·

The offer must be in writing and the exact text must be submitted to and approved by the Securities Commissioner in advance.

 

·	The offer must be worded so that the subscriber must answer affirmatively that the subscriber either accepts or rejects the rescission offer.

 

·	The offer must be mailed to the address of the subscriber which appears on the books of the transfer agent.

 

·	The subscriber shall have 30 days from the date of receipt to accept the offer (acceptance period). Acceptance or rejection shall be effective upon mailing by the subscriber.

 

·	If a subscriber fails to respond, the investment will be deemed rescinded.

 

·	During the acceptance period no other communications other than reminders that the rescission letter be returned may be initiated by the issuer or its agents with any subscribers to whom the rescission offer is being made.

 

·

At the close of the acceptance period, the issuer shall file with the Securities Commissioner a report indicating the date the acceptance period ended, the number of subscribers to whom the offer was made, and the number of subscribers who accepted the rescission offer and number of shares rescinded.

 

·

Resumption of offers and/or sales shall not take place until the Securities Commissioner so orders.

 

We believe that this rescission offer complies in all material respects with the rescission offer requirements of the Indiana Securities Act.

 

Louisiana

 

None of the shares sold in the state of Louisiana may have been issued pursuant to an effective registration statement or an applicable exemption from the registration requirements set forth in the Louisiana Securities Law.

 

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Under Louisiana law, an issuer is civilly liable to a purchaser of securities sold in violation of the registration requirements of the Louisiana Securities Law. The purchaser may sue to recover the consideration paid in cash, plus interest at 8% per year, less the amount of any income received thereon, together with all taxable court costs and reasonable attorney’s fees, upon the tender of the security at any time before the entry of judgment, or for damages, if the purchaser no longer owns the security. The purchaser must bring suit within two years from the date of the sale.

 

However, we may terminate the rights of the purchasers to seek additional remedies under the Louisiana Securities Law by making a written rescission offer, before suit and at a time when the purchaser owned the security, to repay in cash or by certified or official bank check, within 30 days from the date of acceptance of such offer in exchange for the securities, the fair value of the consideration paid, plus interest at 8% per year, less the amount of any income received on the security, and the purchaser fails to accept the offer within 30 days of receiving it. If the written offer is provided to the purchaser at a time when the purchaser no longer owns the security, then the repayment amount is equal to the difference between the fair value of the consideration the purchaser gave for the security and the fair value of the security at the time the purchaser disposed of it, plus interest at 8% per year, less the amount of any income received on the security. No such written offer will be effective unless, if it were an offer to sell securities, it would be exempt under Section 51:709 of the Louisiana Securities Law, or, if registration would have been required, such rescission offer has been registered and effected under the Louisiana Securities Law. The purchaser will no longer have a right of rescission under the Louisiana law if the purchaser fails to accept such offer within the period of time specified.

 

We believe that this rescission offer complies in all material respects with the rescission offer requirements of the Louisiana Securities Law.

 

Massachusetts

 

None of the shares sold in the state of Massachusetts may have been issued pursuant to an effective registration statement or an applicable exemption from the registration requirements set forth in the Massachusetts Uniform Securities Act.

 

Under Massachusetts law, an issuer is civilly liable to a purchaser of its securities sold in violation of the registration requirements. The purchaser may sue to recover the consideration paid, plus interest at 6% per year, costs and reasonable attorneys’ fees, less the amount of any income received on the security, upon the tender of the security, or for damages if the purchaser no longer owns the security. The purchaser must bring suit within four years after the purchaser discovers the violation in question.

 

However, we may terminate the rights of the purchasers to seek additional remedies under the Massachusetts Uniform Securities Act by making a written rescission offer, before suit and at a time when the purchaser owned the security, to refund the consideration paid with interest at 6% per year, less the amount of any income received on the security, and the purchaser fails to accept the offer within 30 days of receiving it, or if the purchaser receives such an offer before suit and at a time when the purchaser did not own the security, unless the purchaser rejects the offer in writing within 30 days of receiving it. The purchaser will no longer have a right of rescission under Massachusetts law if the purchaser fails to accept such offer within the period of time specified.

 

We believe that this rescission offer complies in all material respects with the rescission offer requirements of the Massachusetts Uniform Securities Act.

 

Missouri

 

None of the shares sold in the state of Missouri may have been issued pursuant to an effective registration statement or an applicable exemption from the registration requirements set forth in the Missouri Securities Act of 2003.

 

Under Missouri law, an issuer is civilly liable to persons who purchase securities sold by the issuer in violation of the registration requirements. The purchaser may sue to recover the consideration paid for the security, less the amount of any income received on the security, and interest at 8% per year, costs and reasonable attorneys’ fees, upon the tender of the security, or for actual damages. The purchaser must bring the action within one year after the violation occurs.

 

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However, we may terminate the rights of the purchasers to seek additional remedies under the Missouri Securities Act of 2003 by making a written rescission offer, before suit, which states the respect in which liability may have arisen, fairly advises the purchaser of the purchaser’s rights in connection with the offer and provides any financial or other information necessary to correct all material misrepresentations or omissions in the information that was required to be furnished to the purchaser at the time of the purchase. The offer must present an offer to repurchase the security for cash, payable on delivery of the security, equal to the consideration paid, plus interest at 8% per year, less the amount of any income received on the security, or for damages if the purchaser no longer owns the security. The offer must be accepted by the purchaser within 30 days after the date it is received. The purchaser will no longer have a right of rescission under Missouri law if the purchaser fails to accept such offer within the period of time specified.

 

We believe that this rescission offer complies in all material respects with the rescission offer requirements of the Missouri Securities Act of 2003.

 

Montana

 

None of the shares sold in the state of Montana may have been issued pursuant to an effective registration statement or an applicable exemption from the qualification requirements set forth in the Securities Act of Montana.

 

Under Montana law, a person who offers or sells securities in violation of the registration requirements is civilly liable to the person buying the security. The purchaser may sue to recover the consideration paid for the security, together with interest at 10% per year, costs, and reasonable attorneys’ fees less the amount of any income received on the security, upon the tender of the security. The purchaser may also sue for damages if he no longer owns the security. The purchaser must bring the action for violation of the registration requirements within two years after the violation occurs.

 

However, we may terminate the rights of the purchasers to seek additional remedies under the Securities Act of Montana by making a written rescission offer, before suit and at a time when he owned the security, to refund the consideration paid, together with interest at 10% per year, less the amount of any income received on the security and the purchaser failed to accept the offer within 30 days of its receipt. If the purchaser no longer owns the security, the purchaser may not commence such an action if he received a written offer in the amount that would be recoverable if the purchaser did own the security upon a tender, less the value of the security when the purchaser disposed of it, plus interest at 10% per year.

 

We believe that this rescission offer complies in all material respects with the rescission offer requirements of the Securities Act of Montana.

 

New York

 

Under New York law, there is no requirement to register or qualify securities, and there is no provision for rescission offers. We applied for an exemption under New York law from the broker-dealer registration and securities issuance requirements with the State of New York to issue the shares to you in the public offering without registration or qualification. Because we applied for such an exemption, we believe that the shares of common stock issued by us in the state of New York were issued pursuant to an exemption from registration or qualification under New York law.

 

If shares were issued to you in New York, you do not have a right of rescission under New York law. Accordingly, the rescission offer is being made with respect to individuals who purchased shares of our common stock in New York, pursuant only to federal rights of rescission. The acceptance or non-acceptance of the rescission offer by these individuals will have no effect under New York law.

 

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Oregon

 

None of the shares sold in the state of Oregon may have been issued pursuant to an effective registration statement or an applicable exemption from the qualification requirements set forth in the Oregon Securities Law.

 

Under Oregon law, a person who offers or sells securities in violation of the registration requirements is civilly liable to the person buying the security. If the purchaser still owns the security, the purchaser may sue to recover, upon tender of the security, the consideration paid for the security, plus interest at 9% per year, less any amount received on the security. If the purchaser no longer owns the security, the purchaser may sue to recover damages in the amount that would be recoverable upon a tender, less the value of the security when the purchaser disposed of it, and less interest on such value from the date of disposition. The purchaser must bring the action for violation of the registration requirements within three years after the sale of the security.

 

However, we may terminate the rights of the purchasers to seek additional remedies under the Oregon Securities Law by making a written rescission offer, before suit, containing both (i) an offer to pay the purchaser the consideration paid for the security, interest at 9% per year, less any amount received on the security, and (ii) a statement of the effect on the purchaser’s rights of failure to respond. An action for violation of the registration requirements may be commenced after receipt of a notice, if the purchaser owned the security when the notice was received, accepted the payment offer within 30 days after its receipt, and has not been paid the full amount offered; or if the purchaser did not own the security when the notice was received, and within 30 days after receipt, gave written notice of inability to tender back the security.

 

We believe that this rescission offer complies in all material respects with the rescission offer requirements of the Oregon Securities Law.

 

South Carolina

 

None of the shares sold in the state of South Carolina may have been issued pursuant to an effective registration statement or an applicable exemption from the qualification requirements of the South Carolina Uniform Securities Act of 2005.

 

Under South Carolina law, a person who offers or sells securities in violation of the registration requirements is civilly liable to the person buying the security. The purchaser may sue to recover the consideration paid for the security, less the amount of any income received on the security, and interest at 11.25% per year, costs and reasonable attorneys’ fees determined by the court, upon the tender of the security. If the purchaser no longer owns the security, the purchaser may sue for actual damages that would be recoverable upon a tender less the value of the security when the purchaser disposed of it, plus interest at 11.25% per year, costs and reasonable attorneys’ fees determined by the court. Tender may be made at any time before entry of judgment. Tender requires only notice in a record of ownership of the security and willingness to exchange the security for the amount specified. The legal rate of interest payable under South Carolina law is based on the prime rate as listed in the first edition of the Wall Street Journal published for each calendar year for which the damages are awarded, plus four percentage points, compounded annually. For purposes of the rescission offer, the rate of interest applicable to the rescission offer will be based on the prime interest rate (7.25%) listed in the first edition of the Wall Street Journal published in calendar year 2006. A person must bring an action for violation of the registration requirements within three years after the violation occurred.

 

However, we may terminate the rights of the purchasers to seek additional remedies under South Carolina Uniform Securities Act of 2005 by making a written rescission offer, before suit stating the respect in which liability may have arisen, and fairly advising the purchaser their rights in connection with the offer, and any financial or other information that was required to be furnished to that person at the time of the purchase of the securities. The rescission must include an offer to repurchase the security for cash, payable upon delivery of the security, equal to the consideration paid, including all commissions and fees, plus interest at 11.25% per year, less the amount of any income received on the security. If the purchaser no longer owns the security, the offer may be to pay the purchaser upon acceptance of the offer, damages in an amount that would be recoverable upon a tender, less the value of the security when the purchaser disposed of it, plus interest at 11.25% per year. The offer must be accepted by the purchaser within 30 days after the date of its receipt by the purchaser. The offeror must have the present ability to pay the amount offered or to tender the security. Finally, the offer must be delivered to the purchaser, or sent in a manner that ensures receipt by the purchaser, and the purchaser must accept the offer and be paid in accordance with the terms of the offer.

 

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We believe that this rescission offer complies in all material respects with the rescission offer requirements of the South Carolina Uniform Securities Act of 2005.

 

Utah

 

None of the shares sold in the state of Utah may have been issued pursuant to an effective registration statement or an applicable exemption from the qualification requirements set forth in the Utah Uniform Securities Act.

 

Under Utah law, a person who offers or sells securities in violation of the registration requirements is civilly liable to the person buying the security. The purchaser may sue to recover the consideration paid for the security, together with interest at 12% per year, costs and reasonable attorney’s fees, less the amount of any income received on the security, upon the tender of the security, or for damages if he no longer owns the security. Damages are the amount that would be recoverable upon a tender less the value of the security when the buyer disposed of it, and interest at 12% per year. If the purchaser can show that the violation was reckless or intentional, the purchaser may bring suit for three times the consideration paid for the security, together with interest, costs and attorney’s fees. The purchaser must bring the action for violation of the registration requirements within four years after the act or transaction constituting the violation, or within two years after the discovery by the purchaser of the facts constituting the violation, whichever expires first.

 

However, we may terminate the rights of the purchasers to seek additional remedies under the Utah Uniform Securities Act by making a written rescission offer, before suit and at a time when he owned the security, to refund the consideration paid together with interest at 12% per year, less the amount of any income received on the security, and he failed to accept the offer within 30 days of receipt. If the purchaser no longer owns the security, he may not commence such an action if he received a written offer before suit, unless he rejected the offer in writing within 30 days of its receipt.

 

We believe that this rescission offer complies in all material respects with the rescission offer requirements of the Utah Uniform Securities Act.

 

Vermont

 

None of the shares sold in the state of Vermont may have been issued pursuant to an effective registration statement or an applicable exemption from the qualification requirements set forth in the Vermont Uniform Securities Act.

 

Under Vermont law, a person who offers or sells securities in violation of the registration requirements is civilly liable to the person buying the security. The purchaser of the security may sue to recover the consideration paid for the security, together with interest at 12% per year, costs and reasonable attorneys’ fees, less the amount of any income received on the security, upon the tender of the security, or for damages plus costs and reasonable attorneys’ fees if the purchaser no longer owns the securities. Damages are the amount that would be recoverable upon a tender, less the value of the security when the purchaser disposed of it, and interest at 12% per year. Tender shall require only notice of willingness to exchange the security for the amount specified. The purchaser must bring the action for violation of the registration requirements within three years after the act, omission or transaction constituting the violation, or within two years after the violation is or reasonably should have been discovered, whichever occurs later, but not later than six years after the act, omission or transaction constituting the violation.

 

Under Vermont law, effective as of July 1, 2006, an action may not be maintained if before the action is instituted, the purchaser receives an offer stating the respect in which the civil liability may have arisen and fairly advising the purchaser of that person's rights in connection with the offer, and any financial or other information necessary to correct all material misrepresentations or omissions in the information that was required by this chapter to be furnished to that person at the time of the purchase. The offer must be to repurchase the security for cash, payable on delivery of the security, equal to the consideration paid, together with interest at the rate of 12% per year, less the amount of any income received on the security, or, if the purchaser no longer owns the security, an offer to pay the purchaser upon acceptance of the offer damages in an amount that would be recoverable upon a tender, less the value of the security when the purchaser disposed of it, together with interest at the rate of 12% per year. The offer must be accepted by the purchaser within 30 days of its receipt, the offeror must have the present ability to pay the amount offered or to tender the security, the offer must be delivered to the purchaser in a manner that ensures receipt by the purchaser and the purchaser must be paid in accordance with the terms of the offer.

 

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Virginia

 

None of the shares sold in the state of Virginia may have been issued pursuant to an effective registration statement or an applicable exemption from the qualification requirements set forth in the Virginia Securities Act.

 

Under Virginia law, a person who offers or sells securities in violation of the registration requirements is civilly liable to the person buying the security. The purchaser may sue to recover the consideration paid for the security, together with interest at 6% per year, costs, and reasonable attorneys’ fees, less the amount of any income received on the security, upon the tender of such security, or for the substantial equivalent in damages if he no longer owns the security. Any tender may be made at any time before entry of judgment. The purchaser must bring the action for violation of the registration requirements within two years after the transaction upon which the action is based.

 

However, we may terminate the rights of the purchasers to seek additional remedies under the Virginia Securities Act by making a written rescission offer, before suit, to refund the consideration paid, together with interest at 6% per year, less the amount of any income received on the security, or to pay damages if the purchaser no longer owns the security, and the purchaser refuses or fails to accept such offer within 30 days of its receipt.

 

We believe that this rescission offer complies in all material respects with the rescission offer requirements of the Virginia Securities Act.

 

Washington

 

None of the shares sold in the state of Washington may have been issued pursuant to an effective registration statement or an applicable exemption from the qualification requirements set forth in the Securities Act of Washington.

 

Under Washington law, a person who offers or sells securities in violation of the registration requirements is civilly liable to the person buying the security. The purchaser may sue to recover the consideration paid for the security, together with interest at 8% per year, costs and reasonable attorneys’ fees, less the amount of any income received on the security, upon the tender of the security, or for damages if the purchaser no longer owns the security. Damages are the amount that would be recoverable upon a tender less (i) the value of the security when the purchaser disposed of it, and (ii) interest at 8% per year from the date. The purchaser must bring the action for violation of the registration requirements within three years after the contract of sale.

