Val Stalowir - Chief Executive Officer Iris Snyder - Chief Financial Officer.

David Bain - ROTH Capital Partners Anthony Vendetti - Maxim Group.

Good afternoon, and welcome to Reed's Third Quarter 2018 Earnings Conference Call for the period ending September 30, 2018. My name is David 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 Iris Snyder, Reed's Chief Financial Officer. Following management remarks, we 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, managements remarks may contain forward-looking statements and that management may make additional forward-looking statements in response to your questions.

Forward-looking statements are only current predictions and are subject to known and unknown risks, uncertainties and other factors that may cause our actual results, level of activity, performance or achievements to be materially different from those anticipated by such statements.

These factors include, but are not limited to the company’s ability to manage growth, manage debt, and reach development goals, production and demand for our 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 our filings with the United States Securities and Exchange Commission.

Although we believe that the expectations reflected in forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. In addition, any projections as to the company's future performance represent management's estimates as of today, November 13, 2018.

We assume no obligation to update these projections in the future as market conditions change.

Additionally, please note, 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, and as posted on our Web site at www.reedsinc.com.

Non-GAAP financial information is not meant as a substitute for GAAP results, but is included solely for informational and comparative purposes.

We present Modified EBITDA because we believe it assists investors and analysts in comparing our performance across reporting periods on a consistent basis by excluding items that we do not believe are indicative of core operating performance. I will now turn the call over to Mr. Stalowir. Please go ahead, sir..

Thank you, and good afternoon, everyone. It is my pleasure to speak with you today to discuss our third quarter performance and update you on the progress we've made in our transformation efforts, which we have now substantially completed and only need to finish the last major remaining item which is exiting our manufacturing operations in LA.

During the third quarter, we finalized laying the groundwork for our sales and brand building activities. Having completed our brand refresh work for both Virgil's and Reed's and are preparing to bring new product news and innovation to the craft category.

We have yet to fully turn on these investments to impact sales, but will begin to ship our refreshed packaging and exciting new product offerings over the coming months. During the third quarter, we again delivered core brand growth sales growth and generated normalized gross margins of 29% as Iris will discuss.

Gross margin this quarter also included 160 basis points of slotting costs to support the Virgil's Zero Sugar rollout. We expect further gross margin improvement and remain confident with our near-term target of margins in the mid 30s. We continue to see excellent retailer and consumer response to our Virgil's Zero Sugar launch.

We added 1,100 new doors during the quarter and are now gearing up for the launch of Reed's Zero Sugar in bottles and cans, which should begin to ship during the first quarter of 2019. Before I dive into our sales, marketing and new product strategies, let me discuss our progress on our transformation plan.

As I mentioned, we have just one item left to complete which is the exit from our Los Angeles Manufacturing facility. Exiting manufacturing will complete our transition to an asset light sales and marketing organization and reduce our idle plant charges which were $1.1 million this quarter.

We are in the final stages of the process and expect to complete our transition by year-end. As we discussed over the past few calls, we've been diligently executing the business model optimization plan that will create a solid and scalable foundation from which to drive improved margin performance and sales growth.

This new business platform will allow the company to invest increased capital in sales and brand building resources and initiatives. Our [indiscernible] includes an updated leadership team across all functions and highly experienced Board.

Our renewed strategic focus on our core brands, an optimized business model upon completing the LA plant exit, and improved and flexible capital structure at lower rates and much reduced debt service which was completed with the free financing of our credit agreements last month.

And we laid the groundwork for building brand equity and accelerating sales growth on both brands. We’ve begun to see the benefits of these investments on the Virgil's brand which posted double-digit growth this quarter and will continue to ramp.

We expect to see a similar impact on Reed's brand once the new brand refresh, the new zero sugar offerings and can packages begin to hit shelves in 2019.

We are very pleased to have most of our transformation efforts behind us, so we can now fully focus on the second phase of our value creation plan which is to invest in sales and brand building activities in order to expand our leadership position in two of the fastest-growing categories in beverage.

The most recent 52-week period showed Ginger Beer growing at 12% and the better for you segment of the craft specialty soda category up 27%. We're very proud of the work we’ve completed to transform the Reed's business model.

