha decreased 54%.

Our gross dollars for all beverages decreased 6%. Reed's ginger-based beverages increased 2%. Reed's variety beverages were up 4%. Net label beverages were also up 4%. Virgil's decreased 10% in line with the volume, while Reed's Kombucha also in line with the volume decreased 54%. Gross sales were unchanged at $12.16 per 8-ounce case.

Sales were down an average of 9% in all selling channels. All customers representing 1% of sales in 2015 were still customers in 2016. We believe that, that fact we are still in all of our major accounts yet with the declining volume, this represents consumer preference away from all-sugar sodas, including natural-based products.

In response to the general consumer trends, the company research and development efforts have focused on natural alternatives that have 12 calories per 12-ounce serving. We're in test in the marketplace that have successfully proven the technical viability and expect these to have -- these offerings available in the public as soon as practical.

Gross sales of such items such as the nonbeverage items such as candy, packaging and mail order were not discussed in that above areas. These items as a group totaled $1.7 million in gross sales which decreased about $740,000 or 31% over 2015. This is due directly to the California lawsuit that required the company to find the reliable suppliers. That has been accomplished now.

Promotional and other allowances have, for beverage products, decreased 1% into $3.7 million or 8% of gross for the year ended December 31, 2016. The promotional discounts on an 8-ounce equivalent increased 4% or $0.04 a case to $1.02 from $0.98 from 2015. This increase is primarily attributable to an increase in promotional programs and discounts offered in the fourth quarter of 2016 over a lower sales volume in the same time frame.

Net sales of all items decreased 8% to $42 million from the year ended December 31, 2016, from $46 million the prior year. For beverage products, the net sales of 8-ounce equivalents decreased in 2016 by 3% to $11.60 from $11.92 a case the prior year. The total cost of goods sold associated to that also decreased $33 million in the year ended -- from $33 million, a decrease of $853,000 or 3% from 2015. This decrease was due to a net volume decrease of the 8% and increases in the cost of production. Specific production cost that comprised the additional $2 million or $0.65 per 8-ounce case was comprised of direct write-offs of inventory of $705,000 or $0.19 per 8-ounce case, packaging cost of $0.33 per 8-ounce case, ingredient cost of $0.23 per 8-ounce case. These increases were partially offset by labor productivity decreases of $0.05 per 8-ounce case and a decrease in the reserve for obsolescence of another $0.05. Overall, our gross profit declined 23% from 2015. As a percentage of sales, our gross profit decreased 21% and -- to 21% in 2016 compared to 25% in 2015. As noted above, the gross profit is a result in the decrease in the net selling price of 4% and an increase in the cost of goods sold of 7%.

For our operating expenses, delivering and handling costs decreased to $4 million in the year ended December 31, 2016, compared to $5 million in 2015. That 23% decrease is due to higher full truck quantities. Current rates of 9% of delivery costs are compared to the historic costs and the company expects those decrease that we experienced '15 over '16 to continue as the L.A. brewery plan is finalized.

Selling and marketing expenses for the year were $4 million or another decrease of 24% when compared to $5 million in 2015. The decrease of $1 million is the direct result of labor cost savings of $461,000, sales operations of another $188,000 and sales support of $500,000. Our sales staff decreased from 16 full-time equivalents from 17 in the prior year.

General and administrative costs for the year were $4 million or an increase of 2% from 2015. The total increase of $66,000 is due to decreases in administrative wages of $250,000, operations of $150,000, but an increase in administrative support that include administrative -- an impairment losses in the China Cola brand. General and administrative staffing also decreased to 13 from 15 in the prior year.

Overall, the loss from operations was $3 million in the year ended December 31, 2016, as compared to a loss of $2.7 million in the prior year, or an increase of $300,000, or 12%. This increase, as noted a little earlier, is due to impairment of asset charges and a change in the warranty liability.

