Deal To Watch: Distilled Spirits from Artesian Well Water

Key Stats:

Summary

Dented Brick Distillery has been selected as a “Deal to Watch” by KingsCrowd. This distinction is reserved for deals selected into the top 10%-20% of our due diligence funnel. If you have questions regarding our deal diligence and selection methodology, please reach out to hello@kingscrowd.com.

The craft distilled spirits industry has seen tremendous growth in recent years. Even with that upside, it still accounts for a marginal piece of the broader industry. Between the small market share and strong demand, forecasts suggest that more material upside could exist for the space. Recognizing this opportunity, founder Marc Christensen set out to build a business centered around quality craft distilled spirits. Today, the company is growing at a nice clip, and in an effort to further expand operations, it is seeking additional financing. Growth prospects are appealing and the company’s sales record suggests that the future might be bright.  There are, however, plenty of risks that investors should be aware of.

Problem

The craft distilled spirits industry is an attractive place to be, but the number of brands out there keep expanding at a rapid pace. This denotes just how appealing the prospects are.  But it also shows that very few brands have managed to achieve national recognition and scale. As with most any industry, early-stage fragmentation must eventually be met with consolidation.  That subsequent phase will determine the true winners in the space. Until then, though, this niche of the spirits industry will remain something akin to the Wild West. 

Solution

Dented Brick Distillery believes that it can help this process along by serving to fill the void with its own brand. The company’s roots trace back to 2011, when a group of entrepreneurs that included Christensen, met to discuss the opportunity. Since those humble beginnings, Dented Brick Distillery has grown into a quality provider of craft brews. Today, the company has a presence in at least 14 states.  This is due not only to its DTC (direct-to-consumer) business model, but also to the contracts it has landed with distributors as well. The firm’s product be found in some Wal-Mart locations nationwide.  It also has a presence in regional retailers like Raley’s Stores and Total Wine. 

Though the company was slow to get to market, with not even a product or brand at the start of 2016, it has done well to scale up. In 2018, the company sold 8,052 cases of spirits. Through September of 2019, this number had grown to 14,188, and management believes that 2019 will see total shipments hit or exceed 16,000. As shipments have risen, so too have sales. According to management, revenue in 2017 was a paltry $177,026. This more than doubled to $396,749 last year. If all goes according to plan, the company expects revenue this year to exceed $1 million. There are some risks associated with its debt at this time. Last year at least, 70% of the firm’s revenue came from two different parties.  Over the same time, 82% of its accounts receivable were attributable to three customers. The loss of one or more of these big parties could prove damaging for the firm.

On the top line, things are going well, but the same cannot be said of the bottom line. In 2017, the company generated a net loss of $808,164. This shrank only marginally to $763,039 in 2018. Operating cash flow hasn’t been much better. In 2017, the company saw a net cash outflow of $631,725. This grew to a net outflow last year of $743,243. Part of the company’s problem has to do with its interest expense. In 2017, this came out to $142,916. Last year, the figure was even larger at $200,380. 

Such a high amount of interest is due to the high amount of debt on the firm’s books. According to its financial statements, 2018 saw the firm end with $2.33 million in gross debt. That said, this does not match up with a disclosure in their filings where they said that at the end of the year they took on $3 million worth of debt. Fortunately, the $3 million taken on does have a remarkably low interest rate of only 6%, but it comes with a catch. The company must also have a reserve deposit of one year’s interest (or $180,000) in order to be in compliance with the debt’s covenants. The company did not have that excess cash on hand, so instead it borrowed the $180,000, structured as a note payable. It has an annual interest rate on it of 10%.  But for any amount of interest not paid on time, the company must pay interest on top of that in the amount of 12%, compounded monthly.  

In addition to word-of-mouth and traditional advertising methods, management has come up with some innovative ways to grow the firm. One way is through its celebrity-owner Jan Stephenson, a world-renowned former champion of the LPGA. Customers of key accounts (and presumably major prospective customers) are given the opportunity to golf with her. The company also hosts a Pro-Am golf tournament (or plans to) in each state in which it sells its product. It invites representatives, distributors, and customers to play there.  At each event, each team gets paired up with a professional golfer. Building off of the Stephenson angle, the company has multiple types of rum bearing her name on it. It also holds special events where she publicly endorses their products. 

Another, more interesting, strategy Dented Brick Distillery has worked on is its Whiskey Barrel Program. In exchange for $800, the company will allow customers to brew their own spirits in a barrel that they will own. Every few months, the customer can stop by for a taste. Once the brew is bottled, they will then receive their $800 back, plus 30% (taking total cash proceeds to $1,120), plus their barrel. They can then buy even just one bottle, $1,120 worth of bottles, or the full 200 bottles that a barrel should make, depending on how much they want to spend. This concept is fascinating because it creates a reward for fans, while also fueling the company’s own growth. It is also an interesting marketing technique. 

