JONES SODA CO - Annual Report: 2008 (Form 10-K)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

Commission File Number: 000-28820

 

 

 

 

JONES SODA CO.

(Exact name of registrant as specified in its charter)

 

 

234 Ninth Avenue North

Seattle, WA 98109

(Address of principal executive offices)

 

(206) 624-3357

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by checkmark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by checkmark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  Yes o     No þ

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ

 

As of the last business day of the second fiscal quarter, June 30, 2008, the aggregate market value of such common stock held by non-affiliates was approximately $84,860,888 using the closing price on that day of $3.22.

 

As of March 6, 2009, there were 26,454,391 shares of the Company’s common stock issued and outstanding.

 

Documents Incorporated By Reference:

 

The information required by Part III of this Report, to the extent not set forth herein, is incorporated in this Report by reference to the Company’s definitive proxy statement relating to its 2009 annual meeting of shareholders. The definitive proxy statement will be filed with the Securities and Exchange Commission within 120 days after the end of the 2008 fiscal year.

 

 

EXPLANATORY NOTE

 

Unless otherwise indicated or the context otherwise requires, all references in this Annual Report on Form 10-K to “we,” “us,” “our,” “Jones,” “Jones Soda,” and the “Company” are to Jones Soda Co.^®, a Washington corporation, and our wholly-owned subsidiaries Jones Soda Co. (USA) Inc., Jones Soda (Canada) Inc., myJones.com Inc. and Whoopass USA Inc.

 

In addition, unless otherwise indicated or the context otherwise requires, all references in this Annual Report to “Jones Soda” and “Jones Pure Cane Soda” refer to our premium soda sold under the trademarked brand name “Jones Soda Co.”

 

CAUTIONARY NOTICE REGARDING FORWARD LOOKING STATEMENTS

 

We desire to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. This Annual Report on Form 10-K (Report) and the documents incorporated herein by reference contain a number of forward-looking statements that reflect management’s current views and expectations with respect to our business, strategies, products, future results and events and financial performance. All statements made in this Report other than statements of historical fact, including statements that address operating performance, the economy, events or developments that management expects or anticipates will or may occur in the future, including statements related to distributor channels, volume growth, revenues, profitability, new products, adequacy of funds from operations, cash flows and financing, statements expressing general optimism about future operating results and non-historical information, are forward-looking statements. In particular, the words such as “believe,” “expect,” “intend,” “anticipate,” “estimate,” “may,” “will,” “should,” “plan,” “predict,” “could,” “future,” “target,” variations of such words, and similar expressions identify forward-looking statements, but are not the exclusive means of identifying such statements and their absence does not mean that the statement is not forward-looking.

 

Readers should not place undue reliance on these forward-looking statements, which are based on management’s current expectations and projections about future events, are not guarantees of future performance, are subject to risks, uncertainties and assumptions and apply only as of the date of this Report. Our actual results, performance or achievements could differ materially from historical results as well the results expressed in, anticipated or implied by these forward-looking statements. Except as required by law, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

For a discussion of some of the factors that may affect our business, results and prospects, see “Item 1A. Risk Factors.” Readers are urged to carefully review and consider the various
disclosures made by us in this Report and in our other reports we file with the Securities and
Exchange Commission, including our periodic reports on Forms 10-Q and 8-K, and those described from
time to time in our press releases and other communications, which attempt to advise interested
parties of the risks and factors that may affect our business, prospects and results of operations.

JONES SODA CO.

 

ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2008

 

Table of Contents

 

 

 

Overview

 

We develop, produce, market and distribute a range of premium beverages. With the addition of Jones GABA^tm in the first quarter of 2009, our premium beverages include the following six brands:

 

 

We sell and distribute our products primarily throughout the United States (U.S.) and Canada through our network of independent distributors, which we refer to as our direct store delivery (DSD) channel, national retail accounts, which we refer to as our direct to retail (DTR) channel, as well as through licensing and distribution arrangements. We also sell various products on-line which we refer to as our interactive channel and sell soda with customized labels, wearables, candy and other items. In addition we are expanding our international business outside of North America and have entered the markets of Ireland, the United Kingdom (UK) and Australia through independent distributors.

 

Our company is a Washington corporation formed in 2000 as a successor to Urban Juice and Soda Company Ltd., a Canadian company formed in 1987. Our principal place of business is located at 234 Ninth Avenue North, Seattle, Washington 98109. Our telephone number is (206) 624-3357.

 

Segment Information

 

The Company operates in one reportable segment with operations primarily in the United States and Canada. Refer to Note 12 to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K (Report).

 

Products

 

Our six beverage brands include the following:

 

Jones Pure Cane Soda^tm

 

In November 1995, we launched Jones Soda, a premium carbonated soft drink, under our trademarked brand creating a new category in the New Age beverage market (see “Industry Background” below for a description of the New Age market). Jones Soda comes in 12-ounce, clear long-neck bottles, and every bottle label carries a photo sent to us by our consumers. Over 1,000,000 photos have been submitted to us, mostly via the internet through a patented process which is owned by Jones Soda Co. This unique interaction between the consumer and the brand creates a distinguishable point of difference and strong competitive advantage for Jones Soda. Equally differentiating is the bright colorful look of our drinks with distinctive names such as Fu Fu Berry and Blue Bubble Gum. Jones Soda is made with the highest quality ingredients and flavors. We currently sell Jones Soda in twelve flavors.

 

In 2003, we launched a sugar-free version of our Jones Soda line. These sugar-free sodas are sweetened with Splenda^® and have zero calories and zero carbohydrates. We believe that the launch of our sugar-free Jones Soda provides an alternative for consumers to our regular Jones Soda line and is an important product extension, especially in light of the recent concern and media coverage regarding obesity in young people. We currently have three flavors of sugar-free Jones Soda.

In 2004, we expanded the Jones Soda package lineup to include 12-ounce cans which are available in both 8 and 12 pack varieties. Jones Soda multi-packs are available nationally primarily through the grocery channel and are produced and distributed by National Beverage Corp. (National Beverage). We believe our can business provides our customers with an alternative method of consuming our premium soda and allows for Jones Soda consumption on more usage occasions throughout the year.

 

In keeping with our commitment to produce the highest quality beverage, in the second quarter of 2007, we launched Jones Pure Cane Soda by converting our sweetener system from high fructose corn syrup to pure cane sugar which not only improves the taste and mouth feel but is understood to digest much easier in the body, making Jones Pure Cane Soda a healthier product.

 

Jones 24C^tm

 

In June 2006, we purchased the trademark rights and related assets of 24C. Jones 24C, an enhanced water beverage sweetened with pure cane sugar, has 100% natural flavors and contains daily vitamin requirements (including 500% RDA of Vitamin C) and is available in eight flavors. We began production and distribution of Jones 24C in the first quarter of 2007. 24C is available in 20-ounce PET bottles and as a powdered drink mix.

 

Jones GABA^tm

 

We have an agreement through July 2010 with Pharma Foods International Co., LTD., of Kyoto, Japan; Mitsubishi Corporation, of Tokyo, Japan; and Mitsubishi International Food Ingredients, Inc., of Dublin, Ohio for the supply and non-exclusive use of Pharma GABA in specified beverage applications. Pharma GABA is a naturally produced form of the amino acid gamma amino butyric acid (GABA), which studies have shown to be a key neurotransmitter in the human brain that improves mental focus, balance and clarity, while reducing stress. We introduced our first line of beverages containing Pharma GABA in February 2009. The product, branded Jones GABA and offered in 12-ounce cans, is available in the following flavors: Lemon Honey Tea, Fuji Apple, Nectarine and Grapefruit tea and juice blends. We are marketing the brand by focusing on the benefits of enhanced focus and clarity that studies have shown GABA provides.

 

Jones Organics^tm

 

In April 2005, we launched Jones Organics, a ready-to-drink organic tea, sweetened with organic cane sugar. Jones Organics comes in 14-ounce proprietary clear glass bottles with a design of the fruit on the front label, but does not contain the usual black and white photograph labels used on Jones Soda and Jones Naturals product labels. The Jones Organics line currently consists of six flavors.

 

Jones Naturals^®

 

In April 2001, we launched Jones Naturals, our non-carbonated beverage containing 100% natural flavors and ingredients such as ginseng, zinc and various vitamins in 20-ounce clear glass bottles with primarily black and white photograph labels, similar to the Jones Soda product labels. In 2007, we introduced Jones Naturals in 14-ounce clear glass bottles. The Jones Naturals line currently consists of five flavors.

 

Whoop Ass Energy Drink^®

 

We launched Whoop Ass in October 1999. Whoop Ass is a citrus energy drink in an 8.4-ounce slim can containing riboflavin, niacin, vitamin B6 and thiamin. In 2005, we launched a 16-ounce version of our Whoop Ass Energy Drink. Whoop Ass competes in the Energy Drink category of the New Age beverage industry.

 

Discontinued Product — Jones Energy

 

In 2008, due to the increased competitive landscape of the energy category and increased costs, we discontinued production of Jones Energy, which had originally been launched in November 2001. Jones Energy was a citrus energy drink containing vitamin B6, riboflavin, niacin, thiamin, caffeine and coQ-10 and was available in a 16-ounce can and in an 8.4-ounce “four-pack” carrier format in three flavors.

Industry Background

 

The New Age or Alternative Beverage Category

 

Jones Pure Cane Soda^tm, Jones 24C^tm, Jones GABA^tm, Jones Organics^tm, Jones Naturals^®, and Whoop Ass Energy Drink^® which are classified as New Age or alternative beverages, as well as other brands and products that we may develop in the future, compete with beverage products of all types including soft drinks, fruit juices and drinks, and bottled water. New Age or alternative beverage markets are estimated at over $26.0 billion in total annual sales.

 

New Age or alternative beverages are distinguishable from mainstream carbonated soft drinks in that they tend to contain natural ingredients combined with less sugar and carbonation. As a general rule, three criteria have been established for the New Age or alternative beverage classification: (1) relatively new introduction to the market-place, (2) a perception by consumers that consumption is healthful compared to mainstream carbonated soft drinks, and (3) the use of natural ingredients and flavors in the products. According to market research, the New Age or alternative beverage categories include: energy drinks, premium soda, ready-to-drink (RTD) coffee, RTD tea; RTD tea (nutrient-enhanced), shelf-stable dairy (regular/diet), shelf-stable dairy (nutrient-enhanced), single-serve-fruit beverages (regular/diet), single-serve-fruit beverages (nutrient enhanced), smoothies, sparkling water, sports drinks, vegetable/fruit juice blends, and other New Age beverages.

 

The Carbonated Soft Drink (CSD) Category

 

Our soda originated in the New Age category and our products meet the above mentioned definitions for the New Age or alternative beverage classification, but over time these definitions evolve and categories overlap and blend together. While we intend to maintain our niche alternative positioning, we also strive to expand our sources of growth by attempting to be within the consideration set of shoppers and drinkers of mainstream brands so that it is easier for them to switch to our brands. For that reason, we are endeavoring to expand our points of availability within all stores, including the shelves that are normally restricted to national mainstream brands manufactured by companies such as The Coca-Cola Company and PepsiCo. Our primary package within the mainstream aisle is the 12-ounce can multi-pack, but we have also penetrated this space with the four-pack Jones Soda glass package. These packages and shelf locations allow us to penetrate the larger carbonated soft drink category, estimated at $70 billion in annual sales, providing us access to the important “take home market”.

 

In September 2006, we entered into an exclusive manufacturing and distribution agreement with National Beverage Corp. to manufacture and distribute Jones Soda 12-ounce cans to the more mainstream channels and in-store locations. Beginning in January 2007, National Beverage Corp. started selling Jones Pure Cane Soda to retailers in the grocery and mass merchant channels in the U.S.

 

Business Strategy

 

Our business strategy is to increase sales by expanding distribution of our brands in new and existing markets (primarily within North America), stimulating consumer awareness and trial of our products leading to increased relevance and purchase intent of our brands. Our business strategy focuses on:

 

 

Key elements of our business strategy include the following:

 

Building our Brand

 

We believe the market for alternative beverages is dependent to a large extent on image as well as taste, and that this market is driven by trendy, young consumers between the ages of 12 and 24. Accordingly, our strategy is to develop innovative brand names, relevant programs and trade dress. In addition to creative labeling on our products, we provide our distributors with point-of-sale promotional materials and branded apparel items. We promote interaction with our customers through the use of these point-of-sale items, such as posters, stickers, post cards, hats, pins, and T-shirts. In addition, through the labels on our bottles, we invite consumers to access our website and to send in photographs to be featured on the Jones Soda and Jones Naturals labels. We select photos throughout the year to be placed on our bottles in distribution. We also invite consumers to celebrate special occasions and memories by creating their own label through myJones.com. In that space, consumers have the ability to customize their own label and product with a photo and short caption. We believe that our labeling, marketing and promotional materials are important elements to creating and increasing distributor, retailer and consumer awareness of our brands and products.

 

In-House Brand and Product Development

 

We understand the importance of creating new beverage items and enhancing our existing beverage items to meet the ever changing consumer taste profile. Our strategy is to be focused on innovative products that will be accepted by retailers, distributors and consumers. We believe this is accomplished by keeping open dialog with our retail and distributor partners to ensure we are current with the consumer trends in the beverage industry.

 

We have developed and intend to continue to develop the majority of our brands and products in-house. We used a similar process initially to create the Jones Soda brand, and we intend to continue utilizing this process in connection with the creation of our future brands. This process primarily consists of the following steps:

 

Market Evaluation.  We evaluate the strengths and weaknesses of certain categories and segments of the beverage industry with a view to pinpointing potential opportunities.

 

Distributor Evaluation.  We analyze existing and potential distribution channels, whether DSD or DTR. This analysis addresses, among other things, which companies will distribute particular beverage brands and products, where such companies may distribute such brands and products, and what will motivate these distributors to distribute such brands and products.

 

Production Evaluation.  We review all aspects of production in the beverage industry, including current contract packing capacity, strategic production locations, and quality control, and prepare a cost analysis of the various considerations that will be critical to producing our brands and products.

 

Image and Design.  In light of our market, distributor and production evaluations, we create and develop the concept for a beverage brand or product extension. Our technical services department then works with various flavor concentrate houses to test, choose and develop product flavors for the brand.

 

Due to the limited life cycle of beverages in the New Age or alternative category, we believe that the ongoing process of creating new brands, products and product extensions will be an important factor in our long-term success.

 

National Beverage Corp.

 

In October 2004, we entered into a test of our Jones Soda product in the 12-ounce can format under a two-year exclusive marketing and distribution agreement with Target Corporation. With the expiration of this exclusive agreement with Target in December 2006, beginning in 2007 we expanded distribution to the grocery and mass merchant channel in the U.S. with our exclusive manufacturing and distribution agreement with National Beverage Corp. Through this arrangement, we identify and secure retailers across the U.S. for our

Jones Soda 12-ounce cans, and we are solely responsible for all sales efforts, marketing, advertising and promotion. Using concentrate supplied by Jones, National Beverage both manufactures and sells on an exclusive basis the products directly to retailers. National Beverage is responsible for the manufacturing, delivery and invoicing of the sales of our products in this can package.