We now have the focus, the resources, the tools and the viable gross margins to achieve our goals of capitalizing on the significant growth upside in these fast-growing categories, Let me turn now to our recent gains for Virgil's and then discuss our plans for the Reed's brand.

As I’ve already noted, we continue to gain distribution for Virgil's Zero Sugar. We had 1,100 doors this quarter including regional chain such as Stop & Shop Market Basket, Tops, Big Y, King [Cole] [ph] in the Northeast, National chain such as Wegmans and Giant Carlisle and several natural food accounts including Earth Fare.

These gains add to our second quarter distribution gains including Target and Kroger where Virgil's Zero Sugar is doing well with volumes continuing to build and measured velocities approaching similar levels as some of our more established SKUs.

We will continue to invest in trade program to drive further awareness, trial and repeat purchase on our Virgil's Zero Sugar line.

During the third quarter, we also ran a successful mix-and-match roadshow program featuring Virgil's Zero Sugar product in a western Costco region and our goal is to expand this roadshow program to additional regions in 2019.

Our launch of Virgil in cans and next year's introduction of Reed's in cans will be a compelling new addition to this program and the club channel in general. Turning to Reed's, we've completed our brand refresh work and development of Reed's Zero Sugar offerings and have begun the sell in process to major retailers.

The Reed's Zero feature the same great tasting all-natural zero calorie formula used in our Virgil's Zero line and will be the only all-natural zero sugar Ginger Beer on the market made from fresh organic ginger. Now consumers can enjoy America's number one Ginger Beer without any sugar or calories.

The Reed's brand refresh includes new high-impact graphics and packaging on our 4 pack bottled 4 packs and our plans also include launching Reed's in 4 pack cans. We expect to be shipping the refreshed bottles, cans and zero sugar line in the first quarter of 2019 with product on shelf by the second quarter.

During the third quarter, we also continued to add sales, broker and distributor resources. We partnered with Advanced Solutions to enter the convenience store channel and already launching our first regional C store test.

For the on-premise channel, we’ve partnered with Young's Market, a leading distributor of wine and spirits with reach into 10 western markets. We are initially launching in California and already have our first orders in the fourth quarter. Success in California will be followed by expansion to additional markets and regions.

In parallel, we’ve had productive conversation with similar sized wine and spirit distributors in major markets and initial reactions have been very positive. Interest is especially high on the Reed's can product offerings.

We are also making solid progress in adding new bar liquor store accounts daily in the three major test markets where we’ve invested in experienced on premise field sales personnel.

We remain excited about our opportunity to disrupt and elevate the multibillion-dollar Ginger Beer category as well as upgrading consumers to natural craft offerings from the $80 billion mainstream soda category.

We are confident that we have the right business model, the right team and the right products, packages and branding delivered on our goal of becoming the Sam Adams of natural craft beverage.

As we near the final stage of our transformation with the resources in place to accelerate our investments in sales and our brands, we are excited for the opportunity ahead. I remain very proud of what we've been able to accomplish in a short amount of time.

We’ve made good progress to date and there are significant opportunities for us to capture moving forward. We look forward to updating you each quarter on our progress and continuing to deliver improved financial results and shareholder value. Now let me turn the call over to Iris..

Thank you very much, Val, and good afternoon, everyone. As Val mentioned, we continued to make good progress in our key initiatives. Let me run through the financial results. Net sales decreased 1% to $10.8 million during the third quarter while our core brands generated 3% of growth.

The net sales decline reflects last year's SKU reduction, a sales shift of private label this year from Q3 to Q4 as well as the impact of our sliding investments for Virgil's Zero Sugar which are netted against sales.

The combination of higher revenue per case and a 9% decline in cost of goods sold on a per case basis, contributed to a 30% increase in gross profit. Gross margin as a percentage of net sales increased 590 basis points over the prior year to 25%.

Excluding approximately $500,000 of discrete accruals in inventory revaluation related to the planned exit of the company's manufacturing operations, the gross margin would have been 29% this quarter.

