Reed's (REED) CEO Chris Reed on Q4 2015 Results - Earnings Call Transcript

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

Reed's, Inc. (NASDAQ:REED)

Q4 2015 Earnings Conference Call

March 23, 2016 04:30 PM ET

Executives

Chris Reed - CEO and Founder

Dan Miles - CFO

Analysts

Mitch Pinheiro - Wunderlich Securities

Anthony Vendetti - Maxim Group

Kevin Dede - Rodman

Operator

Good afternoon, and welcome to the Reed's Year-End 2015 Earnings Conference Call for the period ending December 31, 2015. My name is Scott, and I will be your conference call operator today. Participating in today's call, we have Chris Reed, the CEO and Founder of Reed's Incorporated; and Dan Miles, Reed’s Chief Financial Officer. Following management’s remarks they will take your questions.

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

Therefore, the company claims 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, March 23, 2016. Reed's Incorporated assumes no obligations to update these projections in the future as market conditions change.

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

Dan Miles

Hello, everyone. Thank you for your interest in Reed's Inc., and thank you for joining us today for Reed's Inc. 2015 year-end earnings call. My name is Daniel Miles, I am the CFO of Reed's Inc. In addition to today’s press release, we’ve also filed our 10-K for the 2015 fiscal year. Let me start with a recap of our results. I will turn it over to Chris Reed, the CEO and Founder of Reed’s Inc. afterwards.

Fiscal 2015 was a challenging year for Reed’s as we were unable to meet customer demand for our products. The company’s metrics were directly impacted by the failure of our existing co-packers to produce as scheduled. Early in the fourth quarter of 2015, the company had up and running four production facilities and subsequently delivered record fourth quarter sales results.

Sales grew by 3.4%, while net sales grew at a faster pace of 5.8% over 2014. Reed’s branded products grew by 19% while other categories decreased due to the supply chain interruption. Specifically the Virgil's brand decreased 5%, Kombucha 12% while the private labels were essentially flat.

During the year, the company implemented beverage industry standard 8 ounce metric as a tool for measuring volume and volume related metrics to reflect a wide packaging diversity that Reed’s offers. So during this call, I will be referring to 8 ounce equivalents when discussing volumes unless specifically labeled otherwise.

In 2015, case volume increased 9.1% to 3.9 million cases, while sales dollars decreased 5.2% to $12.90 per case. Promotions and allowances for beverage products decreased 19% to 3.765 million or 7.6% of gross sales from 9.7% in the prior year. Non-beverage products such as candy, [grassroot] [ph] sales and mail order are not in the preceding volume metric discussion. These items as a group totaled 1.739 million in gross sales, a decrease of 433,000 or 20% from 2014. The decrease was a direct result of a California lawsuit that required the companies to find alternative suppliers. The company has successfully engaged new suppliers for 2016.

Cost of goods sold consist of raw materials and packaging utilized in the manufacture of product co-packing fees, repackaging fees, inbound freight charges, inventory adjustments and certain internal transfer costs. Our total cost of goods sold increased to 34.34 million in the quarter and year ended December 31, an increase of approximately 3.927 million or 12.9% from 2014. This increase was due to net volume increases of 9.1%, increases in cost of production related to raw material increases. Specific production costs were packaging costs of $0.35 per case and ingredient cost of $0.25 per case on that same 3.9 million 8 ounce equivalent volumes. These increases were partially offset by labor productivity decreases of $0.25 per case.

During 2015, direct write-offs of inventory increased 518,000 or $0.13 per case compared with $0.53 or $0.01 per case in 2014. Additionally in 2015, the company increased the reserve for product obsolescence by $200,000 or an additional $0.05 per case.

Our gross profit of $11.6 million for the year ended December 31, 2015, represents a decrease of $1.4 million or 10.8% from 2014. As a percentage of sales, our gross profit margin decreased to 25.3% as compared to 30% in 2014. Our gross profit decrease between years is primarily driven by the direct write-off of inventory and the increase in obsolescence reserve that I talked about previously totaling $718,000.

Due to the supply chain interruption, additional delivery costs were incurred to get our product that was available to our customers wherever and whenever possible. As a consequence, delivery expenses increased 13.9% over 2014 to $5.1 million or 11.1% of net sales. By fiscal year-end, with four plants up and running, the expense had returned to the expected rate of less than 9% of net sales.

Sales and marketing for 2015 were $4.8 million or relatively flat compared to the $4.8 million in 2014. General and administrative expenses increased $672,000 to $4.3 million in fiscal 2015 when compared to 2014 expenses of $3.6 million. This increase was due to wage related expenses of $362,000, stock compensation of $245,000, bad debt expense of $156,000 and legal cost directly related to the California lawsuit mentioned earlier of $108,000. These increases were offset by partial decreases in professional fees and consulting of $128,000.

Interest expense increased to $1.2 million in the year ended 2015 compared to $797,000 in the same period 2014. During 2015, when the company was experiencing significant production issues, the company incurred liquidity shortages that required re-negotiation with our bank, PMC. A new loan was obtained for $1.5 million that also changed the terms of the existing and term loans. Later both term loan expiration dates were extended to April 1, 2017 that did not involve any further changes to the loans. As a direct consequence, the term change and additional borrowing, the company’s net interest increased.

Loss from operations was $2.6 million for 2015 compared to a gain of $41,000 in 2014. The increase in the operating loss is due to supply chain production interruption and resulting losses of sales, attendant cost directly related to the production interruption and additional inventory waste and delivery expenses.

EBITDA was also impacted by the supply chain interruption. The losses from operation combined with the interest expense were greater than the non-cash increases for stock option and depreciation.

So let me talk somewhat about the cash and liquidity. Our increase in cash and equivalents to $1.8 million at December 31, 2015 compared with $959,000 in 2014, an increase of $857,000 was primarily a result of a cash generated by the financing activities of $2.7 million, less cash used for the capital plan improvements and the loss due to operations of $1.3 million.

As of December 31, 2015, we had stockholders’ equity of 785,000 and working capital of 730,000 compared to stockholders equity of 3.6 million and working capital of 2.2 million at the same time in the prior year. The decrease in working capital of 1.4 million was primarily the result of the cash flow from operations.