 

Independent Distributor Network (DSD)

 

We have focused our sales and marketing resources on the expansion and penetration of our products through our independent distributor network throughout the U.S. and Canada. We have obtained listings for selected stock keeping units (SKUs) of our Jones Pure Cane Soda^tm, Jones GABA^tm, Jones 24C^tm, Jones Organics^tm, Jones Naturals^® and Whoop Ass Energy Drink^® brands with certain key retail grocery, convenience and mass merchandiser accounts, including but not limited to Quality Food Centers (QFC), Target, Kmart, Meijer, 7-11, Stop & Shop, Allsups Convenience Stores, The Kroger Co., Albertsons, Speedway Super America LLC and key Canadian retailers such as Loblaws, all of which are serviced through our independent distributor network.

 

We grant certain independent distributors the exclusive right in defined territories to distribute finished cases of one or more of our brands through written agreements. These agreements typically include invasion fee provisions to those distributors in the event we provided product directly to one of our national retailers located in the distributor’s region. We are also obligated to pay termination fees for cancellations of most of these written distributor agreements, which have terms ranging from one to three years. We select distributors that we believe will have the ability to get our brands and products on the street level retail shelves in convenience stores, delicatessens, sandwich shops and selected supermarkets.

 

Ultimately, we have chosen, and will continue to choose, our distributors based on their perceived ability to build our brand franchise. We currently maintain a network of approximately 175 distributors in 50 states in the United States and 9 provinces in Canada. We also have one distributor in the UK and one in Australia.

 

Direct to Retail National Accounts (DTR)

 

We launched our direct to retail business strategy in 2003 as a complementary channel of distribution to our DSD channel, targeting large national retail accounts. Through these programs we negotiate directly with large national retailers, primarily premier food-service based businesses, to carry our products serviced through the retailer’s appointed distribution system. As of the date of this Report, our most significant DTR accounts are the following:

 

 

Except for our supply agreement with Alaska Airlines & Horizon Air which can be terminated with 120 days written notice from either party, these arrangements are not long term and are terminable at any time by these retailers or us. There are no minimum purchase commitments for any of these retailers. We will continue to look for new opportunities to service and expand our “direct to retail” channel of business.

Sponsorship Arrangements

 

We currently have three major sponsorship agreements with professional sports franchises. We entered into Sponsorship Agreements with Football Northwest LLC (d/b/a Seattle Seahawks) of the National Football League and First and Goal, Inc. effective July 2007; with Brooklyn Arena, LLC and New Jersey Nets Basketball, LLC, effective November 2007; and with Trail Blazer Inc, effective October 2008, all of which provide us with the exclusive beverage rights to sell our beverages at sports venues as well as signage, advertising and other promotional benefits to enhance our brand awareness. We expect these sponsorship arrangements will continue to increase the public awareness and strength of our brand and provide us with other cross-selling opportunities through our licensing business strategy.

 

In June 2007, we announced our entry into a Sponsorship and Beverage Availability Agreement with Football Northwest LLC (d/b/a Seattle Seahawks) and First and Goal Inc. that provides us with exclusive beverage rights for certain soft drinks at Qwest Field in Seattle, Washington, as well as signage, advertising and other promotional benefits to enhance our brand awareness, including sponsorship and trademark rights regarding the use of Seattle Seahawks trademarks. In consideration for our rights under the agreement, we are obligated to pay annual sponsorship fees. The agreement has an effective date of July 1, 2007 and expires on February 28, 2012, and provides Jones Soda with a right of first renewal with respect to its renewal or extension. Generally, either party may terminate the agreement only if the other breaches any material term of the agreement and fails to cure such breach within 30 days of receiving notice of the breach. However, we may terminate the agreement after the 2009 National Football League season by giving written notice of termination by February 10, 2010 and paying a termination fee. In addition, the Seattle Seahawks may terminate the agreement if Jones Soda fails to make a required payment and such failure continues for 30 days after Jones Soda receives written notice of the failure.

 

In November 2007, we announced our entry into a Sponsorship & Beverage Availability Agreement with Brooklyn Arena, LLC and New Jersey Nets Basketball, LLC. The agreement has a commencement date of October 25, 2007. This agreement provides us with exclusive beverage rights for all carbonated soft-drinks and certain other non-alcoholic beverages, as well as sponsorship, promotional, media, hospitality and other rights in connection with the New Jersey Nets basketball team and a proposed new sports and entertainment arena that the Brooklyn Arena and the New Jersey Nets intend to develop in Brooklyn, New York. In consideration for our rights under the agreement, we are obligated to pay annual sponsorship fees. The Brooklyn Arena and the New Jersey Nets may terminate the agreement if we commit one of several events of default and subsequently fail to cure such event of default within the applicable cure period. We may terminate the agreement only if the Brooklyn Arena and the New Jersey Nets commit one of several events of default and subsequently fail to cure such event of default within the applicable cure period, but only if equitable adjustment, make-goods or other remedies implemented by the Brooklyn Arena and the New Jersey Nets are not suitable or appropriate for such event of default.

 

In October 2008, we announced our entry into a Sponsorship & Beverage Availability Agreement with Trail Blazers Inc. that provides us with beverage rights at the Rose Garden and Memorial Coliseum in Portland, Oregon as well as signage, advertising and other promotional benefits to enhance our brand awareness, including sponsorship and trademark rights regarding the use of Portland Trail Blazer trademarks. In consideration for our rights under the agreement, we are obligated to pay annual sponsorship fees. This agreement has an effective date of October 1, 2008 and expires on June 30, 2011 and may be extended by mutual agreement. The agreement may be terminated prior to the expiration of the term if either party materially defaults and subsequently fails to cure such event of default within the applicable cure period.

 

Licensing Arrangements

 

We launched our licensing business strategy in 2004 as a method to extend our brand into non-alternative beverage products and non-beverage products. We currently have licensing arrangements with three companies. In September 2005, we entered into a licensing agreement with Big Sky Brands, Inc. to manufacture and distribute Jones Soda Flavor Booster hard candy. In February 2007, we entered into a licensing agreement with J&J Snack Foods for the use of our flavors and brand name for their ICEE and Slush Puppy iced

beverages. In December 2008, we entered into a licensing agreement with FOG Studios for the use of hard line items such as apparel, glassware and alternative products. With these licensing agreements, we believe that we are able to partner with companies that will manufacture Jones related products and extend our Jones brand into select products that we feel enhance our brand image.

 

Marketing, Sales and Distribution

 

Marketing

 

The Jones marketing team has developed brand positioning and architecture frameworks that we believe enable us to have disciplined control over our brand identity and other marketing parameters. The strategic frameworks steer us in the development and selection of programs that allow direct consumer ownership and participation in management of the brand while still maintaining brand integrity. We have also developed channel, package, price and promotion strategies designed to allow the sales team to realize optimum price points.

 

Despite these disciplined approaches, our marketing content is designed to be pure “New Age” and “Alternative.” We have a successful history of positioning ourselves in alternative outlets with the intent to be where national mainstream brands were not sold including skate board shops, tattoo parlors, beach surfer shacks and snow board huts. We also have a program of sponsoring alternative sport athletes to promote our products, and we market in youth alternative sports such as surfing, hockey, roller derby, and snowboard, skateboard and BMX bike arenas. We believe this effort to position our products in alternative outlets has drawn a younger generation of customers that value their independence, irreverence and rebelliousness away from the larger soft drink brands. We continue to develop our presence in these outlets, and intend to introduce new outlets such as video game stores and contemporary fashion stores.

 

Another core marketing pillar is the open source access consumers have to define the brand. We invite our consumers to send us photos of their lives for use on our label. Every Jones Soda glass bottle has a picture provided to us by a consumer.

 

We also maintain and utilize our website to allow our Jones Soda consumers to create their own personalized 12-pack of Jones Soda (12-ounce bottles) with their own photo in the labels. The strategy of www.myjones.com is to provide a personalized product offering to our consumers as well as provide an innovative marketing opportunity for our Jones Soda brand. Consumers can upload their photos through our patented web-based process and crop and create their own “myJones” labels. The personalized labels are downloaded at our warehouse, applied to 12-packs of Jones Soda and delivered to the consumer. We believe this strategy has increased awareness for, as well as provided for increased consumer interactivity with, the Jones Soda brand, and we anticipate that it will continue to do so.

 

In December 2002, we received notice of issuance of a patent (Patent No. 6,493,677) from the U.S. Patent and Trademark Office for our myJones.com customized branded label process. The patent is titled “Method and Apparatus for Creating and Ordering Branded Merchandise over a Computer Network.” In January 2005, we were granted a second patent by the U.S. Patent and Trademark Office (Patent No. 6,845,362 B2) which is also entitled “Method and Apparatus for Creating and Ordering Branded Merchandise over a Computer Network.”

 

In 2002, we launched the yourJones program, which allows the customization of the front panel of the label of Jones Soda in a manner similar to our myJones business, but on a larger, commercial scale. The premise behind yourJones is to create customized Jones Soda or Jones Naturals bottles, with a personalized photo or brand image, for cross promotion and co-branding purposes or for sale in retail accounts. Like myJones.com, the Jones Soda name always appears on the labels and customers add their own photo/brand and words. We have negotiated arrangements with our co-packing facilities to create short-run productions for these purposes.

 

We participate in blogs as a way of live engagement with our consumers and a way to better understand their needs and issues.

We use point-of-sale materials such as posters, stickers, postcards, hats, pins and T-shirts to create and increase consumer awareness of our proprietary products and brands. In response to consumer demand, we also sell our products and our wearables on our website. In selected cities, we participate at a “grass roots” level at certain community and sporting events in an attempt to create and increase brand awareness and loyalty. We use recreational vehicles, vans and independent distributor vehicles painted with the Jones colors and logos to create consumer awareness and enthusiasm at these events and to assist distributors as they open new retail accounts and markets. In addition to these marketing techniques, we also pursue cross-promotional campaigns with other companies.

 

We work with various public relations agencies and design firms to support our marketing and public relations efforts. We engaged a public relations firm that is active in developing campaigns around custom programs like Campaign Cola, our Presidential candidates-branded bottles and voter-awareness campaign, or creating awareness about our various marketing efforts with the Seattle Seahawks. We worked collaboratively on creative branding projects for developing our Jones GABA packaging.

 

Sales

 

Our products are sold in 50 states in the U.S. and 9 provinces in Canada, primarily in convenience stores, delicatessens, sandwich shops and selected supermarkets, as well as through our national accounts with several large retailers. In 2008, we secured distribution in the UK and Australia with independent distributors in those markets. In 2008, sales in the U.S. represented approximately 79% of total sales, while sales in Canada represented approximately 19%, and we had approximately 2% in other international sales. In 2007, sales in the U.S. represented approximately 85% of total sales, while sales in Canada represented approximately 14%, and we had approximately 1% in other international sales.

 

Distribution

 

For the year ended December 31, 2008, we experienced an improved balance of business across the U.S. and Canada as we developed more regions of those countries. Our top ten DSD customers by revenue represent approximately 21% of total revenue. We anticipate that, as consumer awareness of our brands develops and increases, we will continue to upgrade and expand our distributor network and DTR accounts, which may result in a decreased dependence on any one or more of our independent distributors or accounts.

 

We contract with independent trucking companies to have product shipped from our contract packers to independent warehouses and then on to our distributors and retail accounts. Distributors then sell and deliver our products either to subdistributors or directly to retail outlets. We recognize revenue upon receipt by our distributors and customers of our products, net of discount and allowances, and all sales are final; however, in limited instances, due to credit issues, quality or damage issues, or distributor changes, we may accept returned product.

 

Production

 

Contract Packing Arrangements

 

We do not directly manufacture our products but instead outsource the manufacturing process to third party bottlers and contract packers (also sometimes referred to herein as co-packers). For our bottle products, we purchase certain raw materials such as concentrates, flavors, supplements, sugar, bottles, labels, trays, caps and other ingredients. These raw materials are delivered to our various third party co-packers. We currently use six primary independent contract packers known as co-packers to prepare, bottle and package our bottle products. Our contract packers are located in the Canadian Provinces of British Columbia and Ontario as well as in Oregon, Washington, Minnesota, Tennessee and California. Once the product is manufactured, we purchase and store the finished product at that location or in nearby third party warehouses.

 

We continually review our contract packing needs in light of regulatory compliance and logistical requirements and may add or change co-packers based on those needs. A majority of our co-packing is handled in Canada, and with the recent strengthening of the Canadian dollar against the U.S. dollar, our co-

packing costs have increased. We experienced increases in co-packing fees for 2008 primarily related to fuel and energy surcharge increases. While we expect these trends to continue in 2009, we believe we may see some stabilization or decreases in our co-packing fees as a result of the global economic crisis. We expect to continue to look for alternative or lower-cost co-packing arrangements for our products in the U.S. and in Canada. For example, in the fall of 2008 we reached an agreement with Chism Hardy Enterprises, LLC (Hardy Bottling Company or Hardy) in Memphis, Tennessee to co-pack products to improve our freight costs for the Central, South Central and Southeast U.S.. Hardy began bottling product in February 2009.

 

Other than minimum case volume requirements per production run for most co-packers, we do not typically have annual minimum production commitments with our co-packers. Our co-packers may terminate their arrangements with us at any time, in which case we could experience disruptions in our ability to deliver products to our customers.

 

With respect to our 12-ounce cans of Jones Soda sold by National Beverage Corp. (National Beverage) through the grocery products and mass merchant channel, National Beverage is responsible for all manufacturing, packing and distribution. Under the agreement, sales of product may be made only to our authorized retail accounts purchasing through warehouse distribution, and we are solely responsible for all sales efforts, marketing, advertising and promotion. We sell concentrate to National Beverage for the manufacture of the product, and National Beverage is responsible for the manufacture, storage, inventory, delivery, invoicing, customer credit review and approval, and receivables collection with respect to sales of products to our authorized accounts. National Beverage carries, stores and maintains the finished products.

 

Our agreement with National Beverage has an initial term of five years, expiring on December 31, 2011. Thereafter, the agreement automatically renews in perpetuity for successive additional five-year periods unless terminated by either party as specified in the agreement. We may not terminate the agreement prior to that date unless National Beverage is in material default, and National Beverage will have the right to terminate our agreement upon six months notice at any time after December 31, 2009. The agreement also provides National Beverage the first right to pack and distribute any new products that we desire to sell through warehouse distribution.

 

Raw Materials

 

Substantially all of the raw materials used in the preparation, bottling and packaging of our bottle products are purchased by us or by our contract packers in accordance with our specifications. The raw materials used in the preparation and packaging of our products consist primarily of concentrate, flavors, supplements, sugar, bottles, labels, trays, caps and packaging. These raw materials are purchased from suppliers selected by us or by our contract packers. We believe that we have adequate sources of raw materials, which are available from multiple suppliers.