Noncash transactions. Interest expense increased $500,000 when compared to the same period in the prior year. During 2015, the company's losses incurred liquidity shortage that required the infusions of capital and hence the interest rates increases. As of December 31, 2016, we have a stockholders deficit of $1.7 million and a working capital deficit of $1.6 million, compared to equity of $785,000 in working capital, $730,000 in the prior year. The decrease in our working capital of $2 million was primarily the result of cash flow from operations. The decrease in cash and cash equivalents of $1.4 million was primarily result of cash generated by financing activities of $1.6 million, less the cash used for the plant improvements and cash used for operations of $2.5 million. It should be noted that in the cash for operations, your company paid down $1.5 million to vendors and reduced $1.1 million in inventory. Those trends -- those positive trends continue into 2017.

It should be recognized that the 2015 chain supply interruption have a significant negative impact on the company, and we are still feeling the lingering impact. When we did get back into stock on our core items, our customers did not replace the full line of beverage offerings, and the Kombucha brand lost significant placements in the marketplace.

In 2016, the company did fix the supply chain by delivering 90% -- 97% of all orders on time. We continue to focus on production cost improvements and anticipate better margins driven by improvements in ingredient usage, package pricing and soon, overall labor costs. The L.A. plant infrastructure upgrade, although not fully completed, has already begun generating cost reductions primarily in utility usage from the better operating efficiencies. The company expects to report revenues for the first quarter of 2017 of approximately $8.3 million versus $10 million in the same quarter the prior year. That lower sales volume is anticipated to have an impact on both gross margins and operating margins.

So in closing, our focus is driving sales through innovative new products and improved marketing. The company is under the brand new leadership and operations is aligned to support the anticipated growth that we believe will produce better margins and enhance shareholder volumes. Thank you for the time of listening to the financials, I want to turn the call over to the operator for us to take your questions. So feel free to ask either John, Stefan or myself specific questions at this time. Thank you. Kathy?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of Mitch Pinheiro with Wunderlich Securities.

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Mitchell Brad Pinheiro, Wunderlich Securities Inc., Research Division - SVP and Senior Consumer Research Analyst [2]

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I guess, first, I want to start big picture here. Maybe a question for John or Stefan or both. But so it's going to take time to get back on track, as, I think, John may have said that, to get back your shelf space, improve operating margins. What kind of -- like, what are you thinking in terms of time line? I mean, are we talking -- when do we see tangible improvements? 6 months? 1 year and 6 months? And what would be the biggest issues around -- what is the #1 challenge that you have to overcome?

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John J. Bello, Reed's, Inc. - Chairman of the Board [3]

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I'm happy to take that question. This is John. I've been very involved in the sales side of this since November when I came on board. I'm very impressed with the sales team. It's been somewhat handcuffed by lack of resources and some supply issues. Once supply is up and going and we can ship full loads, I think you're going to see a fairly, I won't say rapid improvement, but as we go into the sales season this year, I think you're going to see some -- an uptick and a reclaiming of a lot of our shelf space. Our core brands are doing great in terms of Virgil's, in terms of Reed's, where we've had a decline, it's basically in the Kombucha, which requires a relaunch. It's a platform which we focused on. I think the biggest thing that we need to do before we really turn on the spigot is to get our margins in line, with pricing and with cost of goods. We're selling a lot of products but the margins are inhibiting and we're not producing the cash flow that we should be. So the first thing we're going to do is basically get cost down, take pricing where we think we can and apply those. It will take 3 to 6 months for those price -- for those pricing to reach us at retail and for us to realize the benefits. So I would say that throughout the course of this year, you will see an uptick. I'm excited about it. We're already starting to see some light from the brand.

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Mitchell Brad Pinheiro, Wunderlich Securities Inc., Research Division - SVP and Senior Consumer Research Analyst [4]

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So -- but you know when it comes to cost saves, it's done, Reed's has taken out a fair amount of cost over the last 1.5 years. And so you still think there's a lot more to do? I mean, significant?

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John J. Bello, Reed's, Inc. - Chairman of the Board [5]

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Yes, just in shipping. Just in shipping. We've been shipping product all around the country. And just improving -- putting production where our business is, we'll save a ton of money with that. It's significant and that hasn't occurred yet.