During the year, the company entered into an additional term loan of $1.5 million with PMC, our primary lender to accommodate future growth including the plant upgrade. The company granted PMC an additional 125,000 warrants.

Let me now share a little light on the overall outlook of the company. It should be recognized that while the supply chain interruption had a significant negative impact on the company, the record fourth quarter results illustrate that the company is on the way to recovery. We believe the company now has operations in place to meet sales orders as they occur at a delivery expense in line with past experience. With the expectation that the LA Brewery upgrade will be completed in the near term, we expect that our customers’ demands for natural beverages will be exceeded.

So now, it’s my pleasure to turn the call over to Chris Reed, the Founder and CEO of Reed’s Inc.

Chris Reed

Thank you, Dan. 2015 was -- started out as a very fast moving year for us and by second quarter demand for a lot of our products were at a growth rate that we hadn’t seen before. And by the third quarter we are actually on pace to break - I think we were looking somewhere close to 30 plus percentage rate of growth. Some of it driven by the demands for the Moscow Mule and our Extra Ginger Brew, once the Number 1 mixture for the Moscow Mule nationwide. And at that time, we anticipated that our newer capacity, our plants, our production plants, which are near capacity would not be able to keep up with demand unless we brought on a third facility. The third facility was scheduled originally to come on in April, it got delayed till June and hiccupped and didn’t come online until the mid-to-end of the third quarter, which shorted us tremendously. But on top of that, our largest co-pack facility for 23 years had a big hiccup, and one of their fillers that fills our product went down at that time. So it was kind of a perfect storm that we didn’t bring on a new facility and we had our largest facility have their first ever month long meltdown. So during that quarter, we delivered to some of our largest customers at a rate of 50% of sales.

So when I look at 2015 results, we probably – we estimate we left approximately $7 million of orders on the table that weren’t filled during the second and third quarter, and we would be reporting a significantly larger year if that had been the case. Also, a lot of inefficiencies were created during that time where we would ship in orders that wouldn’t be completely full because we had to get what we could to a customer and productions were disrupted and there was considerable increase in expenses, which I believe showed up in the gross profit margin erosion during the year. One of the – and the good news, obviously the fourth quarter, as Dan mentioned, we have seen a nice recovery of sales with our products and kind of a forgiveness for the out of stocks in a lot of places.

But in terms of the way we handled the production shortages, we preferentially supplied products on our Reed’s Ginger Brew line, and second priority was the Virgil’s line, and our third priority was the Kombucha line. Right now, the recovery of our brands into the marketplace, when I say recovery, we are still picking up shelf placements that were left vacant and still – and there is a number of large supermarket customers that we are scheduling ourselves back in-line and yet, they don’t turn on a dime. A lot of the smaller accounts as soon as we were back in stock, we’re immediately bringing our products back in. So Ginger Brew has recovered the fastest, Virgil’s is recovering second fast and the Kombucha still has a pretty good way to come back into the market during this time.

So the response to the lack of production was not only to get the facility that we had hoped to have online for the summer months online, which happened in the third quarter, but a fourth facility backup to everything else was brought online, so that we would retain a backup moving forward. And it has – we were experiencing in stock levels at this time higher than at in any time in past history. So we feel that the supply chain problems of 2015 are behind us, they are definitely unfortunate, they definitely took a little wind out of our sale.

2015, a number of things – okay, let me talk for a minute about margins. The margin, we’ve traditionally been running approximately around 30% gross profit margin. And a margin erosion to 25%, there were a number of aggressive write-offs of private label packagings from the past and other ingredients. As Dan Miles came on as a new CFO, and kind of created a very clean slate for moving forward with our financial, so it was – we had a $1.4 million of obsolete packaging write-down that would probably – I am sure it was the largest write-down in the history of the company. So that’s more of a one-time impact on gross profit margins.

During this time, we have been unwinding a number of supply chain imbalances where we would have significant increases in packagings of certain items and less of other items, which made it difficult for the company to stay in the sweet spot of ordering, which is to run large [gang] [ph] runs of our packaging. And in order to get back in the balance, we had to run a number of shorter run packaging runs that are more expensive. So they were a good move from a cash flow perspective, but they were relatively harsh and detrimental to the margins.

So I mean, Dan, I don’t – I am pretty certain, I don’t know if you shared this, but the plan right now is that we are seeing and moving with the plan to recover margins to the 30%, 29% to 30% margin level by the end of the year. Now, that number does not reflect some large projects that have been going on for the last year and a half, which is the West Coast plant improvement and expansion and the East Coast plant -- bringing the economics of our East Coast production in line with competitive production rates.

So what we anticipate is on the West Coast, as our new plant comes online and it has significantly progressed towards that end, we are anticipating somewhere late in the second quarter to have the new production line online and with that we will have the capability to produce everything that the – all of the production needs for the West Coast. And currently, we are supplementing West Coast production demand with productions from the East Coast and shipping west. The estimated freight savings from having the new facility online is approximately $1 million a year. And we anticipate with the fully automated line, and the triple speed of the new equipment, with the same number of employees or less, we will be able to produce at a 3 times clip, which should have further reduction in labor and with the new equipment maintenance and other collateral cost.

So my actual -- Dan and I have discussed kind of going back and forth, but I anticipate somewhere between $1 million for just the freight and $1.5 million with other efficiencies coming in from the faster line. There is some offset with the less labor, running three times as much product for the same number of people that we will be hiring more expensive personnel to run the more sophisticated equipment. So we are not exactly sure how far – how much the labor benefit will be. I know that we are running a relatively labor intensive West Coast production and the automation should reduce labor significantly.