 

For our Jones GABA product, which was introduced in February 2009, we obtain the key ingredient, GABA, pursuant to our supply agreement with Pharma Foods International (“PFI”), Mitsubishi Corporation (“MC”) and Mitsubishi International Food Ingredients (“MIFI”). Under the supply agreement, as amended in March 2009, PFI agrees to manufacture and sell, using MC and MIFI as international intermediaries, Pharma GABA to us, and has granted us the non-exclusive right to use Pharma GABA in specified beverage applications throughout the world. We have certain purchase obligations under the supply agreement which are described in further detail in Part I, Item 7, of this report under “Contractual Obligations.” The supply agreement terminates on July 31, 2010, subject to earlier termination if any party defaults in performing any of its obligations under the agreement and fails to correct such default within one month after notice of default. Although we believe we can obtain adequate supplies of GABA from other sources in synthetic form, Pharma GABA is the only naturally produced form of GABA on the market at this time and we believe may give us a competitive advantage over other beverage products that may include synthetic forms of GABA. There can be no assurance, however, that PFI will continue to supply us with Pharma GABA on acceptable terms beyond the termination date of our current supply agreement, in which case we would be required to obtain synthetic forms of GABA in order to continue to produce our products.

Currently, we purchase our flavor concentrate from our three flavor concentrate suppliers. Generally, flavor suppliers hold the proprietary rights to the flavors. Consequently, we do not have the list of ingredients or formulae for our flavors. In connection with the development of new products and flavors, independent suppliers bear a large portion of the expense for product development, thereby enabling us to develop new products and flavors at relatively low cost. We anticipate that for future flavors and additional products, we may purchase flavor concentrate from other flavor houses with the intention of developing other sources of flavor concentrate for each of our products. If we have to replace a flavor supplier, we could experience disruptions in our ability to deliver products to our customers, which could have a material adverse effect on our results of operations.

 

In addition, with our shift to production using pure cane sugar rather than high fructose corn syrup, we utilize considerable quantities of pure cane sugar. We have three pure cane sugar suppliers and have entered into one to two year supply agreements at fixed prices.

 

The prices of raw materials such as bottles, sugar and certain other ingredients continued to increase in 2008. These increased costs, together with increased costs primarily of energy, gas and freight resulted in increases in certain product costs which exerted pressure on our gross margins in 2008. For 2009, we have one glass supplier with whom we entered into a two year supply agreement at fixed prices. We are still subject to freight surcharges in addition to these agreements, but anticipate a stabilization or reduction of these costs in 2009 due to lower fuel prices.

 

Quality Control

 

Our products are made from high quality ingredients and natural and/or artificial flavors. We seek to ensure that all of our products satisfy our quality standards. Contract packers are selected and monitored by our own quality control representatives in an effort to assure adherence to our production procedures and quality standards. Samples of our products from each production run undertaken by each of our contract packers are analyzed and categorized in a reference library.

 

For every run of product, our contract packer undertakes extensive on-line testing of product quality and packaging. This includes testing levels of sweetness, carbonation, taste, product integrity, packaging and various regulatory cross checks. For each product, the contract packer must transmit all quality control test results to us for reference following each production run.

 

Testing includes microbiological checks and other tests to ensure the production facilities meet the standards and specifications of our quality assurance program. Water quality is monitored during production and at scheduled testing times to ensure compliance with beverage industry standards. The water used to produce our products is filtered and is also treated to reduce alkalinity. Flavors are pre-tested before shipment to contract packers from the flavor manufacturer. We are committed to an on-going program of product improvement with a view toward ensuring the high quality of our product through a program for stringent contract packer selection, training and communication.

 

Regulation

 

The production and marketing of our licensed and proprietary beverages are subject to the rules and regulations of various federal, provincial, state and local health agencies, including in particular Health Canada, Agriculture and Agri-Food Canada and the U.S. Food and Drug Administration (FDA). The FDA and Agriculture and Agri-Food Canada also regulate labeling of our products. From time to time, we may receive notifications of various technical labeling or ingredient reviews with respect to our licensed products. We believe that we have a compliance program in place to ensure compliance with production, marketing and labeling regulations on a going-forward basis.

 

Packagers of our beverage products presently offer non-refillable, recyclable containers in the United States and various other markets. Some of these packagers also offer refillable containers, which are also recyclable. Legal requirements have been enacted in jurisdictions in the United States and Canada requiring that deposits or certain ecotaxes or fees be charged for the sale, marketing and use of certain non-

refillable beverage containers. The precise requirements imposed by these measures vary. Other beverage container — related deposit, recycling, ecotax and/or product stewardship proposals have been introduced in various jurisdictions in the United States and Canada. We anticipate that similar legislation or regulations may be proposed in the future at local, state and federal levels, both in the United States and Canada.

 

Trademarks, Flavor Concentrate Trade Secrets and Patents

 

We own a number of trademarks, including, in the United States and Canada, “Jones Soda Co.^®,” “Jones Pure Cane Soda^tm,” “Jones 24C^tm,” “Jones GABA^tm,” “Jones Naturals^®,” “Whoop Ass Energy Drink^®” and “Jones Energy^tm”. In the United States our trademarks expire 10 years from the registration date and in Canada 15 years from the registration date, although in both Canada and the United States, they may be renewed for a nominal fee. In addition, we have trademark protection in the United States and Canada for a number of other trademarks for slogans and product designs, including “I’ve Got A Jones For A Jones^®,” “Jones Soda Co. and Design^®,” “Whoop Ass and Design^®”, “Corn Is For Cars... Sugar Is For Soda^®,” “Run with the Little Guy!^®” and “My Jones^®”. We have also applied for trademark protection for several marks, including “Jones Soda Co.^®”, in the United Kingdom, Germany, Japan, and other foreign jurisdictions.

 

We have the exclusive rights to 37 flavor concentrates developed with our current flavor concentrate suppliers, which we protect as trade secrets. We will continue to take appropriate measures, such as entering into confidentiality agreements with our contract packers and exclusivity agreements with our flavor houses, to maintain the secrecy and proprietary nature of our flavor concentrates.

 

We have two patents on our “myJones.com” web-based customized branded label process. In December 2002, the U.S. Patent and Trademark Office issued us Patent No. 6,493,677, and in January 2005 they issued to us Patent No. 6,845,365 B2, both entitled “Method and Apparatus for Creating and Ordering Customized Branded Merchandise over a Computer Network”. The term of U.S. patents is 20 years from the date of filing. We intend to explore potential licensing arrangements with third parties to commercialize this patented methodology and defend against patent violations.

 

We consider our trademarks, patents and trade secrets to be of considerable value and importance to our business.

 

Competition

 

The beverage industry is highly competitive. Principal methods of competition in the beverage industry include:

 

 

We compete with other beverage companies not only for consumer acceptance but also for shelf space in retail outlets and for marketing focus by our distributors, all of whom also distribute other beverage brands. Our products compete with all non-alcoholic beverages, most of which are marketed by companies with substantially greater financial resources than ours. We also compete with regional beverage producers and “private label” soft drink suppliers. Our direct competitors in the alternative beverage industry include Cadbury Schweppes (Stewarts and IBC) and Thomas Kemper. We also compete against Coca Cola, Pepsi, Hansen’s, and other traditional soft drink manufacturers and distributors, as well as against other category leaders such as Red Bull and Monster for the energy drink category. As of the date of this report, we believe we are the only beverage company manufacturing and distributing product containing GABA in the U.S.

 

In order to compete effectively in the beverage industry, we believe that we must convince independent distributors that Jones Pure Cane Soda^tm is a leading brand in the premium soda segment of the alternative or New Age beverage industry. In connection with or as a follow-up to the establishment of an independent distributor relationship for the Jones Pure Cane Soda^tm brand, we sell Jones 24C^tm, Jones GABA^tm, Jones Organics^tm, Jones Naturals^®, and Whoop Ass Energy Drink^®, as complementary products that may replace other non-carbonated single-serve fruit beverages, ready-to-drink (RTD) teas or energy drinks. In addition, we have created Jones Pure Cane Soda^tm in a 12-ounce can format that allows us to compete directly in the carbonated soft drink industry. As a means of maintaining and expanding our distribution network, we introduce new products and product extensions, and when warranted, new brands. Although we believe that we will be able to continue to create fashionable brands, there can be no assurance that we will be able to do so or that other companies will not be more successful in this regard over the long term.

 

In addition, in light of the competition for product placement with independent distributors, we obtained several national retail accounts as an additional distribution channel for our products. We believe that this diversification strategy is helpful in alleviating the risk inherent in competition for independent distributors.

 

Pricing of the products is also important. We believe that our Jones Pure Cane Soda^tm, Jones 24C^tm, Jones GABA^tm, Jones Organics^tm, Jones Naturals^®, and Whoop Ass Energy Drink^® products are priced in the same price range or higher than competitive New Age beverage brands and products and compete on quality through our premium product offerings.

 

Seasonality

 

As is typical in the beverage industry, our sales are seasonal. In a typical year, approximately 57% of our sales occur from April to September and approximately 43% occur from October to March. As a result, our working capital requirements and cash flow vary substantially throughout the year. Consumer demand for our products is also affected by weather conditions.

 

Employees

 

As of December 31, 2008, we had 65 employees: 33 were employed in sales and marketing capacities, 19 were employed in administrative capacities, and 13 were employed in customer service, manufacturing and quality control capacities. None of our employees are represented by labor unions. We believe that our relationships with our employees are good.

 

Securities Exchange Act Reports and other Available Information

 

We make available on or through our website at www.jonessoda.com (under “About Jones — Investor Relations — Financial Reports”) certain reports and amendments to those reports that we file with or furnish to the Securities and Exchange Commission (SEC) in accordance with the Securities Exchange Act of 1934, as amended (Exchange Act). These include our annual reports on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K, and Section 16 filings and amendments thereof. We make this information available on our website free of charge as soon as reasonably practicable after we electronically file the information with, or furnish it to, the SEC.

In addition, the following corporate governance materials are also available on our website under “About Jones — Investor Relations — Corporate Governance:”

 

 

A copy of any of the materials filed with or furnished to the SEC or copies of the corporate governance materials described above are available free of charge and can be mailed to you upon request to Jones Soda Co., Corporate Offices, 234 Ninth Avenue North, Seattle, Washington 98109.

 

EXECUTIVE OFFICERS

 

Our executive officers as of December 31, 2008 are as follows:

 

 

Mr. Jones has served as our Chief Executive Officer or Interim Chief Executive Officer since January 1, 2008, and has served as one of the Company’s directors since March 2006. Mr. Jones will resign from his position as our Chief Executive Officer effective May 1, 2009, but will continue to serve as a member of our Board of Directors. Mr. Jones is a former executive of The Coca-Cola Company (Coca Cola) where he spent 17 years from 1986 to 2003 in various marketing and operations roles. In addition to operating Coca-Cola in Great Britain and Japan, Mr. Jones was Chief Executive Officer of The Minute Maid Company in Houston and Chief Marketing Officer of Coca Cola in Atlanta. Mr. Jones founded Brand Ignition, which consults with companies regarding growth strategies and private equity opportunities, in 2003 with two other partners. In 2006, Mr. Jones partnered with Denneen and Company, a Boston-based strategy consulting company on several international consulting assignments. In June 2007, Mr. Jones launched an artisan food production kitchen, Calabria Mia Fine Foods in Toronto. Mr. Jones earned a Bachelor of Arts degree from the University of Toronto.

 

Mr. Ricci joined Jones Soda as Chief Operating Officer in January 2008 and has served as one of the Company’s directors since June 2008. He will become our President and Chief Executive Officer effective May 1, 2009. From May 2003 to January 2008, Mr. Ricci served as General Manager of Columbia Distributing Company, a beverage distribution company, and previously served as its Vice President of Process Improvement and Human Resources from November 2002 to May 2003 and as its Regional Vice President of Sales and Marketing from November 2000 until October 2002. Mr. Ricci also spent 9 years at McNeil Consumer Products in various sales and marketing roles. Mr. Ricci received a B.S. in Business Education from Oregon State University.

 

Mr. O’Brien joined Jones Soda in September 2008 as Chief Financial Officer and Corporate Secretary. Prior to joining Jones Soda, he served as Chief Financial Officer of Pyramid Breweries Inc., a craft beer brewer, from September 2006 until August 2008. Prior to that, Mr. O’Brien served as Chief Financial Officer of Medisystems Corporation, a designer and manufacturer of disposable medical devices, from 2002 until September 2006. From 1999 to 2002, Mr. O’Brien held positions of Corporate Controller and Chief Financial Officer of Flow International Corporation, which develops and manufacturers ultra high-pressure waterjet technology, and provides robotics and assembly equipment. Mr. O’Brien earned a Bachelor of Arts degree in accounting from Western Washington University and a Masters of Business Administration degree from Seattle University. Mr. O’Brien is also a certified public accountant.

Mr. O’Neill joined Jones Soda in April 2008 as Executive Vice President of Sales. Prior to joining Jones Soda, Mr. O’Neill had been Vice President of Global Sales for SynergEyes, Inc., a contact lens manufacturer, since July 2006. From August 2005 until July 2006, he served as Vice President of Sales for Valeant Pharmaceuticals International, a pharmaceutical company, and from February 2002 to August 2005, Mr. O’Neill held a number of sales and marketing positions in the consumer packaged goods and pharmaceutical sectors of Johnson & Johnson. Mr. O’Neill received a Bachelor of Science in Business Administration/Marketing from The University of Akron.

 

 

The following factors may materially adversely affect our business, financial condition or results of operations. In that event, the trading price of our common stock could decline and shareholders may lose part or all of their investment. Therefore, shareholders should carefully consider the risks described below before making an investment decision.

 

Risk Factors Relating to Our Company and Our Business

 

If we are not able to manage our resources and successfully execute on our operating plan, our financial condition and results of operation could be materially adversely affected.

 

We have incurred net losses of $15.2 million and $11.6 million for the years ended December 31, 2008 and 2007, respectively, and have used a significant amount of our cash resources during this period to fund our net losses and working capital and capital expenditure requirements. As of December 31, 2008, we had cash, cash-equivalents and short-term investment of approximately $12.6 million, compared to approximately $27.8 million as of December 31, 2007. Additionally, we had accumulated deficits of $29.4 million and $14.2 million as of December 31, 2008 and 2007, respectively. Cash used in operations for the years ended December 30, 2008 and 2007 was $14.5 million and $3.3 million, respectively.

 

Based on our current plans and amounts expected to be generated from future operations, we believe that our cash and cash equivalents, and net cash provided by operations will be sufficient to meet our anticipated cash needs for working capital and capital expenditures through the end of fiscal 2009 and beyond. This will depend, however, on our ability to execute on our 2009 operating plan and to manage our costs in light of developing economic conditions and the performance of our business. We arrived at our revenue projections for our 2009 operating plan after careful consideration of the macroeconomic factors stemming from the global economic crisis, with an emphasis on our higher-margin, core products, including our Jones Pure Cane Soda glass bottle business. Further, we implemented cost containment measures in the fourth quarter of 2008 and early 2009, including reductions in workforce, to further align our cost structure with our revenue projections. Although we do not believe we are dependent on new product launches to generate sufficient cash flow from operations in 2009, we believe the launch of Jones GABA during the first quarter, plus corresponding line extensions of this product, will help to enhance our sales growth into new markets and consumer groups. We intend to continually monitor and adjust our business plan as necessary to respond to developments in our business, our markets and the broader economy and are prepared, if necessary, to take further action to conserve cash, including further cost reductions in sales, marketing and general and administrative areas. Even with these measures, we do not anticipate reaching profitability in 2009. Moreover, there can be no assurance that we will be able to successfully execute on our operating plan, which is subject to a number of risks described in this “Risk Factors” section and elsewhere in this Report. In that case, we may not be able to generate the level of revenue that we expect or that is necessary to generate the cash flow from operations that we will require. If that happens, we may be required to seek additional financing to fund our working capital and capital expenditure requirements.

