Val Stalowir - Chief Executive Officer Dan Miles - Chief Financial Officer.

Anthony Vendetti - Maxim Group Thompson Clark - Bonner Partners Paul Strigler - Esplanade.

Good afternoon, and welcome to Reed's Fourth Quarter 2017 Earnings Conference Call for the period ending in September 30, 2017 (sic) [December 31, 2017]. My name is Scott, and I will be your conference call operator today.

Today's call is limited to one-hour, and we'll have prepared remarks of Val Stalowir, Reed's Chief Executive Officer; and also, by Dan Miles, Reed's Chief Financial Officer. Following management remarks, they will take your questions. Before we begin today's call, I have a safe harbor statement to read to our listeners.

I would like to remind our listeners that during this call, management remarks may contain forward-looking statements that are subject to risks and uncertainties and that management may take additional forward-looking statements in response to your questions.

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

Non-GAAP financial information is not meant for – 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 that 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 are 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, March 28, 2018. Reed's, Incorporated assumes no obligation to update these projections in the future as market conditions change. And now, I'll turn the call over to Mr. Stalowir. Please go ahead, sir..

Thank you, and good afternoon, everyone. I'm very pleased to speak to you today to discuss our fourth quarter results and update you on the progress we have made with our transformation and value creation plan.

I'm confident that we have the right team, the right board and the right partners in place to capitalize on the substantial opportunity we have with our leading brands that are in growing and on-trend categories.

Our transformation is well underway, and we expect our new strategic focus to improve margins; allow us to invest in sales and marketing; and deliver the financial results that will enhance shareholder value.

We are pleased to announce that we have received a letter of intent relating to the sale of our beverage manufacturing facility and private label business and is a significant step in our transition to an asset-light business model.

I'll begin with a brief overview of the fourth quarter and then discuss our achievements and plans for the ongoing transformation that we are undertaking at Reed's. I will then hand the call over to Dan to provide the financial details.

During the fourth quarter, we generated net sales of $9.7 million, a 5.7% increase over the prior year, reversing the declines over the first 9 months for 2017.

We are pleased to report 6% growth in our core brands, reflecting the benefits of the price increase we announced in the third quarter and our increased focus on our core brands as a result of our SKU rationalization.

We're encouraged by the early results of our efforts, as we were able to report net sales growth, despite the SKU rationalization efforts we've implemented. We also saw improvement in gross margins driven by both the price increase and SKU rationalization and look forward to further improvements as we execute our transformation plan.

We expect to see the benefits of our new logistics and glass supplier agreements in the first quarter and as 2018 progresses. We continue to encounter idle plant cost during the fourth quarter, which will continue until we complete the planned sale of our LA manufacturing facility.

We're already well along in the process given the thorough LOI we've recently received.

As Dan will detail, our reported net loss included significant noncash charges related to our planned plant sale and financing transactions, including the change of terms of our convertible note, which enabled us to lay the foundations for a successful rights offering in December.

All of these items are a reflection of our transformation plans, and I'm confident that these efforts have enhanced our business model and future prospects. In summary, we're pleased with the improving core brand performance and our early progress on the first phase of our transformation and value creation plan.

Let me walk you through the plan and our progress to date. There are five key components to our transformation plan.

The first phase includes new leadership, which is now in place; a new strategic focus, which is also in place and complete; optimizing our business model, which we are in the process of now completing; and improving our capital structure, which is well underway.

And the second phase of the plan will be investments in sales and brands to transform our great products and good brands to great brands and drive sales growth and brand value. The first evidence of this investment will be Virgil's brand refresh and the Zero Sugar launch in April.

As we discussed last quarter, we have already built out the leadership team and continue to enhance the Board of Directors during the fourth quarter with the additions of Jim Bass and Scott Grossman.

Jim brings over 25 years of financial and international management experience, and Scott has two decades of experience investing in and advising public and private companies on enhancing shareholder value.