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Mitchell Brad Pinheiro, Wunderlich Securities Inc., Research Division - SVP and Senior Consumer Research Analyst [6]

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Okay. And -- but would you take -- so you're going to be saving a lot of money, how much needs to be reinvested on the sales side? All of it?

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John J. Bello, Reed's, Inc. - Chairman of the Board [7]

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I think that's a fluid number. I think we want to upgrade the sales force or expand it. We are competing with major sales forces out there that are chipping away at our space. We need to get our distributors focused and excited about the product with the improved margins for us, their margins will improve as well, and I think you'll see a lot more focus and attention to the brand. In addition to that, I just mentioned 2 channels of trade, the up and down the street channel, which we have no involvement in, and the on-premise liquor store channel, which frankly, our competition made their way into the marketplace through that channel and Reed's got its start in the natural channel. And we have yet to really take advantage or exploit this explosion in mixed beverages for ginger products. And we're already working on that. We’ll test that 7-Eleven if you -- and we've already opened up a couple of new liquor distributors. So that's -- we're going to get some increased volume from there, but that volume needs to be profitable, and I think that's our first priority, to make sure that, that happens.

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Mitchell Brad Pinheiro, Wunderlich Securities Inc., Research Division - SVP and Senior Consumer Research Analyst [8]

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Okay. And then when you look -- any update from -- and maybe where are the priorities? Does fountain beverage, where does that fall? And any update on how the testing has gone?

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John J. Bello, Reed's, Inc. - Chairman of the Board [9]

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Dan, you want to talk to that?

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Daniel V. Miles, Reed's, Inc. - CFO [10]

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Yes. We have -- Mitch, we have put out the fountain in the marketplace. And when I said we had proved the technical viability of it, the customers need to develop what is their marketing strategy around those new offerings. While they do that, we're continuing to look at not only the products we develop for them, but how do you roll that out further into the marketplace. And that's where I talked about the 12 ounce -- 12 calories per 12-ounce offerings. To what John had talked about earlier, we need to go to the marketplace with that with the rightest set of financials so that we can properly execute in the marketplace with solid marketing dollars behind that. We are -- with the latest fundraising, we believe we're in the place to do that.

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John J. Bello, Reed's, Inc. - Chairman of the Board [11]

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Let me just comment on the fountain, a very complicated business, a different business for us, not in our mainstream right now. We think there's a lot of opportunity there based on the whole issue with sugar with the mainstream beverage companies. We're working on that. Again, you need resources in order to do it right and the last thing we want to do is do it wrong. So we're going to take our time and energy to make sure that that's done in a way that's productive and works and we get a test that -- beta test that is scalable and we can roll out. The new product introduction that I think is important for us is reduced calorie. All-natural, sweetened systems that, frankly, Chris has perfected. Best I've seen in my time in this business. And that's a focus that we are going to accelerate because I think that's where the opportunity is as the market begins to -- or has created for sugary beverages. And even non-nutritive sweeteners like aspartame and sucralose.

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Mitchell Brad Pinheiro, Wunderlich Securities Inc., Research Division - SVP and Senior Consumer Research Analyst [12]

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And when does low-calorie -- when should we begin to see that?

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John J. Bello, Reed's, Inc. - Chairman of the Board [13]

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I think we're 6 months out from that. Because we really want to do that thing right from a packaging standpoint, a positioning standpoint and make sure the flavor system can, in fact, be manufactured and then introduce it. We have a plan to do that in a way that will work near term -- midterm and long term. Again, we don't want to hurry something that is not going to -- that we're not going to do right.

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Mitchell Brad Pinheiro, Wunderlich Securities Inc., Research Division - SVP and Senior Consumer Research Analyst [14]

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Okay. And then I guess, just last question focusing more on the near term here. If -- Dan, if I did the math right, was revenue down 25% in the first -- in the fourth quarter?

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Daniel V. Miles, Reed's, Inc. - CFO [15]

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Yes, 26.2% to be exact.

