REED'S, INC. - Quarter Report: 2018 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2018

[  ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT OF 1934

For the transition period from _______ to _______

Commission file number: 001-32501

REED’S, INC.

(Exact name of registrant as specified in its charter)

13000 South Spring St. Los Angeles, Ca. 90061

(Address of principal executive offices) (Zip Code)

(310) 217-9400

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark 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 [X] No [  ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [  ]

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

Indicate by check mark whether the issuer is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: There were a total of 25,548,996 shares of Common Stock outstanding as of July 31, 2018.

Special Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2 of Part I of this report includes forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by forward-looking statements.

In some cases, you can identify forward-looking statements by terminology such as “may,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “proposed,” “intended,” or “continue” or the negative of these terms or other comparable terminology. You should read statements that contain these words carefully, because they discuss our expectations about our future operating results or our future financial condition or state other “forward-looking” information. There may be events in the future that we are not able to accurately predict or control. Before you invest in our securities, you should be aware that the occurrence of any of the events described in this Quarterly Report could substantially harm our business, results of operations and financial condition, and that upon the occurrence of any of these events, the trading price of our securities could decline and you could lose all or part of your investment. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, growth rates, levels of activity, performance or achievements. We are under no duty to update any of the forward-looking statements after the date of this Quarterly Report to conform these statements to actual results.

TABLE OF CONTENTS

Part I – FINANCIAL INFORMATION

Item 1. Financial Statements

REED’S INC. CONDENSED BALANCE SHEETS

(Amounts in thousands, except share amounts)

The accompanying notes are an integral part of these condensed financial statements.

REED’S, INC.

CONDENSED STATEMENTS OF OPERATIONS

For the Three and Six Months Ended June 30, 2018 and 2017

(Unaudited)

(Amounts in thousands, except share and per share amounts)

The accompanying notes are an integral part of these condensed financial statements

REED’S, INC.

CONDENSED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT)

For the Six Months Ended June 30, 2018

(Unaudited)

(Amounts in thousands except share amounts)

The accompanying notes are an integral part of these condensed financial statements.

REED’S, INC.

CONDENSED STATEMENTS OF CASH FLOWS

For the Six Months Ended June 30, 2018 and 2017

(Unaudited)

(Amounts in thousands)

The accompanying notes are an integral part of these condensed financial statements.

REED’S, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

Three and Six Months Ended June 30, 2018 and 2017 (Unaudited)

(In thousands, except share and per share amounts)

1. Basis of Presentation and Liquidity

The accompanying interim condensed financial statements of Reed’s, Inc. (the “Company”, “we”, “us”, or “our”), are unaudited, but in the opinion of management contain all adjustments, including normal recurring adjustments, necessary to present fairly our financial position at June 30, 2018 and the results of operations and cash flows for the three and six months ended June 30, 2018 and 2017. The balance sheet as of December 31, 2017 is derived from the Company’s audited financial statements.

Certain information and footnote disclosures normally included in financial statements that have been prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. We believe that the disclosures contained in these condensed financial statements are adequate to make the information presented herein not misleading. For further information, refer to the financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K, as filed with the Securities and Exchange Commission on April 2, 2018.

The results of operations for the interim periods presented are not necessarily indicative of the results of operations to be expected for the full fiscal year ending December 31, 2018.

Liquidity

The accompanying financial statements have been prepared under the assumption that the Company will continue as a going concern. Such assumption contemplates the realization of assets and satisfaction of liabilities in the normal course of business. For the six months ended June 30, 2018, the Company recorded a net loss of $4,991 and used cash in operations of $10,415. As of June 30, 2018, we had a stockholder’s deficit of $2,734 and a working capital shortfall of $289 compared to stockholder’s equity of $508 and working capital of $2,303 at December 31, 2017.

As of June 30, 2018, the Company had a cash balance of $1,807 and had available borrowing on our Revolving Line of Credit of $2,004, for a total of $3,811 of cash availability. The Revolving Line of Credit matures in October 2018. The Company’s Term Loans and Capital Expansion Loan (together, the “Bank Notes”), totaling $6,244 as of June 30, 2018, also become due in October 2018.

