Form 10QSB for SUB-URBAN BRANDS, INC.
20-Nov-2006
Quarterly Report
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION OR PLAN OF OPERATION.
Safe Harbor Statement
We desire to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. This Report on Form 10-QSB contains a number of forward-looking statements that reflect management's current views and expectations with respect to our business, strategies, products, future results and events and financial performance. All statements made in this Report other than statements of historical fact, including statements that address operating performance, events or developments that management expects or anticipates will or may occur in the future, including statements related to distributor channels, volume growth, revenues, profitability, new products, adequacy of funds from operations, statements expressing general optimism about future operating results and non-historical information, are forward-looking statements. In particular, the words "believe," "expect," "intend," " anticipate," "estimate," "may," "will," variations of such words, and similar expressions, identify forward-looking statements, but are not the exclusive means of identifying such statements, and their absence does not mean that the statement is not forward-looking. These forward-looking statements are subject to certain risks and uncertainties, including those discussed below. Our actual results, performance or achievements could differ materially from historical results as well as those expressed in, anticipated or implied by these forward-looking statements. We do not undertake any obligation to revise these forward-looking statements to reflect any future events or circumstances.
Readers should not place undue reliance on these forward-looking statements, which are based on management's current expectations and projections about future events, are not guarantees of future performance, are subject to risks, uncertainties and assumptions (including those described below) and apply only as of the date of this Report. Our actual results, performance or achievements could differ materially from the results expressed in, or implied by, these forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
The following discussion should be read in conjunction with our consolidated financial statements and the related notes that appear elsewhere in this report. Our actual results could differ materially from those discussed in these forward looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below and elsewhere in this report, particularly in the section entitled "Risk Factors" of this report.
As used in this report, the terms "we", "us", "our", and "Sub-Urban Brands" mean Sub-Urban Brands, Inc. and our subsidiary Sub-Urban Industries, Inc.
THE FOLLOWING DISCUSSION AND ANALYSIS PROVIDES INFORMATION THAT OUR MANAGEMENT BELIEVES IS RELEVANT TO AN ASSESSMENT AND UNDERSTANDING OF OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION. THIS DISCUSSION SHOULD BE READ TOGETHER WITH OUR FINANCIAL STATEMENTS AND THE NOTES TO FINANCIAL STATEMENTS WHICH ARE INCLUDED IN THIS REPORT, AND WITH OUR COMPANY'S CURRENT REPORT ON FORM 8-K FILED ON MAY 15, 2006 AND ALL SUBSEQUENT FILINGS.
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Overview
On May 11, 2006, pursuant to an Agreement Concerning the Exchange of Securities by and between Sub-Urban Brands, Inc., (formerly known as DP&D, Inc.), a Nevada corporation ("the Company"), Sub-Urban Industries, Inc., a California corporation ("Sub-Urban"), and the security holders of Sub-Urban (the "Sub-Urban Security Holders"), the Company acquired all of the outstanding securities of Sub-Urban from the Sub-Urban Security Holders in exchange for newly issued unregistered securities of the Company. As a result of the share exchange ("Merger"), the Company, which previously had no material operations, acquired the business of Sub-Urban. The acquisition has been accounted for as a reverse merger (recapitalization) with SUI deemed to be the accounting acquirer.
Pursuant to the Agreement, (i) 31,673,363 shares of the Company's Common Stock were issued in exchange for all 31,673,363 shares of Sub-Urban's Common Stock,
(ii) $2,734,900 face amount of the Company's convertible promissory notes convertible into the Common Stock of the Company at a range of prices from $0.250 per share to $0.375 per share, and subject to respective conversion price adjustments, were exchanged for a like face amount of promissory notes held by the Sub-Urban Security Holders (iii) 16,822,245 Common Stock purchase warrants of the Company convertible at prices ranging from $0.140 to $0.375 per share, were exchanged on a one-for-one basis and are exercisable at the same price and terms per share as the warrants of Sub-Urban, and (iv) 7,732,698 stock options of the Company exercisable at prices ranging from $0.250 to $0.375 per share were exchanged on a one-for-one basis and are exercisable at the same price and terms per share as the stock options of Sub-Urban.