 

With respect to additional financing sources, in November 2008, our $15 million line of credit was terminated. Accordingly, we no longer have this facility available to us to fund any cash shortfall. Although we never drew on this facility, and our current operating plan for 2009 does not depend on obtaining financing, if we have financing requirements in the future there can be no assurance that additional debt or equity financing will be available to us on acceptable terms, particularly in light of our financial condition, results of

operations and the global economic crisis. In that case, we may be forced to delay, curtail or eliminate some or all of our product development, marketing or distribution programs or other aspects of our operations, including but not limited to a further reduction in workforce. In addition, we may have to pursue various other strategies to secure additional financing, which may include, without limitation, public or private offerings of debt or equity securities, joint ventures with one or more strategic partners and other strategic alternatives. There can be no assurance that our efforts in this regard will result in any agreements or transactions. Our inability to generate sufficient cash flow from operations, or to obtain funds through additional financing, could have a materially adverse impact on our financial conditions and results of operations.

 

We rely on our distributors, retailers and brokers, and this could affect our ability to efficiently and profitably distribute and market our products, maintain our existing markets and expand our business into other geographic markets.

 

Our ability to establish a market for our brands and products in new geographic distribution areas, as well as maintain and expand our existing markets, is dependent on our ability to establish and maintain successful relationships with reliable distributors, retailers and brokers strategically positioned to serve those areas. Most of our distributors, retailers and brokers sell and distribute competing products, including non-alcoholic and alcoholic beverages, and our products may represent a small portion of their business. To the extent that our distributors, retailers and brokers are distracted from selling our products or do not employ sufficient efforts in managing and selling our products, including re-stocking the retail shelves with our products, our sales and profitability will be adversely affected. Our ability to maintain our distribution network and attract additional distributors, retailers and brokers will depend on a number of factors, some of which are outside our control. Some of these factors include:

 

 

We may not be able to meet all or any of these factors in any of our current or prospective geographic areas of distribution. Our inability to achieve any of these factors in a geographic distribution area will have a material adverse effect on our relationships with our distributors, retailers and brokers in that particular geographic area, thus limiting our ability to expand our market, which will likely adversely affect our revenues and financial results.

 

We generally do not have long-term agreements with our distributors, and we incur significant time and expense in attracting and maintaining key distributors.

 

Our marketing and sales strategy depends in large part on the availability and performance of our independent distributors. We have entered into written agreements with many of our distributors in the U.S. and Canada, with terms ranging from one to five years. We currently do not have, nor do we anticipate in the future that we will be able to establish, long-term contractual commitments from many of our distributors. In addition, despite the terms of the written agreements with many of our top distributors, there are no minimum levels of purchases under many of those agreements, and most of the agreements may be terminated at any time generally with a termination fee. We may not be able to maintain our current distribution relationships or establish and maintain successful relationships with distributors in new geographic distribution areas. Moreover, there is the additional possibility that we may have to incur additional expenditures to attract and maintain key distributors in one or more of our geographic distribution areas in order to profitably exploit our geographic markets.

Because our distributors are not required to place minimum orders with us, we need to carefully manage our inventory levels, and it is difficult to predict the timing and amount of our sales.

 

Our independent distributors are not required to place minimum monthly or annual orders for our products. In order to reduce inventory costs, independent distributors endeavor to order products from us on a “just in time” basis in quantities, and at such times, based on the demand for the products in a particular distribution area. Accordingly, there is no assurance as to the timing or quantity of purchases by any of our independent distributors or that any of our distributors will continue to purchase products from us in the same frequencies and volumes as they may have done in the past. In order to be able to deliver our products on a timely basis, we need to maintain adequate inventory levels of the desired products, but we cannot predict the number of cases sold by any of our distributors. If we fail to meet our shipping schedules, we could damage our relationships with distributors and/or retailers, increase our shipping costs or cause sales opportunities to be delayed or lost, which would unfavorably impact our future sales and adversely affect our operating results. In addition, if the inventory of our products held by our distributors and/or retailers is too high, they will not place orders for additional products, which would also unfavorably impact our future sales and adversely affect our operating results.

 

Our business plan and future growth is dependent in part on our distribution arrangements directly with retailers and national retail accounts. If we are unable to establish and maintain these arrangements, our results of operations and financial condition could be adversely affected.

 

We currently have distribution arrangements with several large national retail accounts to distribute our products directly through their venues; these retailers include Barnes & Noble, Panera Bread Company, Ruby Tuesday and Alaska & Horizon Airlines. We believe that our “direct to retail” program has increased our national visibility among consumers; however, there are several risks associated with this distribution strategy. First, we do not have long-term agreements in place with any of these accounts and thus, the arrangements are terminable at any time by these retailers or us. The exception is our agreement with Alaska & Horizon Airlines which can be terminated with 120 days written notice from either party. Accordingly, we may not be able to maintain continuing relationships with any of these national accounts. A decision by any of these retailers, or any other large retail accounts we may obtain, to decrease the amount purchased from us or to cease carrying our products could have a material adverse effect on our reputation, financial condition and consolidated results of operations. For example, in 2008, Walmart stopped carrying our product line in its stores, which negatively impacted our sales and results of operations in 2008. In addition, we may not be able to establish additional distribution arrangements with other national retailers.

 

Second, as we become more dependent on national retail chains, these retailers may assert pressure on us to reduce our pricing to them or seek significant product discounts. In general, our margins are lower on our sales to these customers because of these pressures. Any increase in our costs for these retailers to carry our product, reduction in price, or demand for product discounts could have a material adverse effect on our profit margin.

 

Finally, our “direct to retail” distribution arrangements may have an adverse impact on our existing relationships with our independent regional distributors, who may view our “direct to retail” accounts as competitive with their business, making it more difficult for us to maintain and expand our relationships with independent distributors.

 

Our business plan and future growth depend in part on our launch of Jones GABA. If we are unable to successfully implement this strategy, our results of operations and financial condition could be adversely affected.

 

We have allocated significant resources in our efforts to launch Jones GABA in the first quarter of 2009, and our financial condition and results of operation for 2009 will depend, in part, on the success of this product. This success depends in part on our ability to successfully launch Jones GABA and market the product’s ability to enhance levels of mental clarity and focus, as studies have shown. Jones GABA is our first entry into beverage products containing GABA and much of our success will depend on our ability to gain

new points of distribution through our DSD channel. We must also be successful in developing DTR distribution for Jones GABA through existing DTR customers and obtaining new listings in customers that currently do not have points of distribution. Our ability to develop points of distribution for Jones GABA will depend on a number of factors, including:

 

 

We may not be able to perform on all or any of these factors in any of our current or prospective geographic areas of distribution, in which case our results of operations and financial condition will suffer.

 

In addition, Jones GABA will be launched as a premium priced item and part of a new emerging category of functional beverages. The current economic climate may not support a premium priced beverage entry at the level of our expectations for the product line. If we are forced to lower price points due to economic conditions, our efforts may prove to be unsuccessful or unprofitable, in which case our results of operations and financial condition will suffer.

 

We are dependent on National Beverage’s production capacity and capabilities to meet the demand for Jones products in the grocery and mass merchant channel in the U.S.

 

In 2006, we entered into an agreement with National Beverage pursuant to which, beginning in 2007, National Beverage generally has the exclusive right in the United States to manufacture and distribute Jones Soda 8-ounce and 12-ounce cans and 1-liter PET bottles in the grocery and mass merchant channel. The agreement has an initial term of five years, expiring on December 31, 2011, and we may not terminate the agreement prior to that date unless National Beverage is in material default. As a result, our success in the CSD industry will depend to a significant extent on the performance of National Beverage. If National Beverage fails to perform adequately, because, for example, it is unable to manufacture our products in sufficient quantities to meet demand in a timely manner (due to a shortfall in agreed upon capacity in one or all of their factories or significantly increased demand or other reasons) or does not provide acceptable customer service to our grocery and mass merchant customers, our ability to gain market acceptance in the CSD industry could be materially adversely affected and our results of operations would suffer. In addition, National Beverage may be unable to pass cost increases to retailers, thereby reducing our profits from sales in the CSD channel.

 

Moreover, National Beverage will have the right to terminate our agreement upon six months notice at any time after December 31, 2009. If National Beverage were to terminate the agreement, we would need to find alternative manufacturing and distribution arrangements for the CSD channel, which we may be unable to do in a timely manner or on favorable terms, which could adversely affect our results of operations.

 

Finally, National Beverage Corp. purchases concentrate from us in order to manufacture our products, and it places orders for concentrate as required by its production and inventory needs. National Beverage is not required to place any minimum monthly or quarterly concentrate orders with us. This could lead to fluctuating sales of concentrate during any given quarter or year and have an adverse effect on our results of operations.

 

We have dedicated, and will continue to dedicate, significant resources to our sponsorship agreements and may not realize the benefits expected from those agreements.

 

Our sponsorship agreements with the Seattle Seahawks, the New Jersey Nets and to a lesser extent the Portland Trail Blazers, require us to make substantial annual payments in exchange for certain promotional and branding benefits. There can be no assurance, however, that the benefit we anticipate from those and similar agreements, including exclusive beverage rights and other branding opportunities, will compensate for the annual payment commitments required by the agreements. These commitments are significant, totaling approximately $10.6 million over the remaining terms of the agreements as of December 31, 2008 (see the

table of “Contractual Obligations” included under Item 7 of this Report). Moreover, there can be no assurance that our association with these particular teams will have a positive effect on our image and brand. There is a risk that we will be unable to recover the costs associated with our sponsorship agreements, which would have an adverse effect on our results of operations.

 

We rely on third-party packers of our products, and this dependence could make management of our marketing and distribution efforts inefficient or unprofitable.

 

We do not own the plants or the majority of the equipment required to manufacture and package our beverage products and do not anticipate increasing such capabilities in the future. As a consequence, we depend on third parties and contract packers to produce our beverage products and deliver them to distributors. Our ability to attract and maintain effective relationships with contract packers and other third parties for the production and delivery of our beverage products in a particular geographic distribution area is important to the achievement of successful operations within each distribution area. Competition for contract packers’ business is intense, especially in the western United States, and this could make it more difficult for us to obtain new or replacement packers, or to locate back-up contract packers, in our various distribution areas, and could also affect the economic terms of our agreements with our packers. Our contract packers may terminate their arrangements with us at any time, in which case we could experience disruptions in our ability to deliver products to our customers. We may not be able to maintain our relationships with current contract packers or establish satisfactory relationships with new or replacement contract packers, whether in existing or new geographic distribution areas. The failure to establish and maintain effective relationships with contract packers for a distribution area could increase our manufacturing costs and thereby materially reduce profits realized from the sale of our products in that area. In addition, poor relations with any of our contract packers could adversely affect the amount and timing of product delivered to our distributors for resale, which would in turn adversely affect our revenues and financial condition.

 

As is customary in the contract packing industry for comparably sized companies, we are expected to arrange for our contract packing needs sufficiently in advance of anticipated requirements. To the extent demand for our products exceeds available inventory and the capacities produced by contract packing arrangements, or orders are not submitted on a timely basis, we will be unable to fulfill distributor orders on demand. Conversely, we may produce more product than warranted by the actual demand for it, resulting in higher storage costs and the potential risk of inventory spoilage. Our failure to accurately predict and manage our contract packaging requirements may impair relationships with our independent distributors and key accounts, which, in turn, would likely have a material adverse effect on our ability to maintain profitable relationships with those distributors and key accounts.

 

Our business and financial results depend on the continuous supply and availability of raw materials.

 

The principal raw materials we use include aluminum cans and glass bottles, labels and cardboard cartons, aluminum and steel closures, juices, flavorings, sucrose/inverted cane sugar and sucralose, and fortification ingredients which include vitamins, minerals and Pharma GABA. The costs of our ingredients are subject to fluctuation. In addition, with our shift to production using pure cane sugar instead of high fructose corn syrup, we utilize considerable quantities of pure cane sugar. If our supply of these raw materials is impaired or if prices increase significantly, our business would be adversely affected.

 

Due to the consolidations that have taken place in the glass industry over the past few years, the prices of glass bottles continue to increase. The prices of pure cane sugar, sucrose, trays and labels increased in early 2008. In addition, certain of our contract packing arrangements allow such contract packers to increase their charges based on certain of their own cost increases. Although we have mitigated this risk for 2009 through fixed-price purchase commitments for sugar and glass, we are uncertain whether the prices of any of the above or any other raw materials or ingredients will continue to rise in the future and whether we will be able to pass any such increases on to our customers.

 

We have entered into a supply agreement to obtain the key ingredient for our Jones GABA product, Pharma GABA. The supply agreement terminates on July 31, 2010, subject to earlier termination if any party

defaults in performing any of its obligations under the agreement and fails to correct such default within one month after notice of default. Although we believe we can obtain adequate supplies of GABA from other sources in synthetic form, Pharma GABA is the only naturally produced form of GABA on the market at this time and we believe may give us a competitive advantage over other beverage products that may include synthetic forms of GABA. There can be no assurance, however, that our supplier will continue to supply us with Pharma GABA on acceptable terms beyond the termination date of our current supply agreement, in which case we would be required to obtain synthetic forms of GABA in order to continue to produce our products. This may affect the quality or consumer acceptance of our product, which could negatively affect our results of operations and financial condition.

 

We may not correctly estimate demand for our products. Our ability to estimate demand for our products is imprecise, particularly with new products, and may be less precise during periods of rapid growth, particularly in new markets. If we materially underestimate demand for our products or are unable to secure sufficient ingredients or raw materials including, but not limited to, cans, glass, labels, flavors, supplements, and certain sweeteners, or sufficient packing arrangements, we might not be able to satisfy demand on a short-term basis. Moreover, industry-wide shortages of certain concentrates, supplements and sweeteners have been experienced and could, from time to time in the future, be experienced, which could interfere with and/or delay production of certain of our products and could have a material adverse effect on our business and financial results.

 

Disruption of our supply chain could have an adverse effect on our business, financial condition and results of operations.

 

Our ability and that of our suppliers, business partners (including packagers), contract manufacturers, independent distributors and retailers to make, move and sell products is critical to our success. Damage or disruption to our or their manufacturing or distribution capabilities due to weather, natural disaster, fire or explosion, terrorism, pandemics such as avian flu, strikes or other reasons, could impair our ability to manufacture or sell our products. Failure to take adequate steps to mitigate the likelihood or potential impact of such events, or to effectively manage such events if they occur, could adversely affect our business, financial condition and results of operations, as well as require additional resources to restore our supply chain.

 

We rely upon our ongoing relationships with our key flavor suppliers. If we are unable to source our flavors on acceptable terms from our key suppliers, we could suffer disruptions in our business.

