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Reeds, Inc. (NYSEMKT:REED)

Q2 2013 Earnings Call

August 14, 2013 04:15 PM ET

Executives

Jim Linesch - CFO

Chris Reed - Chairman and CEO

Analysts

Andrew Lee

Vipul Sagar - Blash Capital

Joe Munda - Sidoti & Company

Mike Rudin

Ed Lozano - Premiere Group

Jim Linesch

Good afternoon everyone. My name is Jim Linesch, the Chief Financial Officer of Reed’s Inc. I would like to welcome you all to our second quarter earnings conference call. With me today is Mr. Chris Reed, the Chairman and CEO of Reed and Neal Cohane, our Vice President of Sales.

I would like to remind our listeners that in this call, management’s remarks may contain forward-looking statements, which are subject to risks and uncertainties and management may make additional forward-looking statements in response to your questions. 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 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, August 14, 2013. Reed’s Inc. assumes no obligation to update these projections in the future as market conditions change.

Now, I would like to make a few brief comments about our financial performance for the quarter, which will be followed by Chris Reed who will give us an outlook of the company’s business at this time.

Our financial results for the second quarter reflected significant loss reserve on a private label contract in the amount of $412,000. This amount is a provision for a rejection of products produced and represents the cost of the products plus delivery cost. At this time the customer has additional claims and Reed’s has counter-claims relating to their unilateral rejection of the products.

We cannot get determined the ultimate outcome of this matter as circumstances and claims are just unfolding. We do not currently believe that the aggregate losses will be materially higher than this amount, and there is a possibility that the losses could be lower. We will seek to mitigate the losses however possible including possibly reselling the products.

As this private label contract been executed as planned, our revenues for the quarter would have been close to 10 million which was our high target for the quarter and we would have posted net income within the range of our expectations.

Aside from this onetime loss from the private label contract our sales volume is expanding at healthy rates. Overall sales are up by 22%. Our new Kombucha line is expanding rapidly with a 75% increase in volume in the second quarter as compared to the first quarter.

Case volume shipments of our 12 ounce branded natural sodas were up over 20% representing strength in our core business. Our gross margins on a per case basis have increased slightly in the second quarter as compared to last year.

We have experienced a decrease in our gross margin percentage however, primarily due to higher promotional spending in relation to gross market revenues. Since promotional costs are deduction from sales an increase in these cost results in a reduction in our gross margin percentage.

Our ongoing rollout of our new Kombucha line has required a substantial promotional cost as we expand our eight flavors on a national basis. We also have increased the promotion of some of our lower performing products which is a good opportunity for expanding same store sales. Our promotional programs are helping us gain increased market share on an accelerated basis.

Our warehouse and delivery cost continued to be much higher than in 2012. Much of this is due to the fact that we are currently producing a high percentage of our branded products in the east creating higher shipping cost to our west coast customers.

Last year we produced a significant percentage of our branded products in our Los Angeles plant; and our plans are to resume increased productions of branded products in the west as our planned production capacity increases. We have invested about 300,000 in our Los Angeles plant during the first half of this year.

Despite the interruptions during the improvement we have experienced increasing production volume. We feel that production will increase further as we complete our plant upgrades during the third quarter.

Our sales and general administrative cost increased by 368,000 overall during the second quarter over last year primarily due to adding a few sales staff members, and increased legal and consulting cost. We believe that our existing staff is adequate for our current level of business.

While our losses during the quarter have had a negative impact on our networking capital, we feel that the company is adequately capitalized to carry out our current business plans. We look forward to increased working capital through positive contributions from operations in future quarters.

Now I would like to turn this call over to Chris Reed, our President and CEO.

Chris Reed

Thanks Jim, appreciate that. And thank you for joining us today on the Reed’s conference call. This quarter I have a feeling people weren’t really expecting this quarter exactly the way it came down and 22% growth in the past would have been a nice number to post for us we would be very excited about that. But it was in a lot of ways a very frustrating quarter definitely a lot of frustration with our private label customer and we are still winding that many conversations and most of this happened right at the end of the quarter so we had to report something and we took a very conservative approach with the reporting on that. And we will give more information on it, hopefully in the perfect world we will be able to work through our differences on this product and launch with a large major private label, the worst case we the onetime cost sets us back for a quarter and we move on quickly from where we are.

The real excitement for the quarter for us is we get everything we could to produce to meet demand on Kombucha and our own products and particularly for both situations we had a tremendous challenges keeping up with sales and Kombucha we were able to produce enough to grow sales by 75% for the quarter, quarter-over-quarter from first to second and that’s a great result for us and production in the third quarter is even ahead of where we were in second quarter considerably ahead and we are keeping it more with sales but probably walked away from 200,000 or 300,000 of sales in the second quarter of Kombucha that we would have had if we had a perfect ability to keep up with the production requirements to meet those sales.

For the last 10-15 years I can’t remember when we were in this position before where we actually had more sales than product on the floor or ability to produce. This quarter we gave guidance to our production plants on the East Coast of what we expect to the summer and I think we gave a 20% growth and they had for the first time we were caught with an actual equipment problem in the middle of the second quarter, a couple of different times in the second quarter and even in the third quarter. And also simultaneously the core customers at our Copac facility in the East Coast have all grown like we have pretty significantly. So, we have been asking for a certain production level and getting somewhere around 75% to 80% of that and I would say that will probably happen partially in May definitely in June and July and August and September. We are getting less than what we would like to have for sales.

