Jones Soda Imploded

This "earnings" was a six cent loss. That implosion I mentioned was coming certainly looks like it is here.

It truly never ceases to amaze me how earnings can be such garbage for a company, yet the share price goes up...

So, Jones Soda was down after the last earnings report and then it went back up and now it looks like it is finally on it descent. I thought it was a $3-4 stock before it made decisions that destroyed earning potential and margins. Now I wonder if it will survive.

End of post

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Jones Soda - Lawsuit Joke

Lawyers have launched a lawsuit against Jones Soda for an "allegation contained in the Seattle Post-Intelligencer that certain officers and directors of Jones Soda disposed of 'nearly all their shares of the company stock' in what was called 'a highly unusual move" by securities experts "during a wave of positive publicity that kept the stock high.'"

So now dumb is following stupid...

I first looked at Jones Soda in December when it was trading at about $12 and with a quick look I concluded it was an extremely over priced $4 stock. I rated it as under perform in CAPS at Motley Fool.

I watched in amazement at the ascent of this stock and I sometimes use what I see in the stock market as an example of the negligent math skills of adults when I am trying to open student's eyes up as to the importance of math skills. Jones Soda is a company I have mentioned to students, indeed, I have used it as an exemplary example of bad investing with students playing a stock market game.

By April my bewilderment that the stock price had actually doubled lead to me studying the stock to see if I had missed something. So I looked closer and I wrote about my assessment of the stock in "Jones Soda, Breaking down the growth."

The only thing that is unusual about the officers and directors selling shares where they did is that they did not sell them earlier. I saw hype and speculation from investors, not the company.

This is incredibly frivolous and the US really needs to start assigning costs to garbage lawsuits like this. Investors ought to have done their homework on the stock, which would have shown absolutely no fundamental reason to buy, even at today's price.

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Jones Soda Co - Are We Keeping Up?

I first reported on what a disaster Jones Soda (JSDA) was going to be for investors back in April, where I showed where the growth in earnings had come and I concluded those items would "murder" earnings in the future.

Jones Soda has since had two quarterly earnings reports so it is time to take another look, in particular, the last earnings release.

I can hardly get past the highlights:

• 1,722,795 total cases compared to 961,000 cases one year ago
• Revenue increased 29.8% to $13.0 million compared to $10.0 million a year ago.
• Gross margin decreased to 34.2% versus 38.0% last year
• Diluted earnings per share were $0.00 compared to $0.10 a year ago.

The first two points ought to send anyone still vested utterly running from this stock. They have a 79% increase in the number of case equivalents sold but only a 30% increase in revenue. That is an utter implosion of earning potential. To their credit, the third point shows that they managed to only lose 3.8% of their gross margin and on the surface this appears very good as this kind of implosion of earnings could put them into irrecoverable loss position.

As an investor you'd expect a 79% increase in sales to result in a 79% increase in earnings, but the 4th point shows that earning are now non-existent and not the 18c per share as a back of the napkin calculation would lead you to expect. Jones Soda has growth here, but so far entirely at the expense of profitability.

So, looking a little deeper... They had earnings of $40.7 thousand compared to earnings of $2.3 million, or another way of expressing that was that earnings were about 5600% higher a year earlier, or alternatively, this quarter's earnings are 1.8% of the earnings one year ago, 98.2% of the "earnings" disappeared... That is known as an implosion of earnings...

But, that's just on the surface. Above I mentioned how a 79% increase in output with only a 30% increase in revenue could put them in an irrecoverable loss position. One has to ask whether they are in fact in an irrecoverable loss position. Over a year earlier the operating expenses increased to 38.4% of the revenue, from 31.1%, and that is enormous, an increase from $3.1 million to $5.0 million, or an increase of $1.9 million, fully 14.5% of the revenue. The cost of goods increase by $2.3 million, for total increase in costs of $4.2 million, yet the revenue was only up by $3 million. In addition, the licensing revenue was also down by $0.1 million, so "total revenue" was actually only up by $2.9 million.