We have also added new sales, marketing and on-premise talent to the team and engaged experienced marketing and public relations agencies to support our plans. We have also executed our plans for a new strategic focus. We are now directing 100% of our resources to growing Reed's and Virgil's.

The SKU rationalization during 2017 has been completed, and the benefits are evident in our fourth quarter sales growth of core brands. Additionally, our enhanced focus is clear in our sales mix. Year-to-date, in 2018, our Top 5 SKUs account for 73% of total sales, up significantly from the 31% those 5 SKUs represented in 2016.

Our focus will continue to be on higher-margin products and our core brands. We are also refocused on obtaining better margins from new packaging, including our launch of Virgil's Zero Sugar in 12-ounce cans in April. The third leg of our transformation, and we're well underway in this portion, is optimizing our business model.

The strategy is to transform from a capital-intensive, self-production model to an asset-light sales and marketing-driven business model. We've already established multiyear contracts with Owens-Illinois to be our exclusive glass supplier and R.C. Moore as our new logistics partner.

We're in the process of expanding our strategic co-packing partnership on both coasts for both bottles and cans and are identifying and negotiating improved vendor relationships to further lower our cost of goods sold.

The final and most critical part of this transformation effort will be complete when we complete the sale of our Los Angeles manufacturing facility and secure a continuing co-packing agreement to supply our branded West Coast needs moving forward with this new partner and buyer.

The anticipated transaction also affords a very smooth and professional transition of continued supply for our key private label customers.

Having completed a thorough marketing process for the assets and evaluated proposals, we have now moved to the LOI stage, letter of intent stage and will continue to work with the anticipated buyer to finalize a definitive agreement.

The facility sale will remove idle plant cost and lease obligations, and in conjunction with each of the other activities we've outlined, should significantly improve gross margin.

The fourth pillar of our transformation plan is to improve our capital structure, and we've completed the most significant aspect of this effort with the oversubscribed $14 million rights offering we completed this past December. We will use the proceeds to pay our stretch payables and secure improved commercial vendor terms.

We're in the process of seeking better terms and market rates on our asset-based working capital line and we look to further restructure our debt following the plant sale.

We have historically had limited capital to support our sales and marketing efforts and look forward to being able to more effectively drive our business, as we transitioned to the second phase of our transformation plan later this year.

Now this all-important second phase is the fifth pillar of our transformation plan where we will invest in sales and our brands.

We've already added marketing and sales resources, including new broker relationships, that have increased our sales and feet on the street 10-fold, and we see significant opportunities moving forward, which include developing and executing sales-driving brand-building programs; opening new retailer doors, including investing in slotting and in-store trade programs; driving increased sell-through velocity using digital pull and in-store programs, shippers and sampling; launching a brand refresh on both Reed's and Virgil's, including packaging, website and social media enhancements.

The Virgil's refresh really is nearly complete, and the Reed's refresh is well underway. The launch of our new Virgil's Zero Sugar line is set for April.

Our initial introduction and sampling at the National Expo West Trade Show in Anaheim was very well received, and we've been getting high praise from consumers who have sampled the product line and universally strong interest from retailers across all channels.

The product is a major breakthrough in terms of a proprietary natural sweetness system that delivers on great taste with 0 sugar, 0 calories and is all natural. Our tagline is Believe the Unbelievable, and now that people have had a chance to try our products for themselves, we're adding new believers every day.

And finally, we're in the process of adding to our licensed distributor network to expand our presence in the on-premise and liquor distribution channels. Reed's is a leading Ginger Beer and is the only brand powered by fresh organic ginger root, which also makes as the key ingredient to mixing the best tasting Moscow mule.

We want to be able to clearly demonstrate our products superiority by engaging directly with bartenders and liquor store owners in key markets with the help of our new distributor partners. To summarize, we've made very good progress on our transformation to date, and we have significant opportunity to continue to capture moving forward.