 

However, we may terminate the rights of the purchasers to seek additional remedies under the Securities Act of Washington by making a written rescission offer, before suit, which has been passed upon by the director before suit, and at a time when the purchaser owned the security, to refund the consideration paid together with interest at 8% per year, less the amount of any income received on the security.

 

We believe that this rescission offer complies in all material respects with the rescission offer requirements of the Securities Act of Washington.

 

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Israel

 

Israel’s securities law, known as The Securities Law, 5728-1968, prohibits the offering of securities to the public, other than under a prospectus, the publication of which has been permitted by the Israel Securities Authority. The regulations promulgated under The Securities Law provide for an exemption to this general prohibition when the number of investors in Israel to whom the offeror sells the offered securities in an offering, combined with the number of investors in Israel to whom the offeror sold securities during the twelve month preceding the offer, is less than 35 investors. Because we have sold our securities to fewer than 35 investors in Israel at any time, we believe that the shares of common stock issued by us in Israel in the public offering were issued pursuant to an exemption from the prospectus publication requirements under Israeli law.

 

If shares were issued to you in Israel, you do not have a right of rescission under Israeli law. Accordingly, the rescission offer is being made with respect to individuals who purchased shares of our common stock in Israel, pursuant only to United States federal rights of rescission. The acceptance or non-acceptance of the rescission offer by these individuals will have no effect under Israeli law.

 

Funding the Rescission Offer

 

We have entered into an agreement with Mark Reed and Robert T. Reed, Jr. (the “designated purchasers”) that they would irrevocably commit to purchase up to all of the shares in the rescission offer that are tendered to us for rescission. We would assign to the designated purchasers the right to purchase any rescission shares at 100% of the amount required to pay the rescission price under applicable state law. As currently contemplated, the initial $250,000 of rescission shares would be purchased by Mark Reed. If the number of rescission shares tendered for rescission exceeds $250,000 of shares, Robert T. Reed, Jr. would purchase the balance of the rescission shares tendered for rescission to us. Each of the designated purchasers is a brother of Christopher J. Reed, our Chief Executive Officer, Chief Financial Officer and the Chairman of the Board of Directors. Robert T. Reed, Jr. also is our Vice President and National Sales Manager - Mainstream and a beneficial owner of approximately 7.13% of our common stock. Each of the designated purchasers may also participate in the purchase of shares of common stock to be distributed in the public offering. Since up to all of the rescission shares would be purchased by the designated purchasers, none of the rescission shares would be purchased directly by us and would not deplete proceeds from our public offering or other of our then current cash balances. The rescission shares, which may be purchased by the designated purchasers in the rescission offer, would be deemed to be registered shares for the benefit of the designated purchasers pursuant to a registration statement to be filed by us relating to the rescission offer under the Securities Act, effective as of the commencement date of the rescission offer without any further action on the part of the designated purchasers. If we are required to pay the obligation which may be created under the rescission offer, such a refund would materially and adversely effect our financial position.

 

Directors, Officers and Major Stockholders

 

None of our officers, directors or 5% stockholders purchased shares in our initial public offering and are not eligible to participate in this rescission offer for purposes of tendering their shares for rescission. However, we have entered into an agreement with Mark Reed and Robert T. Reed, Jr. (the “designated purchasers”) that they would irrevocably commit to purchase up to all of the shares in the rescission offer that are tendered to us for rescission. Robert T. Reed, Jr. is a beneficial owner of approximately 7.13% of our common stock. If Robert T. Reed, Jr. purchases shares in this rescission offer, he would increase his ownership interest in us.

 

MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES

 

Tax Consequences of the Rescission Offer

 

The following discussion summarizes the material federal income tax considerations relevant to our stockholders who hold shares that are subject to the rescission offer. We do not discuss all income tax considerations that may be relevant to particular stockholders in light of their individual circumstances, such as stockholders who are non-U.S. persons, stockholders who are not individuals, or stockholders subject to the alternative minimum tax provisions of the Internal Revenue Code of 1986, as amended, or the Code. In addition, we do not address the tax consequences of the rescission offer to persons who hold shares that are subject to hedging, conversion, or constructive sale transactions, or whose tax year is other than a calendar year. Finally, we do not address any foreign, state or local tax considerations. ACCORDINGLY, STOCKHOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORS AS TO THE SPECIFIC TAX CONSEQUENCES OF THE RESCISSION OFFER, INCLUDING THE APPLICABLE FEDERAL, STATE, LOCAL AND FOREIGN TAX CONSEQUENCES TO THEM OF THE RESCISSION OFFER.

 

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General

 

The repurchase of shares from our stockholders may be treated by the Internal Revenue Service, or the Service, as, among other things, (i) a redemption of equity securities by us, or (ii) a purchase of securities by a third party. Because we cannot determine in advance how the Service may characterize these transactions, we have described below the treatment under the two most likely characterizations.

 

We have entered into an agreement with Mark Reed and Robert T. Reed, Jr. (the “designated purchasers”) that they would irrevocably commit to purchase up to all of the shares in the rescission offer that are tendered to us for rescission. We would assign to the designated purchasers the right to purchase any rescission shares at 100% of the amount required to pay the rescission price under applicable state law. Each designated person will buy the rescission shares for his own account and with his own funds. There is no plan or intention by us to redeem the shares to be acquired by the designated purchaser.

 

Treatment as Repurchase of Shares

 

We intend to treat the rescission transaction as one strictly between the stockholder and the designated purchaser. A sale to the designated purchaser for an amount of cash equal to the original purchase price, plus applicable accrued interest, would be treated as a sale or exchange, and assuming that such stockholder holds the rescission shares as a capital asset, the sale would be treated as a capital gain or loss (within the meaning of Section 1221 of the Code and administrative and case law thereunder). The amount of the gain would be the amount received by the stockholder (including the accrued interest amount) less the amount originally paid for the rescission shares. In this analysis, we have assumed that the Service will not assert that the designated purchasers are in any way acting as our agent in making the purchase of the rescission shares. If the Service were to assert that the designated purchasers are acting as our agent in making the purchase of the rescission shares, then the tax treatment would more likely be similar to that described in the subparagraph below entitled “Treatment as Redemption of Shares.”

 

Treatment as Redemption of Shares

 

The Service may take the position that the rescission will constitute a taxable redemption of the rescission shares for cash, with the redemption price equal to the amount paid for such shares (and include in the redemption price the interest on the original purchase price of such rescission shares). A redemption for an amount of cash equal to the original purchase price (plus accrued interest) could be treated as a redemption governed by the rules of Section 302 and related sections of the Code. However, the federal tax law governing this proposed transaction is unclear, at best, and we have not received a ruling from the Service regarding such tax consequences. For example, the Service could characterize the rescission offer as the return of the original purchase price, which would ordinarily be nontaxable, plus the payment of interest, which would be taxable as ordinary income.

 

If this tax position as a redemption is sustained, any rescission transaction would be treated as a sale or exchange, and, assuming that such stockholder holds his shares as a capital asset (within the meaning of Section 1221 of the Code and administrative and case law thereunder), the character of any gain or loss to the stockholder would be treated as a capital gain or loss, if:

 

·

It results in a “complete redemption” of the stockholder's interest in us under Section 302(b)(3) of the Code, which would be the case if either (i) all of the shares actually and constructively owned by the stockholder are sold pursuant to the rescission offer, or (ii) all of the shares actually owned by the stockholder are sold pursuant to the rescission offer and the stockholder is eligible to waive, and effectively waives, constructive ownership of the shares under procedures described in Section 302(c) of the Code;

 

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·

It is “substantially disproportionate” with respect to the stockholder under Section 302(b)(2) of the Code, which would occur if (i) the percentage of our voting stock owned by the stockholder immediately after the repurchase, taking into account all shares purchased from the stockholder pursuant to the rescission offer, equals less than 80% of the percentage of our voting stock owned by the stockholder immediately before the repurchase, and (ii) the stockholder, after the repurchase, owns less than 50% of the total combined voting power of all classes of our stock entitled to vote; or

 

·

It is not “essentially equivalent to a dividend” with respect to the stockholder, under Section 302(b)(1) of the Code, which would occur if, in light of the stockholder's individual circumstances, including his relative interest in us, his sale of shares pursuant to the rescission offer results in a “meaningful reduction” of his interest in us.

 

In determining whether any of the above redemption tests are satisfied, a stockholder must take into account not only shares that are actually owned by him, but also shares that are constructively owned by him within the meaning of Section 318 of the Code. Section 318 of the Code provides that a stockholder may constructively own shares actually owned, and in some cases, constructively owned by certain related individuals and shares that he has the right to acquire by the exercise of an option, warrant, or a conversion right. Contemporaneous or related transactions in our capital stock or capital stock rights also may affect the redemption tests.

 

If the rules of Section 302 were to apply and the rescission fails to qualify as a redemption, then the gross proceeds of such transaction would be characterized as a dividend distribution, taxable at ordinary income tax rates to the extent of our accumulated and current earnings and profits (if any), and any excess would be treated as a return of capital, to the extent of the stockholder’s basis in the rescission shares, and any amount in excess of the basis would be treated as a gain from a sale or exchange of a capital asset.

 

THE LAW APPLICABLE TO THE RESCISSION OFFER IS UNCLEAR AND WE HAVE NOT RECEIVED AN OPINION OF COUNSEL OR A RULING FROM THE SERVICE TO THAT EFFECT. THUS, THE SERVICE COULD SUCCESSFULLY ASSERT A CONTRARY POSITION, OR OTHERWISE, RECHARACTERIZE THE TRANSACTION IN WHOLE OR IN PART.

 

THE PRECEDING DISCUSSION IS INTENDED ONLY AS A SUMMARY OF CERTAIN UNITED STATES INCOME TAX CONSEQUENCES OF THE RESCISSION OFFER AND DOES NOT PURPORT TO BE A COMPLETE ANALYSIS OR DISCUSSION OF ALL POTENTIAL TAX EFFECTS RELEVANT THERETO. STOCKHOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORS AS TO THE SPECIFIC TAX CONSEQUENCES TO THEM OF THE RESCISSION OFFER, INCLUDING TAX RETURN REPORTING REQUIREMENTS, THE APPLICABILITY AND EFFECT OF FOREIGN, FEDERAL, STATE, LOCAL, AND OTHER APPLICABLE TAX LAWS AND THE EFFECT OF ANY PROPOSED CHANGES IN THE TAX LAWS.

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This prospectus contains forward-looking statements. The forward-looking statements are contained principally in, but not limited to, the sections entitled “Risk Factors,” “Management’s Discussion and Analysis or Plan of Operation” and “Business.” Forward-looking statements provide our current expectations or forecasts of future events. Forward-looking statements include statements about our expectations, beliefs, plans, objectives, intentions, assumptions and other statements that are not historical facts. Words or phrases such as “anticipate,” “believe,” “continue,” “ongoing,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project” or similar words or phrases, or the negatives of those words or phrases, may identify forward-looking statements, but the absence of these words does not necessarily mean that a statement is not forward-looking.

 

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Forward-looking statements are subject to known and unknown risks and uncertainties and are based on potentially inaccurate assumptions that could cause actual results to differ materially from those expected or implied by the forward-looking statements. Our actual results could differ materially from those anticipated in forward-looking statements for many reasons, including the factors described in the section entitled “Risk Factors” in this prospectus. Accordingly, you should not unduly rely on these forward-looking statements, which speak only as of the date of this prospectus.

 

Unless required by law, we undertake no obligation to publicly revise any forward-looking statement to reflect circumstances or events after the date of this prospectus or to reflect the occurrence of unanticipated events. You should, however, review the factors and risks we describe in the reports we will file from time to time with the SEC, after the date of this prospectus.

 

Management cautions that these statements are qualified by their terms and/or important factors, many of which are outside of our control, involve a number of risks, uncertainties and other factors that could cause actual results and events to differ materially from the statements made, including, but not limited to, the following:

 

·	The effectiveness of our rescission offer to preclude certain holders of our stock from seeking relief for alleged violations of securities laws in connection with securities issuances in connection with our initial public offering,

 

·	Our ability to generate sufficient cash flow to support capital expansion plans and general operating activities,

 

·	Decreased demand for our products resulting from changes in consumer preferences,

 

·	Competitive products and pricing pressures and our ability to gain or maintain its share of sales in the marketplace,

 

·	The introduction of new products,

 

·

Our being subject to a broad range of evolving federal, state and local laws and regulations including those regarding the labeling and safety of food products, establishing ingredient designations and standards of identity for certain foods, environmental protections, as well as worker health and safety. Changes in these laws and regulations could have a material effect on the way in which we produce and market our products and could result in increased costs,

 

·	Changes in the cost and availability of raw materials and the ability to maintain our supply arrangements and relationships and procure timely and/or adequate production of all or any of our products,

 

·	Our ability to penetrate new markets and maintain or expand existing markets,

 

·	Maintaining existing relationships and expanding the distributor network of our products,

 

·	The marketing efforts of distributors of our products, most of whom also distribute products that are competitive with our products,

 

·	Decisions by distributors, grocery chains, specialty chain stores, club stores and other customers to discontinue carrying all or any of our products that they are carrying at any time,

 

·	The availability and cost of capital to finance our working capital needs and growth plans,

 

·	The effectiveness of our advertising, marketing and promotional programs,

 

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·	Changes in product category consumption,

 

·	Economic and political changes,

 

·	Consumer acceptance of new products, including taste test comparisons,

 

·	Possible recalls of our products, and

 

·	Our ability to make suitable arrangements for the co-packing of any of our products.

 

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements.

 

DIVIDEND POLICY

 

We have never declared or paid dividends on our common stock. We currently intend to retain future earnings, if any, for use in our business, and, therefore, we do not anticipate declaring or paying any dividends in the foreseeable future. Payments of future dividends, if any, will be at the discretion of our board of directors after taking into account various factors, including the terms of our credit facility and our financial condition, operating results, current and anticipated cash needs and plans for expansion.

 

We are obligated to pay a non-cumulative 5% dividend from lawfully available assets to the holders of our Series A preferred stock in either cash or additional shares of common stock at our discretion. In 2005, we paid the dividend in an aggregate of 7,362 shares of common stock, and anticipate that we will be obligated to issue at least this many shares annually to the holders of the Series A preferred stock so long as such shares are issued and outstanding. See “Description of Our Securities - Preferred Stock.”

 

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 prospectus. This discussion and analysis may contain forward-looking statements based on assumptions about our future business. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including but not limited to those set forth under “Risk Factors” and elsewhere in this prospectus.

 

Overview

 

We develop, manufacture, market and sell natural non-alcoholic and “New Age” beverages, candies and ice creams. “New Age Beverages” is a category that includes natural soda, fruit juices and fruit drinks, ready-to-drink teas, sports drinks and water. We currently manufacture, market and sell six unique product lines:

 

·	Reed’s Ginger Brews,

 

·	Virgil’s Root Beer and Cream Sodas,

 

·	China Colas,

 

·	Reed’s Ginger Juice Brews,

 

·	Reed’s Ginger Candies, and

 

·	Reed’s Ginger Ice Creams

 

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We sell most of our products in specialty gourmet and natural food stores, supermarket chains, retail stores and restaurants in the United States and, to a lesser degree, in Canada. We primarily sell our products through a network of natural, gourmet and independent distributors. We also maintain an organization of in-house sales managers who work mainly in the stores serviced by our natural, gourmet and mainstream distributors and with our distributors. We also work with regional, independent sales representatives who maintain store and distributor relationships in a specified territory. In Southern California, we have our own direct distribution system.