Having an extra $4.2 million in costs and only an extra $2.9 million in total revenue is very bad. And looking at page 5 of the financial reports what has happened leaps off the page. Looking at the operations only, the earnings before taxes for the three months ending June 30, 2006 were $836 thousand, or about 3.5c per share. After paying taxes as investors ought to expect them to be paid, without that monkey business accounting that grossly overstates earnings and allows executives to have cash-out-the-options liquidity events, the eps ought to have been around 2c, not the misleading-about-operations 10c.

For the quarter ending June 30th of this year they have a $504k loss on operations, or about 2c/share. It wasn't much better the March 31st quarter as that one shows a $428k loss, so the loss on their operations has increased by 18% between quarters, yet at the end of the magic of accounting both quarters actually showed positive earnings, $40.7k and $58.3k. Make no mistake here, Jones Soda's operations are currently being run in a loss position. What is giving the appearance of making ends meet is interest income and deferred taxes.

Interest income was $441k in the March 31 quarter and $416k in the June 30th quarter. This interest income is the largest contributor to giving the appearance of making ends meet and will decline as the capital is spent on expanding the operation and covering the deficit in earnings. The other item that enables the company to look like it isn't in a loss position on operations is income tax benefits. For the March 31 quarter $45k of the "earnings" is positive taxes. For the June 30th quarter there is $128k of positive taxes. So, $416k in interest and $128k in positive taxes enables Jones Soda to show $40k of earnings instead of $504k of losses in the most recent quarter.

So, they have these enormous "growth" plans, a network of 15,000 retail outlet to market their soda through, but where do the earnings come from? Growth at the expense of a profit margin isn't a good thing and the financial reports do not explain how this will be turned around.

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Jones Soda Co, Breaking Down the Growth

When I look at a stock I always look at the fully diluted market cap and the P/E first. As of March 6, 2007 Jones Soda, JSDA, gives 25,667,491 shares, Stock Option 1,424,025 (2006 annual report), for a total 27,091,516. Additionally, it appears they have another 1,930,975 options they can issue. Current price as of Apr 28, 2007 is $23.02. That gives a fully diluted market cap of $623.6 million and if you include the options that can be issued, you get $628 million. I get two different P/E's, depending on which site I look at, 124 on Yahoo, and 99 on The Motley Fool Caps, neither of which looks good.

What do I calculate as a fully diluted P/E based on the 2006 income of $4.574 million and the fully diluted market cap? $623.6/$4.574 = 136.

If I use the 19c eps with the $23.02 price, I get a P/E of 121. If divide the 19c into the $4.574 million of earnings I get 24 million shares, so clearly the P/E of 121 is a understatement. I get a P/E more than 12% greater.

It is absurd to truncate eps calculations when they are mere pennies as from 18c to 19c is 5.6% difference in earnings. At 5c to 6c, you get 20% difference in earning. They ought to have 3 significant figures.

There is no question there is an awesome growth story here in terms of the business, but at the same time, from December 2000 with a share price of 41c to $23.02 today is 5,500% growth in share price, and because of increased shares, the growth in the market cap would be 7600%, yet revenue in 2000 was $19 million and in 2006 it was $39 million, only double.

What is striking about Jones Soda is that eps went from 6c/share to 19c/share, a stellar 217% improvement considering revenue only increased by 16.5%.

Where did the growth come from?

Breaking down Jones Soda's growth numbers show that actual sales revenue went up 16.5%, yet their cost of goods only went up 8.3%. This change enabled them to increase their gross margin by 30%, from $12.3 million to $16 million.

Thirty percent growth in gross margin is great, but, keep in mind that $16 million is only 2.5% of the market cap. They still have to pay promotion, selling, general and administrative expenses from this.

The promotion and selling expenses increased by 10.6%, and as an expense that accounts for more than half the gross margin, keeping this expense down relative to the gross margin is very good. The one place where they did not do so well is the general and administrative expenses which increased by 42%. Combined these expenses actually went up 20%, which exceeds the increase in sales revenue, but, because the margin was up 30%, it further leverage earnings.