The Merger resulted in a change of control of the Company, with the former stockholders of the Company owning approximately 31.4% of the Company's outstanding Common Stock, or approximately 17.8% assuming the conversion of all of the company's outstanding convertible notes, options and warrants. Shareholders of Sub-Urban now own 68.6% of the Company's outstanding common stock. The Agreement was determined through negotiations between the Company and Sub-Urban. Prior to the Merger, two entities affiliated with a principal shareholder of the Company made short term loans totaling $150,000 plus interest at 10% to Sub-Urban which were repaid by Sub-Urban in April 2006. Other than these two short term loans, there were no material relationships between the Company and Sub-Urban, any of their respective affiliates, directors or officers or any associates of such directors or officers.
On August 21, 2006, we moved our corporate offices and entered into a 38 month lease for 10,632 square feet located at 8723 Bellanca Ave, Bldg. A., Los Angeles, CA 90045.
Critical Accounting Policies and Estimates
Our discussion and analysis of financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. These estimates and assumptions provide a basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, and these differences may be material.
We believe the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.
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Convertible Debt Financing and Derivative Liabilities
In accordance with Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended ("SFAS 133"), EITF 00-19, 00-27, 05-02, 05-04 and 05-08. The company has reviewed the terms of its convertible debt financing and the holders' conversion rights provisions (collectively, the features) contained in the terms governing the Debentures which are not clearly and closely related to the characteristics of the Debentures. Accordingly, the features qualified as embedded derivative instruments at issuance and the warrants were free-standing derivative instruments These derivative features do not qualify for any scope exception within SFAS 133, they were required by SFAS 133 to be accounted for separately from the debt instrument and recorded as derivative financial instruments. (See Convertible Debt Notes to Financial Statements for more information). For the nine months ended September 30, 2006, we recorded an aggregate non-cash interest expense items of $2,447,776 including $1,612,224 related to the conversion features on $3,035,800 of our convertible notes; $814,410 related to warrants; and $21,144 related to the value of warrants on $496,394 of the non-convertible notes. During the nine month period ended September 30, 2006, the Company recorded $1,345,000 in warrant liabilities for warrants with mandatory registration rights. These amounts were revalued to market at September 30, 2006 to $1,041,566. During the nine month period ended September 30, 2006, the Company recorded $1,228,689 in conversion feature liabilities. These amounts were revalued to market at September 30, 2006 to $714,348.
Cash Requirements and Additional Funding. We will require additional financing, either from loans, or the issuance of debt and equity securities. We are unlikely to obtain material commercial bank financing. If we cannot obtain sufficient additional financing, we may be forced to slow down or suspend our operations. The success of our business will be dependent on a number of factors, many of which are beyond our control (see "Risk Factors," below). Accordingly, we can give no assurance that the Company will become profitable. Further, we can give no assurance that we will be able to obtain sufficient financing to implement our business plan or that, if financing is obtained, such financing will not materially dilute our existing shareholders. Our ability to obtain additional financing in the coming months will depend upon a number of factors, including market conditions, our results of operations, our success in implementing our business plan for brand launches, our acquisition strategy and investors' perception of our business and prospects.
Assets. Our current assets total $518,843, consisting primarily of inventory net or reserves of $224,942, accounts receivable of $51,647, prepaids and advances of $58,013, and $177,018 representing the unamortized deferred financing costs.
Liabilities and Working Capital. Our liabilities of $5,039,746 are all current and consist primarily of accounts payable of $463,586, accrued salary and benefits of $214,074, secured convertible notes payable in the principal amount of $750,000, convertible notes payable in the principal amount of $2,285,800, and non-convertible notes payable in the principal amount of $496,394. The convertible notes have a conversion price adjustment liability of $49,380, and a conversion feature liability of $714,348. The Company also has warrant liabilities of $1,041,566.
Results of Operations
Nine Months Ended September 30, 2006 Compared to September 30, 2005
In the third fiscal quarter of 2005, we pulled our then current WHITEBOY® products from our distribution channels. As a result of the efforts, in 2006, the Company focused on rebuilding the infrastructure of the Company and redesigning current brands and developing our new brand Mash Culture Lab™ for launch in the third fiscal quarter of 2006. On May 11, 2006 Sub-Urban Industries, Inc., a California corporation, effected a reverse merger with Sub-Urban Brands, Inc., a Nevada corporation. The Company launched its Mash Culture Lab™ apparel brand in August 2006.