 

Currently, we purchase our flavor concentrate from three flavor concentrate suppliers, and we anticipate that we will purchase flavor concentrate from other flavor houses for future flavors and additional products, with the intention of developing other sources of flavor concentrate for each of our products. The price of our concentrates is determined by our flavor houses and us, and may be subject to change. Generally, flavor suppliers hold the proprietary rights to their flavors. Consequently, we do not have the list of ingredients or formulae for our flavors and concentrates and we may be unable to obtain these flavors or concentrates from alternative suppliers on short notice. If we have to replace a flavor supplier, we could experience disruptions in our ability to deliver products to our customers, which could have a material adverse effect on our results of operations.

 

If we are unable to maintain brand image and product quality, or if we encounter other product issues such as product recalls, our business may suffer.

 

Our success depends on our ability to maintain brand image for our existing products and effectively build up brand image for new products and brand extensions. There can be no assurance, however, that additional expenditures and our advertising and marketing will have the desired impact on our products’ brand image and on consumer preferences. Product quality issues, real or imagined, or allegations of product contamination, even when false or unfounded, could tarnish the image of the affected brands and may cause consumers to choose other products.

In addition, because of changing government regulations or implementation thereof, allegations of product contamination, we may be required from time to time to recall products entirely or from specific markets. Product recalls could affect our profitability and could negatively affect brand image. Adverse publicity surrounding obesity concerns, water usage and other concerns could negatively affect our overall reputation and our products’ acceptance by consumers.

 

The inability to attract and retain key personnel would directly affect our efficiency and results of operations.

 

Our success depends on our ability to attract and retain highly qualified employees in such areas as production, distribution, sales, marketing and finance. We compete to hire new employees, and, in some cases, must train them and develop their skills and competencies. Our operating results could be adversely affected by increased costs due to increased competition for employees, higher employee turnover or increased employee benefit costs. In addition, there has been high turnover among our senior executive officers, and all current executive officers began their tenure at the Company in 2008. Any unplanned turnover, particularly involving one of our key personnel, could negatively impact our operations, financial condition and employee morale.

 

Our inability to protect our trademarks, patents and trade secrets may prevent us from successfully marketing our products and competing effectively.

 

Failure to protect our intellectual property could harm our brand and our reputation, and adversely affect our ability to compete effectively. Further, enforcing or defending our intellectual property rights, including our trademarks, patents, copyrights and trade secrets, could result in the expenditure of significant financial and managerial resources. We regard our intellectual property, particularly our trademarks, patents and trade secrets to be of considerable value and importance to our business and our success. We rely on a combination of trademark, patent, and trade secrecy laws, confidentiality procedures and contractual provisions to protect our intellectual property rights. We are pursuing the registration of our trademarks in the United States, Canada and internationally. There can be no assurance that the steps taken by us to protect these proprietary rights will be adequate or that third parties will not infringe or misappropriate our trademarks, patented processes, trade secrets or similar proprietary rights. In addition, there can be no assurance that other parties will not assert infringement claims against us, and we may have to pursue litigation against other parties to assert our rights. Any such claim or litigation could be costly. In addition, any event that would jeopardize our proprietary rights or any claims of infringement by third parties could have a material adverse effect on our ability to market or sell our brands, profitably exploit our products or recoup our associated research and development costs.

 

As part of the licensing strategy of our brands, we enter into licensing agreements under which we grant our licensing partners certain rights to use our trademarks and other designs. Although our agreements require that the licensing partner’s use of our trademarks and designs is subject to our control and approval, any breach of these provisions, or any other action by any of our licensing partners that is harmful to our brands, goodwill and overall image, could have a material adverse impact on our business.

 

We have obtained two U.S. patents on our “myJones.com” methodology. While the number of business method patents issued by the U.S. Patent and Trademark Office has been growing substantially in recent years, there is still a significant degree of uncertainty associated with these patents. It is possible that our patent may be construed by a court of competent jurisdiction in a very limited manner such that it offers little or no basis for us to deter competitors from employing similar processes or does not allow us to defend against third party claims of patent infringement.

Litigation or legal proceedings (including pending securities class actions) could expose us to significant liabilities and damage our reputation.

 

Securities class action derivative lawsuits have been filed against us and current and former officers and members of the Board of Directors. These lawsuits are described more fully in Part I, Item 3. “Legal Proceedings” and in Note 9 to our consolidated financial statements contained in this Form 10-K.

 

We may also become party to other litigation claims and legal proceedings. Litigation involves significant risks, uncertainties and costs, including distraction of management attention away from our current business operations. We evaluate litigation claims and legal proceedings to assess the likelihood of unfavorable outcomes and to estimate, if possible, the amount of potential losses. Based on these assessments and estimates, we establish reserves and/or disclose the relevant litigation claims or legal proceedings, as appropriate. These assessments and estimates are based on the information available to management at the time and involve a significant amount of management judgment. We caution you that actual outcomes or losses may differ materially from those envisioned by our current assessments and estimates. Our policies and procedures require strict compliance by our employees and agents with all United States and local laws and regulations applicable to our business operations, including those prohibiting improper payments to government officials. Nonetheless, there can be no assurance that our policies, procedures and related training programs will always ensure full compliance by our employees and agents with all applicable legal requirements. Improper conduct by our employees or agents could damage our reputation in the United States and internationally or lead to litigation or legal proceedings that could result in civil or criminal penalties, including substantial monetary fines, as well as disgorgement of profits.

 

Changes in accounting standards and subjective assumptions, estimates and judgments by management related to complex accounting matters could significantly affect our financial results.

 

Generally accepted accounting principles and related pronouncements, implementation guidelines and interpretations with regard to a wide variety of matters that are relevant to our business, such as, but not limited to, revenue recognition, stock-based compensation, trade promotions, sports sponsorship agreements and income taxes are highly complex and involve many subjective assumptions, estimates and judgments by our management. Changes to these rules or their interpretation or changes in underlying assumptions, estimates or judgments by our management could significantly change our reported results.

 

If we are unable to build and sustain proper information technology infrastructure, our business could suffer.

 

We depend on information technology as an enabler to improve the effectiveness of our operations and to interface with our customers, as well as to maintain financial accuracy and efficiency. If we do not allocate and effectively manage the resources necessary to build and sustain the proper technology infrastructure, we could be subject to transaction errors, processing inefficiencies, the loss of customers, business disruptions, or the loss of or damage to intellectual property through security breach. Our information systems could also be penetrated by outside parties intent on extracting information, corrupting information or disrupting business processes. Such unauthorized access could disrupt our business and could result in the loss of assets.

 

We face currency risks associated with fluctuating foreign currency valuations.

 

For the year ended December 31, 2008, approximately 19% of our sales were denominated in the Canadian dollar which exposes us to foreign currency exchange rate risk with respect to our sales, expenses, profits, assets and liabilities. As of December 31, 2008, we have not entered into foreign currency contracts or other derivatives to mitigate the potential impact of foreign currency fluctuations. As a result, our reported earnings may be affected by changes in the Canadian dollar.

Risk Factors Relating to Our Industry

 

We compete in an industry that is brand-conscious, so brand name recognition and acceptance of our products are critical to our success.

 

Our business is substantially dependent upon awareness and market acceptance of our products and brands by our target market, consumers between the ages of 12 and 24. In addition, our business depends on acceptance by our independent distributors and retailers of our brands as beverage brands that have the potential to provide incremental sales growth. Although we believe that we have been relatively successful in establishing our brands as recognizable brands in the New Age beverage industry, it may be too early in the product life cycle of these brands to determine whether our products and brands will achieve and maintain satisfactory levels of acceptance by independent distributors and retail consumers. We believe that the success of the Jones 24C, Jones GABA. Jones Organics, Jones Naturals, and Whoop Ass brands will also be substantially dependent upon acceptance of the Jones Pure Cane Soda brand. Accordingly, any failure of our Jones Pure Cane Soda brand to maintain or increase acceptance or market penetration would likely have a material adverse effect on our revenues and financial results.

 

Competition from traditional non-alcoholic beverage manufacturers may adversely affect our distribution relationships and may hinder development of our existing markets, as well as prevent us from expanding our markets.

 

The beverage industry is highly competitive. We compete with other beverage companies not only for consumer acceptance but also for shelf space in retail outlets and for marketing focus by our distributors, all of whom also distribute other beverage brands. Our products compete with a wide range of drinks produced by a relatively large number of manufacturers, most of which have substantially greater financial, marketing and distribution resources than ours. Some of these competitors are placing severe pressure on independent distributors not to carry competitive alternative or New Age beverage brands such as ours. We also compete with regional beverage producers and “private label” soft drink suppliers.

 

Our direct competitors in the alternative beverage industry include Cadbury Schweppes (Stewarts and IBC) and Thomas Kemper. We also compete against Coca Cola, Pepsi, Hansen’s and other traditional soft drink manufacturers and distributors. We compete against other category leaders such as Red Bull and Monster for the energy drink category. These national and international competitors have advantages such as lower production costs, larger marketing budgets, greater financial and other resources and more developed and extensive distribution networks than ours. There can be no assurance that we will be able to grow our volumes or be able to maintain our selling prices in existing markets or as we enter new markets.

 

Increased competitor consolidations, market-place competition, particularly among branded beverage products, and competitive product and pricing pressures could impact our earnings, market share and volume growth. If, due to such pressure or other competitive threats, we are unable to sufficiently maintain or develop our distribution channels, we may be unable to achieve our current revenue and financial targets. As a means of maintaining and expanding our distribution network, we intend to introduce product extensions and additional brands. There can be no assurance that we will be able to do so or that other companies will not be more successful in this regard over the long term. Competition, particularly from companies with greater financial and marketing resources than ours, could have a material adverse effect on our existing markets, as well as on our ability to expand the market for our products.

 

We compete in an industry characterized by rapid changes in consumer preferences and public perception, so our ability to continue developing new products to satisfy our consumers’ changing preferences will determine our long-term success.

 

Our current market distribution and penetration may be too limited with respect to the population as a whole to determine whether the brand has achieved initial consumer acceptance, and there can be no assurance that this acceptance will ultimately be achieved. Based on industry information and our own experience, we believe that, in general, alternative or New Age beverage brands and products may be successfully marketed for five to nine years after the product is introduced in a geographic distribution area before consumers’ taste

preferences change, although some brands or products have longer lives. In light of the limited life of alternative or New Age beverage brands and products, a failure to introduce new brands, products or product extensions into the marketplace as current ones mature could prevent us from achieving long-term profitability. In addition, customer preferences also are affected by factors other than taste, such as health and nutrition considerations and obesity concerns, shifting consumer needs, changes in consumer lifestyles, increased consumer information and competitive product and pricing pressures. Sales of our products may be adversely affected by the negative publicity associated with these issues. If we do not adjust to respond to these and other changes in customer preferences, our sales may be adversely affected.

 

Our results of operations may fluctuate from quarter to quarter for many reasons, including seasonality.

 

As is typical in the beverage industry, our sales are seasonal. In a typical year, approximately 57% of our sales occur from April to September and approximately 43% occur from October to March. As a result, our working capital requirements and cash flow vary substantially throughout the year. Consumer demand for our products is also affected by weather conditions. Cool, wet spring or summer weather could result in decreased sales of our beverages and could have an adverse effect on our results of operations.

 

We have experienced significant fluctuations in quarterly results that have been the result of many factors. In particular, like many other companies in the beverage industry, we generate a substantial percentage of our revenues during the warm weather months of April through September. Management believes that the demand for our products will continue to reflect such seasonal consumption patterns.

 

In addition, our operating results may fluctuate due to a number of other factors including, but not limited to:

 

 

Due to these and other factors, our results of operations have fluctuated from period to period and may continue to do so in the future, which could cause our operating results in a particular quarter to fail to meet market expectations.

The global economic crisis may adversely impact our business and results of operations.

 

The beverage industry can be affected by macro economic factors, including changes in national, regional, and local economic conditions, employment levels and consumer spending patterns. The recent disruptions in the overall economy and financial markets as a result of the global economic crisis have adversely impacted our two primary markets: the U.S. and Canada. This has reduced consumer confidence in the economy and could negatively affect consumers’ willingness to purchase our products as they reduce their discretionary spending. Moreover, current economic conditions may adversely affect the ability of our distributors to obtain the credit necessary to fund their working capital needs, which could negatively impact their ability or desire to continue to purchase products from us in the same frequencies and volumes as they have done in the past. We also may be unable to access credit markets on favorable terms or at all. There can be no assurances that government responses to the disruptions in the financial markets will restore consumer confidence, stabilize the markets or increase liquidity and the availability of credit. If the current economic conditions persist or deteriorate, sales of our products could be adversely affected, the credit status of our customers could be impacted, collectibility of accounts receivable may be compromised and we may face obsolescence issues with our inventory, any of which could have a material adverse impact on our operating results and financial condition.

 

We could be exposed to product liability claims for personal injury or possibly death.

 

Although we have product liability insurance in amounts we believe are adequate, there can be no assurance that the coverage will be sufficient to cover any or all product liability claims. To the extent our product liability coverage is insufficient, a product liability claim would likely have a material adverse effect upon our financial condition. In addition, any product liability claim successfully brought against us may materially damage the reputation of our products, thus adversely affecting our ability to continue to market and sell that or other products. Additionally, we may be required from time to time to recall products entirely or from specific co-packers, markets or batches. Product recalls could adversely affect our profitability and our brand image. We do not maintain recall insurance.

 

Our business is subject to many regulations and noncompliance is costly.

 

The production, marketing and sale of our beverages, including contents, labels, caps and containers, are subject to the rules and regulations of various federal, provincial, state and local health agencies. If a regulatory authority finds that a current or future product or production run is not in compliance with any of these regulations, we may be fined, or production may be stopped, thus adversely affecting our financial condition and results of operations. Similarly, any adverse publicity associated with any noncompliance may damage our reputation and our ability to successfully market our products. Furthermore, the rules and regulations are subject to change from time to time and while we closely monitor developments in this area, we have no way of anticipating whether changes in these rules and regulations will impact our business adversely. Additional or revised regulatory requirements, whether labeling, environmental, tax or otherwise, could have a material adverse effect on our financial condition and results of operations.

 

Significant additional labeling or warning requirements may inhibit sales of affected products.

 

Various jurisdictions may seek to adopt significant additional product labeling or warning requirements relating to the chemical content or perceived adverse health consequences of certain of our products. These types of requirements, if they become applicable to one or more of our major products under current or future environmental or health laws or regulations, may inhibit sales of such products. In California, a law requires that a specific warning appear on any product that contains a component listed by the state as having been found to cause cancer or birth defects. This law recognizes no generally applicable quantitative thresholds below which a warning is not required. If a component found in one of our products is added to the list, or if the increasing sensitivity of detection methodology that may become available under this law and related regulations as they currently exist, or as they may be amended, results in the detection of an infinitesimal quantity of a listed substance in one of our beverages produced for sale in California, the resulting warning requirements or adverse publicity could affect our sales.

Risk Factors Related to Our Common Stock

 

The price of our common stock may be volatile, and a shareholder’s investment in our common stock could suffer a decline in value.