We've already stemmed the sale declines with our early initiatives; begun to improve margins; received the LOI to sell the plant; and raise the capital necessary to enhance our balance sheet and support our plans. We look forward to updating you each quarter on our progress and delivering improved financial and sales results.

Now, let me turn the call over to Dan to run through the financial results..

Thank you, Val, and good afternoon, everyone. During the fourth quarter of 2017, net sales increased $5.7 million to $9.7 million. As Val mentioned, the growth was driven by a 6% gross sales growth in our core brands. While increasing revenue, we also reduced the cost of goods sold per case in our core brands by 2.2% over the prior period.

Both of these favorable trends were driven by our third quarter price increase and our narrowed focus on the core. Gross profit increased 28.8% to $2.1 million in the fourth quarter.

As a percent of net sales, gross margin increased 380 basis points to 21.3%, primarily the result of higher revenue and lower costs sold per case on the core brands that compared to the prior year. If we compare the average of the first nine months of 2017, the gross margin improvement was 410 basis points.

We look for continued sequential improvement in gross margin as our transformation plan progresses. Delivering and handling cost increased 11.4% to $1.2 million or 65 basis points as a percentage of sales, reflecting increased warehouse exit cost.

Selling and market cost decreased 14.3% to $0.7 million, or 165 basis points percentage of sales during the quarter, reflecting a temporarily lowered staffing and sales support. General and administrative expenses increased $6.2 million from $1.2 million over the prior year.

Excluding noncash impairments, G&A increased $2.4 million during the fourth quarter, largely due to noncash stock compensation cost of $0.8 million associated with the restructuring of the board and $200,000 of bad debt expense associated with exiting of certain co-packer.

As Val mentioned, we recognized the $3.9 million noncash impairment during the fourth quarter related to the plant sale of our beverage manufacturing plant assets. Accounting rules dictate that we take the impairment and establish a reserve in anticipation of the sale. And the transaction was triggered by the receipt of the LOI just last weekend.

This noncash charge was the largest contributor to the increased operating loss of $6.1 million we experienced in the quarter. We also incurred a charge of $3.6 million for the extinguishment of the debt that was associated with the change in terms of the company's convertible note.

Although only the terms of the note changed, the noncash charge needed to be run through the income statement. Primarily as a result of this noncash charge, interest expense and other financial costs during the fourth quarter increased to $4.8 million from $0.7 million a year ago.

On December 28, the company completed an equity capital raise in the form of a rights offering, raising the net proceeds of $12.8 million.

We are initially utilizing the capital to reduce our stretch payable and debt, and we are evaluating in – alternative financing arrangements in the intention of substantially lowering the borrowing cost as the result of the company's improved financial position.

Net loss increased to $10.9 million or $0.70 a share in the fourth quarter of 2017 from a loss of $2.4 million or $0.17 a share from the fourth quarter of 2016. Our 2017 net loss includes those significant noncash charges. Excluding these noncash, nonoperating charges, the loss would've been $3.4 million or $0.22 a share.

Modified EBITDA was a loss of $1.2 million in the fourth quarter of 2017, compared to $1 million in the prior year period. Moving to the balance sheet, we ended the fiscal year with $12.1 million in cash and total debt and long-term financing obligations of $15.4 million.

During the fourth quarter, we generated cash from operations of $1.3 million and invested $300,000 in capital expenditures. I would now like to open the lines for questions.

Operator, do we have questions waiting?.

[Operator Instructions] And we have a question from the line of Anthony Vendetti with Maxim Group. Please proceed..

Thanks, good evening. I guess a couple of questions. One is, we've been hearing that there's increased freight costs pretty much across the industry.

I was wondering if you're experiencing that? And how are you mitigating that situation?.

Great question, Anthony, and thank you for asking and giving us an opportunity. In terms of rate on a transportation activity, yes, there is a significant increase.