 

The following table shows a breakdown of net sales with respect to our distribution channels for the periods set forth in the table:

 

		Direct sales to large retailer accounts			% of total sales			Local direct distribution			% of total sales			Natural, gourmet and mainstream distributors			% of total			Total sales
2005		$	1,536,896			16		$	751,999			8		$	7,181,390			76		$	9,470,285
2004			1,983,598			22			395,601			4			6,599,166			74			8,978,365
2003			1,286,365			19			90,121			1			5,405,290			80			6,781,776

 

Historically, we have focused our marketing efforts on natural and gourmet food stores. In 2003, we expanded our marketing efforts to include more mainstream markets. These efforts included selling our products directly to:

 

·	large retail accounts, such as Costco, BJ Wholesale, and Cost Plus World Markets, and

 

·	the natural food section of mainstream national supermarket chains, such as Safeway, Kroger’s, Ralph’s and Bristol Farms.

 

In addition, since 2003, we have introduced new products and offer specialty beverage packaging options not typically available in the marketplace into the marketplace that have contributed to our growth in sales. These products include a 5-liter “party keg” version of our Virgil’s Root Beer and Cream Soda, 12-ounce long neck bottles of our Virgil’s Cream Soda and 750 ml. size bottles of our Reed’s Original Ginger Brew, Extra Ginger Brew and Spiced Apple Brew.

 

We gauge the financial success of our company by a number of different parameters. Because our industry typically values companies on a top-line basis, one of our main company goals is to increase net sales. Our net sales have increased each year during the period from 2001 to 2005, as follows:

 

		2001			2002			2003			2004			2005
Net sales		$	6,200,000		$	6,400,000		$	6,800,000		$	9,000,000		$	9,500,000

 

We believe that the increase in net sales over this period comes from three factors:

 

·	successes in our Southern California direct distribution strategy,

 

·	increases in our core of national distribution to natural and gourmet food stores and mainstream supermarket chains, and

 

·	increases in our direct sales to large retailers.

 

Almost as important as increasing our net sales are increasing our gross margins. We continue to work to reduce costs related to production of our products. However, we have encountered difficulties in increasing our gross margins due to certain factors, including:

 

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·	inefficiencies commensurate with a start-up period for the Brewery that we purchased in 2002 as our West Coast production facility, and

 

·	higher freight, glass and production expenses due to the increase in the cost of fuel and increases in the price of ingredients in our products.

 

In 2002, we purchased and outfitted the Brewery, in part to help reduce both production costs and freight costs associated with our west coast sales. Gross margins decreased from 24.8% in 2002 to 19.5% in 2003 as a principal result of the start-up of the Brewery. Gross margins increased to 20.9% in 2004 as a principal result of attaining greater functionality and efficiencies in our operation of the Brewery by our own personnel and being able to produce and ship products in the western half of the Untied States from a west coast facility. However, in 2005, gross margins decreased to 18.2% as a principal result of increases in fuel prices, which put downward pressure on our margins due to increased freight expenses and increased glass and production costs, both of which are sensitive to fuel costs.

 

In addition, our west coast Brewery facility is running at 40% of capacity. We have had difficulties with the underutilization of the Brewery at 40% of capacity as a result of working out problems associated with the flavor of our ginger brew products produced at the Brewery, causing us to increase freight and other associated expenses with producing and shipping such products nationally from our east coast co-packing facility. Management is committed to selling a high quality, great tasting product. Since the east coast co-packer is producing such a product, management has elected to continue to sell that product on the west coast, even though it negatively impacts our gross margins. As we are able to make the Brewery become more fully utilized, we believe that we will experience improvements in gross margins due to freight and production savings.

 

Trends, Risks, Challenges, Opportunities That May or Are Currently Affecting Our Business

 

Our main challenges, trends, risks and opportunities that could affect or are affecting our financial results include but are not limited to:

 

Fuel Prices - Our freight rates were approximately 9.7% of net sales during 2005. We expect freight rates to increase by an additional 5% to 10% in 2006 as a result of the continuing increase in fuel prices. However, as we increase production at the Brewery, for delivery of products in the western half of the United States, we expect to offset this trend, at least in part, by reducing our need for cross-country freight services from our eastern co-packing facility.

 

Low Carbohydrate Diets and Obesity - Our products are not geared for the low carbohydrate market. Consumer trends have reflected higher demand for lower carbohydrate products. Despite this trend, we achieved an increase in our sales growth in 2005. We monitor these trends closely and have started developing low-carbohydrate versions of some of our beverages, although we do not have any currently marketable low-carbohydrate products.

 

Distribution Consolidation - There has been a recent trend towards continued consolidation of the beverage distribution industry through mergers and acquisitions. This consolidation results in a smaller number of distributors to market our products and potentially leaves us subject to the potential of our products either being dropped by these distributors or being marketed less aggressively by these distributors. As a result, we have initiated our own direct distribution to mainstream supermarkets and natural and gourmet foods stores in Southern California and to large national retailers. Consolidation among natural foods industry distributors has not had an adverse affect on our sales.

 

Consumer Demanding More Natural Foods - The rapid growth of the natural foods industry has been fueled by the growing consumer awareness of the potential health problems due to the consumption of chemicals in the diet. Consumers are reading ingredient labels and choosing products based on them. We design products with these consumer concerns in mind. We feel this trend toward more natural products is one of the main trends behind our growth. Recently, this trend in drinks has not only shifted to products using natural ingredients, but also to products with added ingredients possessing a perceived positive function like vitamins, herbs and other nutrients. Our ginger-based products are designed with this consumer demand in mind.

 

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Supermarket and Natural Food Stores - More and more supermarkets, in order to compete with the growing natural food industry, have started including natural food sections. As a result of this trend, our products are now available in mainstream supermarkets throughout the United States in natural food sections. Supermarkets can require that we spend more advertising money and they sometimes require slotting fees. We continue to work to keep these fees reasonable. Slotting fees in the natural food section of the supermarket are generally not as expensive as in other areas of the store.

 

Beverage Packaging Changes - Beverage packaging has continued to innovate, particularly for premium products. There is an increase in the sophistication with respect to beverage packaging design. While we feel that our current core brands still compete on the level of packaging, we continue to experiment with new and novel packaging designs such as the 5-liter party keg and 750 ml. champagne style bottles. We have further plans for other innovative packaging designs.

 

Packaging or Raw Material Price Increases - An increase in packaging or raw materials has caused our margins to suffer and has negatively impacted our cash flow and profitability. We continue to search for packaging and production alternatives to reduce our cost of goods.

 

Cash Flow Requirements - Our growth will depend on the availability of additional capital infusions. We have a financial history of losses and are dependent on non-banking sources of capital, which tend to be more expensive and charge higher interest rates. Any increase in costs of goods will further increase losses and will further tighten cash reserves. We intend to use the proceeds from our public offering to increase our liquidity to be able to make cash expenditures, as needed.

 

Interest Rates - We use lines of credit as a source of capital and are negatively impacted as interest rates rise. Management believes our public offering will provide capital sufficient for us to reduce our debt level and allow us to lower our incremental borrowing costs.

 

Critical Accounting Policies

 

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP. GAAP requires us to make estimates and assumptions that affect the reported amounts in our financial statements including various allowances and reserves for accounts receivable and inventories, the estimated lives of long-lived assets and trademarks and trademark licenses, as well as claims and contingencies arising out of litigation or other transactions that occur in the normal course of business. The following summarize our most significant accounting and reporting policies and practices:

 

Revenue Recognition. Revenue is recognized on the sale of a product when the product is shipped, which is when the risk of loss transfers to our customers, and collection of the receivable is reasonably assured. A product is not shipped without an order from the customer and credit acceptance procedures performed. The allowance for returns is regularly reviewed and adjusted by management based on historical trends of returned items. Amounts paid by customers for shipping and handling costs are included in sales.

 

Trademark License and Trademarks. Trademark license and trademarks primarily represent the costs we pay for exclusive ownership of the Reed’s® trademark in connection with the manufacture, sale and distribution of beverages and water and non-beverage products. We also own the China Cola® trademark and have applied for a trademark on the Virgil’s name. In addition, we own a number of other trademarks in the United States as well as in a number of countries around the world. We account for these items in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.” Under the provisions of SFAS No. 142, we do not amortize indefinite-lived trademark licenses and trademarks.

 

In accordance with SFAS No. 142, we evaluate our non-amortizing trademark license and trademarks quarterly for impairment. We measure impairment by the amount that the carrying value exceeds the estimated fair value of the trademark license and trademarks. The fair value is calculated by reviewing net sales of the various beverages and applying industry multiples. Based on our quarterly impairment analysis the estimated fair values of trademark license and trademarks exceeded the carrying value and no impairments were identified during the years ended December 31, 2005 or 2004 or during the three months ended March 31, 2006.

 

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Long-Lived Assets. Our management regularly reviews property, equipment and other long-lived assets, including identifiable amortizing intangibles, for possible impairment. This review occurs quarterly or more frequently if events or changes in circumstances indicate the carrying amount of the asset may not be recoverable. If there is indication of impairment of property and equipment or amortizable intangible assets, then management prepares an estimate of future cash flows (undiscounted and without interest charges) expected to result from the use of the asset and its eventual disposition. If these cash flows are less than the carrying amount of the asset, an impairment loss is recognized to write down the asset to its estimated fair value. The fair value is estimated at the present value of the future cash flows discounted at a rate commensurate with management’s estimates of the business risks. Quarterly, or earlier if there is indication of impairment of identified intangible assets not subject to amortization, management compares the estimated fair value with the carrying amount of the asset. An impairment loss is recognized to write down the intangible asset to its fair value if it is less than the carrying amount. Preparation of estimated expected future cash flows is inherently subjective and is based on management’s best estimate of assumptions concerning expected future conditions. No impairments were identified during the years ended December 31, 2005 or 2004 or during the three months ended March 31, 2006.

 

Management believes that the accounting estimate related to impairment of our long lived assets, including our trademark license and trademarks, is a “critical accounting estimate” because: (1) it is highly susceptible to change from period to period because it requires management to estimate fair value, which is based on assumptions about cash flows and discount rates; and (2) the impact that recognizing an impairment would have on the assets reported on our balance sheet, as well as net income, could be material. Management’s assumptions about cash flows and discount rates require significant judgment because actual revenues and expenses have fluctuated in the past and we expect they will continue to do so.

 

In estimating future revenues, we use internal budgets. Internal budgets are developed based on recent revenue data for existing product lines and planned timing of future introductions of new products and their impact on our future cash flows.

 

Advertising. We account for advertising production costs by expensing such production costs the first time the related advertising is run.

 

Accounts Receivable. We evaluate the collectibility of our trade accounts receivable based on a number of factors. In circumstances where we become aware of a specific customer’s inability to meet its financial obligations to us, a specific reserve for bad debts is estimated and recorded which reduces the recognized receivable to the estimated amount our management believes will ultimately be collected. In addition to specific customer identification of potential bad debts, bad debt charges are recorded based on our historical losses and an overall assessment of past due trade accounts receivable outstanding.

 

Inventories. Inventories are stated at the lower of cost to purchase and/or manufacture the inventory or the current estimated market value of the inventory. We regularly review our inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on our estimated forecast of product demand and/or our ability to sell the product(s) concerned and production requirements. Demand for our products can fluctuate significantly. Factors that could affect demand for our products include unanticipated changes in consumer preferences, general market conditions or other factors, which may result in cancellations of advance orders or a reduction in the rate of reorders placed by customers. Additionally, our management’s estimates of future product demand may be inaccurate, which could result in an understated or overstated provision required for excess and obsolete inventory.

 

Income Taxes. Current income tax expense is the amount of income taxes expected to be payable for the current year. A deferred income tax asset or liability is established for the expected future consequences of temporary differences in the financial reporting and tax bases of assets and liabilities. We consider future taxable income and ongoing, prudent, and feasible tax planning strategies, in assessing the value of our deferred tax assets. If our management determines that it is more likely than not that these assets will not be realized, we will reduce the value of these assets to their expected realizable value, thereby decreasing net income. Evaluating the value of these assets is necessarily based on our management’s judgment. If our management subsequently determined that the deferred tax assets, which had been written down, would be realized in the future, the value of the deferred tax assets would be increased, thereby increasing net income in the period when that determination was made.

 

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Results of Operations

 

Three Months Ended March 31, 2006 Compared to Three Months Ended March 31, 2005

 

Net sales increased by $161,936, or 8.9%, from $1,817,336 in the first three months ended March 31, 2005 to $1,979,272 in the first three months ended March 31, 2006. Sales of our core Reed’s Ginger Brew items increased from $916,000 in the first three months ended March 31, 2005 to $1,073,000 in the first three months ended March 31, 2006. Sales of our Virgil’s Root Beer 12 ounce bottles and our new Virgil’s Cream soda increased by $76,000 from $390,000 and $101,000, respectively, in the first three months ended March 31, 2005 to $467,000 and $100,000, respectively, in the first three months ended March 31, 2006. Candy sales increased by $76,000 from $129,000 in the first three months ended March 31, 2005 to $205,000 in the first three months ended March 31, 2006. These increases were offset by decreases in sales in certain of our other products. Sales of our new Virgil’s 5-liter party keg labels decreased from $148,000 in the first three months ended March 31, 2005 to $50,000 in the first three months ended March 31, 2006 due to non-recurring sales to certain large retailers. Ice cream sales increased from $34,000 in the first three months ended March 31, 2005 to $36,000 in the first three months ended March 31, 2006.

 

Cost of sales increased by $202,589, or 13.6%, from $1,486,287 in the first three months ended March 31, 2005 to $1,688,876 in the first three months ended March 31, 2006. As a percentage of net sales, cost of sales increased from 81.8% in the first three months ended March 31, 2005 to 85.3% in the first three months ended March 31, 2006. Costs of sales increased primarily as a result of increased depreciation (0.6%), increased production expenses due to fuel costs (2.5%) and increased packaging costs (0.4%).

 

Gross profit decreased from $331,049 in the first three months ended March 31, 2005 to $290,396 in the first three months ended March 31, 2006. As a percentage of net sales, gross profit decreased from 18.2% in the first three months ended March 31, 2005 to 14.7% in the first three months ended March 31, 2006. Effective February 1, 2006, we approved a price increase in a number of our product lines at an average of approximately 7% in order to attempt to increase our gross profit. The full implementation of the price increase is expected to be completed by the middle of the third quarter of 2006. We expect margins to increase by the end of 2006 due to this price increase, provided that these price increases do not adversely affect our volume of sales.

 

General and administrative and selling expenses increased by $50,719, or 10.2%, from $499,099 in the first three months ended March 31, 2005 to $549,818 in the first three months ended March 31, 2006 and increased as a percentage of net sales from 27.5% in the first three months ended March 31, 2005 to 27.8% in the first three months ended March 31, 2006. The increase in expenses was due to increased salaries due to a larger sales force (0.8%), increased sales expenses from increased fuel costs and increased telephone charges (3.8%), increased utility expenses (1.1%) and increased legal and accounting costs due to the costs associated with being a public reporting company (0.8%). Health insurance costs increased due to more people being covered by our health plan (2.3%). Payroll increased due to temporary employee services incurred as a result of an employee departure during the quarter ended March 31, 2006 (2.0%). We reduced our promotional expenses due to fewer club store demos (-1.9%).

 

Legal defense costs for the three months ended March 31, 2006 and 2005 were $9,568 and $2,216, respectively. These expenses were incurred for a lawsuit brought against us by a consultant alleging funds due him. We mounted a successful defense in this action and were successful on an appeal of this matter.

 

Interest expense increased by $29,397, or 41.3%, from $71,210 in the first three months ended March 31, 2005 to $100,607 in the first three months ended March 31, 2006. The increase in interest expense was due to increasing short term interest rates, increased borrowings on our available lines of credit and increasing our long term debt, which was used to purchase brewing equipment, vehicles and office equipment.

 

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As a result of the foregoing, we experienced a net loss of $241,386 in the first three months ended March 31, 2005 and $369,597 in the first three months ended March 31, 2006. Accordingly, we experienced a net loss of $0.05 per share in the first three months ended March 31, 2005 and $0.07 per share in the first three months ended March 31, 2006.