Additionally, investments in slotting this quarter reduced the gross margin by approximately 160 basis points compared to minimum slotting expense in the prior quarter.

On an adjusted basis, adding back the discrete items in adjusting for slotting the gross margin would have improved 1,200 basis points year-over-year primarily driven by the benefits as a new glass supplier contract with Owens-Illinois, higher average selling prices and the benefits of SKU rationalization.

As Val mentioned, we remain confident with our gross margin trajectory and opportunity for incremental improvement. Delivery and handling costs increased 25% to $1.4 million or 260 basis points higher as a percentage of net sales compared to the prior year.

This increase reflects an industrywide increase in freight rate, transition charges from and to new warehouse partners, and the effects of the initial ramp up of can production on the East Coast. Selling and marketing costs increased 66% to $1.4 million during the quarter.

The 520 basis point increase as a percentage of net sales versus prior year, reflects the company's strategy to enhance brand value and reaccelerate growth of the core brand. The investments focus on and marketing infrastructure, brand refresh work and support of new product launches.

General and administrative expenses increased $2 million in the third quarter compared to $1.1 million in the prior year period.

The third quarter G&A increase reflects noncash stock option expense of approximately $400,000, transition expenses associated with our headquarter relocation to Norwalk, Connecticut of approximately $300,000 and another $100,000 of cost associated with bonus accruals.

The third quarter operating loss narrowed to $2.1 million from $3 million in the prior year and was negatively impacted by the $500,000 of discrete accruals in inventory revaluation related to the planned facility exit and $300,000 of relocation expense, both of which are nonrecurring.

The [technical difficulty] in the third quarter compared to $0.8 million last year. Warrant cost this quarter were de minimis as compared to $1.9 million of warrant modification and expenses associated with the change in fair value of warrant liability in the prior year period. Net loss is $2.7 million or $0.10 per share in the third quarter of 2018.

This is compared to a net loss of $5.6 million or $0.37 per share in the same period last year. Moving to the balance sheet and cash flows we ended the third quarter with $0.2 million in cash and cash equivalent.

While we had a approximately $3 million of availability on our credit facility on September 30, we were managing our cash position to limit our borrowings on our previous credit facility prior to refinancing, which occurred shortly after the quarter ended.

As we announced last month on October 4, we successfully refinanced our credit facilities with Rosenthal & Rosenthal, strengthening our financial profile and significantly reducing debt service and borrowing costs. The $30 million asset based loan replaced our previous credit agreements with PMC.

Based on current interest rates our annual debt service is expected to be reduced by approximately $1.5 million. During the first nine months of 2018, we used cash and operating activities of $10.5 million compared to $4.7 million in the prior period.

As we noted on prior calls, the increase primarily relates to payment of stretched payables during the first quarter of 2018 and investments in inventory during the second quarter.

The added inventory have been put in place to support the planned transition of our LA manufacturing operations, as well as supporting the recent launch of Virgil's Zero Sugar. Now let me turn the call back to the operator to begin the question-and-answer session.

Operator?.

Thank you. [Operator Instructions] Our first question is from David Bain from ROTH Capital Partners..

Thank you. Congrats on the refi and continued Virgil's traction. My first question is, if you could give us a little bit more color on sell-through versus sell-in, with the Zero line. I know you mentioned velocities are approaching levels of your more established SKUs.

I assume that means it’s selling faster than non-mature SKUs or how should we view that in terms of consumer acceptance from the investor or a modeling standpoint?.

Yes, there is two things we are looking at. One is sort of our traction in our big retailers and sort of where their minimums are. And in the few months that we are in, we're approaching closer and closer to sort of their minimum threshold, which I think is pretty good in terms of how short that’s been.

And we've only started promoting in September in terms of couponing and sort of pull activity. So we're really happy with what we've set out in terms of targets and developments in the large retailers like Target and Kroger. And then on the other major sort of guide that we have is syndicated data.

And unfortunately that percentage of ACV of which is a measurement of distribution is still quite small compared to a more established brands, we are comparing sort of Virgil's Zero to Virgil's Root Beer and black cherry which have been on shelf and been selling through for a number of years.

