Shares			Weighted Average Exercise Price			Weighted- Average Remaining Contractual Term (Years)			Aggregate Intrinsic Value
Outstanding at January 1, 2008			749,000		$	6.02			-			-
Granted			275,000		$	1.99			-			-
Exercised			-			-			-			-
Forfeited			(371,500	)	$	6.83			-			-
Outstanding at June 30, 2008			652,500		$	3.85			3.75		$	90,250
Exercisable at June 30, 2008			229,167		$	4.01			2.17		$	10,500

 

Stock options granted under our equity incentive plans vest over two and three years from the date of grant, ½ and 1/3 per year, respectively, and generally expire five years from the date of grant.

We calculated the fair value of each warrant award on the date of grant using the Black-Scholes option pricing model.

 

The following table summarizes warrant activity for the six months ended June 30, 2008:

		Shares			Weighted Average Exercise Price			Weighted-Average Remaining Contractual Term (Years)			Aggregate Intrinsic Value
Outstanding at January 1, 2008			1,688,236		$	5.75			-			-
Granted			200,000		$	2.54			-			-
Exercised			-			-			-			-
Outstanding at June 30, 2008			1,868,236		$	5.41			3.10		$	29,365
Exercisable at June 30, 2008			1,668,236		$	5.75			2.89		$	29,365

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The 200,000 warrants granted during the six months ended June 30, 2008, were granted in connection with a distribution agreement between the Company and a company which is owned by two brothers of Christopher Reed, President and Chief Financial Officer of the Company. The warrants are issuable only upon the attainment of certain international product sales. No warrants vested during the six months ended June 30, 2008. Accordingly, no expense was recorded for these warrants. The warrants will be valued and a corresponding expense will be recorded upon the attainment of the sales goals identified when the warrants were granted.

7.	Related Party Activity

As of December 31, 2007, the Company had a $300,000 note receivable from an entity that is partly owned by an advisor to the board of directors. The note is secured by all the entity’s assets and intellectual property. The note is payable on March 25, 2008 and bears interest at 7.50% per annum with quarterly interest payments. As of June 30, 2008, the Company has determined that the note is deemed uncollectible and the collateral worthless, and has written off the entire balance and associated accrued interest.

For the three months ended March 31, 2008 the Company employed one family member of the majority shareholder, Chief Executive Officer and Chief Financial Officer of the Company in a sales role. He was paid approximately $56,250. No stock options were granted to him during the three months ended March 31, 2008 and $112,500 for the six months ended June 30, 2008.

During the six months ended June 30, 2008, the Company entered into an agreement for the distribution of its products internationally. The agreement is between the Company and a company controlled by two brothers of Christopher Reed, President and Chief Financial Officer of the Company. The agreement remains in effect until terminated by either party and requires the Company to pay the greater of $10,000 per month or 10% of the defined sales of the previous month. During the six months ended June 30, 2008, the Company paid $10,000 for these services. 200,000 warrants were granted during the six months ended June 30, 2008, in connection with this distribution agreement. The warrants are issuable only upon the attainment of certain international product sales. No warrants vested during the six months ended June 30, 2008. Accordingly, no expense was recorded for these warrants. The warrants will be valued and a corresponding expense will be recorded upon the attainment of the sales goals identified when the warrants were granted.

 

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

FORWARD LOOKING STATEMENTS

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.

 

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 - As oil prices continue to increase, our packaging, production and ingredient costs will continue to rise. We have attempted to offset the rising freight costs from fuel price increases by creatively negotiating rates and managing freight. We will continue to pursue alternative production, packaging and ingredient suppliers and options to help offset the affect of rising fuel prices on these expenses.

 

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. 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.

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Consumers 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.

 

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.

 

Interest Rates - We use lines of credit as a source of capital and are negatively impacted as interest rates rise.

 

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 Virgil’s® trademark and the China Cola® trademark. 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 three months ended March 31, 2008 or March 31, 2007.

 

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 three months ended March 31, 2008 or 2007.

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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.