 

Twelve Months Ended December 31, 2005 Compared to Twelve Months Ended December 31, 2004

 

Net sales increased by $491,920, or 5.5%, from $8,978,365 in 2004 to $9,470,285 in 2005. Sales of our core Reed’s Ginger Brew items increased from $3,681,000 in 2004 to $4,103,000 in 2005. Sales of our Virgil’s Root Beer 12 ounce bottles and our new Virgil’s Cream soda increased from $1,591,000 and $139,000, respectively, in 2004 to $2,091,000 and $667,000, respectively, in 2005. Candy sales increased from $699,000 in 2004 to $822,000 in 2005. These increases were offset by decreases in sales in certain of our other products. Sales of our new Virgil’s 5 liter party keg labels decreased from $1,002,000 in 2004 to $575,000 in 2005 due to non-recurring sales in 2004 to certain large retailers. Ice cream sales dropped from $196,000 in 2004 to $145,000 in 2005. Our co-packing sales of private labels from the Brewery dropped from $450,048 in 2004 to $239,835 in 2005.

 

Cost of sales increased by $642,462, or 9.0%, from $7,103,037 in 2004 to $7,745,499 in 2005. Costs of sales as a percentage of sales increased from 79.1% in 2004 to 81.8% in 2005. Costs of sales as a percentage of sales increased primarily as a result of increases in higher freight costs (0.5%), packaging costs (0.8%) and production expenses (4.4%) due to increased fuel costs and increased depreciation (0.3%), offset by decreases in ingredient costs (-3.3%).

 

We calculate gross profit as total revenues less cost of sales. Gross profit decreased from $1,875,328 in 2004 to $1,724,786 in 2005. As a percentage of net sales, gross profit decreased from 20.9% in 2004 to 18.2% in 2005. Effective February 1, 2006 we increased prices in a number of our product lines at an average of approximately 7% in order to attempt to increase our gross profit. We expect margins to increase by the end of 2006 due to this price increase, provided that these price increases do not adversely affect our volume of sales.

 

General and administrative and selling expenses increased by $213,958, or 11.5%, from $1,866,511 in 2004 to $2,080,469 in 2005 and increased as a percentage of net sales from 20.8% in 2004 to 22.0% in 2005. The increase in expenses was primarily due to increased salaries due to a larger sales force, more commissions due to increased number of outside sales brokers, increased sales fuel costs, increased fuel expenses for plant heating requirements and increased legal and accounting costs due to the costs associated with the public offering and becoming a reporting company under the Exchange Act. In addition, if we are able to receive a significant portion of the proceeds from the public offering, we intend to increase our in-house sales force, which we anticipate will permit us to increase sales of our product lines in the future. We anticipate a lead time until these new sales people generate enough additional revenue to support their additional cost.

 

Beginning in January 2000, we extended an interest-free line of credit to one of our consultants, Peter Sharma, III who was a member of our board until January 27, 2006. In July 2005, a repayment schedule began at $1,000 per month and ends with a balloon payment for the remaining balance, due on December 31, 2007. As of December 31, 2005, management has chosen to reserve the entire amount of the outstanding balance of $124,210. Management is pursuing collection efforts. Mr. Sharma was a registered representative of Brookstreet Securities Corporation until May 4, 2006. Brookstreet is one of our underwriters in the public offering. Mr. Sharma received compensation of approximately $28,000 through his former relationship with Brookstreet. We are advised by Brookstreet that Mr. Sharma will not participate in any future sales through Brookstreet in connection with the public offering.

 

Legal defense costs for the years ended December 31, 2005 and 2004 were $36,558 and $80,156, respectively. These expenses were incurred for a lawsuit brought against us by a consultant alleging funds due him. We mounted a successful defense in this action and were successful on an appeal of this matter.

 

Interest expense increased by $54,472, or 21.4%, from $255,032 in 2004 to $309,504 in 2005. The increase in interest expense was primarily due to increased borrowing on our receivable line of credit with our principal lender. We anticipate using a portion of the proceeds from the public offering to pay down existing lines of credit, and expect that such proceeds will reduce our need for debt financing and allow us to obtain more favorable borrowing rates, thus offsetting the rise in the prime rate, and therefore interest expense should decrease.

 

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Loss on extinguishment of debt decreased from $153,000 in 2004 to none in 2005. This loss related to the discount on the conversion of approximately $255,000 of our debt into 25,500 shares of our Series A preferred stock. Upon conversion, the excess of the fair market price of the underlying common stock over the conversion price of $1.50 per share resulted in the loss on extinguishment of debt.

 

As a result of the foregoing, we experienced a net loss of $479,371 and $855,425 in 2004 and 2005, respectively. In addition, we accrued a $29,470 dividend payable to the holders of our Series A preferred stock in 2005, which we elected to pay in the form of 7,362 shares of common stock. Accordingly, we experienced a net loss of $0.10 and $0.18 per share in 2004 and 2005, respectively.

 

Management recognizes the operating losses and costs incurred have negatively impacted liquidity. We anticipate using a portion of the proceeds from the public offering to pay down existing lines of credit, and expect that such proceeds will reduce our need for debt financing and allow us to obtain more favorable borrowing rates, thus offsetting the rise in the prime rate, and therefore interest expense should decrease. In addition, we anticipate that the price increases management instituted will lead to increased gross margins and decreases in loss from operations, thus improving our profitability.

 

Liquidity and Capital Resources

 

Historically, we have financed our operations primarily through private sales of common stock, preferred stock, convertible debt, a line of credit from a financial institution, and cash generated from operations.

 

As of March 31, 2006, we had a working capital deficit of $1,315,156, compared to a working capital deficit of $1,594,758 as of December 31, 2005. This decrease in our working capital deficit should not be viewed as a change in trend. The primary factor contributing to a reduction in our working capital deficit was the cash received from our initial public offering. As of December 31, 2005, we had a working capital deficit of $1,594,758, compared to a working capital deficit of $684,647 as of December 31, 2004. This increase in our working capital deficit was primarily attributable to increases in accounts payable and our line of credit. These increases were required due to the loss we incurred in 2005 and costs incurred for the public offering. Cash and cash equivalents were $195,457 as of March 31, 2006, as compared to $27,744 as December 31, 2005 and $42,488 as of December 31, 2004.

 

As of March 31, 2006, we had outstanding borrowings of $1,539,946 under the following line of credit agreements:

 

·

We have an unsecured $50,000 line of credit with US Bank which expires in December 2009. Interest is payable monthly at the prime rate, as published in the Wall Street Journal, plus 12% per annum. Our outstanding balance was $26,646 at March 31, 2006 and there was $23,354 available under the line of credit. The interest rate in effect at March 31, 2006 was 19.75%.

 

·

We have a line of credit with Merrill Lynch. Robert T. Reed, Jr., our Vice President and National Sales Manager - Mainstream and a brother of our Chief Executive Officer, Christopher J. Reed has pledged certain securities (which do not include any of our securities which are owned by Mr. Reed) in his personal securities account on deposit with Merrill Lynch as collateral for repayment of the line of credit. The amount of the line of credit is based on a percentage value of such securities. At March 31, 2006, the outstanding balance on the line of credit was $642,209, and there was $47,140 available under the line of credit The line of credit bears interest at a rate of 3.785% per annum plus LIBOR (8.695% as of March 31, 2006). In consideration for Mr. Reed’s pledging his stock account at Merrill Lynch as collateral, we have agreed to pay Mr. Reed 5% per annum of the amount we borrow from Merrill Lynch, as a loan fee. During the years ended December 31, 2005 and 2004, we paid Mr. Reed $15,250 and $3,125, respectively, under this agreement. In addition, Christopher J. Reed has pledged all of his shares of common stock to Robert T. Reed, Jr. as collateral for the shares pledged by Robert T. Reed, Jr.

 

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·

We have a line of credit with Business Alliance Capital Corporation. This line of credit allows us to borrow a maximum amount of $1,400,000, based on a borrowing base of accounts receivables and inventory. The borrowing base on the accounts receivable is 80% of all eligible receivables, which are primarily accounts receivables under 90 days. The inventory borrowing base is 50% of eligible inventory. As of March 31, 2006, the outstanding balance on the line of credit was $871,091. The interest rate on this line of credit is prime plus 4.0%, and the interest rate at March 31, 2006 was 10.5%. The line of credit expires on June 30, 2007 and is guaranteed by Christopher J. Reed and his wife, Judy Reed, who are directors and our principal stockholders. This revolving line of credit is secured by all of our assets, including accounts receivable, inventory, trademarks and other intellectual property, building and equipment. As of March 31, 2006, we had approximately $257,000 of availability on this line of credit.

 

At March 31, 2006, we did not have any material commitments for capital expenditures.

 

Net cash used in operating activities was $491,428 in the quarter ended March 31, 2006, as compared to net cash provided by operating activities of $135,465 in the quarter ended March 31, 2005. This increase in net cash used in operating activities was primarily due to the increase in net loss to $369,587 in the quarter ended March 31, 2006, as compared to $241,368 in the quarter ended March 31, 2005, increases in inventory and accounts receivable in the quarter ended March 31, 2006 from the prior corresponding period, offset by decreases in prepaid expenses in the quarter ended March 31, 2006 from the prior corresponding period.

 

Net cash used in operating activities decreased to $42,610 in the year ended December 31, 2005 from $176,020 in the year ended December 31, 2004. This decrease primarily was due to the increase in net loss to $825,955 in 2005, as compared to $479,371 in 2004, decreases in accrued interest and increases in prepaid expenses in 2005 from 2004 and a non-recurring write off in deferred offering costs of $153,000 in 2004, offset by a provision for amounts due from a former director in 2005 and the decrease of accounts receivable and inventory in 2005 from 2004.

 

We used $19,271 in investing activities in the quarter ended March 31, 2006, as compared to $37,001 in the quarter ended March 31, 2005. Net cash used in investing activities in each of these quarters primarily consisted of the purchase of equipment for the Brewery. In the quarter ended March 31, 2005, we made a loan to a director in the amount of $12,813 before we commenced our public offering.

 

We used $214,667 in investing activities in the year ended December 31, 2005, as compared to $248,187 in the year ended December 31, 2004. Net cash used in investing activities in each of these years primarily consisted of the purchase of equipment for the Brewery and loans made to a director before we commenced our public offering. In the years ended December 31, 2005 and 2004, we purchased equipment for the Brewery in the amounts of $181,654 and $204,147, respectively, and made loans to a former director in the amounts of $33,013 and $44,040, respectively.

 

Cash flow provided from financing activities in the quarter ended March 31, 2006 was $678,412, as compared to cash flow used in financing activities of $107,792 in the quarter ended March 31, 2005. We received cash from the sale of common stock of $811,955 in the public offering in the quarter ended March 31, 2006. We increased borrowings on our line of credit in the amount of $93,993 in the quarter ended March 31, 2006, as compared to our making payments on our line of credit in the amount of $194 in the quarter ended March 31, 2005. Deferred offering costs increased to $198,833 in the quarter ended March 31, 2006 as compared to $63,062 in the quarter ended March 31, 2005. The increase in deferred offering costs primarily related to offering costs, such as accounting fees, legal fees, and selling expenses, that we incurred in connection with the public offering. We made principal payments on our long-term debt of $28,703 and $44,536 in the quarters ended March 31, 2006 and 2005, respectively.

 

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Cash flow provided from financing activities was $242,533 in the year ended December 31, 2005, as compared to $453,765 in the year ended December 31, 2004. We increased borrowings on our line of credit in 2005 and long term debt in the aggregate amount of approximately $115,000 primarily to purchase manufacturing equipment to improve the Brewery and vehicles for our Southern California direct distribution program. In addition, we received cash from the sale of common stock of approximately $197,000 in the public offering in 2005 and approximately $334,000 from the issuance of preferred stock in 2004. The slight increase in cash provided by financing activities from 2004 to 2005 was offset by larger increases in cash used in financing activities from 2004 to 2005. Increases in deferred offering costs increased to $332,858 in 2005 from $219,955 in 2004. The increase in deferred offering costs primarily related to offering costs, such as accounting fees, legal fees, and selling expenses, that we incurred in connection with the public offering. We made principal payments on our long-term debt of $263,815 and $208,852 in the years ended December 31, 2005 and 2004, respectively. We also paid to Judy Reed the amount of $21,000 in 2005 as repayment of debt.

 

During the quarter ended March 31, 2006, we had a net loss of $369,597. At March 31, 2006, we had a working capital deficiency of $1,315,156 and an accumulated deficit of approximately $3,630,000. During the year ended December 31, 2005, we had a net loss of $825,955. At December 31, 2005, we had a working capital deficiency of $1,594,758 and an accumulated deficit of approximately $3,260,000.

 

We have a “best efforts” commitment from an underwriter to assist us in continuing the process of raising capital through a public offering of our common stock which we commenced in 2005. We believe that we will be successful in raising additional funds from the public offering. However, we cannot predict the exact amount which will be raised. We intend to resume the offering upon completion of this rescission offer to persons who have purchased shares in the offering to date. We expect the public offering to commence during the summer of 2006. Until the commencement of the public offering, we will continue to experience challenges with managing cash flow, but we believe that we have enough liquidity to operate the business in the short term. The addition of cash from the public offering, if successful, would provide us the ability to improve our liquidity position and provide capital to continue to expand the business. The remaining amount of common stock that we can sell in connection with the offering is 1,666,844 shares at an anticipated offering price of $4.00 per share. If the remainder of the shares were sold, we would receive approximately $6,445,000, net of offering expenses.

 

We have entered into an agreement with Mark Reed and Robert T. Reed, Jr. (the “designated purchasers”) that they would irrevocably commit to purchase up to all of the shares in the rescission offer that are tendered to us for rescission. We would assign to the designated purchasers the right to purchase any rescission shares at 100% of the amount required to pay the rescission price under applicable state law. As currently contemplated, the initial $250,000 of rescission shares would be purchased by Mark Reed. If the number of rescission shares tendered for rescission exceeds $250,000 of shares, Robert T. Reed, Jr. would purchase the balance of the rescission shares tendered for rescission to us. Each of the designated purchasers is a brother of Christopher J. Reed, our Chief Executive Officer, Chief Financial Officer and the Chairman of the Board of Directors. Robert T. Reed, Jr. also is our Vice President and National Sales Manager - Mainstream and a beneficial owner of approximately 7.13% of our common stock. Each of the designated purchasers may also participate in the purchase of shares of common stock to be distributed in the public offering. Since up to all of the rescission shares would be purchased by the designated purchasers, none of the rescission shares would be purchased directly by us and would not deplete proceeds from our public offering or other of our then current cash balances. The rescission shares, which may be purchased by the designated purchasers in the rescission offer, would be deemed to be registered shares for the benefit of the designated purchasers pursuant to a registration statement to be filed by us relating to the rescission offer under the Securities Act, effective as of the commencement date of the rescission offer without any further action on the part of the designated purchasers. If we are required to pay the obligation which may be created under the rescission offer, such a refund would materially and adversely effect our financial position.

 

We may not 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, we eventually may have insufficient working capital to maintain our operations as we presently intend to conduct them or to fund our expansion and marketing and product development plans. In addition, our losses may increase in the future as we expand our manufacturing capabilities and fund our marketing plans and product development. These losses, among other things, have had and will continue to have an adverse effect on our working capital, total assets and stockholders’ equity. If we are unable to achieve profitability, the market value of our common stock will decline and there would be a material adverse effect on our financial condition.

 

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We are conducting the public offering to raise an additional approximate $6,445,000 of net proceeds from the sale of our common stock. We intend to use the proceeds from the public offering for working capital, the expansion and development of our sales and marketing activities and to invest in infrastructure to increase our operational and manufacturing efficiencies. However, the public offering is being conducted on a “best efforts” basis, and we cannot assure you that we will sell the maximum amount of securities being offered thereby. Accordingly, if we cannot receive adequate proceeds from the public offering, we may be limited in our ability to expand our business operations as rapidly as we would deem necessary at any time, unless we are able to obtain additional financing. There can be no assurance that we will be able to obtain such financing on acceptable terms, or at all. If adequate funds are not available or are not available on acceptable terms, we may not be able to pursue our business objectives. This inability could adversely affect our business, results of operations and financial condition.

 

As we are not required to use our capital sources to pay for the repurchase of shares in the rescission offer, we currently believe that our available cash resources and cash flow from operations, without any additional net proceeds from the public offering, will be sufficient to sustain our business operations for at least 13 months after the date of this prospectus. However, we would be required to reduce our level of operations, including reducing infrastructure, promotions, personnel and other operating expenses.

