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Item 7. Management’s Discussion and Analysis

2024-04-15 compared with 2023-04-17 · 63 added, 81 removed, 273 unchanged (35% of the section changed)

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This discussion and analysis contains forward-looking statements that involve risks and uncertainties.

Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and “Cautionary Disclosure Regarding Forward-Looking Statements.”

Unless otherwise indicated by the context, references to “DBG” refer to Digital Brands Group, Inc.

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Business Overview

Recent Development

We have been involved in a dispute with the former owners of H&J regarding our obligation to “true up” their ownership interest in our company further to that membership interest purchase agreement dated May 10, 2021 whereby we acquired all of the outstanding membership interests of H&J (as amended, the “H&J Purchase Agreement”).

Recent Developments

We entered into a license deal for Bailey 44 in January 2023 that is paid quarterly based on the results.

We have received two license payouts since November 2023 for approximately $124,000 in total.

The licensee has asked to add additional categories to their current offering, which we agreed to.

We entered into a retail store sublease for approximately 3.5 years at the Simon Premium Outlet in Allen, TX, a suburb of Dallas.

We plan to open the store in April 2024.

We expect the store to generate meaningful cash flow as we already have excess product that we can sell, which means we will not have to use cash to create inventory for sale.

We expect the store to generate over $1.5 million in annual revenue and over $500,000 in free cash flow.

We have been involved in a dispute with the former owners of Haper & Jones, LLC (“H&J”) regarding our obligation to “true up” their ownership interest in our company further to that membership interest purchase agreement dated May 10, 2021 whereby we acquired all of the outstanding membership interests of H&J (as amended, the “H&J Purchase Agreement”).

Further to the H&J Purchase Agreement, we agreed that if, at May 18, 2022, the one year anniversary of the closing date of our initial public offering, the product of the number of shares of our common stock issued at the closing of such acquisition multiplied by the average closing price per share of our shares of common stock as quoted on the NasdaqCM for the thirty (30) day trading period immediately preceding such date plus the gross proceeds, if any, of shares of our stock issued to such sellers and sold by them during the one year period from the closing date of the offering does not exceed the sum of $9.1 million, less the value of any shares of common stock cancelled further to any indemnification claims or post-closing adjustments under the H&J Purchase Agreement, then we shall issue to the subject sellers an additional aggregate number of shares of common stock equal to any such valuation shortfall at a per share price equal to the then closing price per share of our common stock as quoted on the NasdaqCM.

We did not honor our obligation to issue such shares and the former owner of H&J have claimed that they were damaged as a result.

As part of a proposed settlement with such holders, we have tentatively agreed to the following:

(i) to transfer all membership interests of H&J back to the original owners, (ii) to pay such owners the sum of $229,000, (iii) issue the former owners of H&J an aggregate of $1,400,000 worth of our common stock to be issued on May 16, 2023 based on the lower of (a) the stock closing price per share on May 15, 2023, and (b) the average common stock closing price based on the average of the 5 trading days preceding May 16, 2023, with the closing price on May 9, 2023.

Such tentative terms are to be memorialized in definitive purchase agreements and as such there is no assurance that such arrangements will be finalized.

Digital Brands Group is a curated collection of lifestyle brands, including Bailey 44, DSTLD, Harper & Jones, Stateside, Sundry and ACE Studios, that offers a variety of apparel products through direct-to-consumer and wholesale distribution.

On June 21, 2023, the Company and the former owners of H&J executed a Settlement Agreement and Release (the “Settlement Agreement”) whereby contemporaneously with the parties’ execution of the Settlement Agreement (i) the Company made aggregate cash payment of $229,000 to D.

Jones Tailored Collection, Ltd.

Jones”), (ii) the Company issued 78,103 shares of common stock to D.

Jones at a per share purchase price of $17.925 which represented the lower of (i) the closing price per share of the Common Stock as reported on Nasdaq on June 20, 2023, and (ii) the average closing price per share of Common Stock as reported on the Nasdaq for the five trading days preceding June 21, 2023, and (iii) the Company assigned and transferred one hundred percent (100%) of the Company’s membership interest in H&J to D.

This transaction is known as the “H&J Settlement”.

Digital Brands Group is a curated collection of lifestyle brands, including Bailey 44, DSTLD, Stateside, Sundry 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.

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.

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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.

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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, Stateside in August 2021 and Sundry in December 2022.

We acquired Bailey in February 2020, Stateside in August 2021 and Sundry in December 2022.

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, Stateside and Sundry.

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, Stateside and Sundry.

We did not obtain independent valuations, appraisals or fairness opinions to support the consideration that we paid/agreed to pay.

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Any of the foregoing impacts of our substantial indebtedness could have a material adverse effect on our business, financial condition and results of operations.