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Mitchell Brad Pinheiro, Wunderlich Securities Inc., Research Division - SVP and Senior Consumer Research Analyst [16]

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26%? Okay. And so that's a big drop. I mean, that's like what -- how do you explain that?

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Daniel V. Miles, Reed's, Inc. - CFO [17]

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In the -- well, we've matched up October to October, October '15, as you know, was our record month for the company as we came out of the 2015 supply chain interruption. So we went up and we knew going into the fourth quarter we had a headwind. The unexpected headwind was in the Virgil's brand. We've been working on it. And that, we believe, is reflective as they kind of highlighted somewhat is that the consumer preference to it. So we took large hits into the Virgil's brand itself. We believe we're repositioned, as John says, to come out and continue back into its growth into 2017. We're optimistic we'll be there in 2017. But as I indicated a little bit of the outlook into 2017, there is headwinds. Our Reed's brands continue to maintain and hold their place.

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Mitchell Brad Pinheiro, Wunderlich Securities Inc., Research Division - SVP and Senior Consumer Research Analyst [18]

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I didn't quite understand that on Virgil's. Let me just ask a question, do you ask quarter-to-quarter, or first quarter versus last quarter of last year?

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Daniel V. Miles, Reed's, Inc. - CFO [19]

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Yes, fourth quarter to fourth quarter.

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Mitchell Brad Pinheiro, Wunderlich Securities Inc., Research Division - SVP and Senior Consumer Research Analyst [20]

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Was there any private label impact in that, Dan?

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Daniel V. Miles, Reed's, Inc. - CFO [21]

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Yes, there's private label, there's private label in volume, Kombucha in price. But Virgil's did have both of those elements. Virgil's was the biggest headwind in the fourth quarter.

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Mitchell Brad Pinheiro, Wunderlich Securities Inc., Research Division - SVP and Senior Consumer Research Analyst [22]

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And it was a competitive issue?

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Daniel V. Miles, Reed's, Inc. - CFO [23]

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I think it was a consumer issue. I think that, really, the net effect of the sugary flavors up and down across everyone.

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John J. Bello, Reed's, Inc. - Chairman of the Board [24]

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Okay. But Virgil's has come back in the first quarter this year, both Virgil's and Reed's Ginger products have been consistent and coming back. Where we're having issues are Kombucha and private label. And bottom line, we don't want to be in the private label business, that doesn't help our brand building, unless it makes sense.

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Mitchell Brad Pinheiro, Wunderlich Securities Inc., Research Division - SVP and Senior Consumer Research Analyst [25]

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And then just lastly, so is that, in terms of your first quarter guidance, that's what -- it's sort of a Virgil's issue in the first quarter? Because that's still a pretty meaningful decline in Q1 on a revenue basis.

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John J. Bello, Reed's, Inc. - Chairman of the Board [26]

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No. The first quarter, as I said, we've maintained ourselves with Virgil's and with Reed's, where the big issue is the Kombucha and private label. We lost a big private label account. So that doesn't have brand impact.

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Operator [27]

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(Operator Instructions) And our next 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 and Senior Healthcare Analyst [28]

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Yes, just to follow up on one of those points, and then I had a couple of other question. So the private label, the large private label contracts you've lost, when did you lose that? Did that impact both the fourth quarter and the first quarter? Or just the first quarter?

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Daniel V. Miles, Reed's, Inc. - CFO [29]

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The private label is led by 2 major manufacturers, and both of them had slightly different offerings. One had Kombucha and the other have their own soda. We continue to work with the soda private label one and while they also, like ourselves, hit tremendous headwinds in the fourth quarter and a little bit into the first quarter of this year, they seem to be recovering in their soda offerings. The private label Kombucha has gone to yet another manufacturer, but that business is dead and we have a headwind to push on that. But it will dissipate and be pretty much eliminated in year-over-year comparisons by the third quarter.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research and Senior Healthcare Analyst [30]

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Okay. I guess, a question somewhat discussed. But some of that business you may not care about losing too much because it might be nonbrand building and low margin on the private label side, but it's being stabilized. What do you think your quarterly or annual revenue run rate should be as we move out of the first quarter?

