Digital Brands Group, Inc.

Greetings and welcome to the Digital Brands Group third quarter 2022 earnings call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the final presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Hill Davis, CEO. Thank you, Hill. You may begin.

Yes, good afternoon. Good afternoon. and welcome to the Digital Brands Third Quarter 2022 Earnings Conference Call. This earnings call may contain forward-looking statements as defined in Section 27A of the Securities Act of 1933 as amended, including statements regarding, among other things, the company's business strategy and growth strategy, expressions which identified forward-looking statements speak only as of the date the statement is made, These forward-looking statements are based largely on our company's expectations and are subject to a number of risks and uncertainties, some of which cannot be predicted or quantified and are beyond our control. Future developments and actual results could differ materially from those set forth and contemplated by or underlining the forward-looking statements. In light of these risks and uncertainties, there can be no assurances that the forward-looking information will prove to be accurate. The company will be hosting a Q&A session at the conclusion of prepared remarks and Please note this event is being recorded. So let me start by saying we delivered strong revenue growth and continued operating leverage on our fixed cost in the third quarter. In addition, we have several positive updates to the business, which I will discuss in detail. First, we reduced our debt significantly, which allows us to factor our wholesale purchase orders. This creates a significant change in our working capital cycle. In the past, we had to fund all our production costs up front. Up until recently, this resulted in a four- to five-month negative working capital cycle, which is why we had to borrow money at times to pay for the upcoming product, fabric, and production. Since October 1st, we have been able to factor our purchase orders, which allows us to use that capital to purchase fabric and pay for production. This is a huge change in our cash needs and working cash flow. This is even more critical to our business given our second point, which is the significant increase in our Q1 2023 wholesale bookings versus Q1 2022. Our Q1 wholesale orders for stateside alone are up over 50% from Q1 of last year. Additionally, Distilled has had success in wholesale bookings for Q1 2023 versus no wholesale bookings last year as it was direct to consumer only at that point in time. These increases in wholesale bookings continue to show the strength of our brand and the demand from both the wholesale channel, which is also carrying over into the direct consumer channel. In fact, this strength has led to several groups approaching us about licensing our brand. Licensing revenue could add meaningful revenue streams that is extremely high flow through as there is limited cost associated with this revenue. We are currently reviewing these opportunities and they are significant in nature and we're excited about the potential opportunity. The third point is that we launched the Bailey Shop in October, which is a single e-commerce destination that features all our brands. We have experienced strong results and consumer trends since we launched this multi-brand site. We believe this shows the power of our initial vision and business model and sets a strong foundation to which we can add additional brands like Sundry, as we bring them into our portfolio. We believe our business gets exponentially stronger every time we add a brand and we provide the customer with more options and styles across more brands. And the deal flow we are seeing is higher than we've ever seen given this current market. So we believe that we'll continue to grow our portfolio at significant scale over the next 12 to 18 months. We continue to achieve operating leverage on our fixed cost of business. As our results show, our fixed expenses declined slightly year over year in absolute dollars while we increased revenue. Let me repeat that. Our fixed cost expenses declined slightly year over year in absolute dollars while we increased our revenue. Our net operating loss declined meaningfully year over year. And as we continue to grow our wholesale and our e-commerce revenue, as noted earlier, we expect to continue to get leverage on these expenses and cash flow positive in the first quarter. This leverage will increase as we add more brands to the portfolio. We're going to detail the results for the third quarter 2023 compared to 2022. Net sales were 3.4 million versus 2.2 million in the year-ago quarter, an increase of 58.3% year-over-year. Net sales excluded 0.4 million in deferred revenue, which is associated with the timing of when customers order were placed versus when they were shipped in our men's custom business. There's a four to six week lag time between customer's orders and when they actually get shipped even overseas to Harper and Jones and then shipped to the customer. So again, we have to bear the cost of those fabrics to make the suiting or the shirting or the sport coat or the pant. And then we're not able to recognize the revenue. But what happens is when we do ship that in the fourth quarter, we're going to be able to recognize that revenue without the associated cost to that product. And that's just a gap accounting piece. So we will benefit, gross margin will benefit in Q4 due to this lag in timing. Net sales were also negatively impacted due to stateside wholesale orders shipping after September 30th. A lot of times we'll ship October 1st, 2nd, or 3rd, And again, due to GAAP accounting, you only can recognize the shipping on the ship date. So the revenue associated with these stateside wholesale orders were shipped to our fourth quarter revenue as well. So as you can see, our third quarter revenue would have been significantly higher just due to certain timing around actually recognizing that revenue. And all that revenue will flow through into the fourth quarter results. Gross margin was 48.3% versus 55.9% a year ago. a decrease of 7.6% in gross profit margin. Gross profit margin was negatively impacted by 5.1% due to the accounting treatment of deferred revenue, as we discussed, and the timing of the fabric cost in our men's custom business. This benefit will shift into the fourth quarter as a benefit to gross profit. So in fourth quarter from Harper and Jones, we will benefit from both a revenue as well as a gross profit adjustment that just has to do with the timing. Additionally, our gross profit margin was negatively impacted by price increases in our production expenses during the third quarter, especially at stateside. Please remember that we set the retail price points for these products four to six months ahead of production as we are offering these products at wholesale shows. Therefore, when there is a price increase in our production, we cannot change our pricing right away or during