As you know though, we have two different plans falling on the east and west, and our key driver for rationalizing where we produce and how much we produce is going to be driven on manufacturing closer to customers.

And as such, we actually expect that net-net, we will have – we'll be either flat or slightly up in delivery expenses for the upcoming year..

Yes, given the reduction of transporting products back and forth, which we had to do this year..

And Val, you mentioned increasing co-packing arrangements.

Did you sign up any new co-packers on either the East or West Coast in the last quarter?.

We have not officially signed any new co-packers, but we're evaluating new ones on both coasts, and the good news is the buyer of this plant, we have high confidence in their ability to produce high-quality product and on time.

So, most of what we're looking for is just enhancements and backups as opposed to producing, let's say, a significant portion of our needs..

Okay. Great.

And then do you have an approximate timing on the movement of this agreement from a LOI to a definitive agreement?.

Yes. We're hoping sometime this summer..

Thank you. Our next question is from the line of Thompson Clark with Bonner Partners..

Hi, thanks for the question. Nice job on the gross margin in the quarter. Just wanted to understand a little bit, maybe the business model, so you've given some guidance on gross margin, maybe around 30%.

How should we think about the OpEx line? And where maybe there's leverage in the business? What's variable? What's fixed?.

In the OpEx, because we're going to switch to an asset-light brand development, we are making significant investments in sales and marketing. The fixed part of that would be in headcount, and we have already filled the open spots from last year. The variable part will be the marketing and the spend in the stores.

We have initiated contracts with a couple of major marketing companies, Alliance Group for one, and that will be based on their performance, and so the amount of money earned on brokers and things like that, which is a significant investment, will be tied to the growth.

It will follow a little bit because you make the investment first and realize the benefits later, that's why we expect to be realizing the benefits later in the first half of this year..

Yes. We definitely plan to increase our spending in terms of sales and marketing support moving forward and these improved gross margins and reduction in idle plant cost and restructured capital structure, all of that will provide us more funding to be able to invest in driving brand growth in the market..

And the expansion of the G&A were due to those onetime events that we've talked about, we have no expectation of those to recur again..

Okay. Great.

And maybe I missed it, but what are the net proceeds we expect to get on the equipment sale? Is that disclosed yet, or should we just hang tight?.

No. At this time, we cannot provide further details until a definitive agreement is attached. However, we believe that the selling is a good thing and an important step of our transformation..

Okay. Great.

And then lastly, the candy business, is that in this LOI? Or is that still being shopped? Where are we on that currently?.

No. We're keeping the candy business. We got interest on the candy business, but from our standpoint, we didn't get the value we thought was – that was really fair for what we have. We've never put any focus or spending or effort against it, and that's what we're going to do. We're going to put some thinking around it.

We're going to expand it to potentially our broker partners, and we're going to work that one. That is a nice little business. We've kind of neglected it. Now that we'll have more capital available, we're going to give it a little tender loving care and see where it could run to..

Okay, great thanks for the questions..

[Operator Instructions] And we have a question from the line of Eric Rose, Private Investor..

I was wondering if all the marketing is being outsourced now, there's no in-house sales going on or salesmen, you're outsourcing as much as you can to save money?.

We have internal marketing and sales, so we still have a sales team, which is out in the field, that manages regions of the country and is partnering with our brokers, and we do have internal marketing people that we've brought in, some on a full-time basis, some on a part-time basis. So, there's a mix of outsourcing and adding to our current team..

Okay.

Is there any national advertising in the offing? National being television ads or anything of this sort?.

Yes, unlikely. We will have a digital campaign targeted in markets. We have to walk before we run.

And so, from most of the spending, I'd say 60%, 70% of the spending is really focused on sales, programs, and sales support, and the rest will be really to support the launch of the Virgil's Zero Sugar can line, so we will have marketing pull campaigns, PR campaigns around that launch.