Results of Operations

Three Months Ended June 30, 2007 Compared to Three Months Ended June 30, 2008

Net sales increased by $1,098,456, or 31.6%, from $3,472,360 in the three months ended June 30, 2007 to $4,570,816in the three months ended June 30, 2008. The increase in net sales was primarily due to an increase in our Virgil’s product line and our Reed’s Ginger Brews line. The increase in sales was also primarily due to an increase in net sales due to newly introduced mainstream distributors and an increase in our existing distribution channels of natural food distributors and retailers.

The Virgil’s brand, which includes Root Beer, Real Cola, Cream Soda and Black Cherry Cream soda, Diet Root Beer, Diet Real Cola, Diet Cream Soda and Diet Black Cherry Cream Soda, realized an increase in net sales of $788,000, or 54% to $2,246,000 in the three months ended June 30, 2008 from $1,458,000 in the three months ended June 30, 2007. The increase was the result of increased sales in 12 ounce Root Beer of $225,000 or 32% from $714,000 in the three months ended June 30, 2007 to $939,000 in the three months ended June 30, 2008, increased sales in Cream Soda of $109,000 or 62% from $175,000 in the three months ended June 30, 2007 to $284,000 in the three months ended June 30, 2008, and increased sales in Black Cherry Cream Soda of $31,000 or 31% from $101,000 in the three months ended June 30, 2007 to $132,000 in the three months ended June 30, 2008. Also, the Virgil’s Root Beer five-liter party kegs increased $321,000 or 106%, from $304,000 in the three months ended June 30, 2007 to $625,000 in the three months ended June 30, 2008. In addition, the increase in sales in the Virgil’s Brand was the result of launch of Virgil’s Real Cola in 2008 which realized net sales of $95,000 in the three months ended June 30, 2008.

The Reeds Ginger Brew Line increased $312,000 or 20 % to $1,837,000 in the three months ended June 30, 2008 from $1,525,000 in the three months ended June 30, 2007.

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Net sales of candy increased $48,000, or 27% to $229,000 in the three months ended June 30, 2008 from $181,000 in the three months ended June 30, 2007.

The product mix for our two most significant product lines, Reed’s Ginger Brews and Virgil’s sodas was 51.1% and 41.8%, respectively of net sales in the three months ended June 30, 2008 and was 46.4% and 44.4%, respectively of net sales in the three months ended June 30, 2007.

Cost of sales increased by $509,554, or 18.3%, to $3,301,486 in the three months ended June 30, 2008 from $2,791,932 in the three months ended June 30, 2007. As a percentage of net sales, cost of sales decreased to 72.2% in the three months ended June 30, 2008 from 80.4% in the three months ended June 30, 2007. Cost of sales as a percentage of net sales decreased by 7.6%, primarily as a result of the price increase on April 1, 2008 for the Reed’s Ginger Brew line of beverages offset by fuel and commodity price increases which have caused an increase in our costs of production from our co-packer. Fuel price increases have also increased our costs of delivery. In addition, we had increased costs of packaging. If fuel and commodity prices continue to increase, we will have more pressure on our margins.

 

Gross profit increased $588,902 or 86.5% to $1,269,330 in the three months ended June 30, 2008 from $680, 428 in the three months ended June 30, 2007. As a percentage of net sales, gross profit increased to 27.8% in the first three months of 2008 from 19.6% in the first three months of 2007.

To improve gross margins in 2008, we have raised prices on the Reed’s Ginger Brew line by 20% bringing it more in line with our competitors in the natural soda category. In addition, we are implementing systems to track and manage the approval and use of promotions and discounting to maintain a higher net gross margin. Finally, we are performing a competitive bidding process for our third party co-packing production. We expect to select a co-packer by the third quarter 2008. We expect to lower our costs of production, thus further improving our gross margin while maintaining our product quality.

Operating expenses increased by $372,352, or 27.8%, to $1,710,604 in the three months ended June 30, 2008 from $1,338,252 in the three months ended June 30, 2007 and decreased as a percentage of net sales to 37.4% in the three months ended June 30, 2008 from 38.5% in the three months ended June 30, 2007. The increase was primary the result of increased selling and general and administrative expenses. In March of 2008, we reduced our staff by 17 employees, mostly from the sales staff.   During the first quarter of 2008, we implemented a cost reduction strategy to reduce unnecessary expenses and revised our budget for 2008. We reduced selling expenses by reducing our work force by 17 employees. We expect to save approximately $2,000,000 in annual expense with this reduction. We experienced a $743,640 reduction in operating expenses over the first quarter of 2008 in the three months ending March 31, 2008 expenses were $2,454,274.