We issued a promissory note in the principal amount of $4,500,000 pursuant to the Bailey acquisition.

Upon the IPO closing in May 2021, we repaid $1,000,000 of the outstanding principal on this note in May 2021.

In August 2021, the maturity date was further

extended to December 31, 2022.

We are required to make prepayments of $2,000,000 to $4,000,000 if we complete a secondary public offering.

If a public offering is not consummated before October 31, 2021 and June 30, 2022, we were obligated to repay 10% of the outstanding principal at each date.

We did not make any payments in October 2021, and the lender agreed to defer these payments to the maturity date of the loan, December 31, 2022.

However, no payments have been made - while the parties are undergoing an extension of the maturity date, the note is in technical default.

In addition, we issued promissory notes in the aggregate principal amount of $5,500,000 pursuant to the Sundry acquisition with a maturity date of February 15, 2023.

However no payments have been made and the notes are in technical default.

If such holders enforce their rights in connection with such defaults and achieve a default judgement, this may also result in the acceleration of or default under any other debt to which a cross-acceleration or cross-default provision applies.

We are currently unable to repay or refinance these borrowings so any such action by these lenders could force us into bankruptcy or liquidation.

We currently have $3.5 million in notes outstanding pursuant to our Bailey acquisition.

We are currently unable to repay or refinance borrowings so any such action by these lenders could force us into bankruptcy or liquidation.

In addition, our ability to make scheduled payments on our indebtedness or to refinance our obligations under our debt agreements, will depend on our financial and operating performance, which, in turn, will be subject to prevailing economic and competitive conditions and to the financial and business risk factors we face as described in this section, many of which may be beyond our control.

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Our products for Bailey, DSTLD and Stateside are also sold through a growing number of physical retail channels, including specialty stores, department stores and online multi-brand platforms.

Our products for Harper & Jones are sold through its own showrooms and its outside sales reps, which can use the showrooms to meet clients.

Ability to Acquire Customers at a Reasonable Cost

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Revenue is deferred for orders received for which associated shipments have not occurred.

Accounts Receivable

We carry our accounts receivable at invoiced amounts less allowances for customer credits, doubtful accounts, and other deductions.

We do not accrue interest on its trade receivables.

Accounts Receivable and Expected Credit Loss

We carry our accounts receivable at invoiced amounts less allowances for customer credit losses and other deductions to present the net amount expected to be collected on the financial asset.

All receivables are expected to be collected within one year of the consolidated balance sheet.

We do not accrue interest on the trade receivables.

Management evaluates the ability to collect accounts receivable based on a combination of factors.

Receivables are determined to be past due based on individual credit terms.

A reserve for doubtful accounts is maintained based on the length of time receivables are past due, historical collections, or the status of a customer’s financial position.

An allowance for credit losses is maintained based on the length of time receivables are past due, historical collections, or the status of a customer’s financial position.

Receivables are written off in the year deemed uncollectible after efforts to collect the receivables have proven unsuccessful.

We do not have any off balance sheet cried exposure related to our customers.

We periodically review accounts receivable, estimate an allowance for bad debts, and simultaneously record the appropriate expense in the statement of operations.

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Past due accounts are written off against that allowance only after all collection attempts have been exhausted and the prospects for recovery are remote.

Recovering of accounts receivable previously written off are recorded as income when received.

The Company provides credit to its customers in the normal course of business and has established credit evaluation and monitoring processes to mitigate credit risk.

Goodwill Impairment

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We evaluate the carrying amount of intangible assets and other long-lived assets for impairment whenever indicators of impairment exist.

We test these assets for recoverability by comparing the net carrying amount of the asset or asset group to the undiscounted net

cash flows to be generated from the use and eventual disposition of that asset or asset group.

We test these assets for recoverability by comparing the net carrying amount of the asset or asset group to the undiscounted net cash flows to be generated from the use and eventual disposition of that asset or asset group.

If the assets are recoverable, an impairment loss does not exist, and no loss is recorded.

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Interest expense consists primarily of interest related to our debt outstanding to our senior lender, convertible debt, and other interest bearing liabilities.

H&J sells its products directly to customers through their showrooms and sales reps.

Cost of Net Revenue

H&J’s cost of net revenue sold is associated with procuring fabric and custom tailoring each garment.

Operating Expenses

H&J’s operating expenses include all operating costs not included in cost of net revenue.

General and administrative expenses consist primarily of all payroll and payroll-related expenses, professional fees, insurance, software costs, occupancy expenses related to H&J’s stores and to H&J’s operations at its headquarters, including utilities, depreciation and amortization, and other costs related to the administration of its business.

H&J’s 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.

Interest Expense

H&J’s interest expense consists primarily of interest related to its outstanding debt.

