Digital Brands Group, Inc. — Q3 2021 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2021. The apparel company operated the DSTLD, Bailey 44, Harper & Jones, and Stateside brands, selling through direct-to-consumer, wholesale, and showroom channels. Harper & Jones and Stateside were acquired in May and August 2021, respectively; their results are included only from acquisition dates.
Financial performance and liquidity
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Revenue | $2.16 million | $1.23 million | $3.58 million | $4.48 million |
| Gross profit (loss) | $1.21 million | ($0.49 million) | $1.40 million | $0.59 million |
| Gross margin | 55.9% | (40.1%) | 39.1% | 13.2% |
| Operating loss | ($7.91 million) | ($3.40 million) | ($21.10 million) | ($6.87 million) |
| Net loss | ($8.94 million) | ($3.91 million) | ($22.66 million) | ($8.09 million) |
| Basic and diluted loss per share | ($0.76) | ($5.89) | ($3.77) | ($12.18) |
- For the nine months, operating cash outflow was $11.48 million, investing cash outflow $5.52 million, and financing cash inflow $16.68 million. Cash declined by $0.32 million to $254,527.
- At September 30, current assets were $5.47 million and current liabilities $23.67 million, producing an $18.19 million working capital deficit. Total liabilities were $39.20 million; stockholders’ equity was $1.46 million.
- Debt included approximately $6.00 million of senior venture debt, a $5.27 million face-value Oasis convertible note (reported net of discounts), $3.50 million outstanding on the Bailey acquisition promissory note, and other loans and notes. The venture debt carried 12.5% interest and was scheduled to mature December 31, 2022. The Oasis note is secured by substantially all assets and matures 18 months after issuance.
- Goodwill was $17.77 million and net intangible assets were $16.78 million, together representing a substantial portion of reported assets.
Material changes and unusual items
- Q3 revenue rose 75% year over year, primarily because of the H&J and Stateside acquisitions. Nine-month revenue fell 20%, mainly reflecting COVID-related effects on Bailey, partly offset by acquired-brand sales.
- Gross margin improved substantially versus 2020, which included COVID-related inventory markdowns. Management attributed 2021 margin improvement to the acquired brands and the prior-year markdown comparison.
- Operating expenses rose to $22.50 million for the nine months. They included $4.16 million in stock-based compensation and a $7.04 million increase in the fair value of contingent consideration; the latter was a significant noncash charge. Q3 included a $3.99 million contingent-consideration remeasurement charge.
- The company raised approximately $8.6 million net in its May IPO and approximately $1.4 million net from the underwriters’ over-allotment. Preferred shares and certain debt converted to common stock; shares outstanding were 12,627,488 as of November 12, 2021.
- Management reported substantial doubt about the company’s ability to continue as a going concern, citing recurring losses, negative operating cash flows, and the working capital deficit.
Outlook, risks, and contingencies
- Management expected cash, together with planned financing measures, to fund operations, debt obligations, and capital expenditures for at least one year from the financial statements’ November 11, 2021 issuance date. The plan relied primarily on an unused $17.5 million equity line, subject to registration and other restrictions, and potentially further equity or debt financing. There is no assurance financing will be available on acceptable terms; inability to raise funds could force the company to curtail or suspend plans.
- On October 1, 2021, after quarter-end, the company issued FirstFire a secured convertible note with $1.575 million face value for $1.5 million purchase price; net proceeds were $1.38 million. Conversion terms include a market-price-based discount.
- Management expected COVID-related store closures, reduced traffic, supply-chain disruption, delivery delays, and promotional pressure to continue weighing on results through the balance of 2021. It cited approximately 220 boutique-store closures and 40 department-store closures since the pandemic began, and said many were not expected to reopen.
- Disclosure controls and procedures were deemed ineffective at September 30, 2021 due to material weaknesses. Remediation—including additional financial expertise, consultants, and accounting-system improvements—was ongoing.
- Contingencies included vendor and investor lawsuits, largely related to recorded payables or notes; management did not believe probable losses exceeded recorded amounts. Payroll-related liabilities included approximately $262,000 in estimated penalties.
Key investor verification points
- Whether the equity line and other financing can be drawn, on what terms, and whether resulting share issuance or convertible-note terms will materially dilute existing holders.
- Cash burn, near-term debt payments, covenant compliance, and the company’s ability to address the going-concern uncertainty.
- Post-acquisition revenue, margins, cash generation, and integration costs by brand; reported comparisons are affected by different acquisition dates.
- Assumptions and potential share-settlement exposure underlying the $10.53 million contingent-consideration liability and the significant goodwill and intangible-asset balances.
- Progress remediating internal-control weaknesses and the status or resolution of disclosed litigation and payroll-tax penalties.