Digital Brands Group, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our audited financial statements and related notes for the year ended December 31, 2021 included in Annual Report on Form 10-K filed with the Securities and Exchange Commission, or SEC on March 31, 2022. Some of the statements contained in this discussion and analysis or set forth elsewhere in this Quarterly Report on Form 10-Q, including information with respect to our plans and strategy for our business, constitute forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We have based these forward-looking statements on our current expectations and projections about future events. The following information and any forward-looking statements should be considered in light of factors discussed elsewhere in this Quarterly Report on Form 10-Q, particularly including those risks identified in Part II-Item 1A “Risk Factors” and our other filings with the SEC. Our actual results and timing of certain events may differ materially from the results discussed, projected, anticipated, or indicated in any forward-looking statements. We caution you that forward-looking statements are not guarantees of future performance and that our actual results of operations, financial condition and liquidity, and the development of the industry in which we operate may differ materially from the forward-looking statements contained in this Quarterly Report on Form 10-Q. Statements made herein are as of the date of the filing of this Form 10-Q with the SEC and should not be relied upon as of any subsequent date. Even if our results of operations, financial condition and liquidity, and the development of the industry in which we operate are consistent with the forward-looking statements contained in this Quarterly Report on Form 10-Q, they may not be predictive of results or developments in future periods. We disclaim any obligation, except as specifically required by law and the rules of the SEC, to publicly update or revise any such statements to reflect any change in our expectations or in events, conditions or circumstances on which any such statements may be based or that may affect the likelihood that actual results will differ from those set forth in the forward-looking statements. Business Overview Digital Brands Group is a curated collection of lifestyle brands, including Bailey 44, DSTLD, Harper and Jones, Stateside and ACE Studios, that offers a variety of apparel products through direct-to-consumer and wholesale distribution. Our complementary brand portfolio provides us with the unique opportunity to cross merchandise our brands. We aim for our customers to wear our brands head to toe and to capture what we call “closet share” by gaining insight into their preferences to create targeted and personalized content specific to their cohort. Operating our brands under one portfolio provides us with the ability to better utilize our technological, human capital and operational capabilities across all brands. As a result, we have been able to realize operational efficiencies and continue to identify additional cost saving opportunities to scale our brands and overall portfolio. Our portfolio currently consists of four significant brands that leverage our three channels: our websites, wholesale and our own stores. ● Bailey 44 combines beautiful, luxe fabrics and on-trend designs to create sophisticated ready-to-wear capsules for women on-the-go. Designing for real life, this brand focuses on feeling and comfort rather than how it looks on a runway. Bailey 44 is primarily a wholesale brand, which we are transitioning to a digital, direct-to-consumer brand. ● DSTLD offers stylish high-quality garments without the luxury retail markup valuing customer experience over labels. DSTLD is primarily a digital direct-to-consumer brand, to which we recently added select wholesale retailers to generate brand awareness. ● Harper & Jones was built with the goal of inspiring men to dress with intention. It offers hand- crafted custom fit suits for those looking for a premium experience. Harper & Jones is primarily a direct-to-consumer brand using its own showrooms. ● Stateside is an elevated, America first brand with all knitting, dyeing, cutting and sewing sourced and manufactured locally in Los Angeles. The collection is influenced by the evolution of the classic t-shirt offering a simple yet elegant look. Stateside is primarily a wholesale brand that we will be transitioning to a digital, direct-to-consumer brand. ​ We believe that successful apparel brands sell in all revenue channels. However, each channel offers different margin structures and requires different customer acquisition and retention strategies. We were founded as a digital-first retailer that has strategically 17 Table of Contents expanded into select wholesale and direct retail channels. We strive to strategically create omnichannel strategies for each of our brands that blend physical and online channels to engage consumers in the channel of their choosing. Our products are sold direct-to-consumers principally through our websites and our own showrooms, but also through our wholesale channel, primarily in specialty stores and select department stores. With the continued expansion of our wholesale distribution, we believe developing an omnichannel solution further strengthens our ability to efficiently acquire and retain customers while also driving high customer lifetime value. We believe that by leveraging a physical footprint to acquire customers and increase brand awareness, we can use digital marketing to focus on retention and a very tight, disciplined high value new customer acquisition strategy, especially targeting potential customers lower in the sales funnel. Building a direct relationship with the customer as the customer