Digital Brands Group, Inc. — Q1 2022 Form 10-Q
Business and period: Apparel company operating Bailey 44, DSTLD, Harper & Jones, Stateside and ACE Studios through direct-to-consumer, wholesale and showroom channels. This unaudited report covers the three months ended March 31, 2022; results include full-quarter contributions from Harper & Jones and Stateside, acquired in 2021, so comparison with Q1 2021 is not directly like-for-like.
Financial results
| Metric | Q1 2022 | Q1 2021 |
|---|---|---|
| Revenue | $3.43 million | $408,405 |
| Gross profit (loss) | $1.47 million | $(207,537) |
| Gross margin | 42.9% | (50.8)% |
| Operating loss | $(5.58) million | $(2.35) million |
| Net loss | $(7.83) million | $(3.02) million |
| Net loss per share, basic and diluted | $(0.59) | $(4.55) |
| Cash used in operations | $(635,156) | $(1.64) million |
Revenue increased mainly because the acquired businesses contributed for the full quarter. Gross profit improved from the prior-year loss, reflecting the acquired brands’ margins and prior-year inventory markdowns and liquidation. Operating expenses rose to $7.05 million, including a $1.20 million increase in contingent-consideration fair value, alongside higher personnel, professional-fee, marketing and operating costs. Higher interest expense and a $682,103 derivative-liability fair-value charge contributed to the larger net loss. Depreciation and amortization was $552,004; interest expense was $1.57 million.
Liquidity, debt and balance sheet
- At March 31, cash was $566,013; current assets were $4.62 million and current liabilities were $40.85 million, producing a $36.23 million working-capital deficit.
- Total liabilities were $49.62 million, against total assets of $36.03 million; stockholders’ deficit was $13.58 million. Accounts payable was $8.54 million and contingent consideration was $13.38 million.
- Debt and financing obligations included $6.25 million of venture debt, $8.58 million principal on convertible notes, a $3.50 million Bailey seller note, and $3.50 million of current loan payable. The venture debt and Bailey seller note were deferred to December 31, 2022. The H&J related-party note of $309,489 matured July 10, 2022.
- March 2022 merchant advances provided $727,500 net proceeds, with $1.065 million to be repaid and expected weekly payments. The company reported compliance with their covenants as of the financial-statement date.
- Operating cash outflow was partly offset by $678,351 of financing inflows; cash increased $37,619 during the quarter. Investing cash outflow was $5,576.
Management stated that recurring losses, negative operating cash flow and limited liquidity raise substantial doubt about the company’s ability to continue as a going concern. It expects losses to continue and says additional capital is required; financing availability and terms are uncertain. The company reported an equity line of credit of up to $17.5 million but said drawdowns may be restricted and their feasibility was under review.
Outlook, risks and subsequent events
- No specific revenue, earnings or margin guidance was provided. Management expected COVID-related disruption, store closures, reduced traffic and a promotional marketplace to hurt performance at least through the first two quarters of 2022. It cited higher fabric, shipping and labor costs and longer lead times, and said it was controlling discretionary costs and reviewing inventory commitments. Results are seasonal and historically stronger in the second half.
- On May 10, 2022, after quarter-end, the company sold 37,389,800 shares at $0.25 per share for approximately $9.35 million gross proceeds; estimated net proceeds were approximately $7.95 million. Proceeds were intended for working capital and general corporate purposes, including repayment of $3.07 million of notes issued in April. The offering materially increased shares outstanding; the filing reported 52,243,867 shares outstanding as of May 16, 2022.
- In April, Bailey received forgiveness of its $1.35 million second PPP loan. Convertible-note conversions issued a further 978,476 shares from April 1 through the filing’s issuance date.
- Legal matters included a $469,000 judgment after a vendor settlement was not met, an investor claim of $100,000, and other vendor/service-provider disputes. Management said amounts it believed probable were accrued.
- Disclosure controls were deemed ineffective as of March 31, 2022 because material weaknesses in internal controls had not been fully remediated. Remediation included added financial expertise, external consultants and accounting-system improvements.
Important facts for investors to verify
- Whether the May offering proceeds, note repayment and subsequent share conversions adequately address near-term liquidity and upcoming debt maturities.
- Whether the equity-line facility is usable, and whether additional financing will be available on acceptable terms.
- Whether operating performance improves after separating acquisition-driven revenue growth from underlying organic growth, and whether gross margins can be sustained amid supply-chain and promotional pressures.
- How contingent consideration, derivative liabilities, accrued payroll-tax penalties and litigation exposures may change.
- Progress in remediating internal-control weaknesses and the implications of the substantial-doubt going-concern disclosure.