And my back of the napkin kind of numbers on this are we would have had another 300,000 in Kombucha 200 or 300 we would had 400,000 in the private label if they hadn’t been rejected and probably somewhere between 700,000 and 900,000 of additional branded sales during the quarter pushing us closer to 11 million.

So, on some level those are exciting numbers and actually as we were going through the quarter we were looking at the numbers expecting to hit north of 10 million somewhere around 10.5 to 11 and just doing everything we could to try to keep production at the levels that needed to do to meet those sales. I know the questions are coming so I am going to start answering a little bit. we are talking to three new production facilities and so we are gearing up to have and we should have had this yes and it’s the first time our facility has ever not produced everything we have asked for and I guess we should have anticipated this could happen equipment problems could happen during key months and we would be delayed for a week or two in productions and that would affect things.

So, we have three facilities that we are in negotiations with facilities we have negotiated with prior so there are already contracts that have been drawn up in the past we are anticipating that and Jim didn’t show numbers and I don’t have them off the top of my head but the West Coast plant has been a big project and we were moving a lot more product out of the plant. It was running about 40,000 cases a month and it’s up to 65,000 and I believe in the third quarter we will probably have it go at the end of third quarter closer to 80,000 cases a month. So we will be double where we were at the beginning of the second quarter and the third quarter. And hopefully by the end of the year it’s somewhere around 100,000 cases a month, so it’s an additional 60,000 cases a month or 1.2 million a month over the beginning of the year.

And so a bit of that will be our own core brands and there is plenty of conversations with facilities in the West Coast. There aren’t as many facilities available there as in the Great Lakes and New England marketplace where we don’t exactly need them. So, yes, we’ll continue to, I know there are few options there and we’re still negotiating with them. So I think by the end of the year we will be in a position where we won’t be making excuses like we are for the second quarter and second quarter next year will hopefully be one where we produce whatever our sales force can materialize.

The fact that again we’ve been predicting acceleration with the advent of Kombucha on top of the strength of our own brands, and the fact that we feel comfortable we would hit 35 per quarter 38 those are the kinds of numbers we’d like to see moving forward with the company as we bring in production. I can say this not without repercussions when you don’t show up with the goods, or you have, any of you guys are following it close to the stocks on the shelf could see that Kombucha results for couple of weeks a months for couple of months during the summer here so far, and lot of the key accounts. So it’s been challenging. You don’t want to do that during the launch, but fact that we’re up 300% in production from April to now is still pretty good technical response to our situation. We feel like we could double again by the end of the year if sales flow to that level but again we’d be running at six times where we started the year and it’s still technically a pretty good result.

So without a doubt an exciting quarter, I think that in a way frustrating quarter, but in a way if you were to say, 22% growth, and that’s all we had for demand, to me, that doesn’t feel exciting as we could have hit 37. So, I’m kind of feeling the frustration with the sales force and everybody else that's involved but at deeper level just knowing the demand got to that level. And we were very close to pulling this up, just had Kombucha there is nothing we could have done I don’t believe that we grew that as fast as we could but the unusual problems at our key plant have been frustrating.

And our speed at which we are moving from 40,000 chassis a month on the West Coast, 100,000 by the end of the year, you know and if you are in the plan you’re just seeing, we’re having lots of meetings, we’re driving public purchases, driving the improvements in the three shifts for moving from two long shifts to three shifts, there is a lot of pressures going. We just cannot stand it personally that we’re sitting there and not filling orders. I mean, the simpler thing in life is production and the hard thing in life is building products and getting demand by the consumers. And we have that hard part done, so we are getting the easier but unfortunately we can’t snap our finger and just have it happen.

And hopefully we haven’t discouraged sales in (tenure) that the growth that we are hoping to be able to pull off by not having product available. It's not without repercussions but I am pretty comfortable of our ability to grow the company with the private label even in the light of our current private label situation, private label is still a key way to move forward branded products, solid even with the distraction of the launch of Kombucha, we’re still managing to grow our core brands significantly.

I look at gross margins, that’s kind of like can you cut the branch you still see the sap and the green, those are important things to see that the actual margins are doing very well. I think looking at the quarter from myself personally, knowing that we could have gotten closer to 11 million, knowing that we spent probably an extra $400,000 on promoting this above what we normally do in a key launch knowing private label hit me 400,000 harder than normally could do the onetime cost on the reserve for the private label.

And knowing that West Coast production is an up to 100,000 pieces a month and producing oil in the East Coast another $400,000 of additional shipping from the East to the West. So knowing that sales next year same time with growth with everything else going on with, I mean, personal promise plant will be running at full bore on the West Coast and the 100,000 cases to East Coast will have a backup. And we should be north of where we are now even producing just for this current quarter without any growth we should be able to do 1.2 million better in gross profit.

So we’re long term players here. We like to come, we would have wished we would have come to this call with just blowing, exciting numbers, and yet, we shouldn’t see no reason that we won’t be able to do that in the future for you, the shareholders, and people on the call. Well, the question really comes from an answered now what you see for the third quarter? I don’t believe we’re going to be as constrained as we were in the second quarter.

We are getting the plan on board more, and we are producing now in August considerably more of our own products, so the plan is helping now. Kombucha, we’re keeping up with sales considerably better within the second quarter, but we’re not going to be perfect yet, but we’re hopefully doing a better job with it. I am not seeing a production job number job, Neil and his teams are moving still aggressively to grow sales and bring out new customers.