 

There has been significant volatility in the volume and market price of our common stock, and this volatility may continue in the future. In addition, factors such as quarterly variations in our operating results, changes in financial estimates by securities analysts or our failure to meet our or their projected financial and operating results, litigation involving us, general trends relating to the beverage industry, actions by governmental agencies, national economic and stock market considerations as well as other events and circumstances beyond our control could have a significant impact on the future market price of our common stock and the relative volatility of such market price.

 

If we are not able to achieve our objectives for our business, the value of an investment in our company could be negatively affected.

 

In order to be successful, we believe that we must, among other things:

 

 

We may not be able to meet these objectives, which could have a material adverse affect on our results of operations. We have incurred significant operating expenses in the past and may do so again in the future and, as a result, will need to increase revenues in order to improve our results of operations. Our ability to increase sales will depend primarily on success in expanding our current markets, improving our distribution base, entering into “direct to retail” arrangements with national accounts, and introducing new brands, products or product extensions to the market. Our ability to successfully enter new distribution areas and obtain national accounts will, in turn, depend on various factors, many of which are beyond our control, including, but not limited to, the continued demand for our brands and products in target markets, the ability to price our products at competitive levels, the ability to establish and maintain relationships with distributors in each geographic area of distribution and the ability in the future to create, develop and successfully introduce one or more new brands, products, and product extensions.

 

We may not be able to maintain the listing of our common stock on the Nasdaq Capital Market, which would make it more difficult for investors to sell shares of our common stock.

 

Our common stock is listed on the Nasdaq Capital Market. The Nasdaq Capital Market has several quantitative and qualitative requirements companies must comply with to maintain this listing, including a $1.00 minimum bid price per share and $35 million minimum value of listed securities. Nasdaq has suspended the minimum bid price requirement for all listed companies through April 20, 2009. The level of trading activity of our common stock may decline if it is no longer listed on Nasdaq Capital Market. As such, if our common stock ceases to be listed for trading on the Nasdaq Capital Market for any reason, it may harm our stock price, increase the volatility of our stock price, or make it more difficult to for investors to buy or sell shares of our common stock. In addition, if we are not listed the Nasdaq Capital Market and/or if our public float remains below $75 million, we may be limited in our ability to file new shelf registration statements on SEC Form S-3 and/or to fully use one or more registration statements on SEC Form S-3 which could have a material adverse effect on our ability to raise capital.

 

 

None.

 

We lease approximately 13,534 feet square of office space in Seattle, Washington for our principal executive and administrative offices, and for warehouse purposes. The lease term of five years expires in August 2011, and does not include an option to extend the lease. We believe our leased premises are suitable and adequate for their use. We do not own real property.

 

 

On September 4, 2007, a putative class action complaint was filed against us, our then serving chief executive officer, and our then serving chief financial officer in the U.S. District Court for the Western District of Washington, alleging claims under Section 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder. The case is entitled Saltzman v. Jones Soda Company, et al., Case No. 07-cv-1366-RSL, and purports to be brought on behalf of a class of purchasers of our common stock during the period March 9, 2007 to August 2, 2007. Six substantially similar complaints subsequently were filed in the same court, some of which alleged claims on behalf of a class of purchasers of our common stock during the period November 1, 2006 to August 2, 2007. Some of the subsequently filed complaints added as defendants certain current and former directors and another former officer of the Company. The complaints generally alleged violations of federal securities laws based on, among other things, false and misleading statements and omissions about our financial results and business prospects. The complaints sought unspecified damages, interest, attorneys’ fees, costs, and expenses. On October 26, 2007, these seven lawsuits were consolidated as a single action entitled In re Jones Soda Company Securities Litigation, Case No.  07-cv-1366-RSL. On March 5, 2008, the Court appointed Robert Burrell lead plaintiff in the consolidated securities case. On May 5, 2008, the lead plaintiff filed a First Amended Consolidated Complaint, which purports to allege claims on behalf of a class of purchasers of our common stock during the period of January 10, 2007, to May 1, 2008, against the Company and Peter van Stolk, our former Chief Executive Officer, former Chairman of the Board, and current director. The First Amended Consolidated Complaint generally alleges violations of federal securities laws based on, among other things, false and misleading statements and omissions about our agreements with retailers, allocation of resources, and business prospects. Defendants filed a motion to dismiss the amended complaint on July 7, 2008. After hearing oral argument on February 3, 2009, the Court granted the motion to dismiss in its entirety on February 9, 2009. The Court’s dismissal order requires plaintiffs to file a motion for leave to file any amended complaint. Plaintiffs’ deadline to file a motion to amend is March 25, 2009.

 

In addition, on September 5, 2007, a shareholder derivative action was filed in the Superior Court for King County, Washington, allegedly on behalf of and for the benefit of the Company, against certain of our current officers and current and former directors. The case is entitled Cramer v. van Stolk, et al., Case No. 07-2-29187-3 SEA (Cramer Action). The Company also was named as a nominal defendant. Four other shareholders filed substantially similar derivative cases. Two of these actions were filed in Superior Court for King County, Washington. One of these two Superior Court actions has been voluntarily dismissed and the other has been consolidated with the Cramer Action under the caption In re Jones Soda Co. Derivative Litigation, Lead Case No. 07-2-31254-4 SEA. On April 28, 2008, plaintiffs in the consolidated action filed an amended complaint based on the same basic allegations of fact as in the federal securities class actions and alleging, among other things, that certain of our current and former officers and directors breached their fiduciary duties to the Company and were unjustly enriched in connection with the public disclosures that are the subject of the federal securities class actions. On May 2, 2008, the Court signed a stipulation and order staying the proceedings in the consolidated Cramer Action until all motions to dismiss in the consolidated federal securities class action have been adjudicated.

 

The two remaining shareholder derivative actions were filed in the U.S. District Court for the Western District of Washington. On April 10, 2008, the Court presiding over the federal derivative cases consolidated them under the caption Sexton v. van Stolk, et al., Case No. 07-1782RSL (Sexton Action), and appointed Bryan P. Sexton lead plaintiff. The Court also established a case schedule, which, among other things, sets the close of fact discovery as January 4, 2009, and sets a trial date of May 4, 2009. The actions comprising the consolidated Sexton Action are based on the same basic allegations of fact as in the securities class actions

filed in the U.S. District Court for the Western District of Washington and the Cramer Action, filed in the Superior Court for King County. The actions comprising the Sexton Action allege, among other things, that certain of our current and former directors and officers breached their fiduciary duties to the Company and were unjustly enriched in connection with the public disclosures that are the subject of the federal securities class actions. The complaints seek unspecified damages, restitution, disgorgement of profits, equitable and injunctive relief, attorneys’ fees, costs, and expenses. On June 3, 2008, the parties filed a joint motion to stay the Sexton Action until all motions to dismiss in the federal securities class action have been adjudicated. On June 5, 2008, the Court granted the motion and stayed the Sexton action.

 

The Cramer Action and Sexton Action are derivative in nature and do not seek monetary damages from the Company. However, the Company may be required, throughout the pendency of the action, to advance payment of legal fees and costs incurred by the defendants and the litigation may result in significant obligations for payment of defense costs and indemnification.

 

On August 27, 2008, Advanced Business Strategies filed a Complaint for Damages against us in the Circuit Court for the State of Oregon for breach of contract and breach of implied covenant of good faith and fair dealing, seeking damages in excess of $1.1 million. Advanced Business Strategies has alleged that we improperly terminated their agreement to provide us with certain sales and marketing services. On October 1, 2008, we filed a Notice of Removal from the State Court to the United States District Court, District of Oregon. Our answer to the claims was filed on October 8, 2008; we asserted that Advanced Business Strategies is in breach of the agreement and has failed to mitigate its alleged damages. There is no trial date currently set and discovery is ongoing.

 

We are unable to predict the outcome of any of the actions described above.

 

In addition to the matters above, we are or may be involved from time to time in various claims and legal actions arising in the ordinary course of business, including proceedings involving product liability claims and other employee claims, and tort and other general liability claims, for which we carry insurance, as well as trademark, copyright, and related claims and legal actions. In the opinion of our management, the ultimate disposition of these matters will not have a material adverse effect on our consolidated financial position, results of operations or liquidity.

 

 

No matters were submitted to a vote of security holders during the fourth quarter of fiscal 2008.

 

 

Market Information

 

Our common stock is currently traded on the NASDAQ Capital Market under the symbol “JSDA”. Effective February 20, 2009, we delisted from the TSX Venture Exchange in Canada (symbol “JSD”).

 

On November 28, 2005, we qualified for trading on the NASDAQ Capital Market. Prior to that time, our common stock had been traded on the OTC Bulletin Board since June 23, 2000. The following table shows, for each quarter of fiscal 2008 and 2007, the high and low closing sales prices as reported by the NASDAQ Capital Market.

 

 

As of March 6, 2009, there were 26,454,391 shares of common stock issued and outstanding, held by approximately 317 holders of record, although there are a much larger number of beneficial owners. The last reported sale price per share on March 6, 2009 was $0.78.

 

Dividends

 

We have never declared or paid any cash dividends with respect to our common stock. We do not anticipate paying cash dividends on our common stock in the foreseeable future. Any future determination with regard to the payment of dividends will be at the discretion of the Board of Directors and will be dependent upon our future earnings, financial condition, applicable dividend restrictions and capital requirements and other factors deemed relevant by the Board of Directors.

 

Stock Repurchases

 

The following table contains information for shares repurchased during the fourth quarter of 2008:

 

 

 

Performance Graph

 

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Jones Soda Co., The S&P 500 Index
And A Peer Group

 

 

 

 

The graph above compares the cumulative 5-year total return of holders of Jones Soda Co.’s common stock with the cumulative total returns of the S&P 500 Index and the following group of peer companies from the beverage industry selected by us: Clearly Canadian Beverage Corp., Cott Corp., Hansen Natural Corp., Leading Brands Inc. and National Beverage Corp. The graph assumes that the value of a $100 investment in our common stock, in the peer group and on the S&P 500 on December 31, 2003 would provide a cumulative total return (including stock appreciation plus reinvestment of dividends) as indicated through December 31, 2008. The stock prices included in this graph are not necessarily indicative of future stock price performance.

 

Sales of Unregistered Securities

 

None.

 

The following selected financial and operating data are derived from our consolidated financial statements and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements.

 

 

 

 

The following discussion of our financial condition and results of operations contains forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. As described at the beginning of this Annual Report, our actual results could differ materially from those anticipated in these forward-looking statements. Factors that could contribute to such differences include those discussed below and in the section above entitled “Risk Factors.” You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Annual Report on Form 10-K. Except as required by law, we undertake no obligation to update publicly any forward-looking statements to reflect new information, events or circumstances after the date of this Report, or to reflect the occurrence of unanticipated events You should read the following discussion and analysis in conjunction with our consolidated financial statements and the accompanying notes thereto included elsewhere in this Report.

 

Overview

 

We develop, produce, market and distribute a range of premium beverages. With the addition of Jones GABA^tm in the first quarter of 2009, our premium beverages include the following six brands:

 

 

We sell and distribute our products primarily throughout the United States (U.S.) and Canada through our network of independent distributors, which we refer to as our direct store delivery (DSD) channel, national retail accounts, which we refer to as our direct to retail (DTR) channel, as well as through licensing and distribution arrangements. We do not directly manufacture our products but instead outsource the manufacturing process to third party bottlers and contract packers.

 

In September 2006, we entered into an exclusive manufacturing and distribution agreement with National Beverage Corp. (National Beverage) to manufacture and distribute Jones Soda 12-ounce cans to the more mainstream channels and in-store locations in an effort to expand our points of availability within all stores including the shelves that are normally restricted to national mainstream brands manufactured by companies such as The Coca-Cola Company and PepsiCo. Beginning in January 2007, National Beverage Corp. started selling Jones Pure Cane Soda to retailers in the grocery and mass merchant channels in the U.S. Through this arrangement, we identify and secure retailers across the U.S. for Jones Soda 12-ounce cans, and we are solely responsible for all sales efforts, marketing, advertising and promotion. Using concentrate supplied by Jones, National Beverage both manufactures and sells on an exclusive basis the products directly to retailers. Finally, we also sell various products on-line which we refer to as our interactive channel and sell customized soda, wearables, candy and other items.

 

Our products are sold in 50 states in the U.S. and 9 provinces in Canada, primarily in convenience stores, delicatessens, sandwich shops and selected supermarkets, as well as through our national accounts with several large retailers. We have focused our sales and marketing resources on the expansion and penetration of our products through our independent distributor network and national retail accounts in our core markets consisting of the Northwest, Southwest and Midwest U.S. and Canada, as well as targeted expansion into our less penetrated markets consisting of the Northeast and Southeast U.S. In addition we are expanding our international business outside of North America and have entered the markets of Ireland, the United Kingdom (UK) and Australia through independent distributors.

Beginning in 2004, we launched our licensing business strategy as a method to extend our brand into non-alternative beverage products and non-beverage products. We currently have licensing arrangements with three companies. With these licensing agreements, we believe that we are able to partner with companies that will manufacture Jones related products and extend our Jones brand into select products that we feel enhance our brand image. We do not expect this business to be a material part of our operations in 2009.

 

Our business strategy is to increase sales by expanding distribution of our brands in new and existing markets (primarily within North America), stimulating consumer awareness and trial of our products leading to increased relevance and purchase intent of our brands. Our business strategy focuses on:

 

 

In order to compete effectively in the beverage industry, we believe that we must convince independent distributors that Jones Pure Cane Soda^tm is a leading brand in the premium soda segment of the alternative or New Age beverage industry. Additionally, as a means of maintaining and expanding our distribution network, we introduce new products and product extensions, and when warranted, new brands. In February 2009, we launched Jones GABA, our first line of beverage products containing Pharma GABA, offered in a 12-ounce can. We will market this tea and juice blended beverage by focusing on the benefits of enhanced focus and clarity that studies have shown GABA provides.

 

We have allocated significant resources in our efforts to launch Jones GABA in the first quarter of 2009. Our results with respect to Jones GABA depend in part on our ability to successfully launch Jones GABA and market the product’s ability to enhance levels of mental clarity and focus, as studies have shown. Jones GABA is our first entry into beverage products containing GABA and much of our success will depend on our ability to gain new points of distribution through our DSD channel. We must also be successful in developing DTR distribution for Jones GABA through existing DTR customers and obtain new listings with customers that currently do not have points of distribution. Jones GABA will be launched as a premium priced item and part of a new emerging category of functional beverages. The current economic environment may not support a premium priced beverage entry at the level of our expectations for the product line.

 

The beverage industry can be affected by macro economic factors, including changes in national, regional, and local economic conditions, employment levels and consumer spending patterns. The recent disruptions in the overall economy and financial markets as a result of the global economic crisis have adversely impacted our two primary markets: the U.S. and Canada. This has reduced consumer confidence in the economy and could negatively affect consumers’ willingness to purchase our products as they reduce their discretionary spending. Moreover, current economic conditions may adversely affect the ability of our distributors to obtain the credit necessary to fund their working capital needs, which could negatively impact their ability or desire to continue to purchase products from us in the same frequencies and volumes as they have done in the past. There can be no assurances that government responses to the disruptions in the financial markets will restore consumer confidence, stabilize the markets or increase liquidity and the availability of credit. If the current economic conditions persist or deteriorate, sales of our products could be adversely affected, collectability of accounts receivable may be compromised and we may face obsolescence issues with our inventory, any of which could have a material adverse impact on our operating results and financial condition.

