Reeds' (REED) CEO Christopher Reed on Q2 2014 Results - Earnings Call Transcript

| About: Reed's, Inc. (REED)

Reeds, Inc. (NASDAQ:REED)

Q2 2014 Results Earnings Conference Call

August 12, 2014, 04:30 PM ET

Executives

Larry Tomsic - Interim CFO

Christopher J. Reed - Founder, Chairman, President and CEO

Analysts

Joseph Munda - Sidoti & Co.

Alec Jaslow - Midtown Partners & Co., LLC

Operator

Good afternoon, and welcome to the Reed’s Second Quarter 2014 Earnings Conference Call. My name is [Malden], and I’ll be the conference call operator today. Participating in today’s call we have Chris Reed, the CEO and Founder of Reed’s, and Larry Tomsic, the Interim Chief Financial Officer.

Before we begin today’s call I have a Safe Harbor statement to read to our listeners. I would like to remind our listeners that during this call, management’s remarks may contain forward-looking statements, that are subject to risks and uncertainties and that 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 12, 2014. Reed’s, Inc. assumes no obligation to update these projections in the future and as market conditions change. Following management’s commentary on today’s call we will open-up the lines for questions.

I would now like to turn the call over Larry Tomsic, Interim CFO of Reeds, Inc. Please go ahead sir.

Larry Tomsic

Hello everyone, thank you for joining us today for Reeds second quarter 2014 earnings call. This is Larry Tomsic, the Interim CFO of Reeds, Inc.

Here are some highlights from our second quarter results. Total gross sales for the second quarter ended June 30, 2014 were a record $12.3 million, which is an increase of 11% versus the second quarter of 2013. Our promotional expenses for the second quarter, which includes such items as promotional spends with retailers and slotting fees were 9% of gross sales or $1.137 million for the quarter. Therefore net sales were a second quarter record of $11.2 million which is an 18% increase over the second quarter in 2013.

Second quarter gross sales growth was driven by a 34% increase in Reed's Ginger Brews, a 10% increase in Virgil's craft sodas and a 35% increase in sales of Kombucha. These gross sales increases were partially offset by a 33% decrease in our other product category that includes private label, candy and non-core beverage sales.

Approximately 76% of gross sales came from our core brands. 12% of gross sales were derived from Kombucha and the remaining 12% of gross sales during the second quarter were from the other category, which includes private label, candy and our non-core beverages. Our gross profit for the second quarter increased by $1.2 million to $3.7 million, which is an increase of 51% versus the prior year's second quarter. Our gross margin improved to 31% in 2014 versus 26% for the second quarter in 2013. Part of the reason for that is we had a production issue with a private label product sale last year.

We continue to see improvement in our Los Angeles plant utilization. Cost of goods sold, idled capacity is a measurement that we use for our plant overhead and direct costs in excess of the co-pack labor allocated to finished goods that are produced in our Los Angeles plant. Our idle plant cost for the second quarter was 4% of net sales versus 5% for the second quarter of 2013 due to increased production. Operating expenses although we had an 18% increase in net sales, our total second quarter operating expenses only increased by about 2% to $2.9 million compared to the second quarter of 2013.

Our income from operations was a $116,000 as compared to last year's second quarter operating loss of $369,000. This $1.185 million improvement over last year is the result of $1.25 million increase in higher gross margin that was partially offset by approximately $62,000 of increased operating expenses.

Our interest expense increased $53,000 to $178,000 versus the second quarter last year due in large part to a $50,000 reversal of old accrued interest in the second quarter of 2013. Our interest expense improved by $10,000 versus the first quarter of this year due to lower borrowings.

I am excited to report that we had a net profit of $633,000 or $0.05 per diluted share. This is a significant improvement over last year's second quarter results that showed a $499,000 net loss or $0.04 per diluted share loss. The year-to-date profit was $413,000 which is $0.03 per diluted share.

EBITDA also improved significantly year-over-year. For the second quarter our modified EBITDA was $1.1 million versus a loss of $147,000 in the prior year's second quarter. We had $460,000 of EBITDA adjustment in Q2 consisting of $153,000 of depreciation and amortization expenses, $178,000 of interest expense and $129,000 attributed to stock options and stock compensation expenses.

Balance sheet, our cash and cash equivalents at June 30, 2014 improved to $1.2 million compared to December 31, 2013 which was $1.1 million. Net cash provided by operating activities of $418,000 for the six months ended June 30, 2014 represents an improvement of approximately $1.3 million compared to the period last year. This is primarily due to our operating performance improvement of $973,000 plus reduction of inventory levels of $794,000 and accounts receivable reduction of $516,000.

As of June 30, 2014, we have stockholders equity of $4.1 million and we had working capital of 2 million. Both are significant improvements when compared to stockholders equity of $3.4 million and working capital of $1.3 million at December 31, 2013. Company’s revenue has increased 12% in the first two quarters of 2014 over the first two quarters of 2013. Reed’s and Virgil's sales have grown 24% and 10% year-to-date and Kombucha has grown 74%.