 

Selling expensed increased by $162,904 or 18.3%, to $1,051,008 in the three months ended June 30, 2008 from $888,104 in the three months ended June 30, 2007. The increase in selling expenses is due to increased promotional and advertising expenses, public relations expenses, trade show expenses, travel expenses, and increased usage of brokerage firms for sales offset by lower option expenses and contract services expenses. Promotional and advertising expenses increased $100,938 or 108.2% to $194,204 in the three months ended June 30, 2008 from $93,266 in the three months ended June 30, 2007. This increase was due to the increased use of advertising and promotions with our supermarket customers as we move into more mainstream accounts. Public relations expenses increased $31,280 or 299.3% to $41,730 in the three months ended June 30, 2008 from $10,450 in the three months ended June 30, 2007. The increase in public relations expenses was due to the increased use. Trade show expenses increased $20,795 or 134.2%, to $36,292 in the three months ended June 30, 2008 from $15,497 in the three months ended June 30, 2007. The increase in trade show expenses was due to an increase in trade shows as we start marketing to new channels of trade such as the drug store channel. Travel expenses increased $50,969 or 356.6%, to $65,263 in the three months ended June 30, 2008 from $14,294 in the three months ended June 30, 2007. The increase in travel expenses was due to increased air travel as our sales force focus is redirected to visiting supermarket headquarters and key retailer around the country. Brokerage commission expenses increased $86,478 or 103.2%, to $170,312 in the three months ended June 30, 2008 from $83,834 in the three months ended June 30, 2007. The increase in brokerage commission expenses was due to increased use of outside food brokers to represent us to the supermarket trade. Non-cash stock option compensation expense decreased $69,357 or 413% to ($52,565) in the three months ended June 30, 2008 from $16,792 in the three months ended June 30, 2007. This decrease is due to options which were forfeited as we reduced our sales force in the first quarter of 2008. Contract services expense decreased $18,735 or 43.7% to $24,108 in the three months ended June 30, 2008 from $42,843 in the three months ended June 30, 2007. This decrease is due to the reduction of use of contract services. In March 2008, we announced our new strategic direction in sales, whereby our focus is to strengthen our product placements in our estimated 10,500 supermarkets nationwide. This strategy replaces our strategy in the three months ended June 30, 2007 that focused on both the supermarkets and a direct store delivery (DSD) effort. Since March 2008, our sales organization has been reduced by 16 compared to the level we had at December 31, 2007. We have found that the most effective sales efforts are to grocery stores. We have our products in more than 10,500 supermarket stores across the country and our new direction for 2008 is to remain focused on these accounts while opening new business with other grocery stores leveraging our brand equity. We feel that the trend in grocery stores to offer their customers natural products can be served with our products. Our sales personnel are leveraging our success at natural food grocery stores to establish new relationships with mainstream grocery stores.

General and administrative expenses increased by $209,448 or 46.5% to $659,596 in the three months ended June 30, 2008 from $450,148 in the first three months of 2007. The increase in general and administrative expenses is due to increased legal, accounting and investor relations expenses and officer salaries. Legal, accounting and investor relations expenses increased $152,651 or 571.6% to $179,357 in the three months ended June 30, 2008 from $26,706 in the three months ended June 30, 2007. The increase in legal, accounting and investor relation expenses was due to increased legal and accounting costs mostly related to the increased costs of reporting and compliance with the Securities and Exchange Commission and NASDAQ. Officer salaries increased by $33,806 or 90.1% to $71,306 in the three months ended June 30, 2008 from $37,500 in the three months ended June 30, 2007. The increase was due to the hiring of a Chief Operating Officer in May 2007.

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Interest expense was $49,990 in the three months ended June 30, 2008, compared to interest expense of $64,330 in the three months ended June 30, 2007. Interest income dropped to $145 in the three months ended June 30, 2008, compared to interest income of $29,109 in the three months ended June 30, 2007.

 

Interest income decreased because of our overall decrease in cash and corresponding decrease in interest bearing cash accounts. Interest expenses will probably increase due to the increased reliance of the Company to finance operations with its $3,000,000 inventory and accounts receivable line of credit with First Capital LLC.