On July 19, 2018, the Company executed a term sheet for refinancing of all of these amounts, and management anticipates that the refinancing will be completed prior to October 2018.

Historically, we have financed our operations through public and private sales of common stock, issuance of preferred and common stock, convertible debt instruments, term loans and credit lines from financial institutions, and cash generated from operations. We expect to complete a refinancing of the current credit line and certain term loans and moving forward our primary capital source will be positive cash flow from operations. Beginning in June of 2017, we took decisive action to improve our profitability and operating cash flow, including increased outsourcing of our manufacturing process, streamlining our product portfolio, negotiating improved vendor contracts and restructuring our selling prices. The result was a 14 percentage point increase in gross margin for the six months ended June 30, 2018, as compared to the same period of 2017.

The Company anticipates the exit of our Los Angeles plant to be completed in 2018, and in December 2017 we recorded a $3,925 impairment charge for fixed asset costs that we do not believe to be recoverable. Additionally, as a result of the planned move of our corporate headquarters (see Note 13), we recorded a charge of $642 for one-time severance and other employee termination costs in June of 2018. We may incur additional charges including but not limited to additional cash-related expenses, non-cash impairment charges, discontinued operations and/or other costs in connection with exit and disposal activities. Such transactions will be recognized when appropriate and may require cash payments for obligations such as one-time employee involuntary termination benefits, lease and other contract termination costs, costs to close facilities, employee relocation costs and ongoing benefit arrangements.

If our sales goals do not materialize as planned, we believe the Company will be able to reduce its operating costs sufficiently to still achieve positive cash flow from operations. However, there can be no assurance that we will generate sufficient revenues from product sales in the future to achieve profitable operations. If we are not able to achieve profitable operations at some point in the future, or restructure our debt as planned, we may have insufficient working capital to maintain our operations as we presently intend to conduct them or to fund our expansion, marketing, and product development plans. There can be no assurance we will be able to obtain financing on acceptable terms, or at all.

REED’S, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

Three and Six Months Ended June 30, 2018 and 2017 (Unaudited)

(In thousands, except share and per share amounts)

2. Significant Accounting Policies

Revenue Recognition

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), (“ASC 606”). The underlying principle of ASC 606 is to recognize revenue to depict the transfer of goods or services to customers at the amount expected to be collected. ASC 606 creates a five-step model that requires entities to exercise judgment when considering the terms of contract(s), which include (1) identifying the contract or agreement with a customer, (2) identifying our performance obligations in the contract or agreement, (3) determining the transaction price, (4) allocating the transaction price to the separate performance obligations, and (5) recognizing revenue as each performance obligation is satisfied.

The Company adopted ASC 606 effective January 1, 2018, and adoption of such standard had no effect on previously reported balances. However, the guidance requires additional disclosures to help users of financial statements better understand the nature, amount, timing, and uncertainty of revenue that is recognized.

The Company previously recognized and continues to recognize revenue when risk of loss transfers to our customers and collection of the receivable is reasonably assured, which generally occurs when product is shipped. A written order from the customer must be received and credit acceptance procedures performed prior to shipment of product.

The Company does not have any significant contracts with customers requiring performance beyond delivery, and contracts with customers contain no incentives or discounts that could cause revenue to be allocated or adjusted over time. Shipping and handling activities are performed before the customer obtains control of the goods and therefore represent a fulfillment activity rather than a promised service to the customer. Revenue and costs of sales are recognized when control of the products transfers to our customer, which generally occurs upon shipment from our facilities. The Company’s performance obligations are satisfied at that time.

All of the Company’s products are offered for sale as finished goods only, and there are no performance obligations required post-shipment for customers to derive the expected value from them.

The Company does not allow for returns, except for damaged products when the damage occurred pre-fulfillment. Damaged product returns have historically been insignificant. Because of this, the stand-alone nature of our products, and our assessment of performance obligations and transaction pricing for our sales contracts, we do not currently maintain a contract asset or liability balance at this time for obligations. We assess our contracts and the reasonableness of our conclusions on a quarterly basis.