The East Coast facility is still we’re producing to get production down and not to be shortening our customers and we are still optimizing the cost structures and negotiating pricing with these clients. And my vision for the East Coast is that we will be able to get our cost down by approximately $1 a case at some point in the near future from these activities and we are running currently approximately 200,000 cases minimum a month of the East Coast. So that would be a saving somewhere between $2 million to $2.5 million. The optimism I hope for that is because we’ve been able to negotiate rates in the past on par with dollar a case savings. And we currently seem to be close to those kind of negotiations with our current suppliers for production on the East Coast. I have a backup idea that if we can’t get what we want on the East Coast we’ll do what we do on the West Coast here and produce and put our own production facility on which will have even further savings. But that goal of gross profit margins getting to 30% here through the internal efforts prior to the benefits of the two plant, the East Coast and West Coast plant improvements and economics. That 29% to 30% will increase significantly from the West and East Coast changes in the economics. My estimate is that we’ll save somewhere between $3 million and $4.5 million a year when both coasts running properly and that will translate to another 5 to 6.5 percentage points of gross profit margin.

So our goal in the next 12 months is to move into the correct economics to have the – and keep the supply chain fully operational that was the first goal which we have pretty much satisfied this time but then to negotiate or run or create a new production facility on the East Coast to get the additional savings that we know we have – can negotiate due to current market rates for what we are producing. So we are excited about the movement into the higher margins, there is a big difference between a company running 25% and 35% margins. We anticipate this year to not only recover the missed sales opportunities of $7 million that we felt we left on the table during 2015. We feel comfortable or confident that we will reclaim those sales and continue the expansion of our brands. During the year, we launched the most exciting new product in the history of the company our Stronger Ginger Brew which continues to have more fans than our number one current product which is the Extra Ginger Brew. We’ve taken it to trade shows, we’ve put it into marketplace and our customers tend to prefer our Stronger over our Extra. And it may seem very cannibalistic but our experiences as we launch new skews they find new homes and new customers for them.

We’re focused and brought the Strong Ginger Brew into the marketplace because we wanted to remain as the number one Moscow Mule mixer, they were trend towards stronger spicier mixers and we wanted to stay ahead of that trend. During the year, we also expanded distribution into the Caribbean, South Africa, notable distribution increases in Northern California and the South-Central part of the US. We picked up a very large national chain Rite Aid, a drugstore chain 4,600 stores. We got in the door with private label through our brand Sonoma Sparkler which went into 4,600 stores and currently we’re moving our own products through that foot in the door and doing nicely. We have not reported per se but we're having -- seeing a lot more love from the club stores and we're seeing a lot more in and out business with them and an increase in sales there. We received a significant amount of positive press during the year, including a front cover of Bar Business Magazine with our products on there as we move more and more out of our grocery store competence and into more up and down the street business with focuses and convenience on premise and the nightclub and bar and restaurants.

I also was invited to speak at a very prestigious conference where I was on a panel with the COO of Coke and the CEO of Dr Pepper and CEO of Pepsi Bottling. So it was a first time and I was there to represent the story on craft sodas which in 2015 continued to accelerate in the marketplace as a number top trend, the top trend in beverages. We continue to run promotions with Absolut Vodka. We’re negotiating national distribution with the liquor distribution so that we can support the relationships of our products with large liquor companies, so we can do more co-branded type marketing with them beyond what we’re currently doing. The conventional supermarkets, we’re still moving very quickly there, the Ginger Brew was 28% in conventional supermarkets, Virgil’s had a small decline mostly due to not supplying Virgil’s and preferentially supplying Reed’s during the problems we had for supply chain problems in second and third quarter. In the conventional supermarkets, we were ranked in the Top 50 for the first time and the fastest moving soft drink company in conventional supermarkets at a time where we are having significant supply chain problems, so that’s relatively significant that we didn't derail that and that we continued the momentum in that core and key market for us.

We were invited in November of 2014 to attempt to develop the next-generation soft drinks for a large Fast Casual in the US. That project continued throughout 2015, during that time the client has tasted some of the finest sodas, interesting new beverages to show up on a soda fountain. We figured out how to convert our own brewed sodas which do not lend themselves to a concentrate or a fountain situation, we were able to overcome a significant number of hurdles in the R&D realm to create the first Bag in the Box of our products, the brewed sodas. We created a number of unique products that have not been in the marketplace before. I think we basically brought out our best skill set and that was honed during a bad economy where we jumped into private label and created an R&D department that I believe is unparalleled in the beverage industry. The proof of the pudding will be if we truly get this large opportunity for the company which will have a significant economic impact here.

We are still in the offing for the opportunity, we’re in talks of going into trial here soon and the things that give us the distinct advantage over the Coke and Pepsi products of the world are that we are doing this without sodium benzoate, we’re doing this calories reduced without chemical artificial replacements like aspartame or sucralose and we’re creating unique flavors. We're not telling the client what they’re going to get, we’re delivering the exactly what their creative departments are asking for. This level of flexibility, this level of green cleanness, this level of flavor development. The flavors we presented we showcased the first soda fountain Bag in the Box at the natural products show in Anaheim two weeks ago and 75,000 people, not all of them came and tried it but we are at the show and we were across from some of the largest natural food companies like Kind Bar and Chobani, Greek Yogurt and the world got to experience the future of the soft drink fountain industry. We had flavors there like our Orange Passion Mango, we had our Hibiscus Grapefruit soda along with our Ginger Brew mid-calorie and our mid-calorie cola Virgil’s and Root Beer.

Matter of fact, we don't think we told anyone they were even mid-calorie and no one was able to perceive the significant reduction in calories, it was a very excellent reception. We've had a phenomenal feedback and request for retail accounts looking to get into the natural Bag in the Box for the first time. This part of the business is a big component of the soft drink industry. I give an economic example here, if you wanted 30 gallons of Extra Ginger Brew I could sell you the cases to provide that liquid at approximately $325 delivered through one of my distributors. But for $75, you can get it in a concentrate in a 1 cubic foot delivered to you where you anywhere in the country and you can then throw away the box when you're done. It's not only the most economical way to provide your beverages but it’s also extremely green compared to the packaging and the glass and the cardboard and the energy and fuel and shipping. So I see a future where people care deeply about the economics, the CO2 impact of products. The interesting thing for myself that gives me a great hope that what we're doing here is a significant impact on the beverage industry is every new concept restaurant chain that I've run into personally is a trendy hipster place that has craft beer on draft, a lot of times there is Kombucha on draft and its desperate for this low cost high economic impact highly profitable part of their business which now is either the choices to either bring in a Coke or Pepsi product with all the inconsistency that would represent to the concept such as the clean living no sodium benzoate, no prep in the food attitude that comes with these new concepts or they forgo that area or even a third choice, call it a natural soda even though it's full of sodium benzoate and hope you don't get caught which is also showing up a lot too.