 

In addition, our ability to implement our full business expansion plan is largely dependent upon the outcome of the public offering. If we do not receive the maximum proceeds from the public offering, some or all of the elements of our expansion plan may have to be curtailed or delayed unless we are able to find alternative external sources of working capital. We would need to raise additional funds to respond to business contingencies, which may include the need to:

 

·	fund more rapid expansion,

 

·	fund additional marketing expenditures,

 

·	enhance our operating infrastructure,

 

·	respond to competitive pressures, and

 

·	acquire other businesses.

 

We cannot assure you that additional financing will be available on terms favorable to us, or at all. If adequate funds are not available or if they are not available on acceptable terms, our ability to fund the growth of our operations, take advantage of opportunities, develop products or services or otherwise respond to competitive pressures, could be significantly limited.

 

Recent Accounting Pronouncements

 

In November 2004, the Financial Accounting Standards Board, or FASB, issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4.” The amendments made by Statement 151 clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current period charges and require the allocation of fixed production overheads to inventory based on the normal capacity of the production facilities. The guidance is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Earlier application is permitted for inventory costs incurred during fiscal years beginning after November 23, 2004. We have evaluated the impact of the adoption of SFAS 151, and do not believe the impact will be significant to our overall results of operations or financial position.

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In December 2004, the FASB issued SFAS No. 153, “Exchanges of Non-monetary Assets, an amendment of APB Opinion No. 29, Accounting for Non-monetary Transactions.” The amendments made by Statement 153 are based on the principle that exchanges of non-monetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for non-monetary exchanges of similar productive assets and replace it with a broader exception for exchanges of non-monetary assets that do not have commercial substance. Previously, Opinion 29 required that the accounting for an exchange of a productive asset for a similar productive asset or an equivalent interest in the same or similar productive asset should be based on the recorded amount of the asset relinquished. Opinion 29 provided an exception to its basic measurement principle (fair value) for exchanges of similar productive assets. The FASB believes that exception required that some non-monetary exchanges, although commercially substantive, be recorded on a carryover basis. By focusing the exception on exchanges that lack commercial substance, the FASB believes this Statement produces financial reporting that more faithfully represents the economics of the transactions. The Statement is effective for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is permitted for non-monetary asset exchanges occurring in fiscal periods beginning after the date of issuance. The provisions of this Statement shall be applied prospectively. We have evaluated the impact of the adoption of SFAS 153, and do not believe the impact will be significant to our overall results of operations or financial position.

 

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment.” Statement 123(R) will provide investors and other users of financial statements with more complete and neutral financial information by requiring that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. Statement 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. Statement 123(R) replaces FASB Statement No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Statement 123, as originally issued in 1995, established as preferable a fair-value-based method of accounting for share-based payment transactions with employees. However, that Statement permitted entities the option of continuing to apply the guidance in Opinion 25, as long as the footnotes to financial statements disclosed what net income would have been had the preferable fair-value-based method been used. Public entities (other than those filing as small business issuers) will be required to apply Statement 123(R) as of the first interim or annual reporting period that begins after June 15, 2005. We have evaluated the impact of the adoption of SFAS 123(R), and do not believe the impact will be significant to our overall results of operations or financial position. All options issued prior to December 31, 2005 vested immediately, and therefore, there is no associated unamortized compensation that will be recorded in future periods relating to these options.

 

In May 2005 the FASB issued SFAS Number 154, “Accounting Changes and Error Corrections.” This SFAS provides guidance on accounting for and reporting of accounting changes and error corrections. We have evaluated the impact of SFAS 154 and do not believe the impact will be significant to our overall results of operations or financial position.

 

We do not believe that the adoption of the above recent pronouncements will have a material effect on our financial position or results of operations.

 

On September 22, 2005, the SEC issued rules to delay by one-year the required reporting by management on internal controls over financial reporting for non-accelerated filers. The new SEC rule extends the compliance date for such registrants to fiscal years ending on or after July 15, 2007. Accordingly, we qualify for the deferral until the year ending December 31, 2007 in order to comply with the internal control reporting requirements.

 

Inflation

 

Although management expects that our operations will be influenced by general economic conditions, we do not believe that inflation has a material effect on our results of operations.

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BUSINESS

Background

 

We develop, manufacture, market, and sell natural non-alcoholic and “New Age” beverages, candies and ice creams. “New Age Beverages” is a category that includes natural soda, fruit juices and fruit drinks, ready-to-drink teas, sports drinks and water. We currently manufacture, market and sell six unique product lines:

 

·	Reed’s Ginger Brews,

 

·	Virgil’s Root Beer and Cream Sodas,

 

·	China Colas,

 

·	Reed’s Ginger Juice Brews,

 

·	Reed’s Ginger Candies, and

 

·	Reed’s Ginger Ice Creams

 

We sell most of our products in specialty gourmet and natural food stores, supermarket chains, retail stores and restaurants in the United States and, to a lesser degree, in Canada. We primarily sell our products through a network of natural, gourmet and independent distributors. We also maintain an organization of in-house sales managers who work mainly in the stores serviced by our natural, gourmet and mainstream distributors and with our distributors. We also work with regional, independent sales representatives who maintain store and distributor relationships in a specified territory. In Southern California, we have our own direct distribution system.

 

We produce and co-pack our products principally at our company-owned facility in Los Angeles, California, known as the Brewery, and at a contracted co-packing facility in Pennsylvania. We also co-pack certain of our products at smaller co-packing facilities in the United States and in Europe.

 

Key elements of our business strategy include:

 

·	increased national direct sales and distribution,

 

·	increased store placement with mainstream stores and retailers,

 

·	strong national distributorships,

 

·	stimulate strong consumer demand for our existing brands and products,

 

·	develop additional unique alternative beverage brands and other products, and

 

·	specialty packaging like our 5-liter party kegs, our ceramic swing-lid bottle and our 750 ml. champagne bottle.

 

Our current sales efforts are focused in three areas:

 

·	sales to mainstream, natural and specialty food stores in the United States and, to a lesser degree, Canada, through our regional distributors and sales representatives,

 

·	direct sales effort to large national retailers, and

 

·	direct distribution by our trucks and drivers to retailers in Southern California.

 

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We believe that these marketing efforts have contributed to our growth. We intend to continue to expand our sales personnel in each of these marketing areas with the proceeds from the public offering.

 

In addition, since 2003, we have introduced new products and offer specialty beverage packaging options not typically available in the marketplace into the marketplace that have contributed to our growth in sales. These products include a 5-liter “party keg” version of our Virgil’s Root Beer and Cream Soda, 12-ounce long neck bottles of our Virgil’s Cream Soda, 750 ml. size bottles of our Reed’s Original Ginger Brew, Extra Ginger Brew and Spiced Apple Brew and a one pint version of our Virgil’s Root Beer with a swing-lid. In addition, we have recently introduced a new flavor, our Black Cherry Cream soda in a 12-ounce bottle. These new packaging options are being utilized in our marketing efforts.

 

We create consumer demand for our products by

 

·	supporting in-store sampling programs of our products,

 

·	generating free press through public relations,

 

·	advertising in national magazines targeting our customers,

 

·	maintaining a company website (www.reedsgingerbrew.com), and

 

·	participating in large public events as sponsors.

 

Our business expansion plans are contingent to a great extent on the success of the public offering. If all or most of the shares being offered in our public offering are sold, we expect to be able to increase our marketing, advertising and distribution campaigns, and the number of products we offer. The failure to raise the maximum proceeds offered in our public offering will limit our ability to expand our operations.

 

Our principal executive offices are located at 13000 South Spring Street, Los Angeles, California 90061. Our telephone number is (310) 217-9400. Our Internet address is www.reedsgingerbrew.com. Information contained on our website or that is accessible through our website should not be considered to be part of this prospectus.

 

Historical Development

 

In June 1987, Christopher J. Reed, our founder and Chief Executive Officer, began development of Reed’s Original Ginger Brew, his first beverage creation. After two years of development, the product was introduced to the market in Southern California stores in 1989. By 1990, we began marketing our products through natural food distributors and moved our production to a larger facility in Boulder, Colorado.

 

In 1991, we incorporated our business operations in the state of Florida under the name of Original Beverage Corporation and moved all of our production to a co-pack facility in Pennsylvania. We began exhibiting at national natural and specialty food trade shows, which brought national distribution in natural, gourmet and specialty foods and the signing of our first mainstream supermarket distributor. Our products began to receive trade industry recognition as an outstanding new product. The United States National Association of the Specialty Food Trade, or NASFT, named Original Ginger Brew as an “Outstanding Beverage Finalist” in the United States, and the Canadian Fancy Food Association, or CFFA, awarded us “Best Imported Food Product.”

 

Throughout the 1990’s, we continued to develop and launch new ginger brew varieties. Reed’s Ginger Brews reached broad placement in natural and gourmet foods stores nationwide through major specialty, natural/gourmet and mainstream food and beverage distributors.

 

In 1997, we began licensing the products of China Cola and eventually acquired the rights to that product in December 2000. In addition, we launched Reed’s Crystallized Ginger Candy, a product which we manufacture in Fiji under a proprietary, natural, non-sulfured process. In 1999, we purchased the Virgil’s Root Beer brand from the Crowley Beverage Company. The brand has won numerous gourmet awards. In 2000, we began to market three new products: Reed’s Original Ginger Ice Cream, Reed’s Cherry Ginger Brew and a beautiful designer 10-ounce gift tin of our Reed’s Crystallized Ginger Candy. In December 2000, we purchased an 18,000 square foot warehouse property, the Brewery, in Los Angeles, California, to house our west coast production and warehouse facility. The Brewery now also serves as our principal executive offices. In 2001, we changed our state of incorporation to Delaware and also changed our name to Reed’s, Inc. We also introduced our Reed’s Chocolate Ginger Ice Cream and Reed’s Green Tea Ginger Ice Cream products and expanded our confectionary line with two new candy products: Reed’s Crystallized Ginger Baking Bits and Reed’s Ginger Candy Chews. In 2002, we launched our Reed’s Ginger Juice Brew line, with four flavors of organic juice blends. In November 2002, we completed our first test runs of Reed’s and Virgil’s products at the Brewery and in January 2003, our first commercially available products came off the Los Angeles line. In 2003, we commenced our own direct distribution in Southern California and introduced sales of our 5-liter Virgil’s party keg. In 2004, we expanded our product line to include Virgil’s Cream Soda (including in a 5-liter keg), Reed’s Spiced Apple Brew in a 750 ml. champagne bottle and draught Virgil’s Root Beer and Cream Soda. In 2006, we expanded our product line to include Virgil’s Black Cherry Cream Soda.

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Industry Overview

 

Our beverages are classified as New Age beverages, a category that includes natural soda, fruit juices and fruit drinks, ready-to-drink teas, sports drinks and water. According to Beverage Marketing Corporation, in 2004, total wholesale dollar sales in the New Age segment were approximately $16.5 billion in wholesale dollar sales, an increase of 11.3% from 2003. (Source: Beverage World Magazine, April 15, 2006.)

 

Annual confectionary sales (including chocolate, non-chocolate and gum sales) in the United States were approximately $27.9 billion in 2005, of which approximately $8.7 billion was non-chocolate candy. (Source: National Confectioners Association, 2006 Year in Review.)

 

According to the International Dairy Foods Association (IDFA), total U.S. sales of ice cream and frozen desserts were estimated at approximately $21 billion. The packaged ice cream industry includes economy, regular, premium and super-premium products. Super-premium ice cream, such as Reed’s Ginger Ice Creams, is generally characterized by a greater richness and density than other kinds of ice cream. This higher quality ice cream generally costs more than other kinds and is usually marketed by emphasizing quality, flavor selection, texture and brand image. The International Ice Cream Association attributes almost all of the market growth over the past 10 years to sales of super-premium and premium ice creams, particularly the innovative products. Sales of premium and super-premium styles account for approximately 42% of the total industry revenues, versus approximately 15% for all the “light” formulations combined. (Source: CNN/Money, July 29, 2005.)

 

Our Products

 

We currently manufacture and sell 15 beverages, three candies and three ice creams. We make all of our products using premium all-natural ingredients.

 

We produce carbonated and non-carbonated products. Most sales of our beverage products are of our sodas. According to Spence Information Services (SPINS), which is the only sales information service catering to the natural food trade, for the year 2003,

 

·	Reed’s Ginger Brews and Virgil’s Root Beer held three of the top ten items based on dollar and unit sales among all sugar/fructose sweetened sodas in the natural foods industry in the United States, with Reed’s Extra Ginger Brew holding the number one position, and

 

·	Reed’s Original Ginger Brew and Virgil’s were two of the top ten brands based on dollar and unit sales among all sugar/fructose sweetened sodas in the natural foods industry in the United States, with Reed’s Original Brew holding the number one position.

 

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Our carbonated products include six varieties of Reed’s Ginger Brews, Virgil’s Root Beer and Cream Sodas, China Cola and Cherry China Cola. We also sell four varieties of a new line of non-carbonated ginger brews called Reed’s Ginger Juice Brews.

 

Our candy products include Reed’s Crystallized Ginger Candy, Reed’s Crystallized Ginger Baking Bits and Reed’s Ginger Candy Chews.

 

Our ice cream products include Reed’s Original Ginger Ice Cream, Reed’s Chocolate Ginger Ice Cream and Reed’s Green Tea Ginger Ice Cream.

 

Beverages

 

Reed’s Ginger Brews

 

Ginger ale is the oldest known soft drink. Before modern soft drink technology existed, non-alcoholic beverages were brewed at home directly from herbs, roots, spices, and fruits. These handcrafted brews were then aged like wine and highly prized for their taste and their tonic, health-giving properties. Reed’s Ginger Brews are a revival of this home brewing art and we make them with care and attention to wholesomeness and quality, using the finest fresh herbs, roots, spices, and fruits. Our expert brew masters brew each batch and age it with great pride.

 

We believe that Reed’s Ginger Brews are unique in their kettle brewed origin among all mass-marketed soft drinks. Reed’s Ginger Brews contain between 8 and 26 grams of fresh ginger in every 12-ounce bottle. We use no refined sugars as sweeteners. Our products differ from commercial soft drinks in three particular characteristics: sweetening, carbonation and coloring for greater adult appeal. Instead of using injected-based carbonation, we produce our carbonation naturally, through slower, beer-oriented techniques. This process produces smaller, longer lasting bubbles that do not dissipate rapidly when the bottle is opened. We do not add coloring. The color of our products comes naturally from herbs, fruits, spices, roots and juices.

 

In addition, since Reed’s Ginger Brews are pasteurized, they do not require or contain any preservatives. In contrast, modern commercial soft drinks generally are produced using natural and artificial flavor concentrates prepared by flavor laboratories, tap water, and highly refined sweeteners. Typically, manufacturers make a centrally processed concentrate that will lend itself to a wide variety of situations, waters, and filling systems. The final product is generally cold-filled and requires preservatives for stability. Colors are added that are either natural, although highly processed, or artificial.

 

In addition, while we make no claim as to any medical or therapeutic benefits of our products, we have found friends and advocates among alternative, holistic, naturopathic, and homeopathic medical practitioners, dieticians and medical doctors, who tell us that they recommend Reed’s Extra Ginger Brew for their patients as a simple way to ingest a known level of ginger. The United States Food and Drugs Administration (FDA) include ginger on their GRAS (generally recognized as safe) list. However, neither the FDA nor any other government agency officially endorses or recommends the use of ginger as a dietary supplement.

 

We currently manufacture and sell six varieties of Reed’s Ginger Brews:

 

·	Reed’s Original Ginger Brew was our first creation, and is a Jamaican recipe for homemade ginger ale using 17 grams of fresh ginger root, lemon, lime, honey, fructose, pineapple, herbs and spices. Reed’s Original Ginger Brew is 20% fruit juice.

 

·	Reed’s Extra Ginger Brew is the same approximate recipe, with 26 grams of fresh ginger root for a stronger bite. Reed’s Extra Ginger Brew is 20% fruit juice.

