Digital Brands Group, Inc. — Q3 2022 Form 10-Q
Reporting period: Three and nine months ended September 30, 2022; filed November 14, 2022. The company operates a portfolio of apparel brands, including Bailey 44, DSTLD, Harper & Jones, Stateside and ACE Studios, through direct-to-consumer, wholesale and showroom channels. Financial amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Revenue | $3.42 million | $2.16 million | $10.60 million | $3.58 million |
| Gross profit | $1.65 million | $1.21 million | $5.30 million | $1.40 million |
| Gross margin | 48.3% | 55.9% | 50.0% | 39.1% |
| Operating loss | $2.59 million | $7.91 million | $18.84 million | $21.10 million |
| Net loss | $4.89 million | $8.94 million | $22.26 million | $22.66 million |
| Operating cash flow | Not separately presented for the quarter | $(8.69) million | $(11.48) million |
- Management attributed revenue growth mainly to having full-period contributions from Stateside and Harper & Jones, acquired in 2021, and improved results from other brands. Nine-month comparisons therefore include a different mix and period of acquired operations.
- Q3 gross margin declined year over year, which the company attributed to lower Bailey 44 margins and differences in brand mix. Nine-month gross margin increased, partly reflecting prior-year discounting and liquidation of aged inventory.
- Q3 operating expenses were $4.25 million versus $9.12 million, substantially reflecting a $4.0 million contingent-consideration expense in Q3 2021; Q3 2022 included a $0.70 million benefit from the fair-value change. For the first nine months, contingent-consideration remeasurement added $6.42 million to expense.
- Interest expense was $2.28 million for Q3 and $6.05 million for the first nine months, compared with $0.45 million and $2.02 million, respectively, in 2021. Debt-discount amortization contributed significantly.
- At September 30, cash was $195,399; current assets were $4.81 million and current liabilities were $45.54 million, a working-capital deficit of $40.73 million. Total liabilities were $47.53 million, total assets $35.01 million, and stockholders’ deficit $12.52 million.
- Operating activities used $8.69 million of cash; investing activities used $5,533; financing activities provided $8.36 million. Cash declined by $332,995 from the start of the year.
Debt, liquidity and material developments
- The company reported $9.91 million of convertible-note principal outstanding at September 30, with a net carrying amount of $8.08 million, and $2.10 million of accrued interest payable. Convertible notes mature on various dates through 2023.
- July 2022 notes totaling $1.875 million in face principal matured October 31, 2022 and were reported as in default as of the financial-statement issuance date. The notes’ terms provide for an increase in face value to 120%, 20% annual interest payable monthly, and potential investor conversion after a continuing default. The filing does not clearly state the amount, if any, ultimately paid or cured.
- The company converted $6.25 million of Black Oak venture-debt principal into Series A convertible preferred stock in September; $269,880 of accrued interest remained outstanding. It also had a $3.5 million seller promissory note due December 31, 2022 and other short-term borrowing obligations.
- May’s public offering of 373,898 shares generated $8.1 million in net proceeds. The company also reported $367,696 of deferred offering costs related to an equity line of credit of up to $17.5 million, but said it was reviewing the feasibility of drawdowns and noted contractual restrictions may limit access.
- Management stated the company has not generated profits since inception, expects operating losses to continue, and requires significant capital to meet obligations. The filing says these conditions raise substantial doubt about its ability to continue as a going concern; additional financing is not assured, and failure to secure funding could require curtailing plans or seeking bankruptcy protection.
Outlook, risks and unusual items
- No quantified revenue, earnings or cash-flow guidance is provided. Management expects continued operating losses and says operating expenses may rise as the revenue base grows.
- Management cited supply-chain pressures: fabric costs rose 10%–100%, shipping costs 25%–300%, transit times lengthened by two weeks to two months, and labor costs increased 5%–25%, depending on source and circumstances. The company also described seasonal variation, with historically stronger results in the second half of the year.
- Contingent consideration tied to acquisitions was $18.60 million at September 30, up from $12.18 million at year-end. The H&J agreement calls for additional common shares to be delivered in May 2023 under a formula affected by capital-raise payments and the share price.
- Subsequent events: the company agreed in October to acquire Sundry for $7.5 million cash, $5.5 million in promissory notes bearing 8% annual interest and $1.0 million in common stock; the notes mature February 15, 2023. The filing describes an agreement to acquire, not a completed acquisition. It also reports approximately $5.5 million of Oasis and FirstFire notes converted into 543,845 common shares from October 1 through the filing date.
- A 1-for-100 reverse stock split became effective November 3, 2022; share and per-share amounts in the filing were adjusted retroactively. The company disclosed ineffective disclosure controls and procedures and material weaknesses in internal control over financial reporting; remediation efforts were ongoing.
- Reported contingencies include vendor and service-provider litigation, including a $469,000 judgment after an earlier settlement was not met. Management says relevant amounts believed payable were recorded.
Key facts investors should verify
- Near-term liquidity, cash runway, upcoming maturities and the status of the July notes’ default and any cure.
- Whether the company can access the equity line or obtain other financing on acceptable terms, and the dilution and repayment effects of financing.
- How the Sundry transaction was funded and whether it closed, along with its impact on debt, cash needs and operating results.
- The assumptions behind contingent-consideration valuations and the potential shares payable to sellers.
- Resolution of disclosed litigation and liabilities, and progress in remediating material weaknesses in financial reporting controls.
- The MD&A contains apparent inconsistencies with the financial statements: it describes nine-month net loss as $17.4 million in one passage, while the statements report $22.26 million; it also characterizes the year-over-year change differently. Confirm analysis against the filed financial statements and subsequent disclosures.