Our other category which includes private label, candy and non-core assortment has declined 33% but the company has had good private label orders in the next two quarters. EBIDTA was 1.3 million for the first six months of 2014 and will be approximately $2 million, if the company reaches its goal to generate a modest net profit for the year.

I would now like to turn the call over to Chris Reed, Chris Reed, who is our founder and the CEO of Reed’s Inc. Thank you.

Christopher J. Reed

Thanks Larry. And thanks for joining us today for the conference call. It’s obviously a very exciting quarter for us. And the first quarter we had a slowdown of sorts from weather which claimed it was weather. I think the proof of the pudding is the core brands definitely came back strong in the second quarter as the weather situation abated and we moved in to warmer weather.

Also private label has been the real drag on growth here for the first two quarters and some of that is the change of ownership of one of our large private label customers and change in the mix of what they are buying and the number of strong initial launches last year during the same time where we filled the pipeline so to speak and this year we are just in more of a steady state. So we have trended against some heavier orders. But I think with private label being down almost 50% in the first two quarters we are still predicting kind of an even, or little less than breakeven or growth rate for this year on private label. So we are obviously predicting and looking at bunch of orders and to actually accelerate private label in the second half of the year.

Larry was grouping the private labeling with our candies and other stuff but everything -- as a brand is doing fine and private label which we have less control over is not doing as well, but is being volatile or fluctuating. I think that it looks like may be private label there with Reeds. It’s not a big part of how we think. We obviously want to be a branded company and use the private label for relationship building and definitely surviving a bad economy. But I wouldn’t write off private label. We’ve got a lot of projects in the hopper and some of them are very, very significant financial game changers for the company. It’s not like we are sitting here, thinking private label is not focused on it. A few of projects come through we will have very different earnings in the future.

Now remembering the first quarter we mentioned that we’ve got a big price increase from our East Coast facility and that really attenuated our sales. If that hadn’t happened we probably would posted over $1 million of earnings for the second quarter. And some of the -- now the quarter’s already come and gone and quite frankly I think we are even more excited about what’s happening now than what’s happened in the second quarter. We are obviously very proud of the team that Reed’s putting together such a great quarter. But looking forward, I have projects that we are working on that unwind about $2 million a year of spend. And that’s very exciting for us. It’s something very tangible, something very concrete and something we anticipate having fruition between getting it done somewhere between the first and second quarter of next year.

Probably will start impacting our margins and profitability around the very beginning of the year and fully affecting things in the third quarter is my best guess right now. Part of the project’s not a mystery, we have done some analysis on the West Coast facility here. We have a number we report internally and to Wall Street and it’s the idle plant capacity and I think we figured out the math is we have to upgrade the plant, and so we are in the middle of tripling the speed of the West Coast facility and acquiring equipment. Some third of the equipment’s already acquired, the design work is done and we will effectively evaporate the idle plant capacity number from our financials once that is done. So that should improve operation profitability by $1 million a year and we have another project that will save us about $1 million a year.

So those are very exciting things and on top of that our newly found, not really newly found profitability, a couple of quarters, second quarters before we had [turned out] $0.04 a share and we last year we had private label thing that kind of send us out. And that’s maybe it looked like just an artificial improvement of our gross profits because of that one-time hit to earnings and gross profits last year, but even without that, even building back that $450,000 into last year’s gross profit you can see that gross profit margins for us have definitely increased a couple of percentage points and once the two projects are done we should have another three or four percentage points of gross profit margin.

Now one of the big things that we have been talking about for years and finally have done is we have put out a national TV campaign. And it may feels a little bit like we are up to bat and we are swinging for home run instead of a lot of [bunting] and singles and doubles and that maybe the case. So, we are going to evaluate the current national TV advertising campaign and see how it is going and it is too early to tell. We are in the midst of it. We started our advertising in the third quarter and it started in the first -- after the first week in the July, I think it’s was on 7/3 and has been going. We take a little break and then we start-up again in September. And it’s the program for analyzing us is national TV advertising. We will just kind of look at the products involved namely the extra Ginger Brews and see how that performs with the national ad campaign.

So it won’t be looking at a specific chain or specific region. We will be looking at global, overall sales for that product. We have really have made a commitment to making a poll campaign for the product, we have not made a commitment to TV. We are playing around and once we mentioned that we were going to do that we had an article written in about 90 ad agencies approached us and we have two or three others firms that we would engage. This is not giving us the return on investment that we would like to see and so we’ll be probably playing around not just TV but social media, print, and maybe some regional billboards here over the next year.

The way I look at things are that part of what happened that caused such a dramatic effect in the financials is, as I mentioned before in prior calls, we are targeting the promotional spend that was going in sales that in 2012 was running around 9%, last year ran an average about 12, but in fact started the year at 10%, beginning of 13% and ended around 14%. And it was doing too much erosion on the gross profit and causing us to get into a phase where we continue to do that kind of spend, we end-up having to raise money which is something we say we are not going to do, just to fund operations.

So we have attenuated and figured out the gas pedal for that spend. We have backed it off from an average of 12% last year and a peak of 14% in the fourth quarter to 9% in the first and second quarter and effectively by not eroding the top-line with deals and all kinds of promotional spend we have increased the gross profit margins through that also a part of increase of gross profit margins is the improvement in our plant idle capacity. We increased the -- I think the production went up 28% over the prior year and we are going to continue to see growth, particularly with the new equipment coming on. Probably once it’s on board, next year we will probably be up 40% or 50% over this year. And absorbing lot of fixed overhead and seeing the margins improve dramatically from that.

So the commitment is we are trying to fueling up its funding that advertising that we like to do, like to think that if we get to 0.5 million a quarter next year. And at the same time we still like to retain our profitability. So it’s really important to these projects come through to help fuel the advertising that we like to do and at the same time we like to continue to show some profitability and continue to pay down debt et cetera.

Another thing is coming up here shortly for the company is that the line of credit with our bank is coming due in November and of course they are bidding on the renewal and other players and obviously three years ago we signed up for the line of credit. We are in a very different economy at a very different place in the business and now particularly with the second quarter and the pro forma is showing the increase profitability and gross profits of the company in the future we are finding it pretty easy to get much better deals and availability to continue to operate the company.

So we are not envisioning any kind of an issue with it, we are seeing this as an opportunity to take advantage of all the improvements in the business and profitability and growth and everything that’s going on here.

Kombucha, I think we mentioned it in the first quarter that we are changing packaging component and we were caught off-guard little bit by the advertising we started in the first quarter. We quickly backed off of that and we are just about to be caught up with it but we walked away from about 20,000; 25,000 cases of business we could have had in the second quarter. So instead of 35% growth we should have been more close to 70% growth for the quarter. We are very close to $3 million for the half year even with that and we are anticipating, we did lose a little bit of momentum from doing that but sales are very strong and consumer response is still very strong in the product as a lot of, I would say the product has proven itself in the market and we’ve given 50% to 100% for the year. I think right now we are saying 50%, we might be in a lower level end of that. But we do think we will recoup or regain some momentum here.

We started up the advertising again in the second half of the year for Kombucha and we are more able to keep up with sales as we’ve improved the production capabilities of Kombucha. Obviously we’ve got ourselves into more distribution, [inaudible] stores in the Midwest, also new distributors are on board with it. Manhattan Beer is the largest distributor for Koor’s in the country with 25,000 accounts and started launching and running with Kombucha and that’s been very successful in New York City. We brought on a very large distributor in Southern California here in Haralambos.

I believe we’ve already done somewhere around 7,000 cases and we’ve brought on, probably I think 500,000 new accounts I really don’t know what it is. But I should know that, I know it’s on a recap here but I don’t want to dig --. But it’s been a very successful launch. So we have people on the street in LA and New York and we are really seeing quite a model for that, and probably besides the national advertising some of the new gross profit coming in will be fueling up the expansion of our sales force out in the field in more regions where we are not just doing distribution but we are in distribution with a partnership and with the active sales force on the street.

So that has been really exciting for us. So yes, I don’t want to talk anymore about private label. Yes, we’ve got in to book to million which is a new kind of a Barnes Noble situation, and some distribution with [Dilbert’s]. I’m going to say this, I’m not going to qualify it. There is bunch of distribution we’ve got that we are not telling people. It’s part of the problem of being a public company. We just don’t really want to put a big target on our back and that’s not an allusion to the chain target. We are just getting in to some relationships that are better. You wish you were a private company some time. So there are some exciting new relationships, I think some of you guys will discover them out in the marketplace. But you are probably not going to press release it.

For the moment we don’t want to put out a generic press release saying some big customers buying one of our products and kind of looks stupid in the market. So you anticipate not only that we see that the first quarter was a weather-driven slow down, we see our brands going strongly in to the future, we see that advertising will eventually get a mix if we don’t already have it. That’s going to drive and accelerate sales and we are doing everything we can to generate more internal regenerated capital through our gross profit increases and it’s an exciting time at Reed’s. We can see exactly what we need to do. We may not be completely clear on the advertising marketing but we do know the kind of relationships we want to build with the world’s largest distributors in the country that we have on-board and are bringing on board.

We still put out the best data. We are now the number three premium soda in the supermarket trade. We started at number eight when we went public. And we passed some very large companies, that I am thrilled to have passed. And we are about to pass someone I had never thought we would pass. But Stewart’s is one of the ones we’ve passed, we are beyond Jones, and just for a long way beyond Jones at this point.

But anyway the kind of data we are generating isn’t just good and feels good, it’s the kind of data we walk in to new accounts and we say this is why you might want to consider putting our products on the shelf, a shelf by the way is getting up beat up by slowdown, by consumer shift of preferences moving away from the high tech unhealthy sodas that generate the kind of response, like let’s tax the hell out of it, to products like myself that bring in health benefit to it they are all natural, don’t have GMOs or chemicals in it.

So not only are we the number one I said it before the number one natural soda with the top three sodas and natural foods, five of the top ten. But we are also the top premium and fastest growing premium soda line in the country. So that double bang for your buck on a very competitive aisle. We don’t just come in as number one in one category, we are number one in both. And when a store is thinking about may be putting in one of the two where we cover both. And so our guys are -- that’s why we are able to kick open doors like we do and continue to do.

I’m going to open up the floor to questions in a second. I would just say it feels like we are really on track, it feels like the opportunity to accelerate is coming here or happening now. I would say there is one other highlights of the quarter that I think really bears some focus. Actually Ginger Brew was up 43%, no marketing or advertising happened around it. And all the Ginger Brews are up 34%. So the products that we consider kind of are monster, our big thing are the ones that are performing and that is even before the national ad campaign kicked in.

So anyway, it’s exciting times here and at this time point I am going to open up the floor to questions. This call will not go beyond an hour. So we’ve got I think about 22 minutes for questions that people are having.

Question-and-Answer Session

Operator

Thank you very much. (Operator Instructions). And the first question comes from the line of Joseph Munda with Sidoti & Company. Please go ahead.

Joseph Munda - Sidoti & Co.

Good afternoon, Chris and Larry. Can you hear me okay?

Christopher J. Reed

Hey. Thanks for coming on to the call Joe.

Joseph Munda - Sidoti & Co.

Great quarter Chris. Congratulations. I typically don’t say that but it was very nice quarter on your part here. I just want to get, dive deeper a little bit here on the plant optimization and the improvement in gross margin. Can you kind of give us a little more color in what you are doing and what you are seeing as far as the plant is concerned? And you also mentioned that about a third of the equipment has been purchased already, which means like I am saying here two-thirds needs to be bought. And how much is that going to cost you as far as CapEx is concerned for the rest of the year? Thank you.

Well. Interesting enough, I can’t really say it publicly, some of this, but we aren’t really going to be putting much cash out at all. We're going to lease the equipment that we end up having to buy.

Joseph Munda - Sidoti & Co.

Okay.

Christopher J. Reed

But there will be expenses that you can’t -- I mean you can try to put in the installation into leases to some degree, some of the materials you buy for it, but there will be costs -- probably costs of a couple of hundred thousand over the next six months to bring the new plant online. It was interesting though, the economics of the new plant in LA, the triple the speed, the payback is around a year.

Joseph Munda - Sidoti & Co.

Okay, so --

Christopher J. Reed

One of those, oh my god, how obvious was that.

Joseph Munda - Sidoti & Co.

Okay. So you did about $155,000 in CapEx through the first six months, so you're looking at, what, almost $300,000 in total CapEx for the year based on the new equipment, is that right somewhere in that ballpark?

Christopher J. Reed

Yeah, we probably will not be doing a major install during the third and fourth quarter here, so it will start in the first quarter.

Joseph Munda - Sidoti & Co.

Of next year?

Christopher J. Reed

Yeah. We will have everything lined up, the equipment leased in all, do some basic infrastructure stuff, but the third and fourth quarters and you’ve heard me talk about private label, we are booked. This plant is going to book -- run it full out to make it through the end of the year just because we have a lot of private label and new private label for this year.

Joseph Munda - Sidoti & Co.

And so, in terms of capacity right now, where are you at as far as plant capacity?

Christopher J. Reed

Two shifts, six days a week, we're maxed out, but we have the opportunity to go with a third shift and seven days a week. So, we're running about 80,000 cases a month, and we could run – approximately, we should be able to run 120,000 cases a month with the current equipment.

We should be able to get significantly -- we should be able to get to the three times of that with the new equipment. By the time I've done, this is another thing I didn’t say on the initial part, by the time I've done with my two projects, I will have enough production online to cover about 100 million to 120 million in sales annually, so that will be a big relief. Even this year -- last year, we got caught short with putting up production, and this year we're maxed out in both plants, so we brought on a third plant that starts up on 26th of August in the Midwest that could support another 30 million in sales, so we're finally getting a bit with -- the West Coast plant, it will be able to support somewhere around 60 million in sales.

Joseph Munda - Sidoti & Co.

Okay. That's helpful. As far as -- give me one second here, I’ve got a lot of notes. As far as what is driving the branded label here, I mean it seems to be -- I understand Kombucha, but what is driving brand and label as far as -- is it just expanded distribution because obviously the promo costs are coming down you are saying oryou're seeing nice growth there in the branded business. Can you just give us some insight on what is going on as far as what is driving that growth?

Christopher J. Reed

Well, I appreciate the way you said it because it sounds even better than the way I said it. Yeah, we are promoting less, and we're having a lot of acceleration of growth. I think I am going to be -- I don't know how to describe myself, but I -- how about the word [Moscow mule], I don’t know what's going on exactly. I just – okay, now I did allude that we came up with a new method of making our product that allows us to streamline and go to less expensive bottling, also lets us do export much easier, and some of that is affecting sales. I think the products are tasting much better. So, we had a couple big ah-ha’s after 25 years of making millions and millions of cases of our Ginger Brews that I think are appealing to the customers, but I don't think that’s all of it. I think that we launched at the beginning of the year, we put non-GMO on our products, may sound kind of -- I mean it's all trying to speculate on my part, but I think that has an effect in natural foods where a customer is GMO sensitive.

We don't really know exactly why we're seeing such an increase. I can only give you my speculation. It just seems to be that the Ginger Brews are going quite nicely on their own, maybe they anticipated my national advertising on TV, who knows.

Joseph Munda - Sidoti & Co.

And I know, I’m jumping around here, but in the guidance that you guys gave or the 2014 outlook, you said company expects revenue growth of 15 to 20. Is that gross revenue or is that net revenue growth?

Christopher J. Reed

Net sales.

Joseph Munda - Sidoti & Co.

Net sales. So, 15 to 20, so you are expecting this acceleration that you are seeing in the second quarter to carry for the back half of the year and that’s been driven by, I guess an uptick in private label that you are going to see or is it going to be mostly carried by Kombucha and branded label?

Christopher J. Reed

Well, okay. There’s a few things. Well, Kombucha is now fully in production, so we don’t have that hick up the second quarter had. We don’t have the unusual weather pattern, at least they don’t know this. If we do, we do, but assuming weather is normalized, we should see sales and not the unusual first quarter slow down due to that. And private label will be back up and running. I mean, right now the orders are in, they are in for the third and fourth quarters a while ago, and there are significant new orders above and beyond last year.

So with private label not dragging it down, if the weather holds -- does its job, and Kombucha fully in stock, and the acceleration of our branded products maybe even accelerated more due to 27 million people seeing us on TV. We are giving a modest expectation of what we can see right now.

Joseph Munda - Sidoti & Co.

Okay. So Chris the -- I don’t know if there is any other people in the queue, but it seems like you are shifting the promo spend from the distributors and the slotting fees and shifting that towards ad spend. Is that what you are talking about better return on your investment? Because it seems like in your initial comments you were like, well, we don’t know yet what the impact has been because it’s too early to tell, but is that the case where you are shifting the dollar spend away from the retailer to more in-house national advertising and hoping to pull through sales that way? I am just trying to get a sense. And how -- initially, are you getting any feedback from anybody on the national ad campaign?

Christopher J. Reed

Well. We didn’t have to shift too much. There were a number of programs that were going on in the fourth quarter and the third quarter of last year that had just gotten significantly beyond return on investment situation. They were just too rich of promotions. I think the retailers were going, oh, that’s kind of rich, and it maybe was just us testing out things to accelerate things. The point is we shut down the more aggressive programs, and we’ve kept most of the programs on board that we normally have going.

So retailers haven’t been pushing back, and they feel very well handled and comfortable with what we are doing right now, but it’s true. It is like you could do lot of little ads and you can give your sales force a whole budget to go out into the world and put an ad into each of the little natural food stores around the country or you can consolidate the spend into a national ad, and probably it’s 20 times more effective to do a national ad versus to do little co-op situations all around the country. So, I think we are spending smarter, and as you can see we are increasing sales especially around our core brands with less spend, so it’s a good thing.

But ultimately, I said this to the sales force that if we are highly successful with our new advertising campaign, if it’s giving us a better return on investment, we’ll continue to squeeze the spend in the street. Well everybody, well every push back from our customers saying we are looking -- we want you to spend some money with us. We’ll just basically point them to the sales of the products and say how do you like the acceleration on the brand in your stores, and are you making more money.

So we would ultimately rather than discounting the product and having people buy it because it’s on deal, we’d rather let them hear about an incredible story about the products and go into the store because they just heard about the most amazing Ginger Ale ever created, so that’s a difference and that’s a shift, and we would like to make that shift.

Joseph Munda - Sidoti & Co.

Okay. And then my final question, and I’ll hop back in the queue. As far as Whole Foods is concerned, can you give us the number of stores that you are currently in or a percentage of the amount of Whole Foods you are in?

Christopher J. Reed

Well, we are in all the Whole Foods. There is not a Whole Foods you can walk in to that our products aren’t in there. If you are asking about Kombucha which I think you are?

Joseph Munda - Sidoti & Co.

Yeah.

Christopher J. Reed

We're in 150 right now. So, we've moved – the last quarter, we were like 135, we picked up 15 Whole Foods. They have not been the most open people to our products, but in the mean time we don’t have any shortage of people like Safeway and Kroger’s and other large national retailers that have really appreciated what we're doing and/or even Manhattan Beer. So I mean Kombucha is getting a lot more distribution. It's doing well in those accounts.

Joseph Munda - Sidoti & Co.

Why wouldn't Whole Foods, I mean your Ginger Brew obviously and Virgil’s is there, but why wouldn't they take Kombucha along with it? Do you guys bundle it with the other products or is that a totally separate sale?

Christopher J. Reed

Now, you are starting to -- taking on my poor sales guys. I mean first they tried bundling and tried [threatening], –they’ve done everything. The thing about Whole Foods that's unique is they have a corporate office that has no real power. They can suggest to the regions what to carry, but the regions have the autonomy. And when we started to advertise…

Joseph Munda - Sidoti & Co.

But they're carrying GTS, they're carrying DaVita, that's why I am just a little confused as to…?

Christopher J. Reed

Yeah well, those products got in there and then a new product category came along called high pressure pasteurized juice, and they said to us, look, we like our regional Kombucha companies in our one national brand named GT and that's kind of where we're going to leave it. We don't want any more national brands of Kombucha, and quite frankly the high pressure pasteurized juices are where it's at.

But recently, Kombucha is making news again because it's on fire. It's growing 30% year-over-year. And high-pressure pasteurized juice may be doing really well, but Kombucha is doing really well. And so, the advertising we started and then stopped because we couldn't keep up with production has started up again, and advertising we found was the most powerful way for us to get into Whole Foods because they may be able to tell us no, but they can't seem to tell no to their customers. And when their customers start walking in the door saying where is this stuff, this sounds incredible, I love Reed’s. That really -- that knocked down a number of regions of Whole Foods, but we ultimately will get into the Whole Foods.

Joseph Munda - Sidoti & Co.

Okay, thank you Chris. That was very helpful.

Christopher J. Reed

Thanks and Joe is the analyst with Sidoti for those listening on the call. Thank you, Joe.

Operator

Our next question comes from the line of Alec Jaslow with Midtown Partners. Please go ahead.

Alec Jaslow - Midtown Partners & Co., LLC

Hey Chris, congratulations on a good quarter.

Christopher J. Reed

Well, thanks Alex. I appreciate it. Now you are the analyst at Midtown right?

Alec Jaslow - Midtown Partners & Co., LLC

Yeah. So just wanted to get a sense, when I think about the company, I think about 2012 was a great year. And when I was looking at cost of goods sold as a percentage of sales, you hit 63% this year, but in 2012 you are at around 61%. I am just trying to get a sense if it is realistic to think in the future you can hit around that 61%, and may be also what's the difference between then and now?

Christopher J. Reed

Well, we were running 33%, I don’t know, 2012 did we run 33% margins, that will be pretty good. But with the projects I am working on right now, we should bring another couple million dollars in on an annual basis which works out to somewhere between 3% or 4%. So I am hoping mid-year, next year to be running, assuming I don’t go back to heavy promotions, which I don't think I will, if we're running 9% promotions, we should be seeing 35% to 37% margins.

Alec Jaslow - Midtown Partners & Co., LLC

Okay, and so is Kombucha -- in terms of in the mix of products driving up that cost of goods sold?

Christopher J. Reed

No, well, it shouldn't be. We continue to -- we have a bit of spend going on eroding top line in Kombucha. That's still in kind of a launch phase and there is a bit of deals going on around that product. So as we back off that, the margins will increase but the product is intrinsically -- has more margin. Larry, I am asking Larry, the CFO here, does Kombucha have more margin than our sodas at this point?

Larry Tomsic

Yeah Alec, right now with the Kombucha, we had a learning curve in the production. So, our costs will come down as our yields go up, which we have seen recently in our last batch of Kombucha run. So we will continue to get better in the manufacturing of the Kombucha and the margin will increase over time.

Christopher J. Reed

I mean right now, how are the margins comparing to whole -- to extra or just sodas, you don't have that on top of your head.

Larry Tomsic

No, I don’t.

Christopher J. Reed

But as -- anyway, somewhere around 10% to 15% more margin than the soda. So as we get more -- maybe more heavy in the mix of Kombucha and less of an intro phase where we're doing discounting deals, we’ll see contribution to margin improvement from Kombucha.

Alec Jaslow - Midtown Partners & Co., LLC

Okay. Is private label margins lower than Kombucha or is that similar to the other sodas?

Christopher J. Reed

We typically run -- it’s somewhere between 30, anywhere from 25% to 40% margin on our private label. So that’s slightly lower than the sodas, but once you take -- you look at the 9% erosion off the top line that happens effectively across the board for our branded products because of the discounting and deals and the promotion that go on in the market place, that’s, you know 25% to 40% margin on private label is net, and it is probably similar to what we net on sodas, what we net, 33% overall.

Alec Jaslow - Midtown Partners & Co., LLC

Okay. Forgive me if you talked about this, but I am trying to understand more about the change in packaging on Kombucha, and (inaudible)the recent slowdown affected any of your relationships with suppliers and what not?

Christopher J. Reed

Not suppliers, the sellers. I mean the suppliers are happy with us and they don’t like us to slow down buying. But anyway the retailers -- there were definitely some tough months there in June and early July where we had to negotiate and smooth out relationships because the product with the advertising came up the first quarter was accelerating very quickly, and we kind of dampened it a little bit. But right now, we have a huge queue of Kombucha orders and we are filling them right now. We are on our 40,000 cases being produced in the month, and hopefully we’ll get through a bunch of it this month. But we are seeing that, yes, we threw a little water on the fire, but there is still a lot of dry wood in there and it seems like it’s burning nicely.

Alec Jaslow - Midtown Partners & Co., LLC

That’s really helpful. Thanks. That’s all the questions I have.

Christopher J. Reed

All right. Thanks.

Operator

And the next question comes from the line of [Vipul Sagar with Blanche Capital]. Please go ahead.

Unidentified Analyst

Hi, Chris.

Christopher J. Reed

Hey. How are you doing?

Unidentified Analyst

Great. Good quarter. Thank you. Just a couple of questions on Kombucha, so I just heard you mentioned 40,000 run rate right now.

Christopher J. Reed

That’s what we are producing in this month. I don’t think our run rate is 40, it’s probably somewhere running closer to 30.

Unidentified Analyst

Okay. For the third quarter, it’s around 30k but last quarter how much was it, you did what 1.4 million?

Christopher J. Reed

I have those numbers here. Let me see if I can…

Larry Tomsic

1.4, 1.45, Chris.

Unidentified Analyst

That’s what I thought. Okay, 1.45, number of cases?

Christopher J. Reed

What were the cases for the second quarter?

Larry Tomsic

About 64,000.

Unidentified Analyst

64,000, fantastic.

Christopher J. Reed

We would have -- we thought we would hit another 20,000. We walked away from orders for another 20,000, so probably if everything had been smooth, we’d had about 84,000, 85,000 cases for the quarter. And that’s…

Unidentified Analyst

And in third quarter, you are looking at almost 90,000 cases?

Christopher J. Reed

Yeah. So it’s going very nice.

Unidentified Analyst

Beautiful, beautiful. Okay. That’s all I had a question on.

Christopher J. Reed

You are the man out in Portland, so how do we look at Portland?

Unidentified Analyst

Portland, still some of the places don’t have the new flavors, but New Seasons is doing good. They have everything. So, that’s a good sign. So, I am seeing that thing moving over there pretty well. Even though they came on board late, but they are doing really good, so very good quarter. Keep it up, and talk to you again next quarter.

Christopher J. Reed

All right. Thanks for being -- following us.

Unidentified Analyst

Thank you.

Operator

And our next question comes from the line of [Janet Herman] who is a private investor. Please go ahead.

Unidentified Analyst

I have the question about the Kombucha. Chris, can you tell me does the Kombucha undergo any type of heat or pasteurization process?

Christopher J. Reed

It does in the early stages, that’s we brew the tea and then we put the culture in the tea.

Unidentified Analyst

So, the culture is added after all heat has been applied to the product?

Christopher J. Reed

Yes.

Unidentified Analyst

Okay, so that satisfies the raw organic labeling requirements?

Christopher J. Reed

Kombucha has been, I mean people could challenge that, but has had that moniker since the beginning.

Unidentified Analyst

Okay, and then I am having another question about the ingredients that you are using? Are all of your additives and ingredients being disclosed on your label?

Christopher J. Reed

Yes, all that have to be disclosed, they are typically being disclosed.

Unidentified Analyst

Okay. And so are all of your products, now Kosher certified and have documentations for that?

Christopher J. Reed

Yes.

Unidentified Analyst

Okay, same with GMO?

Christopher J. Reed

What’s the question?

Unidentified Analyst

Do you have certification for your GMO?

Christopher J. Reed

No, we just put on our packaging that we are GMO free. So, we contacted our suppliers and had them verify that we have or all of the ingredients that we are using in our products are GMO free.

Unidentified Analyst

Okay, all right.

Christopher J. Reed

We are pretty savvy about what kinds of products that we have to be concerned about, what are the ingredients that could end up with the GMO component to it, sugar, things like that. So we have made sure that suppliers are clear on that and we kind of keep up with it. We are not using a third-party audit firm at the moment.

Unidentified Analyst

You are not. Do you plan to go to a third-party auditor?

Christopher J. Reed

I don’t know. Sales is asking if some of them have some shelf appeal, so we are having that debate. We just -- we had done the audit ourselves. We wanted to make sure our product didn’t have any GMOs in them. For the most part, they were GMO free. I think we had citric acid in one of the sodas that came from a GMO corn source and so we got a non-GMO citric acid to substitute out, and we are just confirming that all the sugar that we were getting wasn‘t coming from [GMOB].

But -- so we want to get the news out first and now we are considering maybe for marketing it might be good to be part of GMO -- some of the GMO certification groups.

Unidentified Analyst

Are you using any corn syrups at all of your products?

Christopher J. Reed

No. No, I don’t think we buy corn syrup that’s not GMO.

Unidentified Analyst

So all the sugar that’s in your product right now, is that organic beet sugar or what are you using?

Christopher J. Reed

Well, I think beet is an issue with sugar in terms of GMOs, so we are not using any beet sugars.

Unidentified Analyst

Right.

Christopher J. Reed

And I don’t believe sugarcane has any GMO sugarcane yet, but we are having all our suppliers confirm that they are not sending us GMO ingredients.

Unidentified Analyst

Okay, great. Well, thank you for answering my questions today. Have a good day.

Christopher J. Reed

Thanks, appreciated Janet.

Operator

And the next question comes, --it is a follow-up from Joseph Munda with Sidoti & Company. Please go ahead.

Joseph Munda - Sidoti & Co.

Yeah, Chris, real quick on the freight, refrigerated freight, I know that’s a key component on how you move the Kombucha. Can you talk to us, in the ‘Q,’ you talked about you know finding a more efficient way to [move risk] (ph) or you know lower costs, can you kind of speak to how you envision that happening?

Christopher J. Reed

Well, I think that sometime in the next year, we will have a relationship for us to ship bulk Kombucha to the East Coast and have it bottled there. I believe we have found a facility that is capable of that. So that should ease up some of the freight component of that product.

Joseph Munda - Sidoti & Company

Okay, right. As far so, can you explain that to me, you brew it in California and then ship it and then it would be bottled on the East Coast?

Christopher J. Reed

Yes.

Joseph Munda - Sidoti & Co.

Okay. And how much do you think that will save you in costs as far as freight is concerned?

Christopher J. Reed

No, we haven’t really analyzed it to be honest, sorry I mean it’s you know --.

Joseph Munda - Sidoti & Co.

No, no, I listened I got it.

Christopher J. Reed

I mean, I can make a stab at it, it’s probably -- you know probably could get, I would think you’d save a couple of bucks a case of possible you know somewhere around 8% to 10% on your cost of goods or that.

Joseph Munda - Sidoti & Co.

Okay.

Christopher J. Reed

Yeah.

Joseph Munda - Sidoti & Co.

No, but what I am getting at, so this level right, you did about 900,000 in the first quarter and delivering handling expenses, 926,000 in this quarter. Is that a run rate that we can like 900,000 a quarter is that what we're looking at going forward?

Christopher J. Reed

I can't answer that, do you have -- Larry do you have a history on our shipping expenses by quarter?

Larry Tomsic

Well, shipping expenses are going to vary somewhat with the product and you’re right that the mix between East Coast and West Coast will also affect that. As Chris pointed out, we're looking at a third facility on the East Coast. So that will help decrease…

Christopher J. Reed

That's the third facility in the Midwest and that's not the facility that we're doing as a…

Larry Tomsic

But that will help with the freight costs nationally So it looks like --

Joseph Munda - Sidoti & Co.

Yeah, but when is that facility going to come online, let's say I am just trying to get a sense in timing because couple of hundred thousand here, couple of hundred thousand there, it can make a difference on the bottom line. So I am just trying to get a sense of when --?

Christopher J. Reed

Like our delivery costs are shipping and handling, delivery handling was down from last year for the six months. So we're actually -- with more Kombucha sales, we’re actually down.

Joseph Munda - Sidoti & Co.

No, I understand that, but is that safe to assume going forward as well?

Christopher J. Reed

Yeah, I think that we're handling freight better right now. But I would say that probably sometime next year, probably the third quarter of next year, we'll be producing Kombucha on the East Coast. But that's still, that's very early and that's just pure speculation right now.

But it makes sense to me. I have $2 million saving projects going on now, and once they're done, we'll look at lesser projects that save $0.5 million a year or something like that.

Joseph Munda - Sidoti & Co.

Okay. All right. I think and I just have one other follow up here. Chris, as far as the -- I mean do you think you guys are just catching the tailwinds of this natural food trend where people are looking just to eat healthier, I know you’ve touched on it a little bit with the sodas and the sugar, but do you think it's a natural combination for you guys to be included in whether it be gluten free, whether it be other diets or grass-fed meat, you just feel like it’s a natural combination of people when they’re purchasing other produce whether it be organic or not that they're going to throw a case of REED soda in there as well?

Christopher J. Reed

The natural foods was $2 billion when I started, it’s over $100 billion now. It's not a short-term trend, 25 years into it, and it's going to have another 25. I think it just keeps going into the future. It just makes total sense to me as we evolve as a species that we're going to continue to want to improve our quality of life.

It's a bet that I am willing to make and is everybody going to go to drinking water and wheat grass juice, no. They're going to want to have some fun. It’s a way of life and they're going to want to do it clean fun. And Ginger Brew and the proof of the pudding is Ginger Brew just continues to dominate to be the top drink, but when you look at the medical research in ginger and the kind of things that ginger is doing right now, I mean the studies and -- there was study in Africa where they -- this African hospital just like last week had some really deadly bacteria that show up in the hospitals and they found that ginger and honey was more effective than the most powerful antibiotics, and they were just throwing these things into petri dishes trying to kill off these horrible problematic super bugs.

I mean that's on top of the cancer research. So I mean I just think that ginger will have its day in the sun, you will be able to feel good about your ginger, the more you -- especially the more people get to know about what ginger is good for. I mean I’m secretly an herbalist and this is what I do, but I am really clear that ginger is going to have a big day in the sun like (inaudible) brand at some point in the future here. And we're going to position ourselves to be at the right place for all of that.

Joseph Munda - Sidoti & Co.

Okay. Thank you.

Christopher J. Reed

Yeah, sorry to give you the pulpit thing, Joe but that's what we feel about it.

Operator

And so there are no other questions at this time.

Christopher J. Reed

All right, thanks, and we'll look forward to next quarter with you guys.

Operator

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

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