Daniel Miles - CFO Val Stalowir - CEO & Director.

Analysts:.

Good afternoon, and welcome to the Reed's Second Quarter 2017 Earnings Conference Call for the period ending June 30, 2017. My name is Kevin, and I will be your conference call operator today.

Today's call is limited to 1 hour, and we'll start with the prepared remarks with Val Stalowir, Reed's Chief Executive Officer; who will be followed by Dan Miles, Reed's Chief Financial Officer. Following management's remarks, they will take your question. 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.

Additionally, please note non-GAAP financial measures referenced during this call are reconciled to their comparable GAAP financial measures in the press release and the supplemental materials filed with the SEC.

Non-GAAP financial information is not meant as a substitute for GAAP results but is included solely for informational and comparative purposes. The company believes that the presentation of non-GAAP financial measures provides useful information to investors regarding the company's financial condition and results of operations.

Therefore, the company claims the protection of the safe harbor for forward-looking statements that are contained in the Private Securities Litigation Reform Act of 1995.

Actual results may differ from those discussed today due to such risks but not limited to risks relating to demand for the company's products, dependence on third-party manufacturers and distributors, changes in the competitive environment, access to capital and other information detailed from time to time in the company's filings with the United States Securities and Exchange Commission.

In addition, any projections as to the company's future performance represent management's estimates as of today, August 14, 2017. Reed's, Inc. assumes no obligation to update these projections in the future as market conditions change. As a reminder, this call is being recorded, Monday, August 14, 2017.

I'll now turn the call over to Dan Miles, who will begin with his prepared remarks. Please go ahead..

Thank you, Kevin. Good afternoon, Reed's investors, employees and interested parties. My name is Daniel Miles, the Chief Financial Officer of Reed's, Inc., and I want to thank you for participating in today's call. In conjunction with today's press release, we issued our 10-Q that will have additional details about the quarter.

Today marks a milestone in Reed's 30 years of operations. We have a new professional board with a track record of success in building companies. We have a professional CEO, Val Stalowir, who has a track record of building brands and accelerating growth.

I want to thanks Chris Reed for his support of bringing our new board, new management team and continued leadership on our product and innovation efforts. We're in the midst of a turnaround that impacts all stages of the business.

And although the second quarter was challenging, we believe that the current quarter will begin to deliver improved results. Following my comments, Val will share with you the vision of our company. At the completion of both of our remarks, we'll take your questions. So let's discuss the second quarter financial results.

Gross sales revenue of $9.7 million decreased 18% in the first quarter compared to $11.8 million in the prior year quarter.

Gross sales were primarily impacted by private label, Kombucha, and candy decreases that were down 83%, 69% and 52%, respectively, and represented $1.2 million of the $2.1 million decrease in gross sales revenue or more than half of the decrease by themselves.

Ginger Brews and Virgil's products continue to be the strength of the portfolio as the strength realized gross revenue increases of 2% on a 12-ounce basis albeit on a declining volume basis. All other gross revenue declined, in total, 54%.

Net sales of $8.7 million decreased 19% in the second quarter compared to $11 million in the prior year second quarter. Sales discount slowed but were still up almost 3% increase or 9% of gross sales compared to 7% of gross sales in the prior year. This was driven by the lower volume.

Cost of goods sold decreased 14% to $6.5 million from $7.7 million in the second quarter of last year, driven also by the lower sales volume.

The cost of goods sold, which includes the idle plant or the unabsorbed overhead here in Los Angeles, also decreased 14% to $7.2 million from an $8.4 million in the second quarter of last year, and this was driven by the start of the L.A. plant's second shift in the late second quarter. Turning to the operating expenses.

We continue to control and reduce operating expenses and reduced total expenses 3% during the quarter. Delivery and handling expenses of $0.9 million in the second quarter declined 18% versus the same period in 2016. On a percentage of net sales, costs were flat at 10%.

Selling and marketing expenses of $0.7 million in the second quarter of 2017 declined 24% versus the same period in 2016. On a percentage of net sales, sales and marketing decreased to 8% from 9%. The main driver of the decrease was the reduction in employee-related cost.

General and administrative expenses of $1.3 million in the second quarter increased 35% over the same period in 2016. As a percentage of net sales, general and administrative costs increased 14% from 9%, primarily as the result of employee transitional costs, additional legal costs and filing expenses.