So there is a big gap there, there is a big need. We didn't see it to start with, we were brought to this -- this opportunity was brought to us by a creative group looking to move forward with a next-generation and not move backwards with a slow decline of these sodas that have a stigma associated with them, mom just won’t let their kids drink that stuff no more kind of feeling. So we reached out to everyone, we’ve reached out to all that but we’re targeting and continuing to move through the corporate structures of fast casuals and restaurant chains around the country and let them know that while many of them are stuck in contracts, those contracts do come due generally once every seven years and we’re letting them know that moving forward this is very exciting new options here. Now simultaneous to just producing these incredible new sodas, not only our new sodas but a new line of sodas that’s specifically or currently launching in the Bag in the Box soda fountain exclusive to start later in consumer ready to drink packaging.

Simultaneous to that, it became clear to us that the soda machine that all the sodas are being dispensed on just says to people from the get go that this is going to be unhealthy. So we’ve reached out to the CEOs of the largest equipment manufacturers for soda equipment in the world, flown out, had them fly here, many of them have invested in our company, invested in our trade shows and putting our products into their trade shows now trying to have their best foot forward with the future of soft drinks in their newfangled equipment, it doesn't look like a soda fountain, it looks like a craft beer dispenser. We've looked to Australia for need ideas we've seen a lot of European equipment that we’re currently putting in our proposal to large retailers looking at our Bag in the Box. So it's a very exciting times, there is a lot of creative going on here. Again, we are not forgetting our bottled beverage. We see recovery this year, we see the continued expansion. The craft soda is driven by economics, the economics are amazing.

Like the craft beer aisle that now exists in every supermarket, craft sodas are proving themselves to be high gross profit generating skews on the soft drink aisle. We’ve grabbed $300 million worth of IRI data -- scan data from Safeway analyzed it and found our skews to be top items in the store. So if economics truly drive things than there will someday be a very large section of craft sodas in the supermarkets rivaling or on a par or at least significantly well beyond where they are today but moving in the direction of where craft beers have gone. That craft beer aisle probably makes more money than the regular beer aisle at this point. And I believe that we’re looking at the future. Reed’s is still positioned as number one. I think the Bag in the Box establishes us as a leader with a significant R&D advantage giving us a entry into the market for the very first national Bag in the Box. Everybody wants to know how we're doing it right now and we are pursuing legal ways to secure technology to keep us in that competitive advantage.

So I appreciate your time listening to me today and I am going to open up the floor for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question is from the line of Mitch Pinheiro from Wunderlich Securities, please proceed.

Mitch Pinheiro

And I really appreciate the extra, the case equivalent data, really helps, so thank you. A couple of things on the top line. You're now pretty much done your first quarter. I was wondering if you could sort of give us an update as to how you know Reed’s is doing in this quarter that Reed’s brand, the Virgil’s brand or Kombucha, however you’d have that?

Chris Reed

That's a great question, and thanks Mitch for initiating coverage of us the other day, I appreciate you following the company now, I know you follow it for a while but as an analyst. Again, during the supply chain interruptions of the second and third quarter of 2015, we made a conscious decision to preferentially supply the Reed’s line of products. And second preference if we had extra lifetime to produce Virgil’s and third was Kombucha, I mean, it wasn’t completely like we shut down those and ran every bit of Reed’s we needed. We tried to keep a little bit balanced with it but we did lean towards Reed’s. So in the first quarter you're seeing the Reed’s recovery faster and moving into growth mode and the Virgil’s is still in recovery.

And Kombucha, Kombucha overall is probably going to be relatively flat although our Kombucha is down but we picked up some private label Kombucha during 2015. So we’ve kind of had that attitude towards Kombucha. It’s not that we don't think it's a great brand and it's not that we don't think that we’re making the best Kombucha on the planet because we are. We have big plans for own Kombucha but we also do recognize that there is an opportunity for private label there. So we’re creating plans for the Kombucha recovery and the Virgil’s recovery and Reed’s brand itself even though it’s in a growth mode isn't carrying all the gap showing up with Kombucha and Virgil’s.

So we are experiencing something close to flat although we have another week here for the first quarter, so it’s kind of plus or minus here around that. There is still – we also know what’s coming in 2016 and we know that we are bringing on some new large customers and some acceleration in picking up. We kind of can see the gaps still there and some of our slower customers have said things to us like, well, I am sorry, but we can’t put it back into the planogram until July, so that’s the next time I can move things around. So there is still love for the product and we are still in a recovery mode on it, but we are already starting to grow again – well, we did that in the fourth quarter and the first quarter for the Reeds’ products.

Mitch Pinheiro

So you have 13% revenue in the fourth quarter, so are you seeing – is that like a recovery of sort of lost sales and you made it up there and you are now flattish in the first quarter? Was that I sort of…?

Chris Reed

Yeah, I think that’s kind of accurate. I mean, one way to look at it is the fact that many of our distributors are customers by the time we started up production basically at the cusp of, at the end of the third quarter. There was a tremendous amount just we have to stock the warehouse; we have to maintain some kind of inventory just to have these fast-moving items in here. So we probably picked up a bit of filled the warehouse that they have kind of covered for – caused this fourth quarter to be up higher than it might have been in a more steady state situation. But they are also trending in the first quarter against a number of private label projects that aren’t quite there or had a big launch. So there is other dynamics going on in the first quarter than just the simple thing that I have mentioned here. But it looks like our core brands are getting back in there and recovering nicely. The minimum we envisioned for the year is that we get back the $7 million we left on the table, but we also know there is just a lot of new business coming online with some very large customers. And of course, it doesn’t account for anything with bag in the box which is there are some very large projects that are long lead kind of projects.