transacts directly with us allows us to better understand our customer’s preferences and shopping habits. Our substantial experience as a company originally founded as a digitally native-first retailer gives us the ability to strategically review and analyze the customer’s data, including contact information, browsing and shopping cart data, purchase history and style preferences. This in turn has the effect of lowering our inventory risk and cash needs since we can order and replenish product based on the data from our online sales history, replenish specific inventory by size, color and SKU based on real times sales data, and control our mark-down and promotional strategies versus being told what mark downs and promotions we have to offer by the department stores and boutique retailers. We define “closet share” as the percentage (“share”) of a customer’s clothing units that (“of closet”) she or he owns in her or his closet and the amount of those units that go to the brands that are selling these units. For example, if a customer buys 20 units of clothing a year and the brands that we own represent 10 of those units purchased, then our closet share is 50% of that customer’s closet, or 10 of our branded units divided by 20 units they purchased in entirety. Closet share is a similar concept to the widely used term wallet share, it is just specific to the customer’s closet. The higher our closet share, the higher our revenue as higher closet share suggests the customer is purchasing more of our brands than our competitors. We have strategically expanded into an omnichannel brand offering these styles and content not only on-line but at selected wholesale and retail storefronts. We believe this approach allows us opportunities to successfully drive Lifetime Value (“LTV”) while increasing new customer growth. We define Lifetime Value or LTV as an estimate of the average revenue that a customer will generate throughout their lifespan as our customer. This value/revenue of a customer helps us determine many economic decisions, such as marketing budgets per marketing channel, retention versus acquisition decisions, unit level economics, profitability and revenue forecasting. We acquired Bailey in February 2020, H&J in May 2021 and Stateside in August 2021. We agreed on the consideration that we paid in each acquisition in the course of arm’s length negotiations with the holders of the membership interests in each of Bailey, H&J and Stateside. In determining and negotiating this consideration, we relied on the experience and judgment of our management and our evaluation of the potential synergies that could be achieved in combining the operations of Bailey, H&J and Stateside. We did not obtain independent valuations, appraisals or fairness opinions to support the consideration that we paid/agreed to pay. Material Trends, Events and Uncertainties COVID-19 The COVID-19 pandemic is ongoing and dynamic in nature, and continues to drive global uncertainty and disruption. As a result, COVID-19 had a significant negative impact on the Company’s business, including the consolidated financial condition, results of operations and cash flows through of 2021. While we are not able to determine the ultimate length and severity of the COVID-19 pandemic, we expect store closures, an anticipated reduction in traffic once stores initially reopen and a highly promotional marketplace will have a significant negative impact on our financial performance for at least the first two quarters of 2022. We have implemented cost controls to reduce discretionary spending to help mitigate the loss of sales and to conserve cash while continuing to support employees. We are also assessing our forward inventory purchase commitments to ensure proper matching of supply and demand, which will result in an overall reduction in future commitments. As we continue to actively monitor the situation, we may take further actions that affect our operations. ​ 18 Table of Contents Supply Chain Disruptions ​ We are subject to global supply chain disruptions, which may include longer lead times for raw fabrics, inbound shipping and longer production times. Supply chain issues have specifically impacted the following for our brands: ​ ● Increased costs in raw materials from fabric prices, which have increased 10% to 100% depending on the fabric, the time of year, and the origin of the fabric, as well as where the fabric is being shipped; ● Increased cost per kilo to ship via sea or air, which has increased from 25% to 300% depending on the time of year and from the country we are shipping from; ● Increased transit time via sea or air, which have increased by two weeks to two months; and ● Increased labor costs for producing the finished goods, which have increased 5% to 25% depending on the country and the labor skill required to produce the goods. ​ Seasonality ​ Our quarterly operating results vary due to the seasonality of our individual brands, and are historically stronger in the second half of the calendar year. ​ Components of Our Results of Operations Net Revenue DSTLD sells its products to our customers directly through our website. In those cases, sales, net represents total sales less returns, promotions, and discounts. Bailey sells its products directly to customers. Bailey also sells its products indirectly through wholesale channels that include third-party online channels and physical channels such as specialty retailers and department stores. H&J sells its products directly to customers through their showrooms and sales reps. Stateside sells its products directly to customers. Stateside also sells its products indirectly through wholesale channels that include third-party online channels and physical channels such as specialty retailers and department stores. Cost of Net Revenue