Business context and reporting period
Digital Brands Group, Inc. filed this Form 10-K for the fiscal year ended December 31, 2021; it is an annual report, not a standalone fourth-quarter report. The company operates apparel brands through direct-to-consumer, wholesale and showroom channels. Its portfolio included DSTLD, Bailey 44, Harper & Jones (H&J) and Stateside; ACE Studios was planned for a later launch.
During 2021, the company acquired H&J in May and Stateside in August. Reported results include each acquired business only from its acquisition date, so year-over-year comparisons are not like-for-like.
Financial performance and liquidity
| Metric | 2021 | 2020 |
|---|---|---|
| Net revenue | $7.58 million | $5.24 million |
| Gross profit / gross margin | $2.90 million / 38.2% | $0.55 million / 10.6% |
| Operating expenses | $34.24 million | $9.70 million |
| Operating loss | $31.35 million | $9.15 million |
| Net loss | $32.36 million | $10.73 million |
| Basic and diluted loss per share | $4.21 | $16.15 |
| Net cash used in operating activities | $14.22 million | $2.06 million |
| Net cash used in investing activities | $6.01 million | $0.20 million provided |
| Net cash provided by financing activities | $20.18 million | $2.39 million |
Revenue rose about 45%, primarily due to the H&J and Stateside acquisitions. Gross margin improved from the prior year, which included significant inventory write-downs and discounting, as well as the addition of H&J and Stateside. However, operating expenses rose substantially. The financial statements report $34.24 million of operating expenses, including $8.76 million from the change in fair value of contingent consideration, $4.80 million of stock-based compensation and $3.40 million of intangible-asset impairment.
At year-end, cash was $528,394, working capital deficit was $30.27 million, total liabilities were $43.58 million and stockholders’ deficit was $7.09 million. The company disclosed approximately $21.9 million of debt principal outstanding; its senior secured facility had approximately $6.0 million due December 31, 2022. The balance sheet also included a $12.18 million contingent-consideration liability. The filing and auditor’s report state that recurring losses, negative operating cash flow and insufficient liquidity raise substantial doubt about the company’s ability to continue as a going concern.
Material changes versus the prior period
- Revenue increased by approximately $2.35 million, primarily reflecting acquisitions rather than clearly identified organic growth.
- Gross margin expanded to 38.2% from 10.6%; management attributed the change to acquired-brand margins and 2020 inventory markdowns and liquidation.
- Net loss increased by approximately $21.63 million. Higher expenses included acquisition- and IPO-related non-cash items, increased professional, marketing and investor-relations costs, and the Bailey 44 impairment.
- Cash used in operations increased to $14.22 million from $2.06 million. Financing inflows, including IPO proceeds and convertible debt, largely funded the year’s operating and acquisition cash needs.
- Unaudited pro forma results assuming the Bailey, H&J and Stateside acquisitions had occurred at the start of 2020 showed revenue of $11.83 million and net loss of $33.26 million in 2021, versus revenue of $12.99 million and net loss of $12.76 million in 2020. These figures are not forecasts and exclude potential acquisition synergies.
Outlook, risks and unusual items
- Management expected lower wholesale order quantities than pre-pandemic levels through the first half of 2022, though meaningfully higher than in 2020 or 2021. It also warned that COVID-related closures, reduced store traffic and a promotional retail environment could weigh on at least the first two quarters of 2022.
- Supply-chain pressures included fabric-cost increases of 10%–100%, freight increases of 25%–300%, longer transit times and labor-cost increases of 5%–25%. Management said some costs had been passed through or offset by higher-margin online revenue.
- The company planned to rely primarily on a $17.5 million equity line for near-term funding, but had not drawn on it through the filing date. Draws were subject to conditions, including a minimum recent share price above $3.00; availability was therefore not assured. Management also cited possible secondary offerings or debt financing.
- Debt carries significant refinancing, covenant and dilution risks. The senior lender has a security interest in company assets, and certain notes are secured and convertible at prices that can vary with the share price.
- A January 2022 agreement to acquire Sundry contemplated $34.0 million in cash plus $7.5 million in stock, subject to conditions and financing. The filing stated there was no assurance it would close; the contemplated consideration and potential additional shares make funding and dilution important risks.
- The company recorded a $3.40 million impairment of Bailey 44’s brand-name intangible asset in 2021, following a $784,500 impairment in 2020. Several vendor and other legal matters were disclosed; amounts management considered likely to be owed were accrued. One vendor matter resulted in a $469,000 judgment after settlement terms were not met.
- Disclosure controls were deemed ineffective at year-end, and management reported unremediated material weaknesses in internal control over financial reporting. Remediation efforts included additional finance support and work on accounting systems and procedures.
- In December 2021, CEO John “Hil” Davis filed for personal Chapter 7 bankruptcy, as disclosed in the filing.
Important facts for investors to verify
- Whether the company can fund operations and meet obligations given year-end cash of $528,394, a $30.27 million working capital deficit and the auditor’s going-concern warning.
- Whether the equity line’s share-price and other conditions can be met, and the terms and dilution consequences of any alternative financing.
- Debt maturities, covenant compliance, lender waivers and repayment or refinancing plans, particularly for obligations due in 2022.
- How much revenue growth is organic versus acquisition-driven, and whether acquired brands can improve cash generation and profitability.
- The final outcome, financing and potential dilution from the proposed Sundry acquisition, and any subsequent developments after the filing date.
- Progress in remediating internal-control weaknesses, along with the status of contingent consideration, asset impairments and disclosed legal matters.