Six Months Ended June 30, 2007 Compared to Six Months Ended June 30, 2008

Net sales increased by $1,649,866, or 25.4%, from $6,485,050 in the first six months ended June 30, 2007 to $8,134,916 in the first six months ended June 30, 2008. The increase in net sales was primarily due to an increase in our Virgil’s product line and our Reed’s Ginger Brews line. The increase in sales was also primarily due to an increase in net sales due to newly introduced mainstream distributors and an increase in our existing distribution channels of natural food distributors and retailers.

The Virgil’s brand, which includes Root Beer, Real Cola, Cream Soda and Black Cherry Cream soda, Diet Root Beer, Diet Real Cola, Diet Cream Soda and Diet Black Cherry Cream Soda, realized an increase in net sales of $1,364,000, or 57% to $3,742,000 in first six months ended June 30, 2008 from $2,378,000 in first six months ended June 30, 2007. The increase was the result of increased sales in 12 ounce Root Beer of $449,000 or 35% from $1,296,000 in first six months ended June 30, 2007 to $1,745,000 in first six months ended June 30, 2008, increased sales in Cream Soda of $157,000 or 51% from $306,000 in the first six months of 2007 to $463,000 in the first six months of 2008, and increased sales in Black Cherry Cream Soda of $72,000 or 44% from $164,000 in the first six months of 2007 to $236,000 in the first six months of 2008. Also, the Virgil’s Root Beer five-liter party kegs increased $531,000 or 135%, from $392,000 in first six months ended June 30, 2007 to $923,000 in first six months ended June 30, 2008. In addition, the increase in sales in the Virgil’s Brand was the result of launch of Virgil’s Real Cola in 2008 which realized net sales of $100,000 in the first six months ended June 30, 2008.

The Reeds Ginger Brew Line increased $773,000 or 26% to $3,779,000 in first six months ended June 30, 2008 from $3,006,000 in first six months ended June 30, 2007.

Net sales of candy increased $44,000, or 10% to $482,000 in first six months ended June 30, 2008 from $438,000 in first six months ended June 30, 2007.

The product mix for our two most significant product lines, Reed’s Ginger Brews and Virgil’s sodas was 46.2% and 45.7%, respectively of net sales in first six months ended June 30, 2008 and was 49.7% and 39.4%, respectively of net sales in first six months ended June 30, 2007.

 

Cost of sales increased by $1,080,773, or 20.5%, to $6,345,773 in first six months ended June 30, 2008 from $5,265,000 in first six months ended June 30, 2007. As a percentage of net sales, cost of sales decreased to 78.0% in first six months ended June 30, 2008 from 81.2% in first six months ended June 30, 2007. Cost of sales as a percentage of net sales decreased by 3.2%, primarily as a result of the price increase on April 1, 2008 for the Reed’s Ginger Brew line of beverages offset by fuel and commodity price increases which have caused an increase in our costs of production from our co-packer. Fuel price increases have also increased our costs of delivery. In addition, we had increased costs of packaging. If fuel and commodity prices continue to increase, we will have more pressure on our margins.

 

Gross profit increased $569,093 or 46.6% to $1,789,143 in first six months ended June 30, 2008 from $1,220,050 in first six months ended June 30, 2007. As a percentage of net sales, gross profit increased to 22.0% in the first six months of 2008 from 18.8% in the first six months of 2007.

To improve gross margins in 2008, we have raised prices on the Reed’s Ginger Brew line by 20% on April 1, 2008 bringing it more in line with our competitors in the natural soda category. In addition, we are implementing systems to track and manage the approval and use of promotions and discounting to maintain a higher net gross margin. Finally, we are performing a competitive bidding process for our third party co-packing production. We expect to select a co-packer by the third quarter 2008. We expect to lower our costs of production, thus further improving our gross margin while maintaining our product quality. Our current co-packer producing the bulk of our products is charging us considerably over the market.