I guess one other thing I would like to say about Kombucha is, we’re still feeling young in the process. We know we’re in a quarter of the whole food course. We still have a lot of growth there and with half the products, so we are at 1:8 in the whole foods, and I would say we’re 53% penetration natural foods based on data, they told us candy, and yes we’re probably at half point in terms most of them have four items not fully.

The consumers are still just barely discovering us. Run rate for the quarter goes up 3.6 million from 2.4 at prior quarter. We are definitely moving from there. We’re still feeling very young with it. I would say a surprising development in Kombucha is just how much of -- the market we didn’t expect to materialize for us, is the supermarket trade and we have picked up a bit of supermarket during the quarter and that seems to be a trend.

We have some advantages to our product besides the fact that the Kombucha in the marketplace is pretty snarly tasting and people are appreciating the foodie flavor expertise that created the world’s greatest Kombucha of the Reed’s brand. I think besides that we have also managed to come up with six-months Shelf Life our main competitors at one month and I think that supermarkets were just dabbling now with Kombucha although the Nelson data shows a 70% growth for Kombucha year-over year, that dabbling is quickly becoming a full blown Kombucha in the mean stream supermarket kind of movement and Reeds is part of that. And I think because of flavor, we test and sample well when the buyers are tasting and they do appreciate six times longer shelf life on the products.

So, overall, we are already more into the second quarter and what happens, we are already been so frustrated, I have lost some hair, the battles between sales and production you could imagine. I can just say, we probably could have had a little bit better, anticipated better, had our backup facility ready in case something like this happened, it hasn’t happened for 15 years, and maybe we have gotten a little comfortable with that.

Moving forward, we are quickly moving to be a company that won’t have this happened without multiple plants not being able to produce, so we are very excited. We know that we are going to have our opportunity. We are going to continue growing well. We are going capture and not have a production constrain in the future and overall given all the different scenarios, if I just had 22% growth then no issues and produced everything I could have, that's nowhere near as (inaudible) as what happens in all honestly here, and the fact that we are frustrated with us not hitting 35 to 40, we’re already through that, we’re already into our third quarter and planning for the growth that’s coming.

So, I think Kombucha still has deep infancy, doing very well. We sweated the fourth and first quarter Kombucha. We did a hard launch November 1st and we got the hard launch on the second round of four flavors May 1st edition. We haven't come up in sales significantly in the second quarter. We would have been much more nervous about Kombucha just watching it stay relatively flat in all the numbers from in fact the fourth quarter and onto the first quarter.

We are starting to get like, oh my god, we are spending and diverting a lot of attention towards Kombucha, it’s got to do something here and it did do it, how the new customers are coming, I guess the release I don’t know if it’s exactly out as I am speaking. They were converting some tables, I didn’t see them, my cell phone here looking at half of them from (inaudible) I said it. I took a few days off and I am giving an earnings call from (inaudible).

Anyway, it’s exciting times for us. We are just moving as fast as we can to keep up with the growth and again, we still haven’t hit that whole campaign that really is going to drive this business, it’s all pushed as accelerated sales through push and we're spending more time looking at the marketing that's going to make these brands become household name, but seeing the real key is generating internally that capital that will not only go to the bottom line here but also go to fund the marketing programs that will make this thing accelerating further.

So while we're dabbling 2013 with this, we mentioned that we're moving in that direction and there is more and more celebrity and internet type social media going on. I think that's partly why we're seeing such strong growth in our branded while being a tremendous amount of focus on Kombucha. We didn't have the kind of horse power to do both and then in the second quarter we brought on a very large and prestigious natural food brokerage firm, to help those with the launch of Kombucha.

In the past we've launched single skew, single items at a time, Dr. Better, Energy Elixir, Nausea Relief and this is the first time we just came out to the marketplace and asked for a big piece of shelf space for our products. So I rambled a bit, I am going to end it here, let me look at my notes to make sure I covered everything I wanted to. So let me open up the floor to questions. So anyone who has any questions this is a good time for that.

Question-and-Answer Session

Operator

(Operator Instructions). We have a question from Andrew Lee. Please go ahead.

Andrew Lee

Reed thanks for taking my questions. I just a few; one, with the new facility that you are contracting with. So would these given the complexity of the Kombucha brewing process, would this be for branded products or what would that be for?

Chris Reed

It's a good question, thanks for joining Andrew. The Kombucha is on the West Coast the facility; we don't have any plans to produce those productions for Kombucha. But long term knowing whether we'll do for gross margins, we will eventually produce on East Coast. The Copac facility that we're looking to bring on immediately are just for what I call are easier products, the Virgil's line to just take pressure off this.

The Ginger brew line is a complex process; we don't like to share the technology, the trade secrets with too many facilities around the country. But they can only do so many cases, the East Coast line we're currently doing, we'd like them just to run with REEDs and then offload all over Virgil's which is growing about equally with REEDs, offload that to facilities that we now are bringing on board. So all the really complex stuff is going to stay with the current facilities.

Andrew Lee

And do you have a timeframe of when you expect these contracts to go through?

Chris Reed

Well the first thing that's going to happen is the West Coast facility is going to free up approximately 50,000 cases a month and have them by the end of the year, and that represents about 12 million in sales. The East Coast facility probably within the next two or three months will have some negotiations that will allow to produce on the East Coast by the end of the year.