 

·	Reed’s Premium Ginger Brew is the no-fructose version of Reed’s Original Ginger Brew, and is sweetened only with honey and pineapple juice. Reed’s Premium Ginger Brew is 20% fruit juice.

 

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·	Reed’s Raspberry Ginger Brew is brewed from 17 grams of fresh ginger root, raspberry juice and lime. Reed’s Raspberry Ginger Brew is 20% raspberry juice and is sweetened with fruit juice and fructose.

 

·	Reed’s Spiced Apple Brew uses 8 grams of fresh ginger root, the finest tart German apple juice and such apple pie spices as cinnamon, cloves and allspice. Reed’s Spiced Apple Brew is 50% apple juice and sweetened with fruit juice and fructose.

 

·	Reed’s Cherry Ginger Brew is the newest addition to our Ginger Brew family, and is naturally brewed from: filtered water, fructose, fresh ginger root, cherry juice from concentrate and spices. Reed’s Cherry Ginger Brew is 22% cherry juice.

 

All six of Reed’s Ginger Brews are offered in 12-ounce bottles and are sold in stores as singles, in four-packs and in 24-bottle cases. Reed’s Original Ginger Brew is sold by select retailers in a special 12-pack. Reed’s Spiced Apple Brew is now available in a 750 ml. champagne bottle.

 

Virgil’s Root Beer

 

Over the years, Virgil’s Root Beer has won numerous awards and has a reputation among many as one of the best root beers made anywhere. Virgil’s Root Beer won the “Outstanding Beverage” award at the NASFT’s International Fancy Food and Confection Show in 1997.

 

Virgil’s is a premium root beer. We use all-natural ingredients, including filtered water, unbleached cane sugar, anise from Spain, licorice from France, bourbon vanilla from Madagascar, cinnamon from Sri Lanka, clove from Indonesia, wintergreen from China, sweet birch and molasses from the southern United States, nutmeg from Indonesia, pimento berry oil from Jamaica, balsam oil from Peru and cassia oil from China.

 

We collect these ingredients worldwide and gather them together at the brewing and bottling facilities we use in the United States and Germany. We combine and brew these ingredients under strict specifications and finally heat-pasteurize Virgil’s Root Beer, to ensure quality.

 

We sell Virgil’s Root Beer in four packaging styles: 12-ounce bottles in a four-pack, a special ceramic-swing-lid style pint bottle, a 5-liter self-tapping party keg and a draught “pony keg.”

 

Virgil’s Cream Soda

 

We launched Virgil’s Cream Soda in January 2004. We make this product with the same attention to quality that makes Virgil’s Root Beer so popular.

 

Virgil’s Cream Soda is a gourmet cream soda. We brew Virgil’s Cream Soda the same way we brew Virgil’s Root Beer. We use all-natural ingredients, including filtered water, unbleached cane sugar and bourbon vanilla from Madagascar.

 

Virgil’s Cream Soda is currently sold in 12-ounce long neck bottles in colorful 4-packs, a 5-liter party keg version and in our draught format.

 

In 2006, we expanded our product line to include Virgil’s Black Cherry Cream Soda in a 12-ounce bottle.

 

China Cola

 

We consider China Cola to be the best tasting and most natural cola in the world. We restored China Cola to its original delicious blend of raw cane sugar, imported Chinese herbs, essential oils and natural spices. China Cola contains no caffeine. It comes in two varieties, Original China Cola and Cherry China Cola.

 

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Original China Cola is made from filtered water, raw cane sugar, szechwan poeny root, cassia bark, Malaysian vanilla, oils of lemon, oil of lime, oil of orange, nutmeg, clove licorice, cardamom, caramel color, citric acid and phosphoric acid.

 

Cherry China Cola is made from the same ingredients as Original China Cola, with the addition of natural cherry flavor.

 

China Cola and Cherry China Cola sell as singles, in four-packs and in 24-bottle cases.

 

Reed’s Ginger Juice Brews

 

In May 2002, we launched a new line of ginger brews called Reed’s Ginger Juice Brews. They are 100% juice products that are non-carbonated and brewed from organic fresh ginger root and sweetened with organic juices. We created this product, in part, in response to a strong trend we have seen toward organic ingredients and non-carbonated beverages in the marketplace. We wanted to extend our ginger brew line and believe that these new flavors will cater to the growing market for organic non-carbonated beverages.

 

All four of our Reed’s Ginger Juice Brews contain: filtered water, organic fresh ginger root, and organic white grape juice from concentrate. Specifically,

 

·	Reed’s Lemon Guava Ginger Juice Brew adds guava juice from concentrate and lemon juice from concentrate.

 

·	Reed’s Strawberry Kiwi Ginger Juice Brew adds organic strawberry juice from concentrate and organic kiwi juice from concentrate.

 

·	Pineapple Orange Ginger Juice Brew adds organic pineapple juice from concentrate, organic orange juice from concentrate, and organic limejuice from concentrate.

 

·	Reed’s Cranberry Raspberry Ginger Juice Brew adds cranberry juice from concentrate, and organic raspberry juice from concentrate.

 

Reed’s Ginger Juice Brews drinks come in a 16-ounce juice bottle as singles or in cases of 12 and 24 bottles.

 

Reed’s Ginger Candies

 

Reed’s Crystallized Ginger Candy

 

Reed’s Crystallized Ginger was the first crystallized ginger on the market in the United States to be sweetened with raw cane instead of refined white sugar. Reed’s Crystallized Ginger is custom-made for us in Fiji.

 

The production process is an ancient one that has not changed much over time. After harvesting baby ginger (the most tender kind), the root is diced and then steeped for several days in large vats filled with simmering raw cane syrup. The ginger is then removed and allowed to crystallize into soft, delicious nuggets. Many peoples of the islands have long enjoyed these treats for health and pleasure.

 

We sell this product in 3.5-ounce bags, 10-ounce enameled, rolled steel gift tins, 16-ounce re-sealable Mylar bags, and in bulk. We also sell Reed’s Crystallized Ginger Baking Bits in bulk.

 

Reed’s Ginger Candy Chews

 

For many years, residents of Southeast Asia from Indonesia to Thailand have enjoyed soft, gummy ginger candy chews. We sell Reed’s Ginger Candy Chews individually wrapped in soft-packs of ten candies and as individually wrapped loose pieces in bulk. Reed’s has taken them a step further, adding more ginger, using no gelatin (vegan-friendly) and making them slightly easier to unwrap than their Asian counterparts.

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Reed’s Ginger Candy Chews are made for us in Indonesia from sugar, maltose (malt sugar), ginger, and tapioca starch.

 

Reed’s Ginger Ice Creams

 

We make Reed’s Ginger Ice Creams with 100% natural ingredients, using the finest hormone-free cream and milk. We combine fresh milk and cream with the finest natural ginger puree, Reed’s Crystallized Ginger Candy and natural raw cane sugar to make a delicious ginger ice cream with a super premium, ultra-creamy texture and Reed’s signature spicy-sweet bite. Our ice creams are made for us, according to our own recipes, at a dairy in upstate New York.

 

We sell three Reed’s Ginger Ice Cream products:

 

·	Reed’s Original Ginger Ice Cream made from milk, cream, raw cane sugar, Reed’s Crystallized Ginger Candy (finest ginger root, raw cane sugar), ginger puree, and guar gum (a natural vegetable gum),

 

·

Chocolate Ginger Ice Cream made from milk, cream, raw cane sugar, finest Belgian cocoa (used to make Belgian chocolate), Reed’s Crystallized Ginger Candy (fresh baby ginger root, raw cane sugar), chocolate shavings (sugar, unsweetened chocolate, Belgian cocoa, soy lecithin and real vanilla), ginger puree, and guar gum (a natural vegetable gum) creating the ultimate chocolate ginger ice cream, and

 

·	Reed’s Green Tea Ginger Ice Cream made from milk, cream, the finest green tea, raw cane sugar, ginger puree, Reed’s Crystallized Ginger Candy (fresh baby ginger root, raw cane sugar), and guar gum (a natural vegetable gum) creating the ultimate green tea ginger ice cream.

 

We sell Reed’s Ginger Ice Creams in pint containers and cases of eight pints. We also intend to supply Reed’s Ginger Ice Creams in foodservice volume packaging.

 

New Product Development

 

We are always working on development to continue expanding from our Reed’s Ginger Brews, Virgil’s product line, Reed’s Ginger Juice Brew, Reed’s Ginger Ice Cream, and Reed’s Ginger Candy product lines and packaging styles. However, research and development expenses in the last two years have been nominal. We intend to expend some, but not a significant amount, of funds on research and development for new products and packaging. We intend to introduce new products and packaging as we deem appropriate from time to time for our business plan.

 

Among the advantages of our owned and self-operated Brewery are the flexibility to try innovative packaging and the capability to experiment with new product flavors at less cost to our operations or capital. Currently, we sell a half-liter Virgil’s Root Beer swing-lid bottle that is made for us in Europe. We intend to produce several of our beverages in one-liter swing-lid bottles in the United States. Our Reed’s Original Ginger Brew, Extra Ginger Brew Spiced and Apple Brew are available in a 750 ml. champagne bottle and other products are planned to be available with this packaging in the near future.

 

Manufacture of Our Products

 

We produce our carbonated beverages at two facilities:

 

·	a facility that we own in Los Angeles, California, known as The Brewery, at which we produce certain soda products for the western half of the United States, and

 

·

a packing, or co-pack, facility in Pennsylvania, known as the Lion Brewery, with which they contract to supply us with product we do not produce at The Brewery. The term of our agreement with Lion Brewery expires on May 31, 2007 and renews automatically for successive two-year terms unless terminated by either party. The Lion Brewery assembles our products and charges us a fee, generally by the case, for the products they produce.

 

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Our west coast Brewery facility is running at 40% of capacity. We have had difficulties with the underutilization of the Brewery at 40% of capacity as a result of working out problems associated with the flavor of our ginger brew products produced at the Brewery, causing us to increase freight and other associated expenses with producing and shipping such products nationally from our east coast co-packing facility. Management is committed to selling a high quality, great tasting product. Since the east coast co-packer is producing such a product, management has elected to continue to sell that product on the west coast, even though it negatively impacts our gross margins. As we are able to make the Brewery become more fully utilized, we believe that we will experience improvements in gross margins due to freight and production savings.

 

Our Ginger Juice Brews are co-packed for us at H.A. Ryder in Northern California. We supply all the ingredients and packaging. The co-pack facility assembles our products and charges us a fee, by the case. Our ice creams are co-packed for us at Ronnybrooke dairy in upstate New York. We supply all the flavor additions and packaging and the dairy supplies the ice cream base. The co-pack facility assembles our products and charges us a fee, by the unit produced for us. We have half-liter swing-lid bottles of our Virgil’s Root Beer line co-packed for us at the Hofmark Brewery in southern Germany. The co-pack facility assembles our products and charges us a fee by the unit they produce for us. Our arrangements with H.A Ryder, Ronnybrooke Dairy and Hofmark Brewery are on an order by order by basis.

 

We follow a “fill as needed” manufacturing model to the best of our ability and we have no significant backlog of orders.

 

Substantially all of the raw materials used in the preparation, bottling and packaging of our products are purchased by us or by our contract packers in accordance with our specifications. Reed’s Crystallized Ginger is made to our specifications in Fiji. Reed’s Ginger Candy Chews are made to our specifications in Indonesia, and we repackage them at the Brewery in Los Angeles.

 

Generally, we obtain the ingredients used in our products from domestic suppliers and each ingredient has several reliable suppliers. We have no major supply contracts with any of our suppliers. As a general policy, we pick ingredients in the development of our products that have multiple suppliers and are common ingredients. This provides a level of protection against a major supply constriction or calamity.

 

We believe that as we continue to grow, we will be able to keep up with increased production demands. We believe that the Brewery has ample capacity to handle increased West Coast business. To the extent that any significant increase in business requires us to supplement or substitute our current co-packers, we believe that there are readily available alternatives, so that there would not be a significant delay or interruption in fulfilling orders and delivery of our products. In addition, we do not believe that growth will result in any significant difficulty or delay in obtaining raw materials, ingredients or finished product that is repackaged at the Brewery.

 

Our Primary Markets

 

We target a niche in the soft drink industry known as New Age beverages. The soft drink industry generally characterizes New Age Beverages as being made more naturally, with upscale packaging, and often creating and utilizing new and unique flavors and flavor combinations.

 

The New Age beverage segment is highly fragmented and includes such competitors as SoBe, Snapple, Arizona, Hansen’s and Jones Soda, among others. These brands have the advantage of being seen widely in the national market and being commonly well known for years through well-funded ad campaigns. Despite our products’ having a relatively high price for a premium beverage product, no mass media advertising and a relatively small presence in the mainstream market compared to many of our competitors, we believe that results to date demonstrate that Reed’s Ginger Brews and Virgil’s sodas are making market inroads among these significantly larger brands. See “Business - Competition.”

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We sell the majority of our products in natural food stores, mainstream supermarket chains and foodservice locations, primarily in the United States and, to a lesser degree, in Canada.

 

Natural Food Stores

 

Our primary and historical marketing source of our products has been natural food and gourmet stores. These stores include Whole Foods Market, Wild Foods, Trader Joe’s and Wild Oats. We also sell in gourmet restaurants and delis.

 

We believe that our products have achieved a leading position in their niche in the fast-growing natural food industry.

 

With the advent of large natural food store chains and specialty merchants, the natural foods segment continues to grow each year in direct competition with the mainstream grocery trade.

 

Mainstream Supermarkets and Retailers

 

We sell our products in over 1,000 mainstream supermarkets throughout the United States, and to a lesser extent, in Canada. These stores include national and regional supermarket chains, such as Kroger, Ralph’s, Raley’s, Safeway and Winn-Dixie. Generally, these stores market our products in specialty natural and gourmet sections within the stores, although we are increasing our presence in mainstream soft drink sections in these stores.

 

Supermarkets, particularly supermarket chains and prominent local supermarkets, often impose slotting fees before permitting new product placements in their store or chain. These fees can be structured to be paid one-time only or in installments. We pursue broad-based slotting in supermarket chains throughout the United States and, to a lesser degree, in Canada. However, our direct sales team in Southern California and our national sales management team have been able to place our products without having to pay slotting fees much of the time. However, slotting fees for new placements normally cost between $10 and $100 per store per new item placed.

 

We also sell our products to large national retailers who place our products within their national distribution streams. These retailers include Costco, Sam’s Club and Trader Joe’s.

 

Foodservice Placement

 

We also market our beverage products to industrial cafeterias, bars and restaurants. We intend to place our beverage products in stadiums, sports arenas, concert halls, theatres, and other cultural centers as a long-term marketing plan. In addition, we plan to market our ice creams in restaurants nationwide.

 

International Sales

 

We have developed a limited market for our products in Canada, Europe and Asia. Sales outside of North America currently represent less than 1% of our total sales. Sales in Canada represent about 1.3% of our total sales.

 

The European Union is an open market for Reed’s with access to that market due in part to the ongoing production of Virgil’s Special Extra Nutmeg Root Beer in Germany. We market our products in Europe through a master distributor in Amsterdam and sub-distributors in the Netherlands, Denmark, the United Kingdom and Spain. We are currently negotiating with a Dutch company in Amsterdam for wider European distribution.

 

American Trading Corp. in Japan orders our products on a regular basis for distribution in Japan. We are holding preliminary discussions with other trading companies and import/ export companies for the distribution of our products throughout Japan, China and the rest of Asia. We believe that these areas are a natural fit for Reed’s ginger products, because of the importance of ginger in Asian diet and nutrition.

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Distribution, Sales and Marketing

 

We currently have a national network of mainstream, natural and specialty food distributors in the United States and Canada. We sell directly to our distributors, who in turn sell to retail stores. We also use our own sales group and independent sales representatives to promote our products for our distributors and direct sales to our retail customers. In Southern California, we have our own direct distribution in addition to other local distributors. We plan to expand our direct distribution into other markets.

 

One of the main goals of our sales and marketing efforts is to increase the number of sales people and distributors focused on growing our brands. Where a market does not support or lend itself to direct distribution, we intend to enlist local mainstream beverage distributors to carry our products. Our increased efforts in marketing also will require us to hire additional sales representatives and other marketing expenses. We plan to use a portion of the proceeds of the public offering toward hiring the additional sales people needed to support both the expansion of our existing direct distribution and to grow sales through mainstream distributors. We will be dependent upon obtaining the proceeds from the public offering to implement our marketing expansion plans.