We don't anticipate national – let's say, traditional national media investments this year, and I'm not even sure if we'd have it next year. It's more of a focus on digital and viral communication as opposed to traditional advertising..

Okay. Thank you, very much..

Our next question is from Tom Malino, a Private Investor. Please proceed..

Yes, thank you very much for taking my question. I'm a long-term investor.

Can you tell me what the status is with the fountain initiative, or has that died?.

No, the fountain initiative continues. We are continuing to test in our fast-casual partner. We're exploring also options to how can – we can expand via partnerships in terms of service and distribution. That's sort of underway.

There's been no green light to expand it beyond the current test, but we are – on our side we are exploring, partnering with smaller, let's say, food service and restaurant opportunities to expand the test beyond this one partner.

And as I said, we're exploring strategic partnerships that will enhance our ability to roll and service this opportunity going forward..

Great. Thank you very much. Let's get out of this 150 range..

I agree. I agree..

Thank you very much. Keep up the good work guys..

Thanks..

[Operator Instructions] We have a question from the line of David Anderson, Private Investor. Please proceed. .

Yes, thank you.

I was wondering if there was any plans on bringing back the Kombucha fermented tea or any status on that?.

Yes. At this point, we're clearly focused on the Reed's Ginger Beer and Virgil's Craft Soda. We don't have any plans on Kombucha.

Fighting – those two brands and those two categories have significant competitors in them, and so it's going to take all of our focus and efforts and capital to make sure we expand our leadership position in those categories, and it just doesn't allow us the financial support that we would need to really enter the Kombucha space, which is highly competitive with very strong products and brands.

So, at this point, 2018, I don't see us coming back into that category..

Great. Thank you..

Our next question is from the line of Sam Gravino, Private Investor. Please proceed..

The previous caller asked one of my questions, but I'm just wondering, is all of your product now just Reed's, Virgil's and Candy? Is there anything else that you haven't mentioned?.

That is the majority. I would say, year-to-date, those three will account for 95% of our sales..

Okay, thank you..

And we have a question from the line of Paul Strigler with Esplanade. Please proceed..

Congratulations on the progress, guys. Looking at the turnaround in the core brand. In Q3, I think you guys were still trending down about 8.5%.

Obviously, the price increase helped, but there has to be some volume impact there, can you sort of share any information there?.

Yes. I mean, look, we have not had a lot of capital to give the business. It really is the SKU rationalization, so we've taken any of the shelf space that we've had with the brands, the SKUs we weren't focusing on. That allowed us to have more shelf space dedicate to the core brands, which lowered our out of stocks.

So, from that standpoint, I would say most of the benefit came from being more consistently on shelf with the brands and the SKUs we needed to have on shelf because there really wasn't an increased investment in marketing or sales. The only explanation is just better capital management, better inventory management and better shelf management..

Great.

And then on the gross margin expansion for the quarter, was any of that attributable to the new logistics and glass contracts? Because this was really announced late or was that reduction in [indiscernible]?.

Almost no benefit on that, Paul. We're going to start seeing the benefit in this quarter – in the first quarter..

So that 21 or so percent reflects 0, that's just blocking and tackling on your side, nothing [indiscernible]?.

That is correct. Yes. Shifting to higher margins, and we have negotiated several vendor contracts. The R.C. Moore and OI were the big ones, so there is some benefit from our activities, but not those big ones..

Got you.

Great, and idle plant costs were relatively flattish with Q3?.

Yes. And that will still – it will still continue into 2018, but with the settlement of the plant, we expect that to be gone second half of this year..

Look forward to seeing you again. Congratulations. Great progress. Thank you..

Thanks Paul. Say hi to Shawn..

And there are no further questions at this time..

Great. Well, thank you again for your support and for participating on today's call. We look forward to updating you on further progress on the transformation we're undertaking at Reed's and are excited for the opportunities that lie ahead. Please don't hesitate to call with any additional questions and have a great day. Thanks, everyone..

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