Loss per Common Share

Basic earnings (loss) per share is computed by dividing the net income (loss) applicable to common stockholders by the weighted average number of shares of common stock outstanding during the year. Diluted earnings (loss) per share is computed by dividing the net income applicable to common stockholders by the weighted average number of common shares outstanding plus the number of additional common shares that would have been outstanding if all dilutive potential common shares had been issued, using the treasury stock method. Potential common shares are excluded from the computation when their effect is antidilutive.

For the periods ended June 30, 2018 and 2017, the calculations of basic and diluted loss per share are the same because potential dilutive securities would have had an anti-dilutive effect. The potentially dilutive securities consisted of the following:

REED’S, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

Three and Six Months Ended June 30, 2018 and 2017 (Unaudited)

(In thousands, except share and per share amounts)

The Series A Convertible Preferred Stock is convertible into Common shares at the rate of 1:4.

Use of estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Those estimates and assumptions include estimates for reserves of uncollectible accounts, inventory obsolescence, depreciable lives of property and equipment, analysis of impairments of recorded long-term tangible and intangible assets, realization of deferred tax assets, accruals for potential liabilities and assumptions made in valuing stock instruments issued for services.

Recent Accounting Pronouncements

In February 2016, the FASB issued ASU No. 2016-02, Leases (ASU 2016-02”). ASU 2016-02 requires a lessee to record a right of use asset and a corresponding lease liability on the balance sheet for all leases with terms longer than 12 months. ASU 2016-02 is effective for all interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest period presented in the financial statements. The Company is currently evaluating the expected impact that the standard could have on its financial statements and related disclosures.

In July 2017, the FASB issued ASU No. 2017-11, “Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features; (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception” (“ASU 2017-11”). ASU 2017-11 allows companies to exclude a down round feature when determining whether a financial instrument (or embedded conversion feature) is considered indexed to the entity’s own stock. As a result, financial instruments (or embedded conversion features) with down round features may no longer be required to be accounted for as derivative liabilities. ASU 2017-11 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The guidance in ASU 2017-11 can be applied using a full or modified retrospective approach. The adoption of ASU 2017-11 is not expected to have a material impact on the Company’s financial position, results of operations, and cash flows.

In June 2018, the FASB issued ASU No. 2018-07, “Compensation – Stock Compensation (Topic 718); Improvements to Non-Employee Share-Based Payment Accounting” (“ASU 2018-07”). ASU 2018-07 generally aligns the measurement and classification of share-based awards to non-employees with that of share-based awards to employees. Non-employee equity awards will be measured at the fair value of the equity instruments to be issued, as of the grant date, and the resulting amount will be recognized as expense over the expected or contractual term of the award. The ASU applies to all share-based payments to nonemployees in exchange for goods or services used or consumed in an entity’s own operations. It does not apply to instruments issued to a lender or investor in a financing transaction, or to instruments granted when selling goods or services to customers. ASU 2018-07 is effective for annual periods beginning after December 15, 2018, and interim periods within those annual periods. Early adoption is permitted. The Company is currently evaluating the expected impact that the standard could have on its financial statements and related disclosures.

Other recent accounting pronouncements issued by the FASB, its Emerging Issues Task Force, the American Institute of Certified Public Accountants, and the Securities and Exchange Commission did not or are not believed by management to have a material impact on the Company’s present or future consolidated financial statements.

REED’S, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

Three and Six Months Ended June 30, 2018 and 2017 (Unaudited)

(In thousands, except share and per share amounts)

Concentrations

During the three months ended June 30, 2018, the Company’s largest three customers accounted for 24%, 11%, and 10% of gross sales, respectively. During the six months then ended, two of these customers accounted for 25% and 10% of gross sales, respectively.

During the three and six months ended June 30, 2017, the Company’s largest customer accounted for 23% and 22% of gross sales, respectively.

As of June 30, 2018, the Company had accounts receivable from two customers which comprised 25% and 10%, respectively, of its gross accounts receivable. As of December 31, 2017, accounts receivable from two customers comprised approximately 23% and 16% of total accounts receivable, respectively.

During the three months ended June 30, 2018, the Company made 18% of its purchases from its largest vendor. During the six months then ended, 16% of all purchases were made from this vendor.

During both the three and six months ended June 30, 2017, a single vendor accounted for approximately 18% of all purchases.

As of June 30, 2018, a single vendor accounted for 24% of the Company’s total accounts payable. As of December 31, 2017, this vendor accounted for 20% of total accounts payable.

Fair Value of Financial Instruments

The Company uses various inputs in determining the fair value of its financial assets and liabilities and measures these assets on a recurring basis. Financial assets recorded at fair value are categorized by the level of subjectivity associated with the inputs used to measure their fair value. Accounting Standards Codification Section 820 defines the following levels of subjectivity associated with the inputs:

Level 1—Quoted prices in active markets for identical assets or liabilities.

Level 2—Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly.

Level 3—Unobservable inputs based on the Company’s assumptions.

The carrying amounts of financial assets and liabilities, such as cash and cash equivalents, accounts receivable, short-term bank loans, accounts payable, notes payable and other payables, approximate their fair values because of the short maturity of these instruments. The carrying values of capital lease obligations and long-term financing obligations approximate their fair values because interest rates on these obligations are based on prevailing market interest rates.

As of June 30, 2018, and December 31, 2017, the Company’s balance sheets included warrant liabilities aggregating $159 and $36 respectively, measured at fair value based on Level 2 inputs.

3. Inventory

Inventory is valued at the lower of cost (first-in, first-out) or market, and net of reserves is comprised of the following (in thousands):

REED’S, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

Three and Six Months Ended June 30, 2018 and 2017 (Unaudited)

(In thousands, except share and per share amounts)

The Company’s reserve for slow moving and obsolete inventory aggregated $354 and $509 as of June 30, 2018 and December 31, 2017, respectively.

4. Property and Equipment

Property and equipment is comprised of the following (in thousands):

Depreciation expense for the three months ended June 30, 2018 and 2017 was $159 and $138, respectively. Depreciation expense for the six months then ended was $337 and $259, respectively.

During the year ended December 31, 2017, the Company recorded an impairment charge totaling $3,925 as a result of Management’s decision to exit our Los Angeles facility during 2018.

Equipment held for sale consists of the following (in thousands):

5. Intangible Assets and Impairment Policy

Intangible assets are comprised of brand names acquired. They have been assigned an indefinite life, as we currently anticipate that they will contribute cash flows to the Company perpetually. These indefinite-lived intangible assets are not amortized, but are assessed for impairment annually and evaluated annually to determine whether the indefinite useful life remains appropriate. We first assess qualitative factors to determine whether it is more likely than not that the asset is impaired. If further testing is necessary, we compare the estimated fair value of our asset with its book value. If the carrying amount of the asset exceeds its fair value, as determined by the discounted cash flows expected to be generated by the asset, an impairment loss is recognized in an amount equal to that excess. Based on management’s measurement, there were no indications of impairment at June 30, 2018.

REED’S, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

Three and Six Months Ended June 30, 2018 and 2017 (Unaudited)

(In thousands, except share and per share amounts)

Intangible assets consist of the following (in thousands):

6. Advances from Officers

In 2017, Christopher Reed (the former Chief Executive Officer and current Chief Innovation Officer of the Company), Robert Reed (the brother of Christopher Reed), and Daniel Miles (former Chief Financial Officer of the Company), collectively advanced $571 to the Company for working capital uses. As of December 31, 2017, $277 of these advances remained outstanding. This balance was repaid during the quarter ended March 31, 2018 with a three percent fee.

7. Line of Credit and Bank Notes

As of June 30, 2018, the Company had a Loan and Security Agreement with PMC Financial Services Group, LLC (the “PMC Agreement”), which includes a $6,000 Revolving Line of Credit, a $3,000 Term Loan, and a Capital Expansion Loan (“CAPEX Loan”). Amounts borrowed under the PMC Agreement are secured by substantially all the assets of the Company and become due in October 2018.

On July 19, 2018, the Company received a signed term sheet for a secured revolving credit line with borrowing capacity to repay all amounts outstanding under the PMC Agreement as well as provide additional working capital if needed at reduced borrowing costs. Completion of the transaction is subject to negotiation of mutually agreeable definitive agreements. Management anticipates that the refinancing will be completed prior to October 2018.

The provisions of the PMC Agreement, in place as of June 30, 2018, are as follows.

Revolving Line of Credit

The Revolving Line of Credit, which matures on October 21, 2018, provides for borrowings of up to 85% of accounts receivable and 60% of eligible inventory, not to exceed $6,000. It is secured by substantially all of the Company’s assets. As of June 30, 2018, $3,996 was outstanding under the Revolving Line of Credit, and the Company had $2,004 of additional borrowing availability as of that date. Borrowings under the Revolving Line of Credit aggregated $3,301 as of December 31, 2017.

Bank Notes

Bank Notes consist of the following as of June 30, 2018 and December 31, 2017 (in thousands):

The Term Loans are secured by all of the unencumbered assets of the Company and are due on October 1, 2018. The CAPEX loan is secured by all of the property and equipment purchased under the loan, and is due on October 21, 2018.

Interest Rates

Interest rates on borrowings under the PMC Agreement are generally calculated on a sliding scale based on our trailing six month EBITDA. If unused cash availability meets pre-established thresholds, interest rates are generally reduced to a contractual base rate plus any increase in the prime rate. The Revolving Line of Credit also bears a monthly collateral monitoring fee of .45%. The following chart summarizes loan interest rates as of June 30, 2018:

REED’S, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

Three and Six Months Ended June 30, 2018 and 2017 (Unaudited)

(In thousands, except share and per share amounts)

8. Capital Leases Payable

As of June 30, 2018, the Company leased certain assets including equipment for its brewery operations, with an original aggregate value of $944. The Company’s total payment obligation includes interest at rates ranging from 6.51% to 17.31% per annum.

Future minimum lease payments as of June 30, 2018 are as follows:

9. Long-term Financing Obligation

Our Long-term financing obligation is comprised of the following (in thousands):

As the result of a 2009 sale-leaseback transaction, the Company leases two buildings and certain of its brewery equipment (the majority of the assets of our Los Angeles plant). The transaction was accounted for as a long-term financing arrangement, and the proceeds from the sale were recorded as a financing obligation in the initial amount of $3,056. Monthly payments of approximately $35 under the arrangement are recorded as a reduction in the financing obligation and as interest expense at an implicit rate of 9.9%.

REED’S, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

Three and Six Months Ended June 30, 2018 and 2017 (Unaudited)

(In thousands, except share and per share amounts)

In connection with the financing obligation and subsequent amendments, the Company issued 600,000 warrants to purchase its common stock. The 600,000 warrants were valued at an aggregate amount of $1,336 which was recorded as a valuation discount. The discount is being amortized over 15 years, the term of the purchase option.

10. Convertible Note to a Related Party

The Convertible Note to a Related Party consists of the following (in thousands):

On April 21, 2017, pursuant to a Securities Purchase Agreement, the Company issued a secured, convertible, subordinated, non-redeemable note in the principal amount of $3,400, and a warrant to purchase 1,416,667 shares of common stock. The purchaser, Raptor/Harbor Reeds SPV LLC, beneficially owned approximately 27.8% of the Company’s common stock at each of June 30, 2018 and December 31, 2017.

The note bears interest at a rate of 12% per annum, compounded monthly. It is secured by the Company’s assets, subordinate to the first priority security interest of PMC Financial Services Group, LLC. The note may not be prepaid and matures on April 21, 2021. It may be converted, at any time and from time to time, into shares of common stock of the Company, at a revised conversion price of $1.50.

The warrant will expire on April 21, 2019 and has an adjusted exercise price equal to $1.50 per share. The note and warrant contain customary anti-dilution provisions, and the shares of common stock issuable upon conversion of the note and exercise of the warrant have been registered on Form S-1. The investor was also granted the right to participate in future financing transactions of the Company for a term of two years.

11. Warrant Liability

Certain of the Company’s outstanding warrants require the Company to pay cash to the warrant holders, in the event of a fundamental transaction as defined. Such warrants are accounted for as liabilities in accordance with ASC 480. These liabilities are measured at fair value each reporting period and the change in the fair value is recognized in earnings in the accompanying Statements of Operations.

The fair value of the warrant liability was determined using the Black-Scholes-Merton option pricing model at June 30, 2018 and December 31, 2017, using the following assumptions:

The risk-free interest rate is based on rates established by the Federal Reserve Bank. The Company uses the historical volatility of its common stock to estimate its future volatility. The expected life of the warrant is based upon its remaining contractual life. The expected dividend yield reflects that the Company has not paid dividends to its common stockholders in the past and does not expect to do so in the foreseeable future.

REED’S, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

Three and Six Months Ended June 30, 2018 and 2017 (Unaudited)

(In thousands, except share and per share amounts)

12. Stock Based Activity

Common stock issued

On January 10, 2018, the Company’s Board of Directors (“Board”) awarded certain independent Directors an aggregate of 400,000 shares of common stock pursuant to Reed’s 2017 Incentive Compensation Plan (“the Plan”). The shares were issued as compensation for services provided during 2017, accordingly the Company recognized $680, the fair value of the shares, as compensation expense during the year ended December 31, 2017. The shares were issued during the first quarter of 2018.

Stock Awards

The following table summarizes restricted stock activity during the six months ended June 30, 2018:

In the first quarter of 2018, the independent Directors of the Board were granted an aggregate of 70,588 shares of restricted common stock pursuant to the Plan. The shares vest in four equal installments during 2018, and the $120 fair value of the shares is being amortized ratably over that period. During the six months ended June 30, 2018, 34,704 vested shares were issued.

On January 10, 2018, pursuant to its employment agreement with Mr. Valentin Stalowir, Chief Executive Officer of the Company, dated June 28, 2017, the Company’s Board granted to Mr. Stalowir an award of 371,268 shares of restricted common stock with a fair value of $631, pursuant to the Plan. The award vests over 18 months, and the fair value of the grant is being amortized to compensation expense through June 2019. During the six months ended June 30, 2018, 185,634 shares of common stock vested puruant to the award and were issued to Mr. Stalowir.

On March 28, 2018, the Company’s Board awarded Mr. Stalowir an additional award of 412,736 shares of restricted common stock with a fair value of $660 pursuant to the Plan. This award is subject to shareholder approval to increase the number of shares available under the Plan, and will not otherwise be issued until January 2019. The fair value of these shares is also being amortized to compensation expense through June 2019 when the shares vest.

Restricted common stock issued pursuant to the Plan is subject to such restrictions as determined by the Compensation Committee of the Board, which may include restrictions on the sale of such shares or the right to receive dividends thereon. Additionally, the restricted common stock is subject to a risk of forfeiture, generally upon termination of employment or service during the vesting period. Vesting may be dependent upon the recipient’s continued relationship with the Company, or may depend upon the achievement of certain pre-established performance goals.

During the six months ended June 30, 2018, an aggregate of $706 was recognized as compensation expense relative to these awards. As of June 30, 2018, the amount of unvested compensation related to issuances of restricted common stock awards was approximately $706, which will be recognized as an expense in future periods as the shares vest.

Stock options

REED’S, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

Three and Six Months Ended June 30, 2018 and 2017 (Unaudited)

(In thousands, except share and per share amounts)

The aggregate intrinsic value was calculated as the difference between the closing market price as of June 30, 2018, which was $2.85, and the exercise price of the outstanding stock options.

On January 10, 2018, pursuant to its employment agreement with Valentin Stalowir dated June 28, 2017, the Company’s Board granted to Mr. Stalowir options to purchase 371,268 shares of stock, pursuant to the Plan. The options have an exercise price of $1.70, vest over 18 months, and have a 10 year life. The $370 fair value of the options is being amortized through June 2019.

On March 28, 2018, the Company approved the issuance of options to purchase 1,628,500 shares of common stock to certain current employees, officers and Directors pursuant to the Plan. One half of these options vest annually over a four-year period; the other half of these options will vest based on performance criteria to be established by the Board at its discretion. The $1,441 fair value of the options is being amortized through March 31, 2022.

Also, on March 28, 2018, the Company approved the repricing of former Chief Financial Officer Mr. Miles’ 2015 Plan options to the market price of $1.60, and extended the option period an additional four years.

On March 28, 2018, the Board awarded Mr. Stalowir options to purchase 412,736 shares of common stock, which are subject to shareholder approval to increase the number of shares available under the Plan, and are not otherwise issuable until January 2019. One half of these options will vest annually over a four-year period; the other half of these options will vest based on performance criteria to be established by the Board. The fair value of these options of $389 is being amortized through March 31, 2022.

During the three and six months ended June 30, 2018, the Company recognized $309 and $470 of compensation expense relating to outstanding stock options. As of June 30, 2018, the amount of unvested compensation related to stock options was approximately $1,529 which will be recorded as an expense in future periods as the options vest.

As of June 30, 2018, the company has accrued $571 of compensation expense, consisting of amounts due Mr. Stalowir for anticipated performance bonuses earned through that date by the terms of his employment agreement with the Company, as well as the tax liability arising from the share-based awards described above.

Common Stock Purchase Warrants

The intrinsic value was calculated as the difference between the closing market price as of June 30, 2018, which was $2.85, and the exercise price of the Company’s warrants to purchase common stock.

During the six months ended June 30, 2018, warrants to acquire 286,067 shares of common stock were exercised, resulting in proceeds of $578 to the Company.

13. Subsequent Event – Company Relocation

In August of 2018, the company concluded negotiations for a lease on new office space and plans to relocate its Company headquarters to Norwalk, CT over the next several months after completing the exit of the Company’s production facility in Los Angeles, CA. The Company’s move to Norwalk, CT, is consistent with its recent focus on a streamlined sales and marketing organization that is better positioned for future growth and enhanced profitability. The new Norwalk office will serve as headquarters for the Company’s operations, business development, sales and marketing, finance, supply chain, HR and other corporate functions. With key leadership already based in the Tri-State area, including support agencies leading the Company’s marketing, advertising and public relations efforts, this will ensure a seamless transition. The term of the lease is for 6.5 years with monthly payments of $10 during the first 3 years and then adjusting to $20 through December 15, 2024. The Company expects the lease to be executed and effective in August 2018.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and the related notes appearing elsewhere in this report. This discussion and analysis may contain forward-looking statements based on assumptions about our future business.

Overview

In order to strengthen our operations, position ourselves for the future, and develop the Company into a premier sales and marketing organization, we took the following actions beginning in June of 2017:

We are very pleased to report that these and other actions have resulted in selling price growth during the quarter, on a 12-ounce case basis, of 6% on our core brands and an even larger improvement in cost of goods sold (COGS) with a reduction of 12%. Price increases taken in the prior year and COGS reductions this quarter led to our gross margin increasing to 32% from 19% over the same quarter in 2017. When combined with the volume increase, the resulting top line profit almost doubled to $3,042 or 81% over the same quarter in the prior year.

Our operating expenses increased as planned as we added new leadership talent, invested in sales, marketing and brand refresh initiatives, and compensated employees with non-cash performance-based equity awards and accrued for anticipated bonuses. We also accrued for severance as a result of the pending relocation of our headquarters to Norwalk, CT.

We have $3,811 cash available for working capital purposes. We have executed a term sheet for a secured revolving line of credit, and management anticipates that the refinancing will be completed prior to October 2018.

Results of Operations – Three months ended June 30, 2018

The following table sets forth key statistics for the three months ended June 30, 2018 and 2017, respectively, in thousands.