Mitch Pinheiro

Sure. So then looking – it was helpful to hear you talk about East and the West Coast projects and the savings. If I add them up right, it looks like - I mean it’s at least a 1,000 basis points of improvement or so and would that be a 1,000 basis points off of the fourth quarter level?

Chris Reed

Actually, no, here is the way that I am looking at it. It doesn’t quite work out to 1,000 for me. So I will pull out my calculator. Dan and I, the CFO, kind of go back and forth on this a little, but it’s obviously a spread sheet pro forma, it’s not factual. But that being said, the West Coast facility saves approximately – okay, so what’s the basis? Currently we are running 25% and that’s the fourth quarter is always the – what was the fourth quarter? It wasn’t 25? Was it? Gross profits were 25.5% versus - 25.4% versus 22.9%, so fourth quarter is traditionally our worst quarter, so don’t look at the fourth quarter margins as representative. They typically have a lot more private label in there and we’ve always - traditionally if you go back through time, you will see somewhere between 4 and 5 percentage points, 400, 500 basis points of reduction in our gross profit margin.

So the fact that we improved it during that quarter, so some of the hard work the new management team is putting in there. So we are seeing recovery without the new facilities coming onboard somewhere close to the 30% and we have programs and projects in place to get there. So we anticipate - I think that just the write-down alone was 1.5 points, so that alone would bring back – we are probably clearly not at 25 point whatever for the year, we are already 1.5 above that instantly out of the gate. There is another point somewhere else that I believe is coming in right now and we should be able to, without the improvement of the plants, get back between 29% and 30% by the third and fourth quarter of this year. And that’s just getting back in the steady state, believe it or not, due to some of the imbalances that we had in inventory and some of the projects that we are working on to bring in suppliers and get a little bit more contracted into better rates.

Now, the West Coast facility is kind of guaranteed in my mind. We have a deep understanding of what we are doing with the new line and we know what – we haven’t completed vetted the labor. I think Dan has been conservative saying, hey, well, labor may or may not appear, but let’s just - we are definitely going to save the freight because that’s an obvious. I am like you can’t run the line three times faster with less people even if you pay them more without seeing a big savings on labor, but we are just going to - I think somewhere between $1.5 million are the savings that we are going to see on the West Coast.

And the East Coast, I have a scenario where I just build the facility out there like the one on the West Coast and I believe that I come in almost $1.50 a case under that scenario below where I am currently paying for the toll fees, at least the toll fees you saw that hit our margins for 2015. We are already moving into - new negotiated rates are starting to drop. They are significantly lower, but there are still inefficiencies running at the facilities and as they unwind themselves, we will see ourselves moving into more and more improved margins.

Now my intention is, I want to see at least $1 a case savings on the East Coast and that runs at $200,000 cases a year, so somewhere between $2 million and $2.5 million of improvement on the East Cost. Now, if I can do that with contract production, great. If I can’t get what I want, I know how to build the facility and I will even save more money and there may be some other reasons to do it because not every co-pack facility is willing to do all of our packagings, not willing to do necessarily Kombucha and some of the specialty packs that would benefit tremendously from running on both coasts, particularly when it comes to supplying some of our fourth quarter private label stuff where we are shipping it all out of LA because of the uniqueness of the packagings.

So I think the future is in unique packagings. I see future in probiotic Kombucha type products, definitely our brand. So I think there is some argument that we move into our own facility or at least we get very aggressive pricing on the East Coast. So now if you believe I am going to get million off the West Coast, $2 million off the East coast, that’s $3 million. If you believe that we get $1.5 million and $2.5 million, that’s $4 million, so somewhere between $3 million and $4 million improvement. And if you take $3.5 million and divide that by $55 million, you got 6 percentage or 600 point improvement over the 29% to 30% that we are going to do before improvement in those facilities, in the East Coast and West Coast production costs.

Mitch Pinheiro

That’s helpful. So that’s sort of your longer term or intermediate term goal maybe mid-30s at some point?

Chris Reed

Yeah, I think that – yeah, we are going to see an improvement right away once the East Coast plant is up – West Coast plant is up and running. And already we are seeing the benefits of the two new facilities and they are - reduced more normalized pricings to us. We see a big opportunity here. We know that a company like this functions just so much better at 35% to 40% margins and the 25s are just kind of held and 30%, it’s just barely making it okay, but we need to move into the higher margins. There is such motivation because at that point we start throwing off significant amount of money, not just we anticipate profitability in 2016 with just recovery of the supply chain and the margins, but with the new facilities onboard we move into to generating a lot of cash and what that can do to the growth in speeding and acceleration of things here, we are very clear in our vision of why we need to do it. It’s not just the throw down profits, it’s to just have the marketing that doesn’t happen yet around these brands that are waiting – for the world is waiting to hear about. There is still a cult classic in the kind of hidden gem thing.

Mitch Pinheiro

If you look at 2016, as the conventional channel becomes more important to your revenue growth, do you have to spend some of that gross margin savings back in the form of marketing promotion? I don’t think whole foods and the independent channel really were heavy into like requiring that, but are you going to have the money to spend back in conventional or what’s your thought around that?

Chris Reed

Well, I mean, we walk in the door to a conventional supermarket chain with them wanting to upgrade, seeing the gross profits of craft soda showing them the $300 million worth of data snapshot, statistically significant part of the demographics of the US basically proving up craft sodas in America is a really good economic move. But you have them already trying to getting at, trying to getting the story on that. And then we walk in there as the number one craft, we also walk in there as the number one natural soda, so we cover both industries, separate in a lot of ways, because a lot of craft soda have a lot of craft in it, still thinking sodium benzoate is a smart move in artificial flavors and colors. So we bring our naturalness into the soda arena and also dominating both fields.

So that kind of gets us in – there is a demand for what we are doing. There is a kind of paved road in certain way other products have gotten there sooner, products like [indiscernible] bought by Pepsi has gone in there. Now that we are the fastest growing top 50 soft drink company in the grocery chains, there is just lot more profile.