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

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Between -- the first quarter is always our toughest quarter, just like anybody in the beverage world. We should, and we have expectations of approaching last year's numbers, if not exceeding them. And that's -- Anthony, there's a lot of forecasting into that. We believe that the new focus on sales and marketing has the potential to really accelerate that area. But at a minimum, the pricing for our existing sales with the continued reduction in price improvement on the COGS side, we believe we'll generate the margins that we've talked about, approaching 30% for the year, along with the stable sales base, if it does not grow, will turn us back to the profitability this year at the latest. Now the question really gets to be how much can we grow on top of that? And I'm excited with the new team coming on board that we will be able to grow and potentially get back to the $50 million growth sales in the near -- in the future sometime early as next year possibly.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research and Senior Healthcare Analyst [32]

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Okay. So you expect to be profitable for the year in 2017, possibly getting up to $50 million in sales starting in 2018. And then the gross margin getting up to 30%, is that by the end of the year? So exiting 2017 at approximately 30% gross margin?

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Daniel V. Miles, Reed's, Inc. - CFO [33]

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Yes. Exiting the year, but not for the year at 30%, but exiting the year at 30%. We have very significant cost improvement plans that are in the final stages of being implemented that will drive the COGS side. And as John highlighted, in the areas where the appropriate pricing opportunities are, we're going to exploit those.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research and Senior Healthcare Analyst [34]

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Okay. And then lastly, on the -- well, I got a couple of other questions, but on the facility upgrade, is there -- just -- is that almost done? Or is there just a little bit more left, and when should that be complete?

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Stefan Freeman, Reed's, Inc. - Interim CEO and Director [35]

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Well, here's what I'll tell you, we've made significant investment in the plant infrastructure. And that infrastructure improvement was really driven around making sure that we have great quality in the products that we produce here. And also, we're continuing to vet out some of the co-manufacturing to make sure we get it closer to our customer base as possible and that's something that our COO, Mark Beaton, is working on. This is Stefan by the way. And we continue to look at the different co-manufacturers that are present out there to make sure that as we start looking at where our volume is, then we could get as close as possible to that customer. So the plant is running well right now. He’s delivering what we need to meet our product demand for our customers, and we continue to revisit every single opportunity that we have. But for right now, he has what he needs to get the job done.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research and Senior Healthcare Analyst [36]

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Okay, Stefan, that's helpful. And just if you could clarify the fountain soda opportunity. So originally, that opportunity with the large fast casual was for your standard offering and I understand the move towards reduced calorie and an all-natural reduced calorie offering. Is that particular fast casual that's testing your product requiring that the reduced calorie be part of that offering before moving forward, or potentially moving forward for a large national rollout? Or is that separate from their decision going forward?

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Daniel V. Miles, Reed's, Inc. - CFO [37]

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Anthony, I can answer that. This is Dan. The fast casual along with the other fountain opportunities we have said are all looking for reduced calories. So they have looked at a reduced calorie offering and it's part of our presentation. That's already done.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research and Senior Healthcare Analyst [38]

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Okay. So when the comment was made that it's 6 months away, is it 6 months away from perfecting that drink and being able to produce it in a large enough quantity to satisfy this large fast casual or just...

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Daniel V. Miles, Reed's, Inc. - CFO [39]

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No, let me clarify that. We're done. We've proven the technical capability. It is more back to our customers and potential customers to looking at their operation and seeing how it folds into their servings and their menu offerings. It's not an easy switch for them. So we are working with them to help them there.

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Anthony V. Vendetti, Maxim Group LLC, Research Division - Executive MD of Research and Senior Healthcare Analyst [40]

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Got it. So it's on the customer side, but Reed's is ready with a reduced calorie, all-natural beverage that's ready to go as soon as the customers are ready to move forward?