Let me address the financing costs in 2 separate parts. The first part is the interest expense from debt and the second part is the financing charges incurred during the second quarter. These second quarter financing costs were significantly reduced in early July as part of the third quarter financing activity. So let's talk about the first part.

Interest on debt increased to $995,000 from $416,000. The increase is due to a noncash amortization of the April 21 first convertible note of $510,000. And for the second part, financing charges related to warrants netted to a noncash total of $2,321,000.

This amount consists of a $978,000 cost of warrant modification offset by a derivative gain in the second quarter of $3,299,000. It should be noted that during the July warrant financing, the company agreed -- excuse me. One moment, please. Let me start that again.

It should be noted that during the July warrant financing, the company agreed to modify certain parts of its existing warrants with participating warrant holders that will enable the company to eliminate most of the warrant liability in 2017 and reduce the derivative activity.

As a result of the required accounting for the warrant liability, the company realized income of $148,000 or $0.01 per share in the quarter. Regarding the liquidity, when we exclude those warrant financing activity from the cash flow statement operating segment, the company used cash of $804,000, which was used to build the inventory.

Let me now turn the discussion of the company over to our new CEO, Val..

Thanks, Dan. I'd like to first take a moment to thank Chris, Dan, Stefan and Neal and the rest of the management team for their warm welcome and their continued passion and belief in the business.

I would also like to thank the newly installed board for their guidance and support and for affording me the opportunity to lead this great portfolio of leading beverage brands. I look forward to working closely with the team and board to fully realize the significant untapped potential of the Reed's and Virgil's brands.

I've been following the development of Reed's and Virgil's for over a decade, and I'm excited to now be leading the company's turnaround and brand-building efforts and reaccelerating the growth of these iconic brands.

Our team is in the process of raising the level of performance in terms of operation, branding, sales and marketing to match the level of quality and excellence that's already inside every bottle of Reed's and Virgil's.

Reed's is America's best-selling ginger beer and Virgil's is the leading all-natural craft soda and both are benefiting and will continue to benefit from strong consumer trends. These trends include consumers trading up to premium and craft products, consumers looking for increased functional benefits that ingredients like fresh ginger provide.

They are also demanding natural beverages that are free from artificial ingredients, colors and preservatives. Both brands are in the bull's eye of these consumer trends.

The rising tide will raise all boats, but we plan on capturing more than our fair share of that growth moving forward through innovation and increased investment in sales, marketing and channel expansion.

There are several exciting initiatives that will be launched in the marketplaces in the coming months, and I'll detail some of those after my discussion of the second quarter results. As Dan pointed out, our second quarter 2017 results continue to reflect the company's operational challenges and the prior lack of focus on the core brands.

The current management team has initiated a multipronged turnaround plan that covers all aspects of the business, and we believe these efforts will deliver improved results in the coming quarters.

Management has successfully eliminated over 70 SKUs since the start of 2017, which reduces the company's working capital needs and will allow the company to focus all available resources on reaccelerating growth on the core product line.

A total of 71% of the volume lost during the second quarter was driven by what we now define as noncore, products such as Kombucha, private level and candy. This renewed focus on core brands has actually reversed recent sales decline, and our core brands actually posted double-digit growth in July.

On operations, we recently ramped up the Los Angeles plant to run 2 shifts, 6 days a week, which has significantly reduced the idle plant charges and increasing core product shipments to our West Coast customers. In July, we announced Stefan Freeman as our new Chief Operating Officer.

Stefan is evaluating our entire supply chain line by line, vendor by vendor and is developing a plan to increase efficiency and improve our margins. He is leading our negotiations with current and new strategic vendors in an effort to strengthen our relationships, improve quality, terms and performance and reduce overall costs.

His leadership is starting to have a positive impact on gross margins, where they moved from 13% in quarter 1 to 19% in quarter 2 and in July reached 23%. And he's definitely not stopping there.

The company is also exploring various strategies to move to a simpler, asset-light operating model that will allow us to direct more resources towards sales and marketing. Turning to sales.