Yeah, we have been marketing there, it’s already more business in conventional than in natural supermarkets. I think we broke that threshold last year and we’ve been maintaining a pretty lower than traditionally promotional spend, so we were up as high as 14% in the fourth quarter of 2014 averaging I believe 12% for the year ‘14. We brought it down in ’15. We’ve kept it down. I think it’s probably – it’s always better if you’ve got more money to spend in marketing and all that, but I think we’ve been doing pretty well without it. But I do think that it’s kind of like we are in an enviable position and it’s not necessarily the right or smart thing to do to kind of not get aggressive here. So that’s why getting the margins back and then bringing these new facilities on in the West Coast and negotiated correctly or more normalized market rates on East Coast, these are big accelerators for the company and some of that may go into accelerating conventional supermarket. And at the same time we are accelerating up and down the street business. So we’ve been mostly grocery for a long time, but there is an equal opportunity outside of grocery.

Mitch Pinheiro

Okay, thanks. And just two more quick questions. Well, first, Dan, the interest expense, is that the quarterly run rate that you experienced in Q4, is that what to expect in ’16?

Dan Miles

No, it is not. It reflects some of the charges for the refinancing earlier in the year that are now being amortized off. So the run rate is above. Some are just south of 15% closer to 14%.

Chris Reed

I think the dollar amount is less but more importantly when – once we are down in the second and third quarter and the recoveries as we believe it to be here, we will be throwing off significant money and the banks will be renegotiating at the end of ’16 more normalized rate, so this is kind of an unusual situation, anyway I am looking at this interest rate environment, I am hearing 14% or 15% is going – you go to be kidding me. So we expect a significant near future improvement in interest rates.

Dan Miles

Yeah, we are using much of our cash to finish up the plant here. So we are at our maximum borrowing right now and have been for the last say four or five months. But as we come into what I call the selling days, 100 days of selling through the summer, we expect to accumulate cash.

Mitch Pinheiro

Okay. And then final question is on fountain, so there are no tests currently going on, is that correct, but you feel like something I think you said maybe a trial soon. Is that correct?

Chris Reed

I am sorry, ask again, Mitch.

Mitch Pinheiro

So, regarding fountain, just I heard you said – trial soon, are there any tests happening like now or is it just – I mean there was a lot of buzz obviously at expo being there and having seen it and it is a fantastic product. I was just wondering what the after-the-show kind of things have happened.

Chris Reed

We have trials going on with right now the testing and R&D still in the facility here and we are following upon leads of people who want to start up immediately with us and working through the newness of dealing with equipment issues and who buys the equipment and how leases all that stuff and supply chain and all that, so right now we are just starting the first initial talks with retailers out there to be carrying the products and the initiator of this whole project will be – is talking about scheduling in the next few months trial at specific locations for their retail stores.

Mitch Pinheiro

Okay, well, thank you for your time. Appreciate the answers.

Chris Reed

Thanks, Mitch.

Operator

Our next question is from Anthony Vendetti with Maxim Group. Please proceed.

Anthony Vendetti

Thanks. Good evening. Just, Chris, so I understand the margin improvement potential, so the 500 to 600 basis points, that’s off the 29% to 30%, right?

Dan Miles

Yes.

Anthony Vendetti

And that’s more of a second half ’16 situation, right?

Chris Reed

No, it’s pretty – I mean, it’s ongoing. I don’t know how the plot would look exactly, but linearly from here to October, November, it’s going to be a line drawn at maybe more jagged. I think we’ve already recovered a bit, but we will be seeing that and then we are also starting around somewhere in the third quarter there will be another line being drawn and that’s going to be starting to see some of the benefits of the West Coast plant improvement and then probably another [indiscernible] of recovery as we get not just our new suppliers, our new co-pack facilities to just keep us in the product [indiscernible] trying to feel to okay now let’s talk about long term relationship and let’s talk about getting the economics of this where we needed to be so that this big volume we offer you make sense for both of us. So that’s happening simultaneously, so it’s not going to be completely linear, but at the same time it’s almost like they are separate in our heads, but they are going to intermesh each other and influence that margin. So maybe we will even go beyond 30 in the third quarter, who knows, but we surely are doing every dance if we can to get there.

Anthony Vendetti

Okay, that’s a good segue just to update on the fourth quarter. I know it was pretty well laid out as a two-step process to take down the line for a couple of weeks and then get back up and running before your do the last final move. So have you finished the first phase and are you on to the second phase yet? And if not, when do you expect to start the second phase.

Chris Reed

Well, right now what’s going – if I walk out there right now, you come visit the plant, you will see utilities - we had to put in a lot more utilities from plant area to new electrical power from our utility here in South California Edison to more steam for the larger pasteurizer because we don’t use sodium benzoate to preserve our stuff so all that – a lot of that peripheral is getting in over the next short period of time next 30 days. The equipment has been purchased, lot of it is brand new and part of the purchase is a contract to get in here and install it. So the electrical parts once it’s hooked up a lot of the equipment is going to start to be put on the floor, especially the equipment that can be put in place without interrupting any of the operations.

The two week periods are scheduled between now and June 30 from what I hear from Mark Beaton, the new COO. And though the first one hasn’t happened with the -- a lot of the peripheral and utilities are going in and the equipments are here and staging, getting ready for its installation. So it's positioned -- and definitely all the engineering and all the planning has all been laid out and Gantt charted all that stuff that these project managers are doing. So we are working with a group that Mark Beaton worked with who has installed a lot of plants for companies like when he was working for Pepsi and they are just a great, very competent group. So, this is a new level of expertise at Reed’s and this plant going in is definitely in a level beyond my own ability to create and design plants. So we’re very excited about it.

Dan Miles

I saw the plants when I was out there, it looked quite elaborate and looked like it's going to be a brand-new state-of-the-art facility when it's all done.