Moving forward, Dented Brick Distillery has big plans. With the capital raise it is seeking, it hopes to grow its production further. Its goal is to sell 23,000 cases in 2021 and to further grow that to 39,000 cases in 2022. The company’s ambitions don’t end there though. They believe that in a few short years they will see production grow to between 40,000 and 60,000 cases per annum. At that point, management believes that it would be a prime prospect for a larger player to acquire it. 

A Great Market

Over the past several years, the craft brew space has seen extraordinary growth. As of August of 2018, the latest for which data was available, there existed around 1,835 craft brew companies in the US. This was up 15.5% over the 1,589 in operation just one year earlier. Total volume sales by the firms in operation during 2017 (the latest full year for which data has been tabulated) came out to 7.2 million cases. This represents an increase of 23.7% over what was seen just one year earlier. While domestic unit sales are surging, export sales growth is still fairly slow, with growth in 2017 coming out to 5.7%. Total units exported during the year were 598,000.

In dollar terms, the picture is even more impressive. Total sales in 2017 in this space came out to $3.7 billion, which translates to an annualized growth rate of 29.9%. Even with these strong sales, the market share in this space is still remarkably small compared to the broader spirits/alcohol space. By volume, craft brands accounted for just 3.2% of the overall market, while by value this figure is 4.6%. These figures compare favorably relative to the 1.2% and 1.4% market share, respectively, seen in 2012, and compared to the 2.6% and 3.8% market share, respectively, seen in 2016. 

Today, there are really two major classifications of players in the space. Marginal players and big players. The top 2% of craft brewers by size created 57.2% of all cases sold, while 92.3% of players sell between 0 and 10,000 cases. The remaining 5.7% of participants produce less than the big boys, but more than 10,000 cases per annum. This is precisely where Dented Brick Distillery falls into place. It’s also worth mentioning that there are states in the US that have proven to be more appealing to craft startups as well. 33.7% of all distillers are located in only five states. There are also regional preferences as well. A full 32.2% of players in the space are from the western portion of the US, while 29.5% can be found in the south. 

Fueling this growth is continued investment into the industry. In 2017, investors pumped $593 million into the industry. This represented an increase of 49% over the $398 million seen one year earlier.  If the data provided turns out to be accurate, this could be just the beginning for Dented Brick Distillery and its peers. In the second image below, you can see that the industry is forecasting annualized growth in a series of ranges, with some of these as high as 44.6% CAGR through 2021. In all, we are looking at a market share of perhaps up to 12.8% with 31.3 million cases sold every year. More likely than not, the actual growth rate will be slower.  But the bottom line to take here is that this niche space is growing much faster than the broader industry and it’s taking away market share from it. 

Terms of the Deal

Like so many other startups raising money today, Dented Brick Distillery isn’t raising money through equity or debt. Instead, it is using a SAFE. In all, the firm is looking to raise between $50,000 and $1.07 million. The SAFE will eventually convert into units of the company, subject to a valuation cap of $7 million and subject to a discount on the valuation of 20%. For the first $500,000 in commitments, this discount increases to 30%. The minimum investment per participant that’s accepted for this deal is $1,000, and as of this writing the company has $6,100 committed to its cause.

An Eye on Management

At this time, there appear to be two core members of the team: Marc Christensen and Steve Stanko. Christensen is not only the founder of Dented Brick Distillery, he serves as the company’s Managing Member. In the past, he also served as a Board Member for NOW ID International/Interdisciplinary Dance & Design Co. Prior to his time there, he founded OTW Safety, a national manufacturing and distribution business.  He took the company from pre-revenue to generating millions of dollars. Stanko, meanwhile, is not a co-founder of the firm, but he did join on and is currently the company’s COO. Prior to his time at Dented Brick Distillery, he worked as a Senior Program Manager at BAE Systems. Before that, he held the same title with Booz Allen Hamilton for nearly 14 years. 

The Rating: Deal To Watch

After careful consideration, Dented Brick Distillery has been rated a ‘Deal To Watch’. The company’s strong revenue growth in recent years has been encouraging. Management’s own guidance of continued growth this year is equally exciting. Future growth will be costly, but not as much as some might anticipate. This is due to the fact that the facility in which the company is located already has the capacity, in theory, to handle up to 78,000 cases per year of product. This is enough to get the firm to the point of a buyout as they have imagined it. Another strong contributor to this rating is the fact that the industry is growing so rapidly.  This is despite the fact that there is a significant number of players in the space already. This opens the door to interesting prospects.

On the downside, there are a couple of big reservations we have. For starters, the debt on the firm’s books is significant and the interest expense takes a huge chunk out of the revenue the business generates. Even without this interest expense, the firm’s net loss would be a problem, as would its operating cash outflows. These issues are so material for the firm that if it weren’t for management’s guidance (so close to the end of the year too) that this year should see revenue of around $1 million, this could have easily been considered an Underweight prospect. In fact, this particular company should be viewed as teetering on the edge of those two ratings. At the end of the day though, strong projected sales growth, coupled with industry data, tilts this opportunity in favor of being one that investors should take into consideration.