The licensing part of gross margin declined by 6%. Overall the licensing revenue accounted for 2.67c/share of the income.

Earning before interest and taxes increased by a whopping 111%. This kind of number sounds great, but it means that earnings increased from $1.3 million to $2.7 million, or from 2/10ths of one percent of the market cap to 4/10th of one percent of the market cap. This is so far behind the rate of inflation, it is effectively a negative earning rate. It makes up for about 11 of the 19c eps, or 60% of the eps, before taxes.

What made up the other 40% of the EPS?

Taking a closer look at the earning for the year you find that the revenue was way more consistent than the earnings:

2006	Q1	Q2	Q3	Q4	TOTAL
Revenue	8,760,380	10,025,978	10,200,843	10,047,925	39,035,125
Earnings	2,542	2,313,795	194,774	2,063,328	4,574,439
EPS	$0.00	$0.10	$0.01	$0.08	$0.19
Using 3 s.f.	$0.000123	$0.0964	$0.00741	$0.0787	$0.183
Interest	12,710	100,637	438,958	360,252	912,557

What has happened in Q2 is a deferred income tax credit of $1,482,934, or $0.0618 per share, fully 34% of the earnings. This had come from a new equity issue, which leads to another significant portion of the earnings, interest!

The company issued new equity, and much of that was invested and has given interest income. Fully, 20% of the earnings is from interest, or $0.0371 per share.

Together the interest and the deferred taxes make up 52.4% of the earnings.

The are separate adjustment where taxes are paid and the deferred taxes are reduced, leaving $1,144,491 still outstanding, or $0.0465/share.

What would the growth look like without the equity offering?

Without the equity offering there would not be this enormous increase in interest. Based on Q1, there might have $50k of interest income for the year. There would also not be the enormous deferred tax item, and the eps would be less than the 11c eps without taxes calculated above.

I have no idea what taxes would be without the interest income and and with the increased earnings. Taxes paid were $50k in 2005. There is $150k payable liability on the 2006 balance sheet. It would be fair to expect earning to be $100k less due to taxes if the equity offering had not happened, or eps of about $0.10, or a 69% increase, still stellar, but about 1/3rd of the 217% growth.

The earnings per share from actual operations is about 4/10ths of one percent of the market cap. They rest is from a tax thing that can not be repeated, and interest.

The interest component is especially interesting to think about. They have gotten $28,113,000 from an equity offering which has enabled them to earn about $900,000 in interest, or perhaps 5-6%. Investors in the stock then essentially buy these earnings in the form of at a P/E of 136, or 0.7% eps or they are paying a 1200% premium for these earnings.

I repeat, Jones Soda made about $900k of interest, and investors have created $900*136 = $122 million of market cap for it!

Alternatively, say the allocation of market cap to the interest is at 6%, or $15 million of market cap. The deferred tax thing is not worth any market cap, so that leaves about $610 million of market cap for the $2.6 million of business earnings. It gives a P/E of 235. They need to increase the real earnings of the business at least 10-fold to catch up with the market cap.

What is the company doing with all that equity?

It appears that they are preparing to expand directly into business rather than using their licensing option. There agreement with Target ended December 31, 2006, and with it goes some of that licensing revenue. They need to build replacement business for that revenue, and they have raised enough equity to expect to do that.

It took them about 6 years to double their revenue, excluding licensing. This stock is going to crash.

Attention getters for me:

As of December 31, 2006 we had 67 full-time employees.

Ok, so a lot of the business is through distribution, etc., but $623 million of market cap for 67 employees? To me it simply points to the degree to which the business is over valued. That's about $9 million of market cap per employee. It just gets my attention.

Net income for 2005 was $1,285,000 compared to net income of #1,330,000 for 2004. The decrease ... was primarily due to an increase in income tax expense (tax espense increased by 37k) and a smaller contribution from other income (interest income declined by 25k).

These same items are going to murder earnings in the future and if you've understood this post, you'll understand why.

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