Operating expenses increased by $1,832,118 or 77.8%, to $4,164,878 in first six months ended June 30, 2008 from $2,341,760 in first six months ended June 30, 2007 and increased as a percentage of net sales to 51.2% in first six months ended June 30, 2008 from 36.1% in first six months ended June 30, 2007. The increase was primary the result of increased selling and general and administrative expenses. In March of 2008, we reduced our staff by 17 employees, mostly from the sales staff. During the first quarter of 2008, we implemented a cost reduction strategy to reduce unnecessary expenses and revised its budget for 2008. We reduced selling expenses by reducing our work force by 17 employees. We expect to save approximately $2,000,000 in annual expense with this reduction. We believe our operating expenses will decrease approximately $300,000 per month beginning in April 2008.

 

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Selling expensed increased by $732,867 or 50.8%, to $2,175,136 in first six months ended June 30, 2008 from $1,442,269 in first six months ended June 30, 2007. The increase in selling expenses is due to increased salaries of sales personnel, brokerage expenses, promotional and advertising costs, trade show expenses, and travel expenses offset by lower non-cash stock option expense, lower demo expenses, lower contract services and lower auto expenses. Salaries of sales personnel increased $714,045 or 132.1% to $1,254,562 in first six months ended June 30, 2008 from $540,517 in first six months ended June 30, 2007. This increase was due to increased personnel to support the initiative to increase sales of our product to the mainstream consumer through mainstream stores and distributors that support mainstream retailers. Brokerage expenses increased $122,809 or 111.1% to $233,396 in first six months ended June 30, 2008 from $110,587 in first six months ended June 30, 2007. The increase in brokerage commission expenses was due to increased use of outside food brokers to represent us to the supermarket trade. Promotional and advertising expenses increased $105,025 or 88.0%, to $224,360 in first six months ended June 30, 2008 from $119,335 in first six months ended June 30, 2007. This increase was due to the increased use of advertising and promotions with our supermarket customers as we move into more mainstream accounts. Trade show expenses increased $40,599 or 90.6%, to $85,406 in first six months ended June 30, 2008 from $44,807 in first six months ended June 30, 2007. The increase in trade show expenses was due to an increase in trade shows as we start marketing to new channels of trade such as the drug store channel. Travel expenses increased $170,169 or 289.8%, to $228,890in first six months ended June 30, 2008 from $58,721 in first six months ended June 30, 2007. The increase in travel expenses was due to the build up of the sales force at the end of 2007 and their increased activities. These increases were offset by reductions in the following expenses. Non-cash stock option compensation expense decreased $2,919 or 7.0% to $39,000 in first six months ended June 30, 2008 from $41,919 in first six months ended June 30, 2007. This decrease is due to options which were forfeited. Contract services expense decreased $49,636 or 59.6% to $33,677 in first six months ended June 30, 2008 from $83,313 in first six months ended June 30, 2007. This decrease is due to reduced use of outside services. Auto expenses decreased $168,516 or 61.2% to $43,392 in first six months ended June 30, 2008 from $111,908 in first six months ended June 30, 2007. This decrease is due to a reduction of our delivery systems in Southern California in 2008. In March 2008, we announced our new strategic direction in sales, whereby our focus is to strengthen our product placements in our estimated 10,500 supermarkets nationwide. This strategy replaces our strategy in first six months ended June 30, 2007 that focused on both the supermarkets and a direct store delivery (DSD) effort. Since March 2008, our sales organization has been reduced by 16 compared to the level we had at December 31, 2007. We have found that the most effective sales efforts are to grocery stores. We have our products in more than 10,500 supermarket stores across the country and our new direction for 2008 is to remain focused on these accounts while opening new business with other grocery stores leveraging our brand equity. We feel that the trend in grocery stores to offer their customers natural products can be served with our products. Our sales personnel are leveraging our success at natural food grocery stores to establish new relationships with mainstream grocery stores