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We recorded sales of $79,259, for the nine month period ending September 30, 2006, compared to $126,300 for the nine month period ending September 30, 2005, a decrease of 37%, reflecting the Company's investment and focus in development of future products and brand name recognition. Our gross margin was 23% for the current and prior nine-month period. Our operating expenses for the nine-month period ending September 30, 2006 were $3,266,212, compared to $1,306,114 for the nine-month period ending September 30, 2005, an increase of 150%. This change was due primarily to the 148% increase of $1,448,255 in general and administrative expenses; a 178% increase in sales and marketing expenditures of $391,401; and a 112% increase in product development expenses of $120,472.
The increase in general and administrative expenses is due primarily to i) increases in investor relations expense of $503,431, which includes $315,827 in non-cash compensation for a warrant issuance; ii) increases in payroll expenses of $238,310 due to increased headcount; iii) increases of $306,645 in non-cash compensation related to vesting stock options accounting under SFAS123R; iv) increases of $161,715 in investment banking fees related to financings; and v) increases of $118,976 in professional fees primarily related to the merger of May 11, 2006, on-going financings, and compliance requirements as a public company.
The net of other expenses for the nine-month period ending September 30, 2006 were $2,159,804, compared to $397,510, an increase of 443% from the nine-month period ending September 30, 2005. This change is primarily due to an increase of $2,430,906, in non-cash interest expense from equity instruments issued in connection with convertible notes, a non-cash loan guarantee expense of $327,768, an increase of $213,841 for the conversion features of equity instruments, and a non-cash deferred financing cost of $113,176. These increases were offset by a i) non-cash change of $609,413 in preferred stock redemption accretion due to the conversion of preferred stock to common stock prior to the Merger of May 11, 2006; ii) a non-cash gain on the revaluation of warrant liabilities of 303,434; and iii) a non-cash gain on the revaluation of conversion feature liabilities of 514,341.
The Company's net loss was $5,407,699 compared to $1,674,118 for the nine-month period ending September 30, 2006 and 2005, respectively. Cash used for the Company's operating activities was $2,426,149, and $684,830 for the nine-month periods ending September 30, 2006 and 2005,respectively.
Three Months Ended September 30, 2006 Compared to September 30, 2005
The Company launched its Mash Culture Lab™ apparel brand in August 2006.
We recorded sales of $54,222, for the three month period ending September 30, 2006, compared to $22,333 for the three month period ending September 30, 2005, an increase of 142%, due to initial sales of newly launched product and from the liquidation of discontinued product. Our gross margin was 11% for the current period compared to 28% in the three-month period ending September 30, 2005, reflecting the lower margins on the sale of discontinued product. Our operating expenses for the three-month period ending September 30, 2006 were $1,211,563, compared to $516,962 for the three-month period ending September 30, 2005, an increase of 134%. This change was due primarily to the 116% increase of $470,686 in general and administrative expenses; a 216% increase in sales and marketing expenditures of $151,907; and a 177% increase in product development expenses of $72,008.
The increase in general and administrative expenses is due primarily to i) increases in investor relations expense of $98,875; ii) increases in payroll expenses of $40,946 due to increased headcount; iii) increases of $85,906 in non-cash compensation related to vesting stock options accounting under SFAS123R; and iv) increases of $113,289 in investment banking fees related to financing.
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The net of other expenses for the three-month period ending September 30, 2006 were $970,172, compared to $134,760, an increase of 619% from the three-month period ending September 30, 2005. This change is primarily due to an increase of $1,524,020, in non-cash interest expense from equity instruments issued in connection with convertible notes, a non-cash loan guarantee expense of $54,628, an increase of $113,176 for non-cash deferred financing. These increases were offset by a i) a non-cash gain on the revaluation of warrant liabilities of 303,434; and ii) a non-cash gain on the revaluation of conversion feature liabilities of 514,341.
The Company's net loss was $2,175,852 compared to $645,443 for the three-month period ending September 30, 2006 and 2005, respectively.
Liquidity and Capital Resources
At September 30, 2006 the Company had a working capital deficit of $4,520,903. The Company's total assets at September 30, 2006 were $570,226, of which $7,223 was cash and $51,647 in accounts receivable. At September 30, 2006 the Company's total liabilities were $5,039,746. The Company has invested in the redesign and launch of its new brands, and does not anticipate material revenues from these products prior to the first quarter of fiscal 2007. In November 2006, the Company issued a subordinated promissory note with an accredited investor in the amount of $500,000. The Company used the cash proceeds for working capital needs.