Based on our current plans and amounts expected to be generated from future operations, we believe that our cash and cash equivalents, and net cash provided by operations will be sufficient to meet our anticipated cash needs for working capital and capital expenditures through the end of fiscal 2009 and beyond. This will depend, however, on our ability to execute on our 2009 operating plan and to manage our costs in light of developing economic conditions and the performance of our business. We arrived at our revenue projections for our 2009 operating plan after careful consideration of the macroeconomic factors stemming from the global economic crisis, with an emphasis on our higher-margin, core products, including our Jones Pure Cane Soda glass bottle business. Further, we implemented cost containment measures in the fourth quarter of 2008 and early 2009, including reductions in workforce, to further align our cost structure with our revenue projections. Although we do not believe we are dependent on new product launches to generate sufficient cash flow from operations in 2009, we believe our new higher-margin product introductions in 2009, including the launch of Jones GABA during the first quarter, will help to enhance our sales growth into new markets and consumer groups. We intend to continually monitor and adjust our business plan as necessary to respond to developments in our business, our markets and the broader economy. Even with these measures, we do not anticipate reaching profitability in 2009. Refer to “Liquidity and Capital Resources” included in Item 7 of this Annual Report on Form 10-K.

 

Results of Operations

 

Years Ended December 31, 2008 and 2007

 

Revenue

 

For the year ended December 31, 2008, revenue was approximately $35.9 million, a decrease of $3.9 million, or 9.8% from $39.8 million in revenue for the year ended December 31, 2007. The decrease in revenue was primarily attributable to a 7.7% decrease in case sales through our DTR and DSD channels to 2.9 million cases as well as a 43.8% decrease in case sales of concentrate to National Beverage to 1.5 million cases due to the nationwide launch of cans in 2007 which resulted in sufficient inventory levels through the initial launch and reduced the demand for new orders in 2008. These decreases were offset by a reduction of 11.3%, or $580,000, in promotion allowances and slotting fees, which are a reduction to revenue, to $4.5 million from $5.1 million. This resulted from fewer promotion allowance programs in the latter part of 2008 due to lower sales volumes and our cost containment measures which are anticipated to contribute to a continued decline in promotion allowance programs in 2009. Revenues in our DSD channel decreased in 2008 compared to the prior year as a result of lower shipments of Jones Soda glass bottles, our core product, due to a discontinuation of distribution points at some key retailers but this decrease was partially offset by the benefit of a full year of sales of 24C which was launched in September 2007. DTR channel revenue was negatively impacted in 2008 compared to 2007 due to a reduction in the number of retail stores carrying Jones Soda as well as the discontinuance of the Jones Soda 12-ounce bottles at a major retailer.

 

Gross Profit

 

 

For the year ended December 31, 2008, gross profit decreased by approximately $2.1 million or 22.0% as compared to $9.4 million in gross profit for the year ended December 31, 2007. This was primarily a result of lower sales volumes in our DTR channel due to a reduction in the number of retail stores carrying Jones Soda as well as the discontinuance of the Jones Soda 12-ounce bottles at a major retailer. Also contributing to the decrease in gross profit was an increase in freight costs and the shutdown of our St. Louis co-packer which resulted in longer shipping distances to customers in our Midwest and Southeast markets. In 2008, gross profit as a percentage of revenue decreased to 20.5% from 23.7% in 2007.

Licensing Revenue

 

Licensing revenue decreased 49%, or $164,000 to $170,000 for the year ended December 31, 2008, from $334,000 for the year ended December 31, 2007, and consisted primarily of our exclusive licensing arrangements with Big Sky Brands for Jones Soda Flavor Booster Hard Candy. We believe licensing revenue was down due to the negative impact on sales resulting from the economic downturn. We do not expect licensing revenue to represent a material portion of our overall revenues in 2009.

 

Promotion and Selling Expenses

 

Promotion and selling expenses for the year ended December 31, 2008 were $12.3 million, an increase of $435,000, or 3.7%, over $11.9 million for the year ended December 31, 2007. Promotion and selling expenses as a percentage of revenue increased to 34.2% for the year ended December 31, 2008, from 29.8% in 2007. The increase in promotion and selling expenses was primarily due to an increase in selling expenses year over year of $539,000, to $7.2 million, or 20.0% of revenue. This increase was primarily due to increases in sales personnel in conjunction with the emphasis on the CSD channel until the strategic refocus in the fourth quarter of 2008 resulting in a reduction in force. The effect of the workforce reduction is expected to reduce ongoing promotion and selling expenses in 2009. Also contributing to the increase in promotion and selling expenses was an increase in marketing expenses of $99,000 to $4.8 million, or 13.2% of revenue, for 2008 from $4.7 million in 2007. This was primarily due to increases in brand building efforts including promotional events and sponsorships which were offset by a decrease in marketing expense.

 

General and Administrative Expenses

 

General and administrative expenses for the year ended December 31, 2008 were $10.7 million, an increase of $1.8 million or 19.9%, compared to $8.9 million for the year ended December 31, 2007. General and administrative expenses as a percentage of revenue increased to 29.7% for the year ended December 31, 2008 from 22.4% in 2007. The increase in general and administrative expenses was primarily due to an increase in professional fees, including legal fees relating to our securities litigation matter and accounting fees, as well as executive transition expenses of approximately $423,000.

 

Other Income, Net

 

Other income, net decreased to $384,000 for the year ended December 31, 2008, from $1.5 million in 2007, primarily due to a decrease in interest income due to lower levels of cash and short-term investments and lower levels of effective interest rates compared to 2007.

 

Income Tax (Expense) Benefit

 

Provision for income taxes for the years ended December 31, 2008 and 2007 was $203,000 and $2.2 million, respectively. The tax provision for the year ended December 31, 2008 relates primarily to the tax provision on income from our Canadian operations. No tax benefit is recorded for the loss in our U.S. operations as we have recorded a full valuation allowance on our U.S. net deferred tax assets. We expect to continue to record a full valuation allowance on our U.S. net deferred tax assets until we sustain an appropriate level of taxable income through improved U.S. operations. Our effective tax rate is based on recurring factors, including the forecasted mix of income before taxes in various jurisdictions, estimated permanent differences and the recording of a full valuation allowance on our U.S. net deferred tax assets.

 

Net Loss

 

Net loss for the year ended December 31, 2008 increased to $15.2 million from a net loss of $11.6 million for the year ended December 31, 2007. This was primarily due to lower sales in our DTR and DSD channels combined with increased promotion and selling expenses in conjunction with the emphasis on the CSD channel as well as an increase in general and administrative expense primarily resulting from our securities litigation matter and executive transition expenses.

Results of Operations

 

Years Ended December 31, 2007 and 2006

 

Revenue

 

For the year ended December 31, 2007, revenue was approximately $39.8 million, an increase of $796,000, or 2.0% from $39.0 million in revenues for the year ended December 31, 2006. The increase in revenues was primarily attributable to a 21.8% increase in case sales through our DTR, DSD and CSD channels to 5.8 million cases. The increase in case sales was primarily due to an increase in case sales of Jones Soda 12-ounce bottles and 24C, our enhanced water beverage launched in the first quarter 2007, through our DTR and DSD network, as well as a higher overall price per case in 2007. Concentrate case sales to National Beverage for the year ended December 31, 2007 were higher than in 2006, as sales in 2007 include sales of concentrate of Jones Pure Cane Soda and Jones Energy, while concentrate case sales in fiscal 2006 consisted solely of Jones Energy concentrate sales during the second quarter of 2006 and Jones Soda concentrate sales in the fourth quarter of 2006. The increase in concentrate sales of Jones Pure Cane Soda to National Beverage in 2007 was primarily in preparation of the launch of our 12-ounce cans in 2007. The increases in revenue were offset by an increase in promotion allowances and slotting fees, which are a reduction to revenue, to $5.1 million from $480,000 in 2006, primarily resulting from the slotting fees incurred to gain entry into the CSD channel for our 12-ounce cans.

 

Gross Profit

 

 

For the year ended December 31, 2007, gross profit decreased by approximately $5.9 million or 38.3% as compared to $15.3 million in gross profit for the year ended December 31, 2006. This decrease was primarily as a result of increased promotion allowances and slotting fees to $5.1 million in 2007 from $480,000 in 2006 due to the nationwide launch of cans in 2007 through our CSD channel. The decrease was also due to inventory provisions and write-downs of approximately $1.7 million related to, among other items, the transition from high fructose corn syrup to pure cane sugar production during the first three quarters, the discontinuance of our 16-ounce Jones Soda cans and certain special packs and flavors in the fourth quarter. Changes in product mix and sales mix in the DSD and DTR channels also contributed to the lower gross profit as we shipped more product to our DTR customers, where we receive lower gross profit than shipments to our distributors. Additionally, in 2007 we continued to experience higher co-packing costs for some of our products due to increases in energy costs, co-packing fees and freight costs. In response, we continued to shift a portion of our bottling requirements to our U.S co-packers in an effort to reduce freight and co-packing costs. In 2007, gross profit as a percentage of revenue decreased to 23.7% from 39.2% in 2006.

 

Licensing Revenue

 

Licensing revenue decreased 51.2%, or $350,000, to $334,000 for the year ended December 31, 2007 from $684,000 for the year ended December 31, 2006 and consisted primarily of our exclusive arrangements with Big Sky Brands for Jones Soda Flavor Booster Hard Candy and remaining royalties on the sale of remaining high fructose corn syrup inventory through Target Corporation. In contrast, for the year ended December 31, 2006, licensing revenue consisted primarily of royalty payments on the sale of 12-ounce cans pursuant to our exclusive licensing arrangement with Target Corporation that expired on December 31, 2006, and to a lesser extent our licensing arrangement with Big Sky Brands.

 

Promotion and Selling Expenses

 

Promotion and selling expenses for the year ended December 31, 2007 were $11.9 million, an increase of $3.4 million, or 39.8%, over $8.5 million for the year ended December 31, 2006. Promotion and selling

expenses as a percentage of revenue increased to 29.8% for the year ended December 31, 2007, from 21.7% in 2006. The increase in promotion and selling expenses was primarily due to increased promotion expenses resulting from our entry into the CSD channel and our introduction of 24C in various markets in our DSD channel and increased headcount in senior sales and marketing positions in 2007. The increase in promotion and selling expenses in 2007 was also due to hiring a national advertising agency to develop an advertising campaign for our Jones Soda products. Further, 2007 was the first year we incurred expenses related to our Sponsorship Agreement with the Seahawks and New Jersey Nets which included amounts amortized relating to the sponsorship fees, product development costs and marketing costs.

 

General and Administrative Expenses

 

General and administrative expenses for the year ended December 31, 2007 were $8.9 million, an increase of $4.1 million or 87.2%, compared to $4.8 million for the year ended December 31, 2006. General and administrative expenses as a percentage of revenue increased to 22.4% for 2007 from 12.2% in 2006. The increase in general and administrative expenses was primarily due to the executive transition expenses of approximately $1.1 million, a significant increase in legal fees relating to our securities litigation matter, increased negotiation costs of various customer and supplier agreements, audit and consulting fees related to Sarbanes-Oxley Section 404 compliance, depreciation and amortization and stock-based compensation.

 

Other Income, Net

 

For the year ended December 31, 2007, other income, net was approximately $1.5 million compared to approximately $913,000 in 2006 primarily due to interest income from the funds we received from our June 2006 equity offering that were available for the entire year and foreign currency translation gains. Interest income consists of interest income earned on cash on-hand and short-term investments which were invested in money market and short-term fixed-income instruments.

 

Income Taxes (Expense) Benefit

 

For the year ended December 31, 2007, we recorded a valuation allowance on our deferred taxes in the fourth quarter and, thus, recorded a net income tax expense of $2.2 million compared to an income tax benefit of $903,000 in 2006. The tax provision for the year ended December 31, 2007, is based on an expected annual effective tax rate of (22.35)%, compared to a U.S. statutory rate of 34%. The actual effective tax rate for the year ended December 31, 2007 differs from 2006 due primarily to the recording of the valuation allowance on the U.S. deferred tax assets. The tax provision for the year ended December 31, 2006 is based on an effective tax rate of (25.6)% compared to a U.S. statutory rate of 34%. Our effective tax rate is based on recurring factors, including the forecasted mix of income before taxes in various jurisdictions, estimated permanent differences and the related effective tax rates in those jurisdictions.

 

Net (Loss) Income

 

Net loss for the year ended December 31, 2007 was approximately $11.6 million compared to net income of $4.6 million in 2006. The decrease in net income was due to an increase in slotting fees costs, promotion allowances and operating expenses. Operating expenses increased due to increased trade promotion spending for CSD and DSD channels, increased expenses related to increased hiring in sales, marketing and operations departments, depreciation and amortization and legal and compliance costs.

 

Liquidity and Capital Resources

 

As of December 31, 2008 and 2007, we had cash, cash-equivalents and short-term investment of approximately $12.6 million and $27.8 million, respectively and working capital of $17.7 million and $31.5 million, respectively. Accumulated deficit increased to $29.4 million as of December 31, 2008 over the prior year’s deficit of $14.2 million. This increase in our accumulated deficit is due to net losses from operations that we have incurred in each of the last six fiscal quarters. During these periods, we have used a significant amount of our cash resources to fund our net losses and working capital requirements.

Net cash used in operating activities in 2008 increased to $14.5 million compared to $3.3 million in 2007, for a year-over-year increase of $11.2 million. This increase in net cash used in operating activities was primarily due to the increase in our net loss, excluding the one-time non-cash deferred income tax expense in the prior year, driven by lower sales in our DTR and DSD channels combined with increased promotion and selling expenses in connection with the emphasis on the CSD channel in the first three quarters of 2008. Also contributing to net cash used in operating activities was an increase in general and administrative expense primarily resulting from our securities litigation matter and executive transition. Additionally, significant decreases from December 31, 2007 to December 31, 2008 in accounts payable (due in part to the decrease in trade spend expenses as a result of cost containment measures in late 2008) were partially offset by decreases in accounts receivable (due primarily to the decline in DTR and DSD channel revenue) contributed to the increase in cash used by operations.

 

Net cash provided by investing activities totaled approximately $8.5 million and $5.8 million for the years ended December 31, 2008 and 2007, respectively, primarily due to sale of short-term investments offset to a lesser extent, by purchases of fixed assets.

 

Net cash used in financing activities was approximately $88,000 for the year ended December 31, 2008, and consisted primarily of payments on our capital lease obligations compared to net cash provided by financing activities for the year ended December 31, 2007 of $1.5 million comprised primarily of proceeds from exercises of stock options.

 

In early October 2008, we implemented a reduction in workforce that reduced our staff by approximately 30% whose annualized salaries and benefits were approximately $2.6 million. The workforce reduction was implemented in an effort to reduce ongoing operating expenses and improve our overall efficiency. Severance and termination benefits to the affected employees were not material to our financial results for the fourth quarter of 2008.

