Shareholder Newsletter

October 1, 2004 - Issue No. 14

Back to List of Newsletters

DEAR FELLOW SHAREHOLDERS:

LBIX MONTHLY NEWSLETTER

Why would anyone buy shares of Leading Brands? With our stock trading around $1.00 US, and despite what some might suggest, that is not a rhetorical question.

In 1996 this company was for all intents and purposes bankrupt. Its primary source of revenue was the manufacture of private label carbonated soft drinks, an extremely low margin business that was losing money by the bushel. There appeared to be room for only one company in that business and that was Cott. The ‘cola wars’ were in full swing and the trend was clearly toward healthier alternatives. Taking into account a massive potential tax liability, the company was $40,000,000 Cdn in debt.

By the end of that year, we had sold the private label business off, restructured its obligations and re-capitalized the company. We assessed the beverage market and decided that we wanted to capitalize on the move towards more healthful products. If we were going to do that successfully, we needed to identify a unique strategy that would provide us with a material competitive advantage.

We had inherited a hot-fill plant in Edmonton that was conducive to bottling without the use of preservatives, but unfortunately it at that time was also losing a lot of money. The company’s two other businesses consisted of a marginally profitable direct to store distribution operation and a 5 gallon home and office water distribution business. None of these divisions did any business with each other.

Our analysis of the competitive landscape surprisingly revealed that there were no vertically integrated companies in the North American healthy refreshment beverage industry. Most people trying to get a new beverage product to market had to deal with more than twenty intermediaries: flavor houses, bottlers, warehousemen, distributors, brokers, merchandisers, wholesalers, etc., each with its own overheads and profit expectations. Consequently, the margin remaining for the brand owner was to a great extent consumed by these costs. The corresponding risks of introducing a new brand were extremely high and the landscape was littered with these failed attempts.

By early 1997 we conceived our Integrated Distribution System™, or “IDS™”. We would combine our research, design, quality assurance, bottling, logistics, distribution, sales, marketing and merchandising functions to provide a direct to market system that would eliminate about ten costly links in the supply chain that our competitors were forced to use. Where appropriate, we would supplement our system with the services of third parties. Ultimately, we would have more control and greater margin on the products we sold.

By early 1999 we had acquired our only competitor in the hot fill beverage business in Western Canada and spread our direct to store distribution system across the major markets there. We expanded our production capability to include plastic (PET), which was rapidly becoming a major package medium and continued to grow our brand portfolio, principally through licensing brands developed by third parties.

Our market at the time was restricted to the approximately 10 million people of Western Canada and we were producing or distributing approximately 30% of the juices, waters and new age beverages consumed there. To continue to grow and prosper, we needed to expand our horizons.

The vast majority of the products we produced and distributed belonged to other people. That caused a host of issues and concern. Our business was often at the whim of the brand owner, their financial ability, individual goals and marketing acumen. Also, the person whose product we were distributing naturally expected a return on their investment, which either cut into our profit margins or markedly increased our selling price.

By the Fall of 1999 we had extended our business across Canada. We opened sales offices and distribution facilities in Toronto, and ultimately Montreal. Much of that growth was fuelled by our distribution of SoBe, which we ultimately held the rights to Canada for. By the Fall of 2000, however, SoBe had been acquired by Pepsico and our distribution rights were bought out. The Company received more than $10 million Cdn in the Spring of 2001.

Earlier that year we had started the development of TREK® and Pez® 100% Juices™ to increase the offering of our own brands. Those new products would be slotted into our IDS, which was starting to deliver the anticipated greater margins. Our market had also grown to 30 million people.

In early 2002 we were approached by a couple of individuals with a view to expanding our operations into the US. There was great appeal to that concept as the beverage market there is 20 times that of Canada. We decided to seize the opportunity, despite the fact that we were concurrently undertaking substantial expansion in both of our plants. In retrospect, we probably went a year too soon and with the wrong people. Our IDS was never executed in the US and it has taken us most of 2004 to rectify that situation.

Our goal is to continue to increase the number of products we sell over an ever-increasing customer base and do so profitably through our IDS. It is a strategy that is working. Although we experience revenue fluctuations due to changes in co-packing method and the discontinuance of product categories that no longer fit with our plans, there are some specific numbers that cannot be ignored.

In 1996 we produced and distributed 45 million liters of juices, bottled water and new age beverages. In 2003 that number rose to more than 220 million liters, an increase of almost 500%. According to A.C. Neilsen, in 1996, the total market for those products in Western Canada was 153 million liters. Going forward our plan is really quite simple:

1. Continue to profitably operate our core business. That should allow us to generate capital internally so as to grow without diluting our shareholders.

2. Introduce more of our own brands to both fill out our portfolio and provide more diverse sources of revenue. Where possible, be the leader in a category we create or define.

3. Expand the population base that we cover so that our portfolio of brands is made available to an increasingly large market.

Today, our market potential is more than 400 million throughout North America. Did it cost something to expand our opportunities more than 40 fold? Certainly. Is that paying off? We believe so.

Some of our brands may be huge successes, others may not. Some may become household names, others may be niche products. Some will come and go in a short period of time, some may be around for many years. Some may sell well everywhere, others only in specific places.