Chris Reed

Yes. It’s state-of-the-art and I think that I've got lucky with some of the purchases I did before Mark came on and they’ve come in here and they changed my mind on a lot of things and they quite frankly thought through it at a level that an engineering firm like that can do with probably 30 or 40 years of just building 300 plants in different phases. So it's good to have them on board. And I can't wait till the plant is up, it will be a big differentiator and I'm hoping that the numbers that we are thinking about actually get to work. One of the interesting things that has happened since Mark Beaton has been on board, that's probably one thing I haven't mentioned is, I've got a new management because of these opportunities are coming out as relatively fast and Mark has already cut costs in existing plants significantly lower. I mean, it was $600,000 of savings in the 8 or 10 week -- months that he was on board in 2015.

That's a really -- that's a great improvement, even before all this new equipment coming online. Also, they’ve gotten freight down without any new – anything, just freight better negotiated, better organized freights, but as these facilities come on board, more regional facilities, that’s the other thing everybody have to remember, when we started doing more regional south-west, south-east, hitting corners that we’re not in right now, Texas, I don’t know, mid-Country Kansas or Vegas or whatever the heck, once you start doing that, our freight is almost 10%. You started reducing it down to 3%. There is another, if we can get to 30 now, new facilities and negotiated rates get us down -- get us another 5%, then we have all the freight savings, which adds another 5. So there is a theoretical, I want to say, potential for a 40% margin on this and when you get there, when you are hitting about 100 million, so not too far off, you just have to get back into it here, it didn't help what we did in 2015, but it's happening and we are down the road ourselves on this and moving towards all the opportunities that we see. But then for your coverage there, Anthony at Maxim Group.

Anthony Vendetti

Sure. And just last question, so if we look at the base 2015 and put all the issues aside, and you had 7 million potential orders left on the table. If we add that in, it's reasonable to add that in and then put a little growth on that base for 2016, when coming up with our forecast for 2016, right?

Chris Reed

Yes. That's kind of what we're doing for our pro formas, just so we can budget and make sure we are generating cash and moving into better and better situations and definitely getting to bankable situations that we’re getting great interest, better interest rates, but yes, that's kind of the way we’re doing it, but of course our goals are to go way beyond that, are becoming sexy and sexy means bigger players are more interested in us than ever before. And so there is a lot of things, a lot of unknowns that are very huge opportunities here, not just the Bag in the Box, just for our existing packaged goods. So we're hoping to see acceleration, but we're planning on at least steady in what you're talking about.

Anthony Vendetti

Okay. And then just last question on the first quarter, as we come off the fourth quarter, when you are saying relatively flat from the -- you're talking about relatively flat from the fourth quarter, not from the first quarter of ’15, right, you’re talking about -- when we’re looking at first quarter, somewhere in the $12.4 million range is -- or maybe 100,000 or so above that is a good number to look at in terms of the first quarter, is that right?

Chris Reed

Actually, we’re looking at flat year-over-year over 2015.

Anthony Vendetti

Okay.

Chris Reed

When we didn’t run Virgil's Root Beer and we didn't run, and even worse didn’t run the Kombucha, I think we had eight weeks with no Virgil's Root Beer during the third quarter and then we had almost 3 or 4 months with a Kombucha gap there. So there is a big catch-up going on right now, and the good news is that there is still a lot of love for the products and the catch-up is happening. Again, the recovery on the Reed’s products which were out of stock, but not as bad, has happened faster. So -- but, yeah, it's kind of -- it’s not over quarter-over-quarter, but year-over-year.

Operator

Thank you. And we have time for one more question from the line of Kevin Dede with Rodman. Please proceed.

Kevin Dede

Thanks. Good afternoon, Chris and Dan. Hi, Dan, just would you mind checking my arithmetic, I came up with 386,000 adjusted EBITDA for the fourth quarter. Does that number work for you positive?

Dan Miles

Fourth quarter is 272 before the interest is removed. Of that [ph] 272, 242 depreciation, 405 interest, 163 stock. For 810, off 538 brings you back to 272.

Kevin Dede

All right. I’ll look at my math. Thanks for that. Chris, on the Absolut deal that you talked to it, curious, I mean you had mentioned in the past that there was an opportunity to work with them beyond vodka, do you still see that?

Chris Reed

We haven't had conversations with them beyond vodka, but we still have ongoing events and we put together recently a retail pack with Absolut Vodka with our stronger Ginger Brew and a custom 750 and they are a follower of vodka, so that pack went out recently. So, there is a great conversation. We are negotiating talking to the largest liquor distributor in the country and Absolut Vodka joined us on the line to kind of endorse us and all that. So there is, but it hasn't gotten into full-fledged craziness where their 1200 salespeople are out selling in Museum Hill with our stuff yet. So we still have hopes for deeper relationships with them or someone else. So from time to time, we catch the attention of some of the larger liquor companies and I think at this point, they kind of know who we are and they kind of know that we make the greatest mixer ever. There is a lot of events that go on that where we are partnered up with them for a one-off like by Southwest or coachella kind of thing, but we try to -- nothing is formalized, just lots of here and there things going on.

Kevin Dede

Okay. Hey listen, with the opportunity of Bag in the Box, I know the formulation is a little bit different and the production is a little bit different and manufacturing that product, I'm just kind of wondering how you feel, given all the changes you’ve made on the East Coast and West Coast, how you feel you're able to meet demand should that ramp up this year?

Chris Reed

Well, we are anticipating that and our first goal is to run the product here in LA, because we want to maintain strict control over every aspect of it, but in terms of production, effectively, you have to create the concentrate and the syrup, the syrup concentrate, get it into a box into the Bag in the Box, hence the name, Bag in the Box. But it's a hell of a lot more difficult to make a ginger brew and counter pressure it, fill it, pasteurize it, label, put it to an RSC and palletize and shift and it is to take it -- take it almost in the first step and then get it really -- get it ready for Bag in the Box. So we feel very ready to do this. We actually have equipment in house right now to run, but the kind of equipment that we would need to run for a large fast casual, that product, that equipment is being coded right now and it's relatively modest because it’s not really that complex equipment. You basically have a atmospheric filler for a bag. It just pumps it into the bag and then you close it off.