Stateside sells its products directly to customers.

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Cost of net revenue also includes direct labor to production activities such as pattern makers, cutters and sewers.

Cost of net revenue includes an allocation of overheard costs such as rent, utilities and commercial insurance pertaining to direct inventory activities.

of net revenue includes an allocation of overheard costs such as rent, utilities and commercial insurance pertaining to direct inventory activities.

Operating Expenses

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Year ended December 31, 2023 compared to year ended December 31, 2022

The following table presents our results of operations for the year ended December 31, 2022 and 2021:

The following table presents our results of operations for the years ended December 31, 2023 and 2022:

Cost of net revenues

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Other operating expenses

Operating loss

Loss from Operations

Other expenses

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Provision for income taxes

Revenue increased by $6.4 million to $14.0 million for the year ended December 31, 2022, compared to $7.6 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.

Net loss from continuing operations

(Loss) income from discontinued operations, net of tax

Net revenues increased by $0.9 million to $14.9 million for the year ended December 31, 2023, compared to $14.0 million in the corresponding fiscal period in 2022.

The increase was primarily due to full results in 2023 pertaining to the acquisition of Sundry in December 2022.

Our gross profit increased by $0.6 million for the year ended December 31, 2023 to $6.5 million from $5.9 million for the corresponding fiscal period in 2022.

The increase in gross margin was primarily attributable to increased revenue in 2022 and the gross profit achieved by H&J and Stateside since the acquisitions, as well as discounting and liquidation measures by both DBG and Bailey to sell aged inventory in 2021.

The increase in gross margin was primarily attributable to increased revenue in 2023 and the gross profit achieved by Sundry since the acquisition.

Our gross margin was 43.9% for the year ended December 31, 2023 compared to 42.5% for year ended December 31, 2022.

The increase in the gross margin was due to H&J and Stateside’s margins in 2022, as well as discounting and liquidation measures by both DBG and Bailey to sell aged inventory in 2021.

General and Administrative

The increase in gross margin was due to a shift in sales mix towards e-commerce, led by the Sundry business, which is able to achieve higher margins than wholesale.

General and Administrative Expenses

General and administrative expenses decreased by $2.1 million for the year ended December 31, 2023 to $14.3 million compared to $16.4 million in 2022.

The decrease in general and administrative expenses was primarily due to non-cash charges incurred in 2021 upon the IPO, including stock-based compensation expense of $4.8.

This was partially offset by increased general and administrative expenses in 2022 due to full scale operations of all subsidiaries, as well as increased headcount and corporate costs.

The decrease in general and administrative expenses was primarily due to lower consulting and professional fees, as well as other cost cutting measures across our company, as all brands achieved operational synergies in 2023.

General and administrative expenses as a percentage of revenue was 95% in 2023 as compared to 117% in 2022.

Sales and Marketing

Sales and marketing expenses increased by $1.1 million for the year ended December 31, 2022 to $4.9 million compared to $3.8 million in 2021.

The increase in sales and marketing expenses was primarily due to full-year advertising and marketing efforts by each subsidiary.

Sales and Marketing Expenses

Sales and marketing expenses decreased by $0.9 million for the year ended December 31, 2023 to $4.0 million compared to $4.9 million in 2022.

The decrease in sales and marketing expenses was primarily due to decreased spending on advertising and other cost-cutting marketing efforts.

Sales and marketing expenses as a percentage of revenue was 27% in 2023 as compared to 35% in 2022.

Other Operating Expenses

Other operating expenses includes distribution expenses, impairment and change in fair value of contingent consideration.

Other operating expenses was $16.7 million in 2022 as compared to $12.7 million in 2021, an increase of $4.0 million.

The increase was primarily due to a $12.1 million increase in impairment charges on Bailey and Harper’s goodwill and intangible assets, partially offset by a decrease in the change in fair value of contingent consideration of $8.2 million.

Other Income (Expense)

Other operating expenses included distribution expenses, impairment and change in fair value of contingent consideration.

Other operating expenses represented a gain of $9.7 million in 2023 as compared to $16.7 million in 2022, a decrease in expenses of $10.9 million.

In 2022, there were $15.5 million in impairment charges on Bailey’s and Harper’s goodwill and intangible assets.

In 2023, the Company recorded a $10.7 million increase in the change in fair value of contingent consideration pertaining to the Norwest waiver for Bailey and H&J Settlement.

Other Expenses

Other expenses increased by $0.3 million to $6.2 million in the year ended December 31, 2023 compared to $5.9 million in the corresponding fiscal period in 2022.

The increase in other expenses in 2022 was primarily due to amortization of debt discount and related interest expense on the Company’s various convertible notes and change in fair value of derivative liability, partially offset by PPP forgiveness.

