Digital Brands Group, Inc. — Q1 2021 Form 10-Q
Reporting period: Three months ended March 31, 2021; unaudited. The company operates apparel brands DSTLD and Bailey 44, selling through online, wholesale and retail channels. Q1 2020 included Bailey 44 only from its February 12, 2020 acquisition date, so the periods are not fully comparable.
Financial performance and condition
- Revenue: $408,405, down 84% from $2.58 million in Q1 2020.
- Gross profit (loss) and margin: Gross loss was $207,537 versus gross profit of $1.35 million; gross margin was (50.8%) versus 52.5%. Management attributed the deterioration to lower sales and discounting/liquidation of aged inventory, including inventory marked down to net realizable value.
- Operating expenses: $2.14 million, down 27% from $2.93 million, reflecting cost reductions, office consolidation, fulfillment changes and layoffs.
- Operating loss and net loss: Operating loss was $2.35 million versus $1.58 million. Net loss was $3.02 million, compared with $1.91 million; basic and diluted loss per share was $4.55 versus $2.87. Share and per-share data reflect the subsequent 1-for-15.625 reverse split.
- Cash flow: Operating cash use was $1.64 million, versus $840,204. Investing cash flow was zero. Financing provided $1.78 million, principally from $1.35 million of loans payable and $528,650 of convertible notes. Cash increased $135,217 to $711,203.
- Liquidity: Current assets were $1.71 million and current liabilities $15.42 million, a $13.71 million working-capital deficit. Total liabilities were $25.00 million against assets of $16.15 million; stockholders’ deficit was $8.84 million.
- Debt and obligations: Venture debt had a gross balance of approximately $6.00 million, bears 12.5% interest plus fees, and was extended to December 31, 2022; $300,000 was classified as current. A $4.50 million acquisition promissory note bears 12% interest and was due July 31, 2021. The company also reported convertible notes, loan/PPP and SBA obligations, and $1.13 million of accrued interest payable. Accounts payable totaled $5.96 million.
Material changes and management outlook
- Management attributed the sharp revenue decline to COVID-19 impacts on Bailey 44, store closures, supply-chain disruption, and delayed design and release of new collections due to limited working capital. The company reported that sales of new collections began in Q2 2021 and planned further launches in the second half of 2021.
- COVID-19-related impacts included about 220 boutique-store closures (approximately 40% of prior locations), around 40 department-store closures (approximately 35%), furloughs and layoffs of 52 employees, and supply and delivery delays. Management expected closures, reduced traffic and promotional activity to weigh on performance for at least the first two quarters of 2021.
- After quarter-end, the May 2021 IPO raised approximately $8.4 million net, and the June 2021 over-allotment generated approximately $1.4 million net. The filing also cites approximately $9.8 million of aggregate IPO proceeds including the over-allotment; investors should distinguish the initial offering from the later over-allotment when reconciling proceeds. The company said March 31 cash plus IPO proceeds and planned measures were expected to fund operations, debt obligations and capital expenditures for at least one year from the June 28, 2021 issuance date.
- The IPO converted preferred stock and certain convertible debt into common shares. The company also completed its Harper & Jones acquisition in May 2021, issuing 2,192,771 shares and paying approximately $9.6 million, subject to escrow arrangements. Acquisition accounting was still in process at filing.
- Management planned to rely on IPO funding, revenue growth, cost controls and settlement or renegotiation of aged payables and debt. It cautioned that additional financing may be needed and is not assured; failure to obtain funding could force the company to curtail or suspend business plans.
- The filing identifies a going-concern risk, citing continuing losses, negative operating cash flow and historical difficulty meeting obligations. Management also reported that prior debt defaults had been cured after the IPO; the venture-debt agreement included conditional payment requirements tied to potential follow-on offerings.
Risks, contingencies and controls
- Reporting controls: Management concluded disclosure controls were ineffective as of March 31, 2021 because of material weaknesses in internal control over financial reporting. Remediation—including added financial expertise, system improvements and external consultants—was ongoing and not complete.
- Legal matters: The company disclosed vendor and investor lawsuits, including trade-payable claims and a settlement requiring ten monthly payments of approximately $37,000 starting May 2021. It also described service-provider claims totaling approximately $96,900 and a vendor claim for approximately $481,000 of payables plus approximately $296,000 in additional damages. Management generally stated that recorded payables covered expected obligations or that additional loss was not considered probable, while outcomes remain uncertain.
- Other exposures: Three vendors represented 96% of Q1 2021 inventory purchases. Payroll-related liabilities included an estimated $217,000 in penalties. PPP loan forgiveness had not been formally granted at the filing date.
Important facts for investors to verify
- Reconcile the filing’s IPO proceeds disclosures, including the approximately $8.4 million initial net proceeds, approximately $1.4 million over-allotment proceeds, and approximately $9.8 million aggregate figure.
- Track cash burn, working-capital needs, aged payables and whether the company can meet debt maturities and any conditional repayment requirements.
- Assess whether new collections and the Harper & Jones acquisition produce sustainable revenue and gross-margin improvement; acquisition accounting was still incomplete.
- Monitor progress in remediating material weaknesses and the effect of vendor, investor and other legal matters.
- Confirm formal PPP forgiveness and the final terms and amounts of debt repayments, conversions and post-IPO share dilution.