So it's really relatively simple compared to anything we've ever done. The amount of gallons is relatively less right now. This is a concentrate. You get to run, you had a big gig like this one we’re looking at, you're looking at 40,000 gallons a week versus right now I’m running 300,000 cases a month and that’s about 700,000 gallons a month, divide that by four. So it's almost 160,000 gallons right now being produced. So it's a quarter of our gallonage that we're currently producing. And that will be a gig that will proactively double the company. So it's not giving us a lot of issues, it's definitely an issue, and definitely the client wants to make sure we’re very buttoned up on it, but I think we’ve told them if we needed to be up and running in 30 to 60 days, we could do it. But we wouldn't necessarily have the final line on board for that. But in the meantime, we're starting to gear up for launching into the marketplace. So I know there is a lot of pressure based on the show we just went to and conversations in the industry, the cat is out of the bag and I know that second quarter, there is going to be a lot of people knocking on our doors, saying, you promised.

Kevin Dede

Okay. Yeah. So the cat is out of the bag, but it might not be quite out of the box just yet?

Chris Reed

Kevin, that's why you laughed. Okay. Thank you for that.

Kevin Dede

Yeah. So I'm kind of curious, I mean I know you've got to be discrete with regard to what you can offer to us, but I'm just kind of curious on how far you can talk to some of the other players and maybe even beyond that, Chris, just the general -- for the general scope of distribution like one-off bars and one-off restaurants?

Chris Reed

Those one-offs aren’t really what we’re interested in right now though. We’re probably doing a number of one-offs, just to keep proving the concept to you shortly and make sure that everything that we are proving up through our third-party analysis and R&D and all the hard work we've done is going to happen and work out any bugs before we do it in front of a big client, but there is a lot of confidence, the equipment has been running here since last April, so you've almost got a full year on equipment and running it. We've got three different styles of equipment running here, another fourth going on. And so there is a lot of expertise here and so there is a certain amount of getting ready to leapfrog the one-off thing and go for some biggest chains here. But anyway, that being said, we are just, we’ve just committed to too many people who want to start up here, who may want to do one-off, but they have hundreds and hundreds of accounts. So there is a lot of trialing that's being asked for right now and that's just something we are gearing up for.

Kevin Dede

Okay. So would you expect to run those trials concurrently with the lead driver of this project, the trial that you’re running or will hope to run?

Chris Reed

Some of them will probably happen sooner to be honest with you.

Kevin Dede

Okay. When do you think you can talk to us about the pluses and minuses that you are experiencing?

Chris Reed

Pluses and minuses of what?

Kevin Dede

The trials themselves.

Chris Reed

I mean, we will have more experience obviously by the first earnings call for the first Q.

Kevin Dede

Okay, fair enough. Great.

Chris Reed

I mean, it's moving very fast. Every week, if you talk to me and I was giving you information I’m allowed to share, every week, there is new things that are moving for us in a good way. But right now, we're ready to go with the client, but we keep -- we are like heavy in R&D, because it’s so much that we've learned about what we’re doing here. So we keep having, we are having breakthroughs still, which is kind of exciting. We thought we had it nailed and we have it nailed, but we haven’t even nailed better now. So it's like -- it’s not only flavor, but stability, all kinds of stuff. So we’re vetting our own staff and we’re spreading [ph] our people with a lot of technical skills that are helping a lot. So right now if you have a best casual somewhere Kevin and you want to put in a couple thousand of these, we're ready to go.

Kevin Dede

Okay, that's kind of I guess what I was hoping to hear. Yeah. So I’ve some questions for you on Kombucha, but given you've been on the line for a better part of an hour and a half, Chris, I'll defer to your judgment on whether or not you want to take them?

Chris Reed

Kombucha, I think I mentioned it, it got hurt the hardest because it was the least preference -- it got the lowest priority for production during the supply chain issues of third quarter and partially second quarter. So it was a conscious choice to keep Reed’s line more viable and it's recovering and with the -- the private label actually stayed relatively the same year-over-year for -- quarter-over-quarter first quarter. So that is not too bad, but we have big plans for re-launch and where actually, there is a lot of stuff going on in R&D there. So we’re not still there with our Kombucha. Like everything else, it's got a plan and we are executing it to get back to where we are going.

And a lot of the conventional supermarkets who didn’t get products for a couple of months were -- again, the conversations go like this, yeah, yeah, yeah, okay, okay, but the planogram is not open again until X symbol, we know we love you for our sodas and you do so much great stuff. So we'll get you in there. So, and there is other people we probably test off, and they’re saying, hey, you know what, don’t do that to us and we don't like it. But we will recover a lot of what we are doing and there is just no Kombucha out there like that. But some of the faith and belief and it is just how good this uptake compared to the crap out there. Everybody thinks Kombucha takes break, who beats us first, and then they go out pacing. So you have to believe there is a customer out there who is going to appreciate the quality of our Kombucha and we’ll get it together.

Kevin Dede

So, yeah, my question really is centered on the re-launch and how much attention you're able to give it with all the other things you have going on and the timing and whether or not you are re-engineering the bottle and labeling situation?

Chris Reed

You do the math. If you’ve recovered your third quarter, you do it, 15 million to 17 million and if you had a 32% to 35% margin, when we get back to that, you will start to throw off significant amount of money and you can throw it the bottom line some of it and throw some of it into Kombucha advertising, but tell you what, if you start advertising Kombucha at 100K a month, you’re basically telling everybody in that world of Kombucha drinking, here is a coupon to the best Kombucha on earth and you’ll see the damping pick up again. So we try to know what to do, but right now, we are building facilities and stuff. So we’re not going to do it in the kind of money, in terms of way, but we may sacrifice margin for volume and ultimate more gross profits than we would generate here shortly with some kind of aggressive promotions. So we will be able to probably say a lot more about Kombucha by the May 15 announcement for the first quarter.

Kevin Dede

Okay, fair enough, Chris. I’ll look forward to that. Thanks so much for staying online for as long as you have.

Chris Reed

No problem. Kevin. Thanks for covering us with Wainwright.

Operator

And those are all the questions we have for today.

Chris Reed

All right. Thanks for joining us and look forward to seeing everybody in the future.

Dan Miles

Thank you everyone and thank you Scott for hosting it.

Operator

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

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