Our net loss increased by $5.6 million to a loss of $38.0 million for the year ended December 31, 2022 compared to a loss of $32.4 million for the corresponding fiscal period in 2021 primarily due to our increased operating expenses and other expenses, partially offset by a higher gross profit in 2022 and tax benefit recorded in 2021.

The increase in other expenses in 2023 was primarily due to $1.4 million on loss on extinguishment of debt in 2023 and the change in fair value of derivative liability, partially offset by PPP forgiveness.

Net Loss from Continuing Operations

Our net loss from continuing operations decreased by $29.3 million to a loss of $8.7 million for the year ended December 31, 2023 compared to a loss of $38.0 million for the corresponding fiscal period in 2022 primarily due to the impairment, change in fair value of contingent consideration and higher gross profit.

Liquidity and Capital Resources

Each of DBG, Bailey, H&J and Stateside has historically satisfied our liquidity needs and 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.

Each of DBG, Bailey, Stateside and Sundry has historically satisfied our liquidity needs and funded operations with borrowings capital raises and internally generated cash flow, Changes in working capital, most notably accounts receivable, are driven primarily by levels of business activity.

Historically each of DBG, Bailey, Stateside and Sundry 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 December 31, 2023, we had cash of $20,773, but we had a working capital deficit of $17,655,720.

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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

If the Company is unable to secure additional funding, it may be forced to curtail or suspend its business plans.

The report of our independent registered public accounting firm for the year ended December 31, 2023 included herein contains an explanatory paragraph indicating that there is substantial doubt as to our ability to continue as a going concern as a result of recurring losses from operations.

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The following table presents selected captions from our condensed statement of cash flows for the years ended December 31, 2023 and 2022:

Net cash provided by operating activities:

Non-cash adjustments

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Net cash used in operating activities

Net cash used in investing activities

Net cash provided by investing activities

Net cash provided by financing activities

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Our cash used in operating activities decreased by $4.6 million to $6.0 million to cash used for the year ended December 31, 2023 as compared to cash used of $10.6 million for the corresponding fiscal period in 2022.

The decrease in net cash used in operating activities was primarily driven by an increase in non-cash adjustments of $5.4 million and more cash provided by changes in our operating assets and liabilities in 2022, partially offset by an increase in our net loss in 2022.

The decrease in net cash used in operating activities was primarily driven by a lower net loss in 2023, partially offset by a decrease in non-cash adjustments of $21.8 million and more cash provided by changes in our operating assets and liabilities in 2022.

Cash Flows Used in Investing Activities

Our cash used in investing activities was $7.3 million in the year ended December 31, 2022 as compared to cash used of $6.0 million for the corresponding fiscal period in 2021.

Cash used in 2022 was primarily related to the cash consideration in the Sundry acquisition.

Cash used in 2021 was primarily related to the cash consideration in the H&J and Stateside acquisitions.

Our cash provided by investing activities was $0.1 million in the year ended December 31, 2023 as compared to cash used of $7.3 million for the corresponding fiscal period in 2022.

Cash provided in 2023 was primarily due to a reduction of deposits, partially offset by purchase of property.

Cash Flows Provided by Financing Activities

Cash provided by financing activities was $4.7 million for the year ended December 31, 2023 compared to cash provided of $18.6 million for the corresponding fiscal period in 2022.

Cash inflows in 2023 included $8.1 million in equity proceeds after offering costs, $1.2 million in proceeds from the exercise of warrants, $5.4 million from the issuance of notes, loans and merchant advances, partially offset by note, loan and merchant advance repayments of 10.1 million.

Cash inflows in 2022 were primarily related to $16.4 million in equity proceeds after offering costs, $10.2 million from convertible notes and loans, partially offset by note repayments of $7.4 million.

Cash inflows in 2021 were primarily related to $8.6 million in net proceeds from the IPO after deducting underwriting discounts and commissions and offering expenses, as well as $1.4 million in net proceeds from the underwriter’s exercise of their over-allotment option.

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.

In September 2022, the entire outstanding principal was converted into preferred stock.

As of December 31, 2022 we have $4.0 million in outstanding principal pertaining to our convertible notes which mature in February 2023.

As of December 31, 2022, we have an additional 10.4 million in outstanding principal on other loans, primarily our promissory notes due to the Bailey44 and Sundry Sellers.

As of December 31, 2023, we have $9.7 million in outstanding principal on debt, primarily our promissory notes due to the Bailey44 Sellers, the March 2023 Notes, PPP and merchant advances.

Aside from our remaining non-current SBA obligations, all outstanding loans have maturity dates through 2024.

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FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

This information required by this item may be found on pages F-1 through F-36 of this annual report on Form 10-K.

The information required by this item may be found on pages F-1 through F-36 of this annual report on Form 10-K.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis