Reed’s, Inc. (REED:BUY) Q4 was disappointing as results slipped back to a loss due to continued high marketing and promotional expenses.

Q4 HIGHLIGHTS

• Q4 EPS was a loss of $(0.05) per share vs. $(0.07) in Q4:12 and our estimate of $0.00. Q4 net revenues grew 23% to $9.6 million from $7.8 million LY but were shy of our $9.9 million estimate.
• Q4 gross margin rose 160 bps to 27.5% (vs. our 32.4% est.) but would have been 29.2% had promotional spending & discounts been kept to Q4:12 levels.
• Q4 SG&A expenses grew 11.5% to $3.1 million but fell 250 bps to 32.4% of revenues as net revenues increased 23%.
• A key focus in 2014 will be reducing the amount of promotions & discounts which reduce gross margins. Such costs ballooned to 12% of gross revenue in 2013. Over time, the goal is to reduce them back to the 9%-10% level.
• Reflecting reductions to our sales and gross margins estimates and less expense leverage than previously forecast, we are reducing our 2014-15 EPS estimates. Our FY:14 estimate is reduced to $0.01 from 0.08 per share, while FY:15 is trimmed to $0.12 per share from $0.18.
• Our $8.50 price target (previously $9.50) is based on an EV/Revenue multiple of 2.5x applied to a revised FY:14 revenue estimate of $46.9 million.
• Despite Q4 results and reductions to our estimates and price target, we believe our thesis remains intact and that REED can deliver annual revenue growth of 15%-20% with improving profitability as the company begins to leverage its operating model. Accordingly, we maintain our BUY rating.

RISKS 

• Failure to successfully grow the kombucha probiotic tea product line.
• Failure to generate consistent and improving profits on strongly rising sales.
• Quality and depth of management team and recent management turnover.