Again the constraints we're seeing right now are normally the seasonality of the soft drink industry, where everybody is coming in with their sales and (inaudible) production and putting more pressure (inaudible). We have a wonderful situation with our products; we don't see the seasonality that most people do, partly that's a situation because the natural food industry tends to have more steady sales year around. Or better yes people stop eating as healthy during the summer which tends to slow down our summer season, but they pick up their healthy eating in the spring and fall. So that gives us a boost to our spring and fall.

So we probably won't be after September our facilities that we’re currently in even before new facilities, we won't be sharing we're constrained as much. So it's just happening right now. But before we get back to another busy season we'll have facilities on line.

Vipul Sagar - Blash Capital

Thanks for the insight on that. And on the private label issue in the quarter, can you elaborate a bit more, what was the cause I guess of deal that going through?

Chris Reed

We had an issue with the supplier; we had a first time issue, the crowns that we used, the caps on the bottles were leaking. And for some percentage of the product that we shift, we isolated the problems in a very timely manner offered to replace that product and in theory due to the codes out there, that was our right. But anyway that was the main issue with it, they had second thoughts about the product launch themselves, they developed a pretty coffee (ph) flavor that I believe and actually told us that they weren't happy with their flavor. But we shared with them that that flavor was developed by us but it was, the art direction was done by their flavor development people and they signed off on their flavor and we were there during all the productions out there and blessed all the productions that we produced.

So it's not clearly a fault of Reeds, the crowns are clearly a fault of the crown manufacturer. We have some opportunities to reclaim this. But it’s not that “he said – she said” kind of stuff; isn’t where we are at. What we really want to do is bring the private label customer back on board, the products that we developed for them were the right products for them, and it represents a huge potential for our company so we’re talking to upper management and just letting know that we are the king of what they want to get done. There is nowhere else to go for what we develop. And I think logic would say that, and economics would say that the parties are going to work something out here. It’s unfortunate and we learned from it. But it’s just, we are not perfect. The world doesn’t run perfectly all the time. Fortunately it’s a onetime thing.

Vipul Sagar - Blash Capital

Okay, thanks for elaborating on that. And then I want to finish off with one quick question on Kombucha, I know you guys have been spending a lot of marketing dollars from running that recently, last few months, were you seeing your competition doing anything similar right now?

Chris Reed

The main competitor doesn’t normally go to even the trade show. I don't believe that they have the kind of deep relationship we do with grocery, although anyone looking at the Neilson data would immediately fix them because they’re really a dominant force even now. Believe me I want to say that we’re clearly number two for a number of large brands than Kombucha besides a leader (inaudible). These are brands that been out for four or five years. So we’ve been out since November 1st. We were in that first year, and we are a clear number two in the marketplace, this is every exciting for us.

The marketing is going on. It is hard for us to tell. I don’t think we had a microscope on what the number one guy who was doing prior to us coming into the marketplace. I believe because of this short shelf life from time to time (inaudible) really amazing promotions particularly locally where he produces in LA but it could be a little more promotion going on, definitely has a very big pockets at this point, with the size of the company and the margins but no one has been able to say to us that they’re seeing the people who are – particularly this brokerage firm that we brought on to supplement our own sales force has a tremendous expertise in Kombucha and they have not told us that there’s seeing anything unusual outside of the normal summer promotions which are relatively mild. We haven’t seen any advertising et cetera. And quite frankly the growth rate, what we will do annually, what we will chip away, maybe on his business and his growth rate and we are really a fly on an elephant at this point. If they see us at the marketplace but, there is surely no reason to be nervous yet, for them, I mean 3.6 million of the 300 million being sold, moving up to the 5 million to 6 million is still very young.

Vipul Sagar - Blash Capital

Just wanted to confirm, you said the Kombucha revenue grew from 3.6 million from 2.4 in the prior quarter.

Chris Reed

The prior quarter was 2.4, about 3.6. It really is 30,000 cases, yes 2.4, we went to about 50,000 case which is about 4 million.

Vipul Sagar - Blash Capital

Okay. Let me add.

Chris Reed

So we had another 15,000 pieces that we just didn’t deliver. Third quarter we were able to do better and still a nice curve going on with the growth particularly with the second quarter, third quarter is still on a nice improvement.

Operator

Our next question comes from Vipul Sagar with Blash Capital, please go ahead.

Vipul Sagar - Blash Capital

Last quarter you did 600,000 mineral bottle sales, what was the amount this quarter, the second quarter?

Chris Reed

The gross amount was somewhere around 950.

Vipul Sagar - Blash Capital

950, yes, and then on the recent conference you said you are running at about 1.5 million or 1.4 million for the third quarter run rate.

Chris Reed

Yes-yes. That sounds about right.

Vipul Sagar - Blash Capital

So basically the cases have gone from 10,000 to second quarter you did, how many cases per month?

Chris Reed

Like 16.

Vipul Sagar - Blash Capital

16, okay. And now this quarter you’re doing about…?

Chris Reed

About mid-20s, 22,000 to 26,000 a month something like that.

Vipul Sagar - Blash Capital

And this is all in the West Coast right?

Chris Reed

No, no, no it's throughout the whole country.

Vipul Sagar - Blash Capital

No, this is Kombucha we are talking about.

Chris Reed

Yes we launched Kombucha, hard launched November 1st in the Unify…

Vipul Sagar - Blash Capital

Would you manufacture them on the West Coast that’s what I am asking?

Chris Reed

Yes, yes all production is in the West Coast.

Vipul Sagar - Blash Capital

Okay now the LA plant you said you have gone from 40,000 cases a month to 65,000 and in the third quarter you are doing about 80,000 and your goal is 100 by the fourth quarter?