Our Plan for Operations for in 2006
The first nine months of 2006 consisted of the Company repositioning its initial brand offering WHITEBOY® for men. The Company was able to successfully release WHITEBOY® for men as a high-end specialty brand with distribution to image-based retailers. The brand was selected by the internationally recognized Fred Segal of Santa Monica, CA for delivery in the 3 rd quarter of 2006. The repositioning of the WHITEBOY® for men brand allowed the Company to continue developing its multi-brand revenue model. The Company spent the first 9 months of 2006 developing two more brands using the "Rooster" logo created by WHITEBOY Ò for men. The development of MASH CULTURE LAB Ô and WHITEBOY® for girls began in February of 2006 culminating with their wholesale launch at the New York Pool Trade Show in July of 2006. These two brands, unlike WHITEBOY Ò for men, are seeking larger distribution paths through specialty retail chains and department stores.
The Company also focused on attracting industry-leading talent to design and produce our core offerings. The Company hired Ashley Scranton as design director for WHITEBOY® for girls with her focus on developing an appealing mass distributed brand. The company also hired Melanie Weaver as director of production for all brands owned and distributed by Sub-Urban Brands, Inc. Ms. Weaver immediately moved nearly all sourcing and production overseas to decrease the Company's costs of production.
In continuing to develop WHITEBOY Ò for men as a high-end exclusive specialty brand, the Company initiated its practice of partnering with widely known and respected artists to design its collection. The Company entered into a seasonal agreement with well-known punk rock fashion icon Heidi Minx of Franky and Minx Ò
. Ms Minx developed the majority of the Fall 2006 offering of WHITEBOY Ò for men.
The Company also completed staffing its regional based sales force by adding representatives to the West Coast, the Southwest, the Southeast and the Midwest to compliment our east coast showroom. The Company negotiated commission based agreements, paying 10% for sales made within their respective territories for the distribution of our brands. These sales agreements are cancelable by the Company with 30 days written notice.
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We also used the first 6 months of operation in 2006 to continue our goal of becoming a publicly Company trading in the Over-The- Counter bulletin board market. The Company realized this goal on May 11, 2006 when we completed a successful merger with DP&D, Inc, a Nevada corporation.
The Company will continue to sell its three brands in the wholesale environment as well as continue its retail operations online. The Company attended several wholesale tradeshows in the third quarter of fiscal of 2006, and revenues are anticipated commencing in the first quarter of 2007. These tradeshows are industry known and are located in New York City, Las Vegas, Los Angeles, Atlanta, Chicago, Miami and Dallas. In addition, the Company has instituted an internal sales campaign utilizing two sales representatives contacting over 3,000 retail stores by phone and mail seeking orders for the Company's brands.
The Company will be seeking international distributors who represent premium lifestyle and street brands in their respective countries. We will focus on agreements for distribution in Japan, Australia, Europe and Canada. The Company has also begun seeking high margin recurring revenues streams through licensing of additional branded products. The Company will actively seek distribution arrangements for one or all of its brands in footwear, belts, bags, headwear and other apparel and accessory related products.
The Company is also actively pursuing emerging and or established apparel companies for acquisition to complement WHITEBOY Ò for men, WHITEBOY Ò for girls and MASH CULTURE LAB Ô . The company has issued two non-binding letters of intent for two companies with established brands and revenues. Subject to successful financing activities, the Company intends to make one or both of these acquisitions by 12/31/2006 that is consistent with our multi brand approach to generating revenue in addition to our current offerings in apparel.