 

We currently maintain two separate sales organizations, one of which handles natural food store sales and the other of which handles mainstream store sales. We currently have three in-house sales managers and eight independent sales representatives. These sales forces consist of in-house sales managers and independent sales representatives who support our distributors and direct selling efforts. The natural food store sales force works mainly in the natural and gourmet food stores serviced by natural and gourmet distributors. Representatives are responsible for the accounts in their territory and they stay on a focused schedule of visits to maintain store and distributor relationships. In the future, we intend to integrate both our distribution and sales forces.

 

Our sales force markets existing products, run promotions and introduce new items. Our in-house sales managers are responsible for the distributor relationships and larger chain accounts that require headquarter sales visits and managing our independent sales representatives.

 

We also offer our products and promotional merchandise directly to consumers via the Internet through our website, www.reedsgingerbrew.com.

 

Marketing to Distributors

 

We market to distributors using a number of marketing strategies, including direct solicitation, telemarketing, trade advertising and trade show exhibition. These distributors include natural food, gourmet food, and mainstream distributors. Our distributors sell our products directly to natural food, gourmet food and mainstream supermarkets for sale to the public. We maintain direct contact with the distributors through our in-house sales managers. In limited markets, where use of our direct sales mangers are not cost-effective, we utilize food brokers and outside representatives.

 

Marketing to Retail Stores

 

We market to retail stores by utilizing trade shows, trade advertising, telemarketing, direct mail pieces and direct contact with the store. Our sales managers and representatives visit these retail stores to sell directly in many regions. Sales to retail stores are coordinated through our distribution network and our regional warehouses.

 

Direct Sales and Distribution

 

In June 2003, we started Direct Sales and Distribution (DSD) to stores in Southern California, using a direct hired sales team and our delivery trucks. Our in-house sales manager works directly with our new route drivers and with distributors in the Southern California area. A DSD system allows us to have greater control over our marketing efforts, as we become less dependent on distributors who have relationships with our competitors. We hope to expand our DSD network to areas outside of Southern California as our resources will allow.

 

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Southern California sales represented approximately $750,000 and $400,000 in 2005 and 2004, respectively. These new direct-distribution accounts also include retail locations, including many new independent supermarkets, “mom and pop” markets and foodservice locations. In addition, direct distribution facilitates our new placements at hospitals, the Getty Center in Los Angeles, Fox Studios and other cultural and institutional accounts.

 

Marketing to Consumers

 

Advertising. We utilize several marketing strategies to market directly to consumers. Advertising in targeted consumer magazines such as “Vegetarian Times” and “New Age” magazine, in-store discounts on the products, in-store product demonstration, street corner sampling, coupon advertising, consumer trade shows, event sponsoring and our website www.reedsgingerbrew.com are all among current consumer-direct marketing devices.

 

In-Store Draught Displays. As part of our marketing efforts, we have started to offer in-store draught displays, or Kegerators. While we believe that packaging is an important part of making successful products, we also believe that our products and marketing methods themselves need to be exceptional to survive in today’s marketplace. Our Kegerator is an unattended, in-store draught display that allows a consumer to sample our products at a relatively low cost per demonstration. Stores offer premium locations for these new, and we believe unique, draught displays.

 

On Draught Program. Our West Coast Brewery has initiated an on-draught program. We have installed draught locations at Fox Studios commissaries and in approximately 12 restaurants in Southern California. Currently, we are serving Virgil’s Root Beer, Virgil’s Cream Soda, and Reed’s Extra Ginger Brew on draught. In addition, all of our other carbonated drinks are available in draught format.

 

Proprietary Coolers. The placement of in-store branded refrigerated coolers by our competitors has proven to have a significant positive effect on their sales. We are currently testing our own Reed’s branded coolers in a number of locations.

 

Competition

 

The beverage industry is highly competitive. The principal areas of competition are pricing, packaging, development of new products and flavors and marketing campaigns. Our products compete with a wide range of drinks produced by a relatively large number of manufacturers. Most of these brands have enjoyed broad, well-established national recognition for years, through well-funded ad and other branding campaigns. In addition, the companies manufacturing these products generally have greater financial, marketing and distribution resources than we do.

 

Important factors affecting our ability to compete successfully include taste and flavor of products, trade and consumer promotions, rapid and effective development of new, unique cutting edge products, attractive and different packaging, branded product advertising and pricing. We also compete for distributors who will concentrate on marketing our products over those of our competitors, provide stable and reliable distribution and secure adequate shelf space in retail outlets. Competitive pressures in the New Age beverage categories could cause our products to be unable to gain or to lose market share or we could experience price erosion.

 

We believe that our innovative beverage recipes and packaging and use of premium ingredients and a trade secret brewing process provide us with a competitive advantage and that our commitments to the highest quality standards and brand innovation are keys to our success.

 

Our premium New Age beverage products compete generally with all liquid refreshments and in particular with numerous other New Age beverages, including: SoBe, Snapple, Mistic, IBC, Stewart’s, Henry Weinhard, Arizona, Hansen’s, Knudsen & Sons and Jones Sodas.

 

Our Virgil’s and China Cola lines compete with a number of other natural soda companies, including Stewarts, IBC, Henry Weinhard, Blue Sky, A&W and Natural Brews.

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We also generally compete with other traditional soft drink manufacturers and distributors, such as Coke and Pepsi.

 

Reed’s Crystallized Ginger Candy competes primarily with other candies and snacks in general and, in particular, with other ginger candies. The main competitors in ginger candies are Royal Pacific, Australia’s Buderim Ginger Company, and Frontier Herbs. We believe that Reed’s Crystallized Ginger Candy is the only one among these brands that is sulfur-free.

 

Reed’s Ginger Ice Creams compete primarily with other premium and super-premium ice cream brands. Our principal competitors in the ice cream business are Haagen-Dazs, Ben & Jerry’s, Godiva, Starbucks, Dreyer’s and a number of smaller natural food ice cream companies.

 

Proprietary Rights

 

We own or have made applications for several trademarks that we consider material to our business, including Reed’s, Virgil’s and China Cola. Two of our material trademarks are registered trademarks in the U.S. Patent and Trademark Office: Reed’s(R) and China Cola(R), and we have reapplied for a trademark on the name Virgil’s. Registrations for trademarks in the United States will last indefinitely as long as we continue to use and police the trademarks and renew filings with the applicable governmental offices. We have not been challenged in our right to use any of our material trademarks in the United States. We intend to use a portion of the proceeds of the public offering to obtain international registration of certain trademarks in foreign jurisdictions, as we see fit.

 

In addition, we consider our finished product and concentrate formulae, which are not the subject of any patents, to be trade secrets. Our brewing process is a trade secret. This process can be used to brew flavors of beverages other than ginger ale and ginger beer, such as root beer, cream soda, cola, and other spice and fruit beverages. We have not sought any patents on our brewing processes because we would be required to disclose our brewing process in patent applications.

 

We generally use non-disclosure agreements with employees and distributors to protect our proprietary rights.

 

Government Regulation

 

The production, distribution and sale in the United States of many of our products is subject to the Federal Food, Drug and Cosmetic Act, the Dietary Supplement Health and Education Act of 1994, the Occupational Safety and Health Act, various environmental statutes, and various other federal, state and local statutes and regulations applicable to the production, transportation, sale, safety, advertising, labeling and ingredients of such products. California 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. The law exposes all food and beverage producers to the possibility of having to provide warnings on their products because the law recognizes no generally applicable quantitative thresholds below which a warning is not required. Consequently, even trace amounts of listed components can expose affected products to the prospect of warning labels. Products containing listed substances that occur naturally in the product or that are contributed to the product solely by a municipal water supply are generally exempt from the warning requirement. While none of our beverage products are required to display warnings under this law, we cannot predict whether an important component of any of our products might be added to the California list in the future. We also are unable to predict whether or to what extent a warning under this law would have an impact on costs or sales of our products.

 

Measures have been enacted in various localities and states that require that a deposit be charged for certain non-refillable beverage containers. The precise requirements imposed by these measures vary. Other deposit, recycling or product stewardship proposals have been introduced in certain states and localities and in Congress, and we anticipate that similar legislation or regulations may be proposed in the future at the local, state and federal levels, both in the United States and elsewhere.

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Our facilities in the United States are subject to federal, state and local environmental laws and regulations. Compliance with these provisions has not had, and we do not expect such compliance to have, any material adverse effect upon our capital expenditures, net income or competitive position.

 

Environmental Matters

 

Our primary cost of environmental compliance is in recycling fees, which approximated $40,000 in 2005. This is a standard cost of doing business in the soft drink industry.

 

In California, and in certain other states where we sell our products, we are required to collect redemption values from our customers and remit those redemption values to the state, based upon the number of bottles of certain products sold in that state.

 

In certain other states and Canada where our products are sold, we are also required to collect deposits from our customers and to remit such deposits to the respective state agencies based upon the number of cans and bottles of certain carbonated and non-carbonated products sold in such states.

 

Employees

 

We currently have 30 full-time employees, as follows: one in general management, nine in sales and marketing support, five in operations and 15 in production. We employ additional people on a part-time basis as needed.

 

We have never participated in a collective bargaining agreement. We believe that the relationship with our employees is good.

 

Properties

 

We own an 18,000 square foot warehouse, known as the Brewery, at 13000 South Spring Street in an unincorporated area of Los Angeles County, near downtown Los Angeles. The property is located in the Los Angeles County Mid-Alameda Corridor Enterprise Zone. Businesses located in the enterprise zone are eligible for certain economic incentives designed to stimulate business investment, encourage growth and development and promote job creation.

 

We purchased the facility in December 2000 for a purchase price of $850,000, including a down payment of $102,000. We financed approximately $750,000 of the purchase price with a loan from U.S. Bank National Association, guaranteed by the United States Small Business Administration. We also obtained a building improvement loan for $168,000 from U.S. Bank National Association, guaranteed by the United States Small Business Administration. Christopher J. Reed, our founder and Chief Executive Officer, personally guaranteed both loans. Both loans are due and payable on November 29, 2025, with interest at the New York prime rate plus 1%, adjusted monthly, with no cap or floor. As of December 31, 2005, the principal and interest payments on the two loans combined were $7,037 per month. This facility serves as our principal executive offices, our West Coast Brewery and bottling plant and our Southern California warehouse facility.

 

Legal Proceedings

 

From time to time, we are a party to claims and legal proceedings arising in the ordinary course of business. Our management evaluates our exposure to these claims and proceedings individually and in the aggregate and provides for potential losses on such litigation if the amount of the loss is estimable and the loss is probable.

 

On January 20, 2006, Consac Industries, Inc. (dba Long Life Teas and Long Life Beverages) filed a lawsuit in the United States District Court for the Central District of California against Reed’s Inc. and Christopher Reed, Case No. CV06-0376. The complaint asserts claims for negligence, breach of contract, breach of warranty, and breach of express indemnity relating to Reed’s, Inc.’s manufacture of approximately 13,000 cases of “Prism Green Tea Soda” for Consac. Consac contends that we negligently manufactured the soda resulting in at least one personal injury. Consac seeks $2.6 million in damages, plus interest and attorneys fees. Some of the allegations made against the company are covered by insurance and some allegations are not covered by insurance. Although we believe that we have meritorious defenses to this proceeding, there can be no assurances as to its outcome.

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From August 3, 2005 through April 7, 2006, we issued 333,156 shares of our common stock in connection with our initial public offering pursuant to a Registration Statement on Form SB-2. The shares issued in connection with the initial public offering may have been issued in violation of either federal or state securities laws, or both, and may be subject to rescission. In order to address this issue, we intend to make this rescission offer to the holders of these shares prior to the effective date of the registration statement relating to the public offering.

 

If this rescission offer is accepted, we could be required to make aggregate payments to the holders of these shares up to $1,332,624, plus statutory interest. This exposure is calculated by reference to the acquisition price of $4.00 per share for the common stock in connection with the initial public offering, plus accrued interest at the applicable statutory rate. It is our intention that if any of the shares are tendered for rescission, the shares will be purchased by others and not from our funds. If we are required to pay the obligation which may be created under the rescission offer, such a refund would materially and adversely effect our financial position.

 

Federal securities laws do not provide that a rescission offer will terminate a purchaser’s right to rescind a sale of stock that was not registered as required or was not otherwise exempt from such registration requirements. If any or all of the offerees reject the rescission offer, we may continue to be liable under federal and state securities laws for up to an amount equal to the value of all shares of common stock issued in connection with the initial public offering plus any statutory interest we may be required to pay. We also understand that the SEC and certain state regulators, including California, have requested additional information regarding the rescission offer. If it is determined that we offered securities without properly registering them under federal or state law, or securing an exemption from registration, regulators could impose monetary fines or other sanctions as provided under these laws.

 

Except as set forth above, we believe that there are no material litigation matters at the current time. Although the results of such litigation matters and claims cannot be predicted with certainty, we believe that the final outcome of such claims and proceedings will not have a material adverse impact on our financial position, liquidity, or results of operations.

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MANAGEMENT

 

General

 

Our directors currently have terms which will end at our next annual meeting of the stockholders or until their successors are elected and qualify, subject to their prior death, resignation or removal. Officers serve at the discretion of the board of directors. Except as described below, there are no family relationships among any of our directors and executive officers. Our board members are encouraged to attend meetings of the board of directors and the annual meeting of stockholders. The board of directors held two meetings and adopted two unanimous written consents in lieu of meetings in 2005.

 

The following table sets forth certain biographical information with respect to our directors and executive officers:

 

Name		Position		Age
Christopher J. Reed		President, Chief Executive Officer, Chief Financial Officer and Chairman of the Board		47
Eric Scheffer		Vice President and National Sales Manager - Natural Foods		38
Robert T. Reed, Jr.		Vice President and National Sales Manager - Mainstream		50
Robert Lyon		Vice President Sales - Special Projects		56
Judy Holloway Reed		Secretary and Director		46
Mark Harris		Director		49
Dr. D.S.J. Muffoletto, N.D.		Director		51
Michael Fischman		Director		50

 

Christopher J. Reed founded our company in 1987. Mr. Reed has served as our Chairman, President, Chief Executive Officer and Chief Financial Officer since our incorporation in 1991. Mr. Reed has been responsible for our design and products, including the original product recipes, the proprietary brewing process and the packaging and marketing strategies. Mr. Reed received a B.S. in Chemical Engineering in 1980 from Rennselaer Polytechnic Institute in Troy, New York.

 

Eric Scheffer has been our Vice President and National Sales Manager - Natural Foods since May 2001. From September 2000 to May 2001, Mr. Scheffer worked as Vice President of Sales for Rachel Perry Natural Cosmetics. Mr. Scheffer was national sales manager at Earth Science, Inc. from January 1999 to September 2000, where he managed the United States and Canadian outside sales force. Mr. Scheffer was national sales manager at USA Nutritionals from June 1997 to January 1999, where he led a successful effort bridging their marketing from natural foods to mainstream stores. He worked for Vita Source as Western sales manager from May 1994 to June 1997 and was their first sales representative.

 

Robert T. Reed Jr. has been our Vice President and National Sales Manager - Mainstream since January 2004. Prior to joining us, Mr. Reed was employed with SunGard Availability Services from 1987 through 2003. He started with SunGard as an Account Manager. Over the years, Mr. Reed earned promotions to Director of Sales in 1989, Vice President of Sales in 1992 and Senior Vice President of Sales in 1997. In March 2000, Mr. Reed was appointed President of SunGard eSourcing, a subsidiary of SunGard Availability Services, with annual revenue in excess of $70 million and over 300 employees. During Mr. Reed’s tenure with SunGard Availability Services, revenues increased from $30 million to over $1.2 billion. He earned a Bachelors of Science degree in Business and Finance from Mount Saint Mary’s University in 1977. Mr. Reed is the brother of Christopher J. Reed, our Chairman, President, Chief Executive Officer and Chief Financial Officer.