So it's I caution to interpret too much because the ACV is one-fifth the size of where our established is, but on a sales per point of distribution, the Zeros are doing as well as our regular flavors on a sales per point.

So that tells me the velocities in a short amount of time are in the ballpark of brands that have been on the shelf for a lot of years. So that that to me is encouraging. The question is going to be, are those rates going to continue as the ACV for zero continues to grow, which is our plan.

I mean right now we're probably in the mid-teens and sort of the best or most widely distributed zero whereas we are probably in the 40s or 50s at least in grocery in terms of the more established..

Okay, great. That’s very helpful. Okay.

And then, can you get a little bit more granular with the plant plans and -- so is the potential sale, is there -- it look like there is probably not going to be deal with potential buyers and what exactly happens if there's not before year-end when you exit? How does that work?.

Yes, that’s a good question. So it's something that we’ve always been working on for a long time. Now we have a competitive process, we have more than one bidder and we are coming down to the final strokes.

We have a draft, definitive documents and we expect to sign something more definitive this week and then drive to close in short order before the end of the year. And the terms are similar to what we had reflected in the 2017 financials.

And there's even upside in terms of toll fees being more attractive than what we had thought in terms of the first round. So what’s taken us long is when we went down the road pretty deep with the first bidder, and then the terms changed pretty significantly, we kind of regrouped and started over and attracted different competitive set.

So that is why it's taken as long as it has. It's a little -- its definitely complex process because there's a discrete amount of potential interested buyers and what this facility is. And we are also trying to attract the right partner to be a solid and dependable co-packer for our core brand on the West Coast.

Now the good news is we are adding another co-packer on West Coast which we will announce fairly shortly. So we won't be 100% dependent on the LA plant producing everything we need. But we still like to give all of our employees there the best chance of transitioning to a good partner to produce -- continue to produce our product.

So we're pretty confident we are going to get a deal done this year. If we don't get a deal done, the good news is that we have an option to buy the plant, and the plant's value has actually appreciated.

And so we've hired a commercial firm to do an appraisal and right now there is a good chance that we could buy and sell this property without a lot of out-of-pocket investment in getting that done and extinguish the lease obligation, and then we would sell all the new equipment and everything else to bring in cash.

Again, it would be in the range of what we would expect to bring in versus selling the facility -- selling the beverage business. So from that standpoint Plan B is not that bad. It's just more work. But obviously the preferred option is to find a partner and exit to them, which right now I'm pretty confident that’s going to happen..

Okay, great. And then just final one, if I may, because this comes up with certain investors.

Can you give us any insight as to how you look at the potential for a CBD within the context of your future offering if at all?.

Look, that -- you’re not the first to ask. So we are an all natural craft soda. We have 30,000 distribution doors. So we have an infrastructure that's pretty rare in the industry. And so -- and we are looking at functional beverages. Ginger is a superfood, it's a functional beverage, it’s all-natural. It has sort of a counterculture brand image.

And so, of course, we are looking at all fast-growing new breakthrough ingredients. And so we are looking at all that space. We are looking and learning in that space in general. So from that standpoint, we are doing the good diligence that our management team should be doing in beverage and evaluating sort of breakthrough ingredients and/or offerings.

So that’s the way I would answer that..

Yes, fair enough..

The other piece here, David -- I’m so sorry, David. The other piece is when you take a look at some of our major retailers, they’re not going to distribute anything that is still federally illegal. CBD right now until the farm bill passes, as is, that's when CBD will no longer be considered illegal substance.

There is no way whole foods or any of the other major retailer partners that we have would bring anything on that is still officially federally illegal to carry..

Sure. Understood. Okay. Thank you very much..

[Operator Instructions] Our next question is for Anthony Vendetti with Maxim Group..

Thanks. Good afternoon, guys..

Good afternoon..

The third quarter revenue from your core brands, from Reed's and Virgil's made up how much of total revenue?.

It grew by 3% -- 80% of our total revenue..

It grew by 3% and it was 80%? Okay. Thanks, Iris..

Yes, we’ve private label that hits third and fourth quarter. There were some timing issues where our large private label customers ordered later this year, that it impacted sort of revenues. And so from that standpoint, you'll see little margin depression and sales from into Q3 and Q4 for our private-label business..