General and administrative expenses increased by $1,090,251 or 121.2% to $1,989,742 in first six months ended June 30, 2008 from $899,491 in the first six months of 2007. The increase in general and administrative expenses is due to increased legal, accounting and investor relations expenses, officer salaries, general liability insurance, outside services, and office supplies. Legal, accounting and investor relations expenses increased $326,492 or 266.4% to $449,036 in first six months ended June 30, 2008 from $122,544 in first six months ended June 30, 2007. The increase in legal, accounting and investor relation expenses was due to increased legal and accounting costs mostly related to the increased costs of reporting and compliance with the Securities and Exchange Commission and NASDAQ. Salaries increased by $243,914 or 219.6% to $354,981 in first six months ended June 30, 2008 from $111,067 in first six months ended June 30, 2007. Officer salaries increased by $116,848 or 155.8% to $191,848 in the three months ended June 30, 2008 from $75,000 in the three months ended June 30, 2007. The increase was due to the hiring of a Chief Operating Officer in May 2007 and a Chief Financial Officer in October 2007. Liability insurance expenses increased $62,451 or 155.0% to $70,262 in first six months ended June 30, 2008 from $29,752 in first six months ended June 30, 2007. This increase was mainly due to increased sales and coverage. Outside services expenses increased $40,512 or 136.2% to $70,262 in first six months ended June 30, 2008 from $29,752 in first six months ended June 30, 2007. This increase was due increased use of outside services. Office supplies expenses increased $14,419 or 80.6% to $32,304 in first six months ended June 30, 2008 from $17,885 in first six months ended June 30, 2007. This increase was due to increased staff in general. In addition, we had a one-time non cash expense of $320,762 for consulting services, for which we issued stock.

Interest expense was $106,428 in the six months ended June 30, 2008, compared to interest expense of $111,883 in the six months ended June 30, 2007. Interest income dropped to $975 in the six months ended June 30, 2008, compared to interest income of $52,600 in the six months ended June 30, 2007.

 

Interest income decreased because of our overall decrease in cash and corresponding decrease in interest bearing cash accounts. Interest expenses will probably increase due to the increased reliance of the company to finance operations with its $3,000,000 inventory accounts receivable line of credit with First Capital LLC.

 

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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. On December 12, 2006, we completed the sale of 2,000,000 shares of our common stock at an offering price of $4.00 per share in our initial public offering. The public offering resulted in gross proceeds of $8,000,000 to us. In connection with the public offering, we paid aggregate commissions, concessions and non-accountable expenses to the underwriters of $800,000, resulting in net proceeds of $7,200,000, excluding other expenses of the public offering. In addition, we issued, to the underwriters, warrants to purchase up to approximately an additional 200,000 shares of common stock at an exercise price of $6.60 per share (165% of the public offering price per share), at a purchase price of $0.001 per warrant. The underwriters’ warrants are exercisable for a period of five years commencing on the final closing date of the public offering. From August 3, 2005 through April 7, 2006, we had issued 333,156 shares of our common stock in connection with the public offering. We sold the balance of the 2,000,000 shares in connection with the public offering (1,666,844 shares) following October 11, 2006.

From May 25, 2007 through June 15, 2007, we completed a private placement to accredited investors only, on subscriptions for the sale of 1,500,000 shares of common stock and warrants to purchase up to 749,995 shares of common stock, resulting in an aggregate of $9,000,000 of gross proceeds to us. We sold the shares at a purchase price of $6.00 per share. The warrants issued in the private placement have a five-year term and an exercise price of $7.50 per share. We paid cash commissions of $900,000 to the placement agent for the private placement and issued warrants to the placement agent to purchase up to 150,000 shares of common stock with an exercise price of $6.60 per share. We also issued additional warrants to purchase up to 15,000 shares of common stock with an exercise price of $6.60 per share and paid an additional $60,000 in cash to the placement agent as an investment banking fee. Total proceeds received, net of underwriting commissions and the investment banking fee and excluding other expenses of the private placement, was $8,040,000.

As of June 30, 2008, we had an accumulated deficit of $13,585,890 and we had working capital of $1,702,206, compared to an accumulated deficit of $11,081,141 and working capital of $2,942,909 as of December 31, 2007. Cash and cash equivalents were $39,963 as of June 30, 2008, as compared to $742,719 as of December 31, 2007. This decrease in our working capital and cash position was primarily attributable to our net loss for the six months ended June 30, 2008 offset by an increase in our inventory at June 30, 2008. In addition to our cash position on June 30,2008, we had availability under our lines of credit of approximately $164,000.

Net cash used in operating activities during the six months ended June 30, 2008 was $2,401,381 which was due primarily to our net loss of $2,481,188. In the six months ended June 30, 2008, we used $158,431 of cash in investing activities, which was due primarily to the purchase of various equipment to support business growth.

