Digital Brands Group, Inc. — Q2 2022 Form 10-Q
Reporting period: Three and six months ended June 30, 2022. Digital Brands Group operates apparel brands including Bailey 44, DSTLD, Harper & Jones, Stateside and ACE Studios through direct-to-consumer, wholesale and showroom channels. The company’s 2022 comparisons include fuller-period results from acquisitions of Harper & Jones and Stateside.
Key financial results
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Revenue | $3.74 million | $1.00 million | $7.17 million | $1.41 million |
| Gross profit | $2.17 million | $0.39 million | $3.64 million | $0.19 million |
| Gross margin | 58.1% | 39.3% | 50.8% | 13.2% |
| Operating loss | $10.67 million | $10.84 million | $16.25 million | $13.19 million |
| Net loss | $9.53 million | $10.70 million | $17.37 million | $13.72 million |
| Operating cash used | Not separately presented | Not separately presented | $6.61 million | $6.60 million |
- Revenue growth was primarily attributed to the acquired brands’ inclusion for more of 2022, rather than solely to organic growth. Management attributed improved gross margins to acquired-brand margins and 2021 discounting to clear aged inventory.
- Q2 net loss narrowed year over year, helped by higher gross profit and other income. For the first half, net loss increased, principally due to higher operating expenses, including a $7.12 million increase in contingent-consideration fair value.
- Q2 operating expenses were $12.84 million; first-half expenses were $19.89 million. First-half interest expense was $3.77 million, including substantial amortization of debt discounts.
- Cash was $802,724 at June 30, 2022, versus $528,394 at year-end 2021. First-half cash from financing was $6.88 million; investing cash flow was zero. Ending cash reflects a $274,330 increase over the six-month period.
- Current assets were $5.62 million against current liabilities of $43.97 million, producing a $38.35 million working-capital deficit. Total liabilities were $51.30 million and stockholders’ deficit was $14.88 million.
- Significant reported obligations included $6.25 million of venture debt and $3.50 million owed to Bailey’s sellers, both with payments deferred to December 31, 2022; $8.03 million principal on convertible notes; and $19.30 million of contingent consideration. The filing reports $8.0 million of convertible-note principal maturing on various dates through 2023.
Material changes, financing and outlook
- In May, the company sold 37,389,800 shares at $0.25 per share, raising $9.3 million gross and approximately $8.05 million net. Common shares outstanding rose from 13.0 million at December 31, 2021 to 52.9 million at June 30, 2022, a significant increase in dilution.
- Management stated that the company has not generated profits since inception, expects further operating losses, and requires additional capital. The filing says these conditions raise substantial doubt about the company’s ability to continue as a going concern. Management expects to seek equity, debt or other financing; availability and terms are uncertain, and failure to obtain funding could require curtailing plans or seeking bankruptcy protection.
- An equity line agreement provides for up to $17.5 million of potential purchases, but drawdowns may be restricted; management was reviewing their feasibility.
- After quarter-end, the company issued July notes with aggregate face value of $3.125 million for $2.5 million in subscription proceeds, carrying a 20% original issue discount and an October 31, 2022 maturity. The notes include repayment requirements linked to future financings and default terms that can increase the balance, impose 20% interest and permit conversion.
- The June agreement to acquire Sundry contemplated $5 million cash plus additional consideration involving $7 million in cash or shares and $20 million in shares, subject to closing conditions, including shareholder approval and sufficient cash or borrowing capacity. The filing does not establish that the acquisition had closed.
- Management cited supply-chain pressures: fabric costs up 10%–100%, freight costs up 25%–300%, transit times extended by two weeks to two months, and labor costs up 5%–25%, with variation by source and circumstances. Results are seasonal and historically stronger in the second half. No quantitative earnings or revenue guidance is provided.
Risks, contingencies and unusual items
- Contingent-consideration remeasurement added $7.12 million of first-half expense and raised the recorded liability to $19.30 million. The filing says the liability had not yet been settled in shares as of issuance; a later amendment set additional H&J shares for delivery in May 2023 based on a stated formula.
- Bailey received forgiveness of $1.76 million of PPP loans, contributing to other income. The Q2 results also included a favorable derivative-liability fair-value change.
- The company disclosed lawsuits and vendor disputes, including a $469,000 judgment after settlement terms were not met, a $100,000 investor claim, and other service-related claims. Management says amounts it believes it will owe are accrued.
- Disclosure controls and procedures were deemed ineffective at June 30, 2022 because material weaknesses in internal control remained unremediated. The company cited insufficient accounting and reporting resources and systems and described consultant hiring and other remediation efforts.
- Management identified potential exposure to interest and penalties on payroll-related liabilities; accrued payroll liabilities included approximately $262,000 in estimated penalties.
Important facts for investors to verify
- Near-term liquidity, debt maturities and the company’s ability to fund operations, including whether the equity line can be drawn and on acceptable terms.
- The details and dilution impact of post-quarter July notes and warrants, and any subsequent repayment, default or financing events.
- Whether the proposed Sundry acquisition closed, its final cash and share consideration, and the funding required.
- The assumptions behind the $19.30 million contingent-consideration liability and the number and value of shares ultimately deliverable to sellers.
- Progress remediating material weaknesses and whether disclosure controls and reporting processes become effective.
- Updates on disclosed litigation, vendor obligations and the timing of debt payments deferred to December 2022.