DSTLD, Bailey and Stateside’s cost of net revenue include direct cost of purchased merchandise; inventory shrinkage; inventory adjustments due to obsolescence, including excess and slow-moving inventory and lower of cost and net realizable reserves, duties; and inbound freight. H&J’s cost of net revenue sold is associated with procuring fabric and custom tailoring each garment. Operating Expenses Our operating expenses include all operating costs not included in cost of net revenues. These costs consist of general and administrative, sales and marketing, and fulfillment and shipping expense to the customer. General and administrative expenses consist primarily of all payroll and payroll-related expenses, stock-based compensation, professional fees, insurance, software costs, and expenses related to our operations at our headquarters, including utilities, depreciation and amortization, and other costs related to the administration of our business. Sales and marketing expense primarily includes digital advertising; photo shoots for wholesale and direct-to-consumer communications, including email, social media and digital advertisements; and commission expenses associated with sales representatives. 19 Table of Contents We expect to incur additional expenses as a result of operating as a public company, including costs to comply with the rules and regulations applicable to companies listed on a national securities exchange, costs related to compliance and reporting obligations pursuant to the rules and regulations of the SEC and higher expenses for insurance, investor relations and professional services. We expect these costs will increase our operating costs. Distribution expenses includes costs paid to our third-party logistics provider, packaging and shipping costs to the customer from the warehouse and any returns from the customer to the warehouse. At each reporting period, we estimate changes in the fair value of contingent consideration and recognize any change in fair in our consolidated statement of operations, which is included in operating expenses. Additionally, amortization of the identifiable intangibles acquired in the acquisitions is also included in operating expenses. Interest Expense Interest expense consists primarily of interest related to our debt outstanding to our senior lender, convertible debt, and other interest bearing liabilities. Results of Operations Three Months Ended March 31, 2022 compared to Three Months Ended March 31, 2021 The following table presents our results of operations for the three months ended March 31, 2022 and 2021: ​ ​ ​ ​ ​ ​ ​ ​ ​ Three Months Ended ​ ​ March 31, ​ 2022 2021 Net revenues ​ $ 3,432,410 ​ $ 408,405 Cost of net revenues ​ 1,958,911 ​ 615,942 Gross profit (loss) ​ 1,473,499 ​ (207,537) General and administrative ​ ​ 4,611,235 ​ ​ 1,907,518 Sales and marketing ​ ​ 1,040,572 ​ ​ 170,820 Other operating expenses ​ 1,403,169 ​ 63,578 Operating loss ​ (5,581,477) ​ (2,349,453) Other expenses ​ (2,251,465) ​ (674,482) Loss before provision for income taxes ​ (7,832,942) ​ (3,023,935) Provision for income taxes ​ — ​ — Net loss ​ $ (7,832,942) ​ $ (3,023,935) ​ Net Revenues Revenues increased by $3.0 million to $3.4 million for the three months ended March 31, 2022, compared to $0.4 million in the corresponding fiscal period in 2021. The increase was primarily due to full results in 2022 pertaining to the acquisition of H&J in May 2021 and Stateside in August 2021. Gross Profit (Loss) Our gross profit increased by $1.7 million for the three months ended March 31, 2022 to $1.5 million from a gross loss of ($0.2) million for the corresponding fiscal period in 2021. The increase in gross margin was primarily attributable to increased revenue in the three months ended March 31, 2022 and the gross profit achieved by H&J and Stateside since the acquisitions. Furthermore, in the three months ended March 31, 2021, we made mark downs to net realizable value for certain inventory that liquidated and sold in the second quarter of 2021. Our gross margin was 42.9% for three months ended March 31, 2022 compared to (50.8)% for the three months ended March 31, 2021. The increase in the gross margin was due to H&J and Stateside’s margins in 2021, as well as discounting and liquidation measures by both DBG and Bailey 44 to sell aged inventory in 2021. 20 Table of Contents Operating Expenses Our operating expenses increased by $4.9 million for the three months ended March 31, 2022 to $7.1 million compared to $2.2 million for the corresponding fiscal period in 2021. The increase in operating expenses was primarily due to the change in fair value of contingent consideration of $1.2 million, as well as increased personnel costs, professional fees, marketing expenses and overall operations due to the Company’s full results of the H&J and Stateside acquisitions. We expect operating expenses to increase in total dollars and as a percentage of revenues as our revenue base increases. Other Expenses Other expenses increased by $1.6 million to $2.3 million in the three months ended March 31, 2022 compared to $0.7 million in the corresponding fiscal period in 2021. The increase in the other expense was primarily due to the change in fair value of derivative liability pertaining to the convertible notes and interest expense and amortization of debt discount on the outstanding notes. Net Loss Our net loss increased by $4.8 million to a loss of $7.8 million for the three months ended March 31, 2022 compared to a loss of $3.1 million for the corresponding fiscal period in 2021 primarily due to change in fair value of contingent consideration of $1.2 million, as well as increased personnel costs, professional fees, marketing expenses, other operating expenses and interest expense, partially offset by higher gross profit. Liquidity