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Daniel V. Miles, Reed's, Inc. - CFO [41]

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Yes, I believe that if they'd cut us a purchase order, we'd be delivering it in less -- in very, very short periods of time. The technical part of it is done.

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Operator [42]

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And our next question comes from Bill Smith with Wm Smith & Co.

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William S. Smith, Wm Smith & Co. - President [43]

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Could you talk maybe a little bit about your new investors, the Raptor/Harbor Reeds fund? And so it's strictly a financial investment to this group? Or would there be some type of strategic component as well?

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Stefan Freeman, Reed's, Inc. - Interim CEO and Director [44]

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This is Stefan, but I think John is the best one to answer that question.

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John J. Bello, Reed's, Inc. - Chairman of the Board [45]

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Yes, happy to answer the question. I think they're not a strategic player per se, but I think their investment is strategic, meaning that it's long term. And I think they have had -- and I've worked with this group before on other investments, I know the people. I know their capacity, and I know their interest in consumer products. They're very excited about Reed's and the potential for Reed's. And they will be there when we need them and it's just not a financial play per se.

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William S. Smith, Wm Smith & Co. - President [46]

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Okay. And John, did you make the introduction to them, since you had experience working with them in the past? Is that how Reed's -- they came to Reed's?

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John J. Bello, Reed's, Inc. - Chairman of the Board [47]

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Yes, I did.

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Operator [48]

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And our next question comes from the line of Gary Greenberg, and he's a private investor.

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Unidentified Shareholder, [49]

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I also had some questions on this new investment. What are the details? I mean you say there’s going to be -- $3.4 million, I think, you said? Do they get stock? Or what's the agreement on?

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Daniel V. Miles, Reed's, Inc. - CFO [50]

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Hi, this is Dan. Thank you for the question. We released all the press earnings and there's an 8-K that really goes into detail of it. But basically, it is a debt financing with a convertible note. So at the option of the holders of the note, they can convert at a set price. But it is, quite frankly, a debt infusion for the company where it's noncash. So cash is not impacted by the direction of the cash coming into the company, which will free up our opportunities to invest. We have a little bit of working capital use up front, but the majority of it goes towards investment in sales and marketing.

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Unidentified Shareholder, [51]

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Okay. I just want to make some suggestions as a long-term shareholder. I've been investing 10 years, I think, since the beginning or when Chris first went public. And I think one of the problems the company has had is keeping the investment community updated and timely reports, like you haven't reported since last October. And here it is already at the end of April, the first quarter, you're already into the second quarter. So I think it would be -- for the investment community, and not only the individual investors, but to make more timely reports and to keep the investment community more updated on what you're doing, because it's continuously been going on for years. I know you just started, but we've been hearing about this soda getting in restaurants for, I think 3, 4 years, and it's supposed to be Virgil, now it's not going to be Virgil, it's going to be another type of soda, so I wish you good luck. But I hope you do keep us more informed than it has been in the past.

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Stefan Freeman, Reed's, Inc. - Interim CEO and Director [52]

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Gary, this is Stefan Freeman. What I would tell you, and I will give you my personal pledge, is that we will make sure that we're as transparent and we keep everyone informed as to what this company is doing in the right amount of time such that you can manage your portfolio.

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Operator [53]

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And Mr. Miles, I will now turn the call back over to you.

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Daniel V. Miles, Reed's, Inc. - CFO [54]

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All right. And thank you very much, Kathy, and all the investing community and friends of Reed's. I want to thank you all for listening in to our 2016 earnings release. We'll be getting together very shortly within the next couple of weeks to talk about the first quarter. We've given you a little bit of a preview of it. We look forward to having the time to discuss with you the opportunities and further how we've done and responded to you with all the changes that we've announced today. We'll have a little more clarity on that. I look forward to talking to you in 2 weeks. Thank you very much and talk to you then. Good day.

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Operator [55]

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Thank you, ladies and gentlemen. That does conclude the conference today. We thank you for your participation and ask you that you please disconnect your lines. Have a great day.

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Daniel V. Miles, Reed's, Inc. - CFO [56]

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Thank you.