 

In November 2008, our $15 million line of credit with Key Bank National Association was terminated after discussions that were initiated by Key Bank given the current economic climate and our financial condition and operating results. We considered different borrowing alternatives with Key Bank but these alternatives would have required us to maintain a fully secured position at all times on the loan, which we did not consider to be an effective lending position. As a result, we elected not to pursue such alternatives. We remained in compliance with all covenants through the termination date.

 

Based on our current plans and amounts expected to be generated from future operations, we believe that our cash and cash equivalents and net cash provided by operations will be sufficient to meet our anticipated cash needs for working capital and capital expenditures through the end of fiscal 2009 and beyond. This will depend, however, on our ability to execute on our 2009 operating plan and to manage our costs in light of developing economic conditions and the performance of our business. We arrived at our revenue projections for our 2009 operating plan after careful consideration of the macroeconomic factors stemming from the global economic crisis, with an emphasis on our higher-margin core products, including our Jones Pure Cane Soda glass bottle business. Further, we implemented cost containment measures in the fourth quarter of 2008 and early 2009, including reductions in workforce, to further align our cost structure with our revenue projections. Although we do not believe we are dependent on new product launches to generate sufficient cash flow from operations in 2009, we believe the launch of Jones GABA during the first quarter, plus corresponding the extensions of this product, will help to enhance our sales growth into new markets and consumer groups. We intend to continually monitor and adjust our business plan as necessary to respond to developments in our business, our markets and the broader economy and are prepared, if necessary, to take further action to conserve cash, including further cost reductions in sales, marketing and general and administrative areas. Even with these measures, we do not anticipate reaching profitability in 2009.

 

Our current operating plan for 2009 does not depend on obtaining financing; however, if we are unable to generate sufficient cash flow from operations to cover our working capital and capital expenditure requirements, we may need to obtain funds through additional financing or securing a replacement credit facility, which may not be available to us on acceptable terms, if at all. In addition, we may have to explore various strategies to secure any necessary additional financing, which may include, without limitation, public or private offerings of

debt or equity securities, joint ventures with one or more strategic partners and other strategic alternatives. There can be no assurance that our efforts in this regard will result in any agreements or transactions.

 

Contractual Obligations

 

Our commitments as of December 31, 2008 with respect to known contractual obligations were as follows (in thousands):

 

 

Our sponsorship obligations include commitments under our Sponsorship Agreements with the Seattle Seahawks, the New Jersey Nets and the Portland Trail Blazers. These obligations vary in terms and commit us to payments from 2008 to 2016. We describe these arrangements in Part I, Item 1 (Business) of this report.

 

Purchase obligations reflected in the table above include approximately $5 million in sugar under our supply agreements with our three pure cane sugar suppliers and approximately $1.8 million in glass under our supply agreement with our glass supplier. They are include commitments under our Pharma GABA supply agreement to order approximately $1.8 million of Pharma GABA by December 31, 2008 and, on or before January 31, 2009, to pay 50% of that amount, with the remaining portion to be paid in six equal monthly installments commencing on February 24, 2009 and ending July 26, 2009.

 

In addition, we are required to use our commercially reasonable best efforts to purchase an additional $8.4 million of Pharma GABA through the end of the term of the agreement in July 2010 according to the following schedule: (1) approximately $3.4 million of Pharma GABA by July 31, 2009 and (2) an additional approximately $5.1 million of Pharma GABA by July 31, 2010. The $8.4 million is not included in the table above because it does not represent a firm commitment.

 

We have no off-balance sheet arrangements.

 

Contingencies

 

We are subject to the possibility of losses from various contingencies. See Item 3 — Legal Proceedings for disclosure of the Federal Securities Class Action and Shareholder Derivative Litigation as well as other matters. We are unable to predict the outcome of these actions. These actions could result in significant liability and could have a material adverse effect on our business, results of operations, or financial condition.

 

Critical Accounting Policies

 

The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates based on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form our basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, or if management made different judgments or utilized different estimates. Many of our estimates or judgments are based on anticipated future events or performance, and as such are forward-looking in nature, and are subject to many risks and uncertainties, including those discussed below and elsewhere in this Report. We do not undertake any obligation to update or revise this discussion to reflect any future events or circumstances.

There are certain critical accounting estimates that we believe require significant judgment in the preparation of our consolidated financial statements. We have identified below our accounting policies and estimates that we consider critical to our business operations and the understanding of our results of operations. This is not a complete list of all of our accounting policies, and there may be other accounting policies that are significant to us. For a detailed discussion on the application of these and our other accounting policies, see Note 1 to the Consolidated Financial Statements included in this Report.

 

Revenue Recognition

 

We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectibility is reasonably assured. Revenue is recorded net of provisions for discounts, slotting fees and allowances in accordance with Emerging Issues Task Force (EITF) No. 01-9, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products). Such incentives are recognized as a reduction in revenue at the later of the date on which the related revenue is recognized or a commitment is made, except in the case of slotting which is recognized when the commitment is made.

 

With respect to our DSD and DTR channels, our products are sold on various terms for cash or credit. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery. We recognize revenue upon receipt of our products by our distributors and retail customers in accordance with written sales terms, net of provisions for discounts and allowances. All sales to distributors and customers are final sales; however, in limited instances, due to product quality issues or distributor terminations, we may accept returned product.

 

With respect to our CSD channel, we recognize revenue from the sale of concentrate to National Beverage Corp. on a gross basis upon receipt of concentrate by National Beverage. The selling price and terms of sale of concentrate to National Beverage are determined in accordance with our manufacturing and distribution agreement with them. Our credit terms from the sale of concentrate typically require payment within 30 days of delivery. Generally we do not accept returns on sales of concentrate to National Beverage; however, in limited instances, due to product quality or other custom package commitments, we may accept returned product.

 

Licensing revenue is recorded when we receive a sale confirmation from the third party.

 

Inventory

 

We hold raw materials and finished goods inventories, which are manufactured and procured based on our sales forecasts. We value inventory at the lower of cost or market, which is based on estimated net realizable value, and include adjustments for estimated obsolescence, on a first in-first out basis. These valuations are subject to customer acceptance, planned and actual product changes, demand for the particular products, and our estimates of future realizable values based on these forecasted demands. We regularly review inventory detail to determine whether a write-down is necessary. We consider various factors in making this determination, including recent sales history and predicted trends, industry market conditions and general economic conditions. The amount and timing of write-downs for any period could change if we make different judgments or use different estimates. We also determine whether an allowance for obsolescence is required on products that are over 12 months from production date or any changes related to market conditions, slow-moving inventory or obsolete products.

 

Deferred Income Taxes

 

The determination of our provision of income taxes requires significant judgment, the use of estimates, and the interpretation and application of complex tax laws. To the extent management believes it is more likely than not that we will not be able to utilize some or all of our deferred tax assets prior to their expiration, we are required to establish valuation allowances against that portion of deferred tax assets. The determination of required valuation allowances involves significant management judgment and is based upon our best estimate of anticipated taxable profits in various jurisdictions with which the deferred tax assets are associated. Changes in expectations could result in significant adjustments to the valuation allowance and material changes to our provision for income taxes.

During the fourth quarter of fiscal 2007, we concluded that it was appropriate to record a charge of approximately $5.5 million to establish a full valuation allowance against the tax benefits arising from losses in our U.S. operations. As of December 31, 2007, we had incurred cumulative losses in recent years with respect to our U.S. operations, and we increased our cumulative losses in our U.S. operations by $15.1 million in 2008. In accordance with the relevant accounting guidance, we considered future projections of U.S. pretax income as a material factor in our analysis of the realizability of our net U.S. deferred tax assets. Nonetheless, it was difficult to overcome the cumulative losses and thus, we continue to establish a full valuation allowance against our U.S. deferred tax assets. This is due to the fact that the relevant accounting guidance puts more weight on the negative objective evidence of cumulative losses in recent years than the positive subjective evidence of future projections of pretax income. We analyze the realizability of our deferred tax assets on a quarterly basis, but reasonably expect to continue to record a full valuation allowance on future U.S. tax benefits until we sustain an appropriate level of taxable income through improved U.S. operations and tax planning strategies. No valuation allowance was recorded for deferred tax assets recorded in the Canadian subsidiary, as this subsidiary remains profitable.

 

We adopted the provisions of Financial Accounting Standards Board Interpretation No. 48 (FIN 48) on January 1, 2007. The adoption of FIN 48 did not impact the consolidated financial condition, results of operations or cash flows. We believe that we have appropriate support for the income tax positions taken and to be taken on our tax returns and that our accruals for tax liabilities are adequate for all open years based on an assessment of many factors including past experience and interpretations of tax law applied to the facts of each matter. No accruals exist under FIN 48 as of December 31, 2008.

 

 

In the normal course of our business, our financial position is routinely subject to a variety of risks. The principal market risks (i.e., the risk of loss arising from adverse changes in market rates and prices) to which we are exposed are fluctuations in energy and commodity prices affecting the cost of raw materials (including, but not limited to, increases in the price of bottles, PET plastic bottles, as well as cane sugar), and the limited availability of certain raw materials and co-packer capacity. We are also subject to market risks with respect to the cost of commodities because our ability to recover increased costs through higher pricing is limited by the competitive environment in which we operate.

 

We mitigate the risk of fluctuations in commodity prices through the purchase commitments we have for glass and sugar, which provide for a majority of our forecasted material demand. We have entered into fixed price purchase commitments with three pure cane sugar suppliers and one glass supplier for one to two year terms. We are still subject to freight surcharges in addition to these agreements, but anticipate a reduction in 2009 due to lower fuel prices.

 

With respect to foreign currency risk, approximately 21% of sales are international and primarily are comprised of sales to Canada. As a result, we are subject to risk from changes in foreign exchange rates. These changes result in cumulative translation adjustments, which are included in accumulated other comprehensive income (loss). We do not consider the potential loss resulting from a hypothetical 10% adverse change in quoted Canadian exchange rates, as of December 31, 2008, to be material.

 

Additionally, we may be subject to interest rate risk on our investment portfolio to the extent we maintain an investment portfolio. We are also subject to other risks associated with the business environment in which we operate, including the collectibility of accounts receivable and obsolescence of inventory due to changes in market conditions or new product initiatives. We believe that our exposure to these risks as of December 31, 2008 is not material.

 

We do not use derivative financial instruments to protect ourselves from fluctuations in interest rates or foreign currency fluctuations. We have entered into one-to to two-year agreements with our sugar suppliers for the supply of sugar at fixed prices. We have also entered into a two year agreement with our glass supplier for the supply of glass at fixed prices. We do not use futures contracts to hedge against fluctuations in commodity prices.

 

 

To the Board of Directors and Shareholders of Jones Soda Co.

Seattle, Washington

 

We have audited the accompanying consolidated balance sheet of Jones Soda Co. and subsidiaries (the “Company”) as of December 31, 2008 and the related consolidated statement of operations, shareholders’ equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, such 2008 consolidated financial statements present fairly, in all material respects, the financial position of Jones Soda Co. and subsidiaries as of December 31, 2008, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 13, 2009 expressed an unqualified opinion on the Company’s internal control over financial reporting.

 

/s/ DELOITTE & TOUCHE LLP

 

Seattle, Washington
March 13, 2009

 

The Board of Directors and Stockholders of Jones Soda Co.:

 

We have audited the accompanying consolidated balance sheets of Jones Soda Co. and subsidiaries as of December 31, 2007, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2007. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Jones Soda Co. and subsidiaries as of December 31, 2007, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2007, in conformity with United States generally accepted accounting principles.

 

/s/ KPMG LLP

 

Chartered Accountants

Vancouver, Canada

March 13, 2008

JONES SODA CO.

 

 

See accompanying notes to consolidated financial statements.

JONES SODA CO.

 

 

See accompanying notes to consolidated financial statements.

JONES SODA CO.

 

 

See accompanying notes to consolidated financial statements.

JONES SODA CO.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

 

See accompanying notes to consolidated financial statements.

JONES SODA CO.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years Ended December 31, 2008, 2007 and 2006

 

 

Jones Soda Co.^® develops, produces, markets, licenses and distributes premium beverages and related products. Our primary product lines include the brands Jones Pure Cane Soda^tm, a premium soda; Jones 24C^tm, an enhanced water beverage; Jones GABA^tm, a functional tea, juice blend launched in February 2009, Jones Organics^tm, a ready to drink organic tea; Jones Naturals^®, a non-carbonated juice and tea drink; and Whoop Ass Energy Drink^®, a high energy drink. We are a Washington corporation and have three operating subsidiaries, Jones Soda Co. (USA) Inc., Jones Soda (Canada) Inc., myJones.com, Inc. as well as one non-operating subsidiary, Whoopass USA Inc.

 

Basis of presentation and consolidation

 

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany transactions between the Company and its subsidiaries have been eliminated in consolidation.

 

Use of estimates

 

The preparation of the consolidated financial statements requires management to make a number of estimates and assumptions relating to the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Significant items subject to such estimates and assumptions include, but are not limited to, inventory valuation, depreciable lives of capital assets, valuation allowances for receivables, trade promotion liabilities, stock-based compensation expense, valuation allowance for deferred income tax assets and contingencies. Actual results could differ from those estimates.

 

Cash and cash equivalents

 

We consider all highly liquid short-term investments with an original or remaining maturity of three months or less at the date of purchase to be cash equivalents.

 

Short — term investments

 

Short-term investments have a remaining maturity of less than twelve months. All short-term investments are classified as available-for-sale securities and are recorded at fair value. Unrealized holding gains and losses are recorded, net of tax, as a separate component of accumulated other comprehensive income. The estimate of fair value is based on publicly available market information or other estimates determined by management. Interest income on our short term investments of $495,000, $1.4 million and $922,000 for the years ended December 31, 2008, 2007 and 2006, respectively, and was recorded in other income, net on our consolidated statements of operations.

 

Fair value of financial instruments

 

The carrying amounts for cash and cash equivalents, receivables and payables approximate fair value due to the short-term maturity of these instruments. The carrying value of other long-term liabilities approximated fair values because the underlying interest rates approximate market rates at the balance sheet dates.

 

Accounts receivable

 

Our accounts receivable balance includes balances from trade sales. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable. We determine

 

JONES SODA CO.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

the allowance for doubtful accounts based on historical write-off experience. Account balances that are deemed uncollectible, are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. Allowances for doubtful accounts of $330,000, and $317,000 as of December 31, 2008 and 2007, are netted against accounts receivable. Activity in the allowance for doubtful accounts consists of the following as of December 31 (in thousands):

 

 

Inventories

 

Inventories consist of raw materials and finished goods and are stated at the lower of cost or estimated net realizable value and include adjustments for estimated obsolescence. Cost is based on actual cost on a first-in first-out basis. The provisions for obsolete or excess inventory are based on estimated forecasted usage of inventories. A significant change in demand for certain products as compared to forecasted amounts may result in recording additional provisions for obsolete inventory. Provisions for obsolete inventory are recorded as cost of goods sold.

 

Fixed assets

 

Fixed assets are recorded at cost and depreciated on the declining balance basis over the estimated useful lives of the assets as follows:

 

 

Intangible assets