 

Net cash provided by financing activities during the six months ended June 30, 2008 was $1,857,056. The primary components of that were the net proceeds from the refinanincing of our land and buildings and our obtaining of a line of credit.

 

As of June 30, 2008, we had outstanding borrowings of $879,205under our line of credit agreement:

 

We recognize that operating losses negatively impact liquidity and we are working on decreasing operating losses, while focusing on increasing net sales. We are currently borrowing near the maximum on our line of credit. We have approximately $500,000 to $1,000,000 in excess inventory over our normal inventory levels. We believe the operations of the company are running at approximately breakeven, after adjusting for non-cash expenses . Between the reduction of our inventory to more normal levels and our current breakeven operating status, we believe that our current cash position and lines of credit will be sufficient to enable us to meet our cash needs through at least the end of 2008. We’re planning on registering a S-3 shelf offering in the next 2-3 months. We believe that if the need arises we can raise money through the equity markets.

 

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.

If we continue to suffer losses from operations, the proceeds from our public offering and private placement may be insufficient to support 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 and would be required to reduce our level of operations, including reducing infrastructure, promotions, personnel and other operating expenses. These events could adversely affect our business, results of operations and financial condition.

In addition, 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,

 

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·

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

References to the “FASB”, “SFAS” and “SAB” herein refer to the “Financial Accounting Standards Board”, “Statement of Financial Accounting Standards”, and the “SEC Staff Accounting Bulletin”, respectively.

In December 2007, the FASB issued FASB Statement No. 141 (R), “Business Combinations” (FAS 141(R)), which establishes accounting principles and disclosure requirements for all transactions in which a company obtains control over another business. Statement 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Earlier adoption is prohibited.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51”. SFAS No. 160 establishes accounting and reporting standards that require that the ownership interests in subsidiaries held by parties other than the parent be clearly identified, labeled, and presented in the consolidated statement of financial position within equity, but separate from the parent’s equity; the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income; and changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary be accounted for consistently. SFAS No. 160 also requires that any retained noncontrolling equity investment in the former subsidiary be initially measured at fair value when a subsidiary is deconsolidated. SFAS No. 160 also sets forth the disclosure requirements to identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS No. 160 applies to all entities that prepare consolidated financial statements, except not-for-profit organizations, but will affect only those entities that have an outstanding noncontrolling interest in one or more subsidiaries or that deconsolidate a subsidiary. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited. SFAS No. 160 must be applied prospectively as of the beginning of the fiscal year in which it is initially applied, except for the presentation and disclosure requirements. The presentation and disclosure requirements are applied retrospectively for all periods presented.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities - an amendment of FASB Statement No. 133” (“SFAS No. 161”).  SFAS No. 161 amends and expands the disclosure requirements of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”). The objective of SFAS No. 161 is to provide users of financial statements with an enhanced understanding of how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations, and how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows.  SFAS No. 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements.  SFAS No. 161 applies to all derivative financial instruments, including bifurcated derivative instruments (and nonderivative instruments that are designed and qualify as hedging instruments pursuant to paragraphs 37 and 42 of SFAS No. 133) and related hedged items accounted for under SFAS No. 133 and its related interpretations.  SFAS No. 161 also amends certain provisions of SFAS No. 131. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged.  SFAS No. 161 encourages, but does not require, comparative disclosures for earlier periods at initial adoption. 

The Company does not believe the adoption of the above recent pronouncements, will have a material effect on the Company’s results of operations, financial position, or cash flows

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.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not applicable.

 

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Item 4. CONTROLS AND PROCEDURES

 

(a)   Management's Evaluation of Disclosure Controls and Procedures.

 

As of June 30, 2008, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our “disclosure controls and procedures,” as such term is defined under Exchange Act Rules 13a-15(e) and 15d-15(e).

 

Our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2008, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

     

(b) Changes in Internal Controls.

  

There were no changes in our internal controls over financial reporting during the quarter ended June 30, 2008 that materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

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Part II

 

Item 1. Legal Proceedings

 

There has been no change to our disclosure regarding legal proceeding as set forth in our Annual Report on Form 10-KSB for the year ended December 31, 2007.

Except as set forth in such disclosure, 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.

 

Item 1A. RISK FACTORS 

Not applicable

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable

Item 3. Defaults Upon Senior Securities