and Capital Resources Each of DBG, Bailey, H&J and Stateside has historically funded operations with internally generated cash flow and borrowings and capital raises. Changes in working capital, most notably accounts receivable, are driven primarily by levels of business activity. Historically each of DBG, Bailey, H&J and Stateside has maintained credit line facilities to support such working capital needs and makes repayments on that facility with excess cash flow from operations. As of March 31, 2022, we had cash of $566,013, but we had a working capital deficit of $36.2 million. The Company requires significant capital to meet its obligations as they become due. These factors raise substantial doubt about our Company’s ability to continue as a going concern. Throughout the next twelve months, the Company plans to continue to fund its capital funding needs through a combination of public or private equity offerings, debt financings or other sources. There can be no assurance as to the availability or terms upon which such financing and capital might be available in the future. If the Company is unable to secure additional funding, it may be forced to curtail or suspend its business plans. On May 10, 2022, the Company sold 37,389,800 shares of its common stock pursuant to a Registration Statement on Form S-1 and related prospectus at a public offering price of $0.25 per share. The gross proceeds from the offering, before deducting underwriting discounts and commissions and other offering expenses payable by the Company, were $9,347,450. Cash Flow Activities The following table presents selected captions from our condensed statement of cash flows for the three months ended March 31, 2022 and 2021: ​ ​ ​ ​ ​ ​ ​ ​ ​ Three Months Ended ​ ​ March 31, ​ 2022 2021 Net cash provided by operating activities: ​ ​ Net loss ​ $ (7,832,942) ​ $ (3,023,935) Non-cash adjustments ​ $ 3,652,067 ​ $ 363,501 Change in operating assets and liabilities ​ $ 3,545,719 ​ $ 1,017,858 Net cash used in operating activities ​ $ (635,156) ​ $ (1,642,577) Net cash used in investing activities ​ $ (5,576) ​ $ — Net cash provided by financing activities ​ $ 678,351 ​ $ 1,777,794 Net change in cash ​ $ 37,619 ​ $ 135,217 ​ 21 Table of Contents Cash Flows Used In Operating Activities Our cash used by operating activities decreased by $1.0 million to cash used of $0.6 million for the three months ended March 31, 2022 as compared to cash used of $1.6 million for the corresponding fiscal period in 2021. The decrease in net cash used in operating activities was primarily driven by an increase in non-cash charges and cash provided by changes in our operating assets and liabilities, partially offset by a higher net loss in 2022. Cash Flows Provided By Investing Activities Our cash used in investing activities was $5,576 in 2022 due to purchases of property and equipment. Cash Flows Provided by Financing Activities Cash provided by financing activities was $0.7 million for the three months ended March 31, 2022, compared to $1.8 million for the corresponding fiscal period in 2020. Cash inflows in the three months ended March 31, 2022 were primarily related to $0.9 million in proceeds from venture debt and loans, partially offset by factor repayments of $0.2 million. Cash inflows in the three months ended March 31, 2021 were primarily related to proceeds from a loan payable of $1.3 million and proceeds from convertible notes payable of $0.5 million. Contractual Obligations and Commitments In March 2017, we entered into a senior credit agreement with an outside lender for up to $4,000,000, dependent upon the achievement of certain milestones. The initial close amount was a minimum of $1,345,000. The loan bears interest at 12.5% per annum, compounded monthly, including fees. A 5% closing fee is due upon each closing, legal and accounting fees of up to $40,000, and management fees of $4,167-$5,000 per month. As of March 31, 2022, we owed our senior secured lender approximately $6.3 million that is due on the scheduled maturity date of December 31, 2022. We have $8.6 million in outstanding principal pertaining to our convertible notes which mature in various dates through 2023. Critical Accounting Policies and Estimates Our management’s discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of our consolidated financial statements and related disclosures requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, costs and expenses and the disclosure of contingent assets and liabilities in our financial statements. We base our estimates on historical experience, known trends and events and various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates under different assumptions or conditions. Emerging Growth Company Status We are an emerging growth company as that term is used in the Jumpstart Our Business Startups Act of 2012 and, as such, have elected to comply with certain reduced public company reporting requirements. Section 107 of the JOBS Act provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. In other words, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have elected to take advantage of the benefits of this extended transition period. Our financial statements may, therefore, not be comparable to those of companies that comply with such new or revised accounting standards Off-Balance Sheet Arrangements We did not have during the periods presented, and we do not currently have, any off-balance sheet arrangements, as defined in the rules and regulations of the Securities and Exchange Commission. ​ 22 Table of Contents ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are a smaller reporting company as defined by Rule 12b-2 of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”) and are not required to provide the information required under this item. ​