I recently read a great book on branding entitled “The Origin of Brands”. I heartily recommend it to anyone who is interested in learning how we approach branding and marketing. In that book the authors indicate that it takes several years to properly build a brand. I certainly do not disagree with that proposition. I suggest to you that Gatorade was broadly available for 25 years before North America took notice of it. I know that in 2000 most of the people I knew had never heard of SoBe; it is generally considered a runaway success, but had been launched in 1996. How many people outside of New York City and LA have heard of Vitamin Water?

We will never risk our company on one brand or initiative. We will never be a ‘one trick pony’. That is a very risky proposition. It necessitates that you hit it big, and do it the first time. More fatally, it requires that you ultimately sell off your brand to some larger company before it starts to decline, as they all ultimately do. To risk your investment on one event over which you have no control is too much risk for me. It requires too much good fortune and impeccable timing.

From our perspective, we don’t ‘need’ any one of our products to be the next Snapple or SoBe, brands that at their peak sold tens of millions of cases a year. Our overhead costs are more than covered by our base business. If we let our IDS and its hybrid distribution system do its work and have just one moderate success, we will all be very happy. A quick numerical example is perhaps easiest to understand. If we can contribute an average of $4.00 per case to before tax earnings for each incremental case we sell - which is from our experience a reasonable assumption - what does a moderately successful brand selling, say, 2,000,000 cases per annum do for the value of our company? What if one or a group of those brands produce 10,000,000 cases in incremental sales?

That is why we continue to do what we do.

I met a fellow a couple of weeks ago who was the CEO of a pharmaceutical company. He had five products in development awaiting approvals that took four to five years. In the interim he had no income from them, only the costs of development. But to be incredibly successful all he needed was for just one of those new products to be accepted and find a market. Our concept is not too dissimilar, but because our business is already profitable, our risk profile is much lower.

On another topic; from time to time we field questions as to why we do not disclose each new retail chain listing or detailed operational data. I tried to respond to those questions in our last conference call, but understand that the recording was not particularly clear, for which I apologize.

All industries are extremely competitive and the beverage industry is no exception. Smaller public companies are in many ways at a distinct disadvantage to larger public and all private ones in that it is far too easy for anyone with knowledge of the workings of the industry to take otherwise innocuous operational numbers and use them to divine the pricing programs, product margins and operating cost structures of their competitors. It is a very simple process for me or anyone else who understands this industry to use a few apparently errant pieces of data and to dissect the financial statements of a competitor. The result? Our ability to compete against them is enhanced. We can undercut pricing schemes at critical times of the year, learn promotion patterns, determine their raw materials costs, etc. When that information comes from a customer or supplier, it makes it even easier for us to turn it to our advantage.

We have no intention of providing detailed case sales numbers or other indicators that would prejudice our business. As a shareholder, that should be your interest as well. Our financial statements speak for themselves. If you spend the time to understand them and read our MD&A disclosure you will be able to make a proper assessment of our financial performance and compare it against others in the industry.

As for retail listings, what possible difference does it make to a shareholder to learn about every listing that we might obtain for a product? There is no doubt that some companies try to hype their stock by regularly disclosing that information. How many of them announce when they lose a listing? We may from time to time provide information in a summary fashion, but we are not going to make it a habit to announce that kind of event. Why? Because it is often not that significant and can be more misleading than not.

Our sales people often call to let me know when they have secured an account. Before congratulating them I ask a number of specific questions: what listing fees (if any) were paid, how were they paid, what was the pricing structure, what promotions are we supporting, what inside programs are we required to pay, what distribution method are we using, are they taking full or partial trailer load orders, what are the delivery points, are we paying any commissions on the sale? Without that information and more, all anyone knows is that the product will at some time in the future hit a store shelf. It may sell, it may not. It may provide a positive contribution to earnings, it may not. No one can ever determine from that tidbit whether it was a good transaction or a bad one and no responsible company would release the metrics necessary to allow that question to be answered.

So, for those of you interested in owning the shares of a beverage company that discloses unnecessary competitive information please call me and I’ll happily give you some names. For those who want to invest in companies that announce each retail listing, they are pretty easy to find. For the rest of you, who want to own part of an innovative, profitable, integrated business in a growing segment of a large industry, you might want to stick around.

Thank you for your continued support.

Sincerely,
LEADING BRANDS, INC.

Per:

Ralph D. McRae
Chairman & CEO

Disclaimer:
Certain information contained in this press release includes forward-looking statements. Words such as “believe”, “expect,” “will,” or comparable terms, are intended to identify forward-looking statements concerning the Company’s expectations, beliefs, intentions, plans, objectives, future events or performance and other developments. All forward-looking statements included in this press release are based on information available to the Company on the date hereof. Such statements speak only as of the date hereof. Important factors that could cause actual results to differ materially from the Company’s estimations and projections are disclosed in the Company’s securities filings and include, but are not limited to, the following: general economic conditions, weather conditions, changing beverage consumption trends, pricing, availability of raw materials, economic uncertainties (including currency exchange rates), government regulation, managing and maintaining growth, the effect of adverse publicity, litigation, competition and other risk factors described from time to time in securities reports filed by Leading Brands, Inc.