Okay. And then idle manufacturing costs were $1.1 million this quarter.

Is that -- all of that in cost of goods sold?.

It is included in the cost of goods sold, correct. And the reason why that idle cost includes the $500,000 of the discrete accruals and inventory reevaluation that both Val and I discussed..

Okay. So it's all in there. Okay, good..

Yes..

And then you have a $30 million line of credit.

Have you accessed any of it at this point or how much of it is still available?.

We closed and funded on October 4, so moving our -- all of our lines from PMC over to this asset base line of credit was Rosenthal & Rosenthal..

Okay.

And have you used any of it other than moving it all over there?.

Yes, we are using it as our working capital line of credit at the moment. Yes..

Okay. And then, Val, maybe you could just talk about -- I know you’re adding doors and so forth.

But any major wins you can talk about this quarter or is this not the quarter for that in terms of restocking or what can you mention about that?.

Yes, I mentioned we had some good hits for Virgil's in the Northeast with Stop & Shop, Big Y, etcetera. Wegmans more nationally, Giant-Carlisle. So we had some good grocery hits. We won't be -- there is new news that we are working on, which we can't talk about right now. That are pretty large opportunities for us.

But that’s what hit in the third quarter..

Okay.

And then the old Virgil's packaging that should cycle through by the end of this year?.

We will start cycling actually the first of the year. So all the packaging in terms of the 4 packs and the labels and all that, should be -- that production should start up in the first of January, like the first part of January. And so it's cycling through the first quarter..

So cycle through the first part. Okay, great..

Because we haven't seen the benefit of any of the redesigns really on shelf. I mean the cans launched early, so there was sort of the new branding treatment on the cans. But neither the Reed's nor the Virgil had the benefit of the new improved packaging on shelf..

Okay, great. Okay. That’s it for me now. Thank you..

Next we have a follow-up question from David Bain with ROTH Capital..

Thank you. I’m wondering if you could take a step back and speak to the CSD competitive space a bit.

I mean, you mentioned the CSD growth number industry followers see that as well and I’m wondering if it's leading to new entrants of note that you’re viewing out there or since you put in your new products with Virgil's have you seen any sort of defense coming out of your competitors in terms of discounting or anything else?.

That's a good question. So in the Ginger Beer category, the playing field is pretty set. There's been no significant entrants in that space. All of them are kind of growing and Bundaberg -- I would say Bundaberg, Fever-Tree, Gosling's are still the major players there and continue to be. So there's no real new entrants there.

And some of them had actually slowed down in their growth and ACV expansion. And we feel pretty confident in our ability to compete given our product superiority in terms of organic ginger root and our formulas and the content in the flavors that we use. In terms of the craft soda space, that also has been kind of a quiet category.

Zevia is doing very well. That's really the star of that category. Its growing both ACV and sales and we have what we believe is a 2.0 in terms of taste on Zevia, because we are using a proprietary blend of natural sweeteners as opposed to Zevia alone.

And so that is the major, let's say, competitor that we are looking and they have taken steps in terms of discounting more aggressively. They know we are coming. They’re at our next booth over and over again last --earlier this year.

And so I think that’s going to be sort of the fight for the consumer who really wants all natural great taste, we believe we're the natural evolution of that offering. And we are excited to get on shelves and have that comparison made. There are couple of other players, I think DRY Soda is also starting to get their tail in this space as well.

But I can't say that there is any major new entrants in this space, the sort of full sugar category is still dominated by sort of ingredient challenged products like IBC and Stewart's. So there's no -- like the 27% growth coming from what I define is [indiscernible]. That was really the zero sugars. And that primarily has been driven by Zevia..

Okay, great. Very helpful. Thank you..

Ladies and gentlemen, we’ve reached the end of the question-and-answer session. I would like to turn the call back to Val Stalowir for closing remarks..

I would like to thank everyone for their continued support and for participating on today's call. Also please note that we are launching new Investor Relations Web site this week. Please visit www.reedsinc.com over the coming days to view our improved online investor support. Thanks again and have a great day..

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time..