Chris Reed

Yes.

Vipul Sagar - Blash Capital

Okay here is a question I have is, which is the ideal capacity cost that keeps on basically it is a cost and what is the revenue number that you look at where it will soak up all this ideal capacity cost, what is the approximate revenue number where you would…?

Chris Reed

Sales out of the West Coast facility?

Vipul Sagar - Blash Capital

Well yes the idle…

Chris Reed

40% number.

Unidentified Analyst

Do you have an approximate number where once Reed reaches this number all this ideal capacity cost will be soaked up. I am just trying getting at what level does Reed get to and sales what is that level they have to get to?

Chris Reed

All right and again it would be West Coast, it would be sales supported by West Coast production. It’s not a national thing it’s a number that we track based on what’s happening at the West Coast and so Jim you would have to answer that.

Vipul Sagar - Blash Capital

Yes it's more of a CFO question.

Jim Linesch

I don’t have an answer for that.

Vipul Sagar - Blash Capital

Okay.

Jim Linesch

I feel that that data is proprietary to the company.

Vipul Sagar - Blash Capital

Okay.

Chris Reed

And the 100,000 cases and it's clear we can absorb more of that as overhead as we go from 40 to 60. We saw a better performance in the second quarter over the first quarter and we are talking about going from 40 to 100, you are going to absorb a lot more. But you are going to also have more expenses associated with it you won’t have as much overhead there will be direct expenses associated with the labor (inaudible) et cetera. And definitely we are spending a bit of time speeding up the plan itself. Kombucha was running very slow and now we are probably running 200% to 300% faster than Kombucha so that will absorb a lot more of the rate on it.

But it’s not a straight linear thing. there is a lot of fixed cost, variable cost improvements happening in just the operation itself and some of the equipment jobs that we are doing we are rebuilding equipment and we are able to run it 20%-30% faster. It’s a lot to factor in. but that’s a great question and I think that we will be addressing that and starting to be able to talk to that in future quarters. We'll have a closer to an answer by the time we talk next quarter.

Vipul Sagar - Blash Capital

Okay and then on the West Coast at least in the West Coast I have not seen any of the new four flavors but yet on the East Coast people who drink Kombucha they have seen all the new eight flavors basically. So why even though you manufacture this in LA it’s not showing up on your relationships in the West Coast? The four new flavors I mean I haven’t seen the coconut or the (inaudible) anywhere. I see the old four everywhere but I don’t see the new four.

Chris Reed

You are in Portland right?

Vipul Sagar - Blash Capital

Yes.

Chris Reed

All right I will have to ask the Portland guy but it’s again even the first four flavors are pretty much at their infancy. You are just starting to see those come up…

Vipul Sagar - Blash Capital

Yes I have been started seeing this in the last couple of months more than this month.

Chris Reed

Okay now you are in Portland, hard launch is November 1st, you are seeing the first four flavors show up in the last few months. What was the delay on that for your marketplace it was nine months, eight months?

Vipul Sagar - Blash Capital

Yeah about five months I would say. If you did in November, I started seeing in couple of places somewhere around in…

Chris Reed

I would expect you to see the same kind of delay, somewhere around from maybe hard launch to end of the year so you are going to see another five or six months you will start seeing Portland will show up with that.

Vipul Sagar - Blash Capital

Okay.

Chris Reed

And that's a best guess at this point. I would like to be able to say it seems obvious but there is certain amount of getting the stores used to your products and say okay look don’t get too pushy, we are going to try this for a few months, you do really well we will talk later about the new flavors. But our people just keep putting the pressure on it and again it’s all push. At some point we want to start making some noise where consumers are coming in there, are seeing it in advertisements in some of the key publications that show up in the national food industry. So that part has not happened yet so much.

Vipul Sagar - Blash Capital

Okay. And then the other question was about new flavors. You went from four to eight, are you planning for new flavors before the year-end or something next year?

Chris Reed

We keep dabbling. There is probably two or three flavors that are in a state that could be launched within a month or two. Quite frankly, we are still getting used to the fact the trade, the new places that we’re going outside of what we anticipated…

Vipul Sagar - Blash Capital

The supermarkets…

Chris Reed

We’re just getting to a point where we can keep up with the sales right now. And I think that we’re not anticipating that launch right now, we’re not looking at November 1st for another four flavors. I am not saying we couldn’t pull it off, but we are probably just going to grow the flavors for a while.

Vipul Sagar - Blash Capital

Okay, and so, if you had to summarize what the third quarter, it seems like almost half year through you’re looking at. You are doing more and more of your branded that you need for the West Coast you are doing in the LA plant, more of it than the second quarter. And then the East Coast, you said they had a shortfall or they had a problem with production. When are they going to be up and satisfy your orders?

Chris Reed

We'll still have shortages from them in September, but we’re hoping it’s not going to be as bad as it was in July.

Vipul Sagar - Blash Capital

Because I’m not seeing them and like shortages anywhere where I go basically, so I mean basically it’s an East Coast thing again?

Chris Reed

No, not really. I have to look exactly where it was but it’s just nice that they didn’t do and how exact percentages that we are out of stock at our distributors. But again it wasn’t that much product, it was somewhere around 10% or more we could have sold, somewhere around 7% or 8% more sales from branded. So are you going to notice a 7% or 8% drop in availability, maybe not, did show up late in the afternoon in most grocery stores in the U.S., you’re going to find the product is not on the shelf anyway past noon. People just think it’s normal behavior. I often times even buy out the shelf.

Vipul Sagar - Blash Capital

Well, the funny part was at Fred Myers they were out of RGB across the board but they had all the Virgil basically. And that was where I’ve never seen anything like that before where a store is out of the Gingibu.

Chris Reed

Well, that’s part of it. It’s beautiful. Look it’s horrible. It’s horrible what you’re going through it, it’s horrible. But coming out of it and being able to be 45 days from the end of the quarter and already going through all the emotions around not levering product. Thinking, oh my god, the easiest thing we can do on planet earth is deliver freaking product.

But now just in hindsight, my god we have generated so much demand for our product, we will never do that again. We’re going to have a second back up on everything and we’ve never had that before and it’s been okay but it’s not been this big. All we have to do is have a hick up in growth 10% or 20% more and our plants are doing what the hell are you doing. So we still have their luxury. We have to have second facility going onboard. We should have anticipated it for this year and we can beat ourselves up as much we want and we were fine until we had a hick up and had a pasteurize fall apart for a week and they had to rebuild something. We shouldn’t be that close to the edge. And you could be upset at us for that. But the great news is demand is in all time high and we’re only getting better.

Vipul Sagar - Blash Capital

Okay, and has any private label approached you for Kombucha like without the regain just the private label?

Chris Reed

Have we made that announcement to the world?

Vipul Sagar - Blash Capital

No.

Chris Reed

Have we had private label approached? Yes.

Vipul Sagar - Blash Capital

Okay, well that’s all the questions I had. Thank you very much.

Chris Reed

Thanks. We appreciate you’re following the company by the way. Because you have some of the best damn questions anyone asked about.

Vipul Sagar - Blash Capital

Okay, thank you.

Chris Reed

You keep us our toes there in Portland.

Operator

Our next question comes from Joe Munda with Sidoti. Please go ahead.

Joe Munda - Sidoti & Company

Private label, can you break out private label in branded as far as sales breakdown?

Jim Linesch

Our private label was about 1 million and our branded, it depends on how you look at it gross or net. But on a gross basis, it was 9.6.

Joe Munda - Sidoti & Company

9.6, so on a net basis it was…

Jim Linesch

On a net basis it was about 8.6.

Joe Munda - Sidoti & Company

8.6, okay, and that includes Kombucha or is that separate?

Jim Linesch

Correct.

Joe Munda - Sidoti & Company

That includes Kombucha. Okay. And Jim can you give us what was the comparison to second quarter of ’12 in both lines, do you have in hand that?

Jim Linesch

No, I don’t.

Joe Munda - Sidoti & Company

Okay, I’ll go back. Chris, so I missed the part with the plant issues, but it seems like too much demands not being able to keep up with these orders, is that pretty much issue here?

Chris Reed

Yes, we had 22% growth, we could have based on the orders that we didn’t fill, it looks like somewhere around -- and I am reversing out the private label issue that had gone down the way it was supposed to, we would have around 35% to 37% quarter and it is what it is. We are handling production availability issues for the future. I think we have done a great job already with Kombucha. The plant is accelerating quickly from second quarter 40,000 cases to 80,000 cases by end of third quarter on a monthly basis, so it’s picking up the slack and we’re also having more time to respond to on the east coast.

So, we’re still going to have in our minds whether we reported officially, we’re still going to know that third quarter could have been even more accelerated in what we report, but it's good stuff going on and we will unwind our ability to supply product. That’s the simplest thing we can do here is make it. It is demand and new customers that’s the real challenge in life.

Joe Munda - Sidoti & Company

Okay, you’re running the plant now, right, I think on the last call you’ve spoke that you’re taking a more active role in running the plant operations, am I correct?

Chris Reed

Yes, I am de facto plant manager. I do have an individual there who is an engineer and he has been assistant to all other plant managers and he is running the day-to-day operations in terms of getting all the projects moving in forward, but the time it was taking me to get the plant managers to get things done, I took the same time and just directed things. And I love to bring those plant managers back into the plant, the last two that were on board earlier year and showing how a real plant is brought on line, but we have tripled refrigeration. We have doubled the plant compressed air. We have added 50% more steam. We rebuilt a number of pieces of equipment, they’re running at speed we’ve never seen and quite frankly Kombucha is running at 250% to 300% faster than it was when other people were running the plant.

So, when I say I am getting it done, I don’t see any hindrance to be getting, to doubled where we were when I took over by the end of the third quarter and by the end of the fourth quarter it will be up another 250% of where we started, I started this gig, and those are big numbers but so far we’re hitting those number and I don’t see and I know what’s coming on board and I feel very comfortable once those plants will get there and probably bring someone board once all the heavy lifting is done to run it who can keep it, just keep together what I put together.

Joe Munda - Sidoti & Company

So my real question is, when did you realize, was there just a wave of demand somewhere in the quarter that you just didn’t anticipate or was this something that you guys saw in the beginning and it was just not able to get that backup facility running? And go head I am sorry.

Chris Reed

Well, look there was equipment mess up, two times, we had equipment mess up where we lost a week and once the plant gets down for a week there is 150,000 cases that are never going to recover and they just go after all the Co-Packers there and say we’re going to reduce everybody by this percentage and that happened in the second and third quarter and we've just had to scramble and now we’re bringing on second east coast facility as a backup and the west coast plant is starting to pick up the slack just starting in August and will do much more in September.

And we had some pretty good movement of sales that was not anticipated. We anticipated 20% growth and I don’t look it, I don’t want to say the quarter is great, I am just saying sometimes we have months that beyond our expectation. We have a flat kind of 20% for the year and 25ish, but we could have months where things get a little bit out of hand.

Joe Munda - Sidoti & Company

So you are saying that you think that the growth is above that level in the third quarter?

Unidentified Company Representative

Well, I don’t know if we’re going to able to keep up with the growth in production to allow to be that. So we’re not to attenuate as badly as we did the second quarter.

Joe Munda - Sidoti & Company

So, you think that you could have been at the almost $11 million level had you not have these pickups. so that’s something that you guys can achieve in the third quarter or is it something in between where you guys are now in this quarter and that 11 million?

Chris Reed

I have to get the numbers out for the third quarter from last year but we’re definitely growing faster than, I think 20%, I think we've kind of given the guidance this year we'll grow the same percentage or better than we did last year. And I think we're on pace for that, and if Kombucha keeps rolling the way it is and the branded products keep rolling the way they are, we'll have the acceleration of beyond that, we expect.

But again there is some attenuation for production on it, except we won't see the same attenuation that we had with Kombucha, because Kombucha is catching up and the branded, hopefully we're going to unwind a little better and have more availability with the West Coast.

I don't want to predict the third quarter for you guys. I can't say we're going to come in at 35% or anything like that, right now. I know that we had a great July and I can't tell you if we backed up, with an August that's just as robust or whether we just did a lot of sales in July there, now backing off in August or anything like that. Because things are very solid there and I'll wait till the third quarter to give you better news than that if it happens.

Joe Munda - Sidoti & Company

As far as the backlog is concerned, you got to have an order backlog here right?

Chris Reed

Cash flow is great because we're evaporating products; we're still not completely caught up on stuff. So we’re producing it, Kombucha is starting too caught and the branded stuff is still slogging everybody for as much production as we can get at the moment.

Joe Munda - Sidoti & Company

Is there any other options to like contract out as far as, I know you don't want to give away the recipe, but if you are seeing so much demand, there has got to be some stuff that you can offset?

Chris Reed

I think you have to understand we're not seeing so much demand at our current facility is not giving us everything that we want now. It's just they are overwhelmed because they got backlog because of the equipment hiccup in July, beginning in July, that hiccup is propagating through August and they don't think it's going to unwind all the way till September, because on top of that everybody is asking for more than they anticipated for the year, and it's not just us, it's a couple other customers that they have putting the same kind of pressures on them.

So we're just getting unbelievable levels and we just (inaudible) but it turns the facilities are bringing and turning on the (inaudible) at a new facility. You got to negotiate the contract; they too sometimes are sitting there down in a very busy season not anticipating us coming in there. We talked three, six months out. If you find someone who is just sitting there idle time in the middle of summer, you almost don't want to work there.

So there are options right now and we'll probably have someone by the end of the third quarter and definitely by the fourth quarter at places that we can produce, and if we get lucky and someone who can give us September production we'll jump on it.

Joe Munda - Sidoti & Company

What about Jones Soda?

Chris Reed

What about it?

Joe Munda - Sidoti & Company

Can they give you production, are they a possible candidate?

Chris Reed

No, they do actually produce a different style product with an ROPP cap. They don't produce they have fill pack facilities and we know the people who run those facilities and we're talking to them. So we wouldn't go to Jones for any particular expertise there, that's for certain. I don't want anyone to take it the wrong way, their expertise is in marketing, we’re engineers we know how to produce, we just needed to get ready for next year.

Joe Munda - Sidoti & Company

So these constraints, you are saying should go away by September or so. And we should see a smoother gross margin line going forward.

Chris Reed

Right, I would say that we wouldn't be holding back sales later in the year. We'll see an improvement from freight, from producing on the West Coast. So I figure it's hitting our quarter about 400,000 right now. And the aggressive promotions, we're looking at it now to figure out, whether we want to be with this, we didn’t anticipate the private label reserve happening on top of accelerated promotions for Kombucha. We're clearly seeing an opportunity here and we don't want it to go away. We’re number two in the country for Kombucha and it doesn't happen because we sit on your hand, because you got aggressive and you are putting a lot of attention on it. So as long as we keep performing we'll probably continue to be a bit aggressive with it.

Operator

Our next question is from Edward from Premier Group. Please go ahead.

Unidentified Analyst

Chris, Jim congratulations on continuing the top line growth, I do share your disappointment on the production issues, and I know you probably could have blown away the 35% you were shooting for. I have just a couple of questions around margins. If I look historically, the company has been kind of running at about 30% gross margin; give or take and with the Kombucha coming online, was that intended to improve that gross margin over time? Is it a higher margin item once they stabilize? Or is that just going to continue that roughly 30% gross margins, first question?

Chris Reed

We anticipate better margins from Kombucha, and considerably 5%; probably more like 10% better margin.

Unidentified Analyst

So the Kombuchas are running higher than 30% gross margin.

Jim Linesch

That’s correct.

Unidentified Analyst

Okay great

Chris Reed

And quite frankly we ran about 34% gross margin last year, with an 8% MCB charge back, promotional expense off the top. We are up 4% on that. We had another 4% for the onetime reserve for the private label. So the 26 that you’re looking at is really running at 30, but if we were running the normalized promotion levels that we’ve seen historically, that you saw last year, you would be probably around 34%. But we will see an improvement from Kombucha. It’s just when you’re launching a new product, you got to stick it good, especially when you got a guy who is dominating the field and runs a very fast clip. So many people have battered themselves against the wall of this guy’s product. And we are the first real contender out there to come in there and grab and grow significantly. And if you look, you have a lot of markets outside of his key markets. People want Kombucha but they don't necessarily want who is Kombucha, because they are going, you know what, this would be the first time our customers are seeing Kombucha, we like your shelf life, we like the quality of your products and we are going to enter Kombucha, you know initially with you. They had big plans for Kombucha but they are definitely shifting from our original plan. I know that wasn’t your question.

Operator

Our next question is from James Kuzowsky with Dry House (ph) Capital Management, please go ahead.

James Kuzowsky

I just wanted ask about your operating expense in terms of pretty big entries, since second quarter last year. And I know you saw it around the same level in the first quarter this year. What do you anticipate with that, are there some onetime charges in there that you think you can smooth out going forward.

Jim Linesch

Well we do have some onetime cost will come through and some of them are a bit seasonal. We have our annual audit to come through in the beginning of the year and we also had a little bit higher legal cost this year that we don’t anticipate ongoing. We have added four new additional people to our sales staff and that would be a permanent increase. We are up about say 380 quarter-to-quarter comparison and I would say roughly half of that is probably ongoing cost and the other half can vary depending on circumstances.

Chris Reed

Jim, can I ask you for a clarification? In my mind, this is Chris. The west coast freight, is that thrown into that? Will trade in warehouses or is that a separate line item.

Jim Linesch

Well right now what I am talking about is only the sales and the G&A.

Chris Reed

All right, because once the west coast facility is running at full clip and doing the west coast production of branded product, that unwind another 400,000 a quarter, right?

Jim Linesch

That’s correct, in the delivery.

Chris Reed

However that, wherever the SG&A, wherever that number is showing up, that’s something we anticipate with the onetime expenses but you’re saying it’s somewhere around half of the 400,000; another 200K seems to be kind of onetime expenses. You have one (inaudible) there.

Jim Linesch

I was only referring to the SG&A.

Chris Reed

Right. You said three divided by two so; we know we have things that we kept doing now, that we’re definitely working towards, that will and prove what the quarters look like in the future, so anyway.

James Kuzowsky

That was really helpful. So basically with the shipping cost, maybe something around 600,000 but be more normalized if everything was getting shipped out of your West Coast plant.

Jim Linesch

Yes, with the volume of 9.5, it probably will be a little bit higher than 600. It would be in the range of say 7% to 8% of our net revenues.

Operator

Our next question is from Mike Rudin. Please go ahead.

Mike Rudin

I was wondering about Kombucha production issues you’ve had, since you started, and you have been working on this building, different problems in that. Where do you stand in that now? Are those issues, are they all have been addressed, are you happy with your production now or does it still need more improvement?

Chris Reed

Well we are engineers so we are always looking at how we can be improving it, but we have taken the time to produce a case down by probably 60% or 70% since the beginning of the year. I do think that we can improve the speed of the line at least another 50% but we are comfortably running out 15,000 cases a couple of times a month right now. We needed to take less time because we need the plant for running everything else that we run from private label to now being back in to our branded. So time is definitely precious to the plant while we are also expanding the hours in the shifts to do it and rebuilding equipment so that everything is just up all the time.

Mike Rudin

Okay are you past the point like right now if you couldn’t make any more improvements to the Kombucha production and you had to produce it like you are doing now, would you keep on doing it? Are you past the point of, gee I don’t know if we can make this product efficient enough or are you still have to further…?

Chris Reed

It’s a funny (inaudible) to make sense. The economics are fine right now it’s…

Mike Rudin

Okay.

Chris Reed

We could go faster, continuously faster, we already know we can do better, we know exactly how to get it…

Mike Rudin

Okay that's great and then lastly I know you were shooting for like a run rate of 7.5 by the end of this year, that's still your goal? Do you still think you might get that or not?

Jim Linesch

Yes.

Chris Reed

Yes the answer is yes.

Jim Linesch

I would say the answer is a big yes.

Mike Rudin

Okay that is all I have thank you.

Chris Reed

Well what we are trying to do right now from a production standpoint is our ability to go to (inaudible) that happens.

Operator

And we have another question from Ed Lozano with Premiere Group. Please go ahead.

Ed Lozano - Premiere Group

How is inventory and cash looking going into the first quarter? Thank you.

Jim Linesch

Well our cash balance was over 800,000 at the end of the quarter. Inventory is about flat overall. It tends to vary depending on what projects we are involved in. But it’s definitely not up and…

Chris Reed

And while we anticipate the third quarter and fourth quarter, third quarter will generate cash and we'll see improvements. We will actually have some inventories that have been waiting for the West Coast plant to come on board that allow some cash to be freed up so we see our cash situation improving through the end of the year. Jim would you agree with that?

Jim Linesch

I absolutely do yes.

Chris Reed

Yes all right.

All right it sounds like it’s getting quite there. We might have gone through the questions. I appreciate everybody taking the time. Is there a question there?

Operator

No I am sorry we have no more questions in queue.

Jim Linesch

Okay great.

Chris Reed

Thanks for joining us for the second quarter. I think we are in the midst of our third quarter. It’s exciting times for Reed’s and we look forward to seeing you guys for the third quarter and sharing those results and signing off for now. Thanks again.

Jim Linesch

Thank you.

Operator

Thank you ladies and gentlemen you may all disconnect.

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