 

Robert Lyon has been our Vice President Sales - Special Projects since June 2002. In that capacity, Mr. Lyon directs our Southern California direct sales and distribution program in mainstream markets. Over the past five years, Mr. Lyon also has operated an organic rosemary farm in Malibu, California, selling bulk to re-packagers. In the 1980s and 1990s, Mr. Lyon operated a successful water taxi service with 20 employees and eight vessels of his own design. He also built the national sales team for a jewelry company, Iberia from 1982 through 1987. Mr. Lyon holds several U.S. patents. He earned a Business Degree from Northwestern Michigan University in 1969.

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Judy Holloway Reed has been with us since 1992 and, as we have grown, has run the accounting, purchasing and shipping and receiving departments at various times since the 1990s. Ms. Reed has been one of our directors since June 2004, our Secretary since October 1996 and our Director of Office Operations and Staff Management since June 2004. In the 1980s, Ms. Reed managed media tracking for a Los Angeles Infomercial Media Buying Group and was an account manager with a Beverly Hills, California stock portfolio management company. She earned a Business Degree from MIU in 1981. Ms. Reed is the wife of Christopher J. Reed, our Chairman, President, Chief Executive Officer and Chief Financial Officer.

 

Mark Harris has been a member of our board of directors since April 2005. Mr. Harris is an independent venture capitalist and has been retired from the work force since 2002. In late 2003, Mr. Harris joined a group of Amgen colleagues in funding NeoStem, Inc., a company involved in stem-cell storage, archiving, and research to which he is founding angel investor. From 1991 to 2002, Mr. Harris worked at biotech giant Amgen managing much of the company’s media production for internal use and public relations. Mr. Harris spent the decade prior working in the aerospace industry at Northrop with similar responsibilities.

 

Dr. Daniel S.J. Muffoletto, N.D. has been a member of our board of directors since April 2005. Dr. Muffoletto has practiced as a Naturopathic Physician since 1986. He has been chief executive officer of Its Your Earth, a natural products marketing company since June 2004. From 2003 to 2005, Dr. Muffoletto worked as sales and marketing director for Worthington, Moore & Jacobs, a Commercial Law League member firm serving FedEx, UPS, DHL and Kodak, among others. From 2001 to 2003, he was the owner-operator of the David St. Michel Art Gallery in Montreal, Québec. From 1991 to 2001, Dr. Muffoletto was the owner/operator of a Naturopathic Apothecary, Herbal Alter*Natives of Seattle, Washington and Ellicott City, Maryland. The apothecary housed Dr. Muffoletto’s Naturopathic Practice. Dr. Muffoletto received a Bachelors of Arts degree in Government and Communications from the University of Baltimore in 1977, and conducted postgraduate work in the schools of Public Administration and Publication Design at the University of Baltimore from 1978 to 1979. In 1986, he received his Doctorate of Naturopathic Medicine from the Santa Fe Academy of Healing, Santa Fe, New Mexico.

 

Michael Fischman has been a member of our board of directors since April 2005. Since 1998, Mr. Fischman has been President and chief executive officer of the APEX course, the corporate training division of the International Association of Human Values. In addition, Mr. Fischman is a founding member and the director of training for USA at the Art of Living Foundation, a global non-profit educational and humanitarian organization at which he has coordinated over 200 personal development instructors since 1997. Among Mr. Fischman’s personal development clients are the World Bank, Royal Dutch Shell, the United Nations, the US Department of Probation, the Washington, D.C. Police Department, and Rotary Clubs International.

 

Other than the relationships of Christopher J. Reed, Judy Holloway Reed, and Robert T. Reed, Jr., none of our directors or executive officers are related to one another.

 

Peter Sharma, III resigned as one of our directors on January 27, 2006.

 

Currently our Chief Executive Officer, Christopher J. Reed, serves as our Chief Financial Officer. Mr. Reed does not have any formal financial training as a Chief Financial Officer. During the next 12 months, we intend to hire a Chief Financial Officer. In addition, we intend to hire a Distribution Manager with extensive experience in the beverage arena with specific experience in setting up a regional distributor network.

 

II-4

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(i)

Any preliminary prospectus or prospectus of the undersigned small business issuer relating to the offering required to be filed pursuant to Rule 424;

 

(ii)

Any free writing prospectus relating to the offering prepared by or on behalf of the undersigned small business issuer or used or referred to by the undersigned small business issuer;

 

(iii)

The portion of any other free writing prospectus relating to the offering containing material information about the undersigned small business issuer or its securities provided by or on behalf of the undersigned small business issuer; and

 

(iv)

Any other communication that is an offer in the offering made by the undersigned small business issuer to the purchaser.

 

(e) Insofar as indemnification for liabilities arising under the Securities Act of 1933 (the “Act”) may be permitted to directors, officers and controlling persons of the registrant pursuant to the provisions described in Item 24 above, or otherwise, the registrant has been advised that in the opinion of the SEC for matters under the securities laws, such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable.

 

In the event that a claim for indemnification against such liabilities (other than the payment by the registrant expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit, or proceeding) is asserted by such director, officer, or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act of 1933 and will be governed by the final adjudication of such issue.

 

(g) That, for purposes of determining liability under the Securities Act to any purchaser:

 

(1) If the small business issuer is relying on Rule 430B:

 

(i)

Each prospectus filed by the undersigned small business issuer pursuant to Rule 424(b)(3) shall be deemed to be part of the registration statement as of the date the filed prospectus was deemed part of and included in the registration statement;

 

(ii)

Each prospectus required to be filed pursuant to Rule 424(b)(2), (b)(5), or (b)(7) as part of a registration statement in reliance on Rule 430B relating to an offering made pursuant to Rule 415(a)(1)(i), (vii), or (x) for the purpose of providing the information required by section 10(a) of the Securities Act shall be deemed to be part of and included in the registration statement as of the earlier of the date such form of prospectus is first used after effectiveness or the date of the first contract of sale of securities in the offering described in the prospectus. As provided in Rule 430B, for liability purposes of the issuer and any person that is at that date an underwriter, such date shall be deemed to be a new effective date of the registration statement relating to the securities in the registration statement to which that prospectus relates, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. Provided, however, that no statement made in a registration statement or prospectus that is part of the registration statement or made in a document incorporated or deemed incorporated by reference into the registration statement or prospectus that is part of the registration statement will, as to a purchaser with a time of contract of sale prior to such effective date, supersede or modify any statement that was made in the registration statement or prospectus that was part of the registration statement or made in any such document immediately prior to such effective date; or

 

(2) If the small business issuer is subject to Rule 430C, include the following:

II-5

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Each prospectus filed pursuant to Rule 424(b)as part of a registration statement relating to an offering, other than registration statements relying on Rule 430B or other than prospectus filed in reliance on Rule 430, shall be deemed to be part of and included in the registration statement as of the date it is first used after effectiveness. Provided, however, that no statement made in a registration statement or prospectus that is part of the registration statement or made in a document incorporated or deemed incorporated by reference into the registration statement or prospectus that is part of the registration statement will, as to a purchaser with a time of contract of sale prior to such first use, supersede or modify any statement that was made in the registration statement or prospectus that was part of the registration statement or made in any such document immediately prior to such date of first use.

II-6

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SIGNATURES

 

In accordance with the requirements of the Securities Act of 1933, the registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form SB-2 and authorized this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Los Angeles, State of California, on July 31, 2006.

 

	REED’S, INC.
	By:	/s/ Christopher J. Reed
		Christopher J. Reed Chief Executive Officer

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Christopher J. Reed and Judy Holloway Reed, jointly and severally, as his attorneys-in-fact, with full power of substitution in each, for him in any and all capacities to sign any amendments to this Registration Statement on Form SB-2, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitutes, may do or cause to be done by virtue hereof.

 

In accordance with the requirements of the Securities Act of 1933, as amended, this Registration Statement was signed by the following persons in the capacities and on the dates stated.

 

Signature		Title		Date
/s/ Christopher J. Reed		Chief Executive Officer, Chief Financial Officer and		July 31, 2006
Christopher J. Reed		Chairman of the Board of Directors (Principal Executive
		Officer and Principal Accounting Officer)
/s/ Judy Holloway Reed		Director		July 31, 2006
Judy Holloway Reed
/s/ Mark Harris		Director		July 31, 2006
Mark Harris
/s/ Daniel S.J. Muffoletto		Director		July 31, 2006
Daniel S.J. Muffoletto
/s/ Michael Fischman		Director		July 31, 2006
Michael Fischman

 

II-7

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EXHIBIT INDEX

 

1.1	Underwriting Agreement - US EURO Securities, Inc. *
1.2	Subscription Agreement *
1.3	Underwriters’ Warrant *
3.1	Certificate of Incorporation *
3.2	Amendment to Certificate of Incorporation *
3.3	Certificate of Designations *
3.4	Certificate of Correction to Certificate of Designations *
3.5	Bylaws, as amended *
4.1	Form of common stock certificate *
4.2	Form of Series A preferred stock certificate *
4.3	2001 Employee Stock Option Plan *
4.4	Convertible promissory notes issued to investors *
4.5	Amendment to Promissory Note *
5.1	Legal opinion of Jenkens & Gilchrist, LLP
10.1	Purchase Agreement for Virgil’s Root Beer *
10.2	Brewing Agreement dated as of May 15, 2001 between the Company and The Lion Brewery, Inc. *
10.3	Loan Agreement with U.S. Bank National Association for purchase of the Brewery *
10.4	Loan Agreement with U.S. Bank National Association for improvements at the Brewery *
10.5	Loan Agreement with Bay Business Credit *
10.6	Credit Agreement with Merrill Lynch *
10.7	Form of Promotional Share Lock-In Agreement *
10.7(a)	Promotional Share Lock-In Agreement For Christopher J. Reed *
10.7(b)	Promotional Share Lock-In Agreement For Robert T. Reed, Jr. *
10.7(c)	Promotional Share Lock-In Agreement For Robert T. Reed, Sr. *
10.7(d)	Promotional Share Lock-In Agreement For Peter Sharma, III *
10.7(e)	Promotional Share Lock-In Agreement For Joseph Grace *
10.7(f)	Promotional Share Lock-In Agreement for Judy Holloway Reed *
10.7(g)	Promotional Share Lock-In Agreement for Eric Scheffer *
10.7(h)	Promotional Share Lock-In Agreement for Mark Harris #
10.8	Loan Agreement dated September 28, 2004 with Bay Business Credit *
10.9	Sirius/Pureprophet, Ltd. Vendor’s Credit Line Agreement with Original Beverage Corp. *
10.10	Terms Of Amortization for Peter Sharma III for Sirius/Pureprophet, Ltd. - Vendor’s Credit Line Agreement with Original Beverage Corp. *
10.11	Co-Sign Agreement *
10.12	Loan Agreement with Robert T. Reed, Sr. *
10.13	Loan Agreement with William Holiman *
10.14	Loan Agreement with Bay Business Credit *
10.15	Loan Agreement with Robert T. Reed, Sr. *
10.16	Loan Agreement with Robert T. Reed, Sr. *
10.17	Amendment to Loan Agreement with Bay Business Credit *
10.18	Suspension of Loan Payment Agreement with Robert T. Reed, Sr. *
10.19	Agreement to Assume Repurchase Obligations #

10.20

Loan and Security Agreement with Business Alliance Capital Corporation dated June 3, 2005, and Amendment No. 1 thereto dated June 29, 2006

14.1	Code of Ethics #
23.1	Consent of Weinberg & Co., P.A.
23.2	Consent of Jenkens & Gilchrist, LLP (contained in Exhibit 5.1)
24	Power of Attorney (included in the signature page to the Registration Statement) #

 

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* Previously filed as part of the registrant’s Registration Statement on Form SB-2 (File No. 333-120451) and incorporated herein by this reference.

 

# Previously filed as part of this Registration Statement on Form SB-2 (File No. 333-135186).

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APPENDIX A

 

FORM OF NOTICE OF ELECTION

 

Reed’s, Inc.

13000 South Spring Street

Los Angeles, California 90061

Attn: Christopher J. Reed

 

Dear Mr. Reed:

 

I have received the prospectus of Reed’s, Inc. (“Reed’s”) relating to its rescission offer, dated ___________, 2006, pursuant to which Reed’s has offered to repurchase certain shares of its common stock that may have been issued in violation of federal or state securities laws, or both. I advise Reed’s as follows by placing an “X” in the proper spaces provided below (and filling in the appropriate table(s), if applicable):

 

Shares of Common Stock

¨		1.		I hereby elect to reject the rescission offer and desire to retain the shares.
¨		2.		I hereby elect to accept the rescission offer and rescind the sale of ________________ (fill in number) shares and to receive a full refund for all sums paid therefore together with interest at the applicable statutory rate per year. My Stock Power(s) is/are also enclosed with this Notice of Election

Date of Purchase (The date you were issued stock. If you do not know, leave blank.)		Number of Shares Purchased		Certificate Number (If you do not know, leave blank.)

IF PERSONS DESIRING TO ACCEPT THIS RESCISSION OFFER INTEND TO MAKE USE OF THE MAILS TO RETURN THEIR STOCK POWER(S), INSURED REGISTERED MAIL, RETURN RECEIPT REQUESTED, IS RECOMMENDED AND SHOULD ALSO PROVIDE THEIR DOCUMENTATION, INCLUDING THIS NOTICE OF ELECTION, BY FACSIMILE TO CHRISTOPHER J. REED AT THE FOLLOWING FACSIMILE NUMBER: (310) 217-9411.

 

TO THE EXTENT I HAVE ACCEPTED THE OFFER, I AGREE I WILL NOT HAVE ANY FURTHER RIGHT, TITLE OR INTEREST IN THOSE SHARES OF COMMON STOCK AND ANY SUBSEQUENT APPRECIATION IN THE VALUE OF THE SHARES UNDERLYING THE SHARES OF COMMON STOCK.

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For California residents:

 

THIS OFFER OF REPURCHASE HAS BEEN APPROVED BY THE CALIFORNIA COMMISSIONER OF CORPORATIONS IN ACCORDANCE WITH SECTION 25507(b) OF THE CALIFORNIA CORPORATE SECURITIES LAW OF 1968 ONLY AS TO ITS FORM. SUCH APPROVAL DOES NOT IMPLY A FINDING BY THE COMMISSIONER THAT ANY STATEMENTS MADE HEREIN OR IN ACCOMPANYING DOCUMENTS ARE TRUE OR COMPLETE; NOR DOES IT IMPLY A FINDING THAT THE AMOUNT OFFERED BY REED’S, INC. IS EQUAL TO THE AMOUNT RECOVERABLE BY THE BUYER OF THE SECURITY IN ACCORDANCE WITH SECTION 25503 IN A SUIT AGAINST REED’S, INC., AND THE COMMISSIONER DOES NOT ENDORSE THE OFFER AND MAKES NO RECOMMENDATION AS TO ITS ACCEPTANCE OR REJECTION.

 

Dated: ______________, 2006
Print name of stockholder:		Name of stockholder:
Authorized signature:		Authorized signature (if shares held in more than one name):
Title of authorized signatory (if applicable):		Title of authorized signatory (if applicable):
Address of stockholder:		Phone number of stockholder:
Fax number of stockholder:		Email of stockholder:

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APPENDIX B

 

REED’S, INC.

STOCK POWER

 

FOR VALUE RECEIVED, the undersigned hereby sells, assigns and transfers unto Reed’s, Inc., a Delaware corporation or its designee, _________________ shares of Common Stock of Reed’s, Inc., and does hereby irrevocably constitute and appoint Christopher J. Reed and Judy Holloway Reed, and any of them, the undersigned’s Attorney to transfer said shares on the books of said corporation with full power of substitution in the premises.

 

Dated: _____________, 2006		SELLING STOCKHOLDER
		Print Name(s) of Selling Stockholder(s)
		Authorized Signature
		Title of Authorized Signatory (if applicable) 1
		Authorized Signature (if shares held in more than one name)
		Title of Authorized Signatory (if applicable)
		Address of Selling Stockholder (Line 1)
		Address of Selling Stockholder (Line 2)
		Phone
		Email
		Fax

 

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1

Trustees, officers and other fiduciaries or agents should indicate their title or capacity and print their names under their signatures.

 

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