Neal and his team have done a great job getting our brands back on shelf, and we now believe we fully bring our presence in our biggest channel, which is conventional grocery. There is still a small amount of work left to be done in naturals, but that should be completed by the end of the year.

The sales team also recorded some solid retailer wins during the second quarter. In conventional grocery, Reed's Ginger Brews were authorized in 300-plus stores in the Albertson's Southwest Division, which includes Safeway and VONS.

The root -- the Ginger Brews and Virgil's Root Beer, Cream and Orange Cream were authorized in 150-plus Shaw's stores in the Northeast. And Reed's Stronger and Original Ginger Brews were authorized at all 50 Vallarta Supermarkets in Southern California.

Reed's Extra Ginger Brew and Virgil's Root Beer 12-packs were authorized in 200-plus Smart and Final stores, which is a warehouse-style conventional grocery store on the West Coast.

In the drug channel, we had a successful Rite Aid test of Reed's Extra Ginger Brew, Virgil's Root Beer and Virgil's Cream in 1,000 stores, and now we'll be expanding into 4,000 locations in Rite Aid. In international, we are expanding our U.K. presence with the launch of Virgil's Root Beer, Cream and Black Cherry in 400-plus Tesco locations.

We also marked our renewed focus on the liquor store and on-premise channel for the Reed's brand by securing a partnership with MS Walker Fine Wine & Spirit Distributors in both Massachusetts and Rhode Island.

We define on-premises bars, restaurants and hospitality, where our ginger beer is primarily used as a mixer to make the best tasting Moscow mule and dark consumer cocktails on the planet. This is an area that we have not focused on, and we will be directing many more hours and resources in penetrating this on-premise market.

And now for the fun part, new innovation and initiatives that we'll be launching in the coming months to bring excitement to the brands and giving the brands more and new weapon to help expand their leadership positions. Neither brands has had a major branding or packaging update in decades.

Both Reed's and Virgil's brands are going through a full brand refresh along with an upgraded glass package. The Virgil's brand refresh will launch in Q1 next year and Reed's will follow shortly thereafter. The branding refresh will also include an upgrade of the company's website and all of its social media platforms.

We will also be launching a new package type for both brands, which will be the 12-ounce slim can and will give the portfolio a more effective offering to pursue underdeveloped channels, such as convenience stores, on-premise accounts and international sales.

This new can will also be used to further expand our presence on the mainstream grocery CSD aisle. The company will launch its first slim can to support the quarter 1 launch of Virgil's innovative new line of no-sugar products.

Chris Reed and his team have done an incredible job developing what I call the 2.0 of all-natural sweeteners that deliver the bold taste of full sugar with only 5 calories. Mainstream CSDs have been in decline for years, and diet actually has been declining even faster than full sugar.

Given the recent negative coverage of diet sodas and the general consumer trend of health and wellness, consumers are moving away from artificial ingredients and sweeteners and moving toward all-natural beverages. Unfortunately, most of the all-natural beverages on the market that provide no sugar really don't taste very good.

And Chris has managed to develop a proprietary blend of natural sweeteners that taste like a full sugar beverage with only 5 calories per 12 ounce serving. The only way to really truly appreciate the breakthrough that Chris and his team have achieved is by trying the product.

So we plan on launching the new Virgil's no sugar line during Q1 next year in both 12-ounce bottles and new slim cans, and the flavors will include root beer, cream, black cherry, orange, cola, lemon lime and [indiscernible].

The Reed's and Virgil's brands have a tremendous amount of upside, and these are just a handful of initiatives that will be implemented to begin -- to capture the untapped potential for both of these brands over the coming months. Thanks for listening.

And for myself, the team and the board, I want to say how excited we are about the future here at Reed's, and it's now our job to turn these words into action and begin to consistently deliver on the promises we've committed to.

We are fully into our turnaround plan to optimize the company's operations and profitability, and we started to implement some of our growth plans, which will drive improved company performance and shareholder value over the coming months. The team and I are happy to answer any questions..

Operator:.

Kevin, that's it for the call. I would like to encourage any of the listeners, if they have anything later they would like to share with us directly, please send us an email question and we'll be responding just as quickly as we possibly can this week. If there are no questions, we'll go from there..

So ladies and gentlemen, that does conclude your conference call for today. We thank you for participating, and you may now disconnect..