MCL™, is marketed to individuals between the ages of 13 and 29 who enjoy the "urban" or the "board" (surf/skate) lifestyles, but are not hard-core in either. We believe that while our core customer is fond of the "urban" and "board" lifestyles, neither fully represents that customer's identity. We believe that there is a growing marketplace where rock, rap, electronic music and sports are merging; this is the melting pot MASH CULTURE LAB™ represents, which we term the "Suburban" market and which is sometimes referred to as "Mash" or "Mash Culture". We believe that the "Suburban/Mash" target market dwarfs both the "urban" and "board" markets, although it is heavily influenced by both, as well as by many other factors. We have been a leader in identifying this "Mash Culture" and have incorporated it into our designs, marketing and management programs as well as identified it as our brand name. We believe that the racial, cultural and economic diversity of the large cities will greatly expand in the next few years. "Mash Culture", which borrows the best of existing trends and ideas, will be the source of creative dynamism, because it addresses our target market's desire to be interesting and unpredictable. Fueled by technology, it is already changing fashion, design and music. MASH CULTURE LAB™ is targeted for specialty chain and department store distribution. MCL™ is to have a much larger distribution than WHITEBOY® for men in that the garments have been designed for a broad appeal. We have spent considerable time ensuring that the quality of the garment meets or exceeds that of our competition. In addition, we believe our graphics are a distinguishing feature for MCL™. We use theme-based concepts and hand-drawn art to achieve fresh designs. We believe that our leading-edge graphics along with premium-quality garments will allow us to develop MCL™ into a widely distributed distinctive brand. We further believe that theme-based collections with a single point of view gives the retailer the ability to buy deeper into the line with the assurance of merchandising the product in stores. We have also developed a signature print known as the "COCK CAMO" using our rooster logo design. This signature print features a prancing rooster on a camouflage print fabric, which we believe clearly distinguishes us from our competitors. While not a specific garment type, the "COCK CAMO" is becoming an integral part of the MCL™ brand.
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The Company will continue its aggressive multi media image based marketing campaign known as "Get Cocky" for the next 6 months. This campaign will consist of street marketing in 8 major metropolitan markets, advertising in trade and fashion magazines, product placement in fashion magazines, celebrity gifting and co-branded marketing initiatives with Fortune 500 media organizations. The Company will continue developing media and entertainment industry relationships with EMI Capital Group and Emmis Communications, Inc.
We will continue in our efforts to produce better made garments at a lower cost through our overseas vendors for our mass distributed brands WHITEBOY Ò for girls and MASH CULTURE LAB Ô . The Company will focus on its knit based products being produced in China and India, and denim and woven products will also be produced in China and India for WHITEBOY Ò for girls and MASH CULTURE LAB Ô . WHITEBOY Ò for men will primarily be manufactured in Los Angeles due to its highly customized offering and the need to turn new product every 6-10 weeks. Our production arrangements are contracted for by purchase orders at an arms-length negotiated price and delivery date.
In the three-month period ending September 30, 2006 we moved our operations to a larger facility near the Los Angeles airport, and moved our warehousing and distribution in-house.
In order to complete our business strategy of developing a multi brand offering, the Company will need to raise $8,000,000 in financing in the fourth quarter of 2006. These proceeds will be used to continue to develop our three current brands, finance production, execute strategic acquisitions and for the general operating costs of the Company. Further, we can give no assurance that we will be able to obtain sufficient financing to implement our business plan or that, if financing is obtained, such financing will not materially dilute our existing shareholders. Our ability to obtain additional financing in the coming months will depend upon a number of factors, including market conditions, our results of operations, our success in implementing our business plan for brand launches, our acquisition strategy and investors' perception of our business and prospects.
Risk Factors
RISKS RELATED TO OUR BUSINESS
The Company acquired SUI on May 11, 2006, which had a limited operating history, and, accordingly, is subject to substantial risks inherent in the commencement of a new business enterprise. Prior to the acquisition of SUI, the Company had no operations.
We have incurred losses since inception, including a loss of $2,689,842 in 2005, and expect to incur net losses for the foreseeable future.
Our business strategy is unproven, and we may not be successful in addressing early stage challenges, such as establishing our position in the market and developing our products and services. To implement our business plan, we will require additional financing. We cannot guaranty that such additional financing will be available. In the absence of additional financing we may be required to significantly reduce our operations.
Our prospects must be considered speculative, considering the risks, expenses, and difficulties frequently encountered in the establishment of a new business, specifically the risks inherent in developmental stage companies. We expect to continue to incur significant operating and capital expenditures and, as a result, we expect significant net losses in the future. We cannot guaranty that we will be able to achieve profitable operations or, if profitability is achieved, that it will be maintained for any significant period, or at all. If we are unable to achieve profitable operations, investors will likely lose their entire investment.