that period to reflect that price increase. However, we can increase our retail price points for the next period, which we have done. We will experience the benefit of these price increases starting in the first quarter of 2023. So this was a one-time event that will flow through into Q3 and some into Q4, but will not flow through in the first quarter and going forward. And again, there's just a lag from As an example, Q1 shows – or for the Q1 shipments, we were showing those in August, September, and October. So we set the retail price then for the Q1 shipments. So we already knew that cost was there, and we have since adjusted our retail pricing to reflect that cost, and we'll get that margin back at stateside. I think that's really important because we are able to catch that up. General administrative expenses as a percentage of revenue decreased 38.5% to 105.8% of revenues versus 172% a year ago. General administrative expenses were $3.6 million versus $3.7 million, $100,000 lower in the year-ago quarter. We continue to get leverage on our fixed cost, and we do not expect any additional increases in general administrative expenses or in our production expenses for cost of goods sold either. Sales and marketing expenses were 35.8% of revenue versus 60.4% a year ago, a decrease of 40.8%. Sales and marketing expenses were $1.2 million versus $1.3 million a year ago, which is $100,000 less. We slowed our digital advertising spend in the third quarter in advance of our Bailey shop rollout in October. In October, we redirected our advertising spend from each of our brand sites to our Bailey Shop site, which features all our brands on a single site. This shift in our advertising strategy resulted in sales and marketing efficiencies going forward and will continue to do so. And I think that's really important because we're not advertising against three or four sites now. We're predominantly advertising against one site, putting that dollars there so we can drive more traffic. And as we stated, we are seeing at the Bailey shop, customers buy multiple brands in a single cart, which shows the power of what we're doing. Because then our customer acquisition to acquire a customer is less than $15. Whereas right now, most digital customer acquisition cost is running $75 to $125. I cannot express how important this is. If you take a brand like Sundry that has several hundred thousand if not million email customer people on their list, and to be able to drive them to their site and acquire a customer for $15 when on average they're spending $280, both the CAC and the LTV for our business is incredibly high. And this is the power of our model right here is that we can drive down CAC, we can drive up LTV, we can cross merchandise across the brands as customers add multiple brands to a cart, And the more data we have, the more personalized we're able to get in what we're able to show the customer in terms of their looks. So as we look at the data, if a customer is more athleisure or they're more prep or they're more tailored, we're then able to create looks and styles and email those customers based on those looks and styles. And being able to acquire customers for $15 or less is even better than the go-go days of social media when Facebook and Insta and even TikTok just launched. And I cannot stress enough, how this also changes our cash, both near term, but also the profitability going forward as our LTV goes way up as well. Distribution expenses were 2.9% of revenue versus 4.9% a year ago, a decline of 41.4%. Distribution expenses were 98,000 versus 105,000 a year ago. We expect to continue to benefit from reduction in our distribution expenses associated with operating One distribution center versus two distribution centers as we collapse stateside D.C. into our single D.C. that we have now. Loss from operations was $2.6 million versus $7.9 million a year ago, which is a decline of $5.3 million from a year ago, which again shows the leverage we're getting on our business and that we expect to continue to get, especially with our Q1 wholesale bookings coming in. Interest expense was $2.3 million versus $0.5 million a year ago. I think the most important thing here is going forward, interest expense should be less than $150,000 a quarter due to the elimination of the debt that we discussed. Net loss attributable to common stockholders was $4.9 million, of which $2.3 of that was interest expense. This was $9.26 per diluted share, which includes the interest expense compared to net loss attributable to common stockholders a year ago of $8.9 million. We're $75.83 per diluted share a year ago. When closing, we believe this quarter is the strongest reflection yet that we are on a clear and short path of profitability with our current brand. We have incredibly strong Q1 wholesale orders. We believe the sundry acquisition should create even more positive EBITDA upon acquisition. And then as you can see, the Bailey shop is driving unbelievable growth. success, both in traction across brands, but in lowering our customer acquisition costs online and driving up our AOV, which is also driving our LTV. So our e-commerce continues to get leverage and our wholesale continues to accelerate. So with that, I will open it up to Q&A, please.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. The confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Thank you. Our first question is from Maya L., private investor. Please proceed with your question.

Hello. First, I want to congratulate you on an awesome quarter, really impressive growth. And then I wanted to ask you, at what point would you guys consider going private since there's such a deep disconnect from share price and the numbers you guys are bringing in?

Yeah, thank you for your question. It's a really interesting question and something that we're discussing internally. I think at some point you've got to look at this meaningfully deep, deep disconnect, and we know what we'd get on the private markets. We do have very high interest in this, as you can imagine. One of the big things that's happening in this world is, especially with the Apple iOS privacy and also with the department store shrinking and the wholesale channel, which we don't have a lot of exposure to, Because you're seeing that these brands are needing to what they call platform or come together to actually really drive growth or survive. And I think what we're hearing from the conversations we're having is that we have proved that this works and that we know how to do it. And that if we could come into a portfolio of PE or VC brands and bring this expertise and wrap all their brands up in there and then go public nine months later or a year later at 500 million in revenue then there's a massive arb for them so these are obviously conversations that uh that have been had and having and it's something we'll we honestly have to look at because at some point if there's this much of a disconnect it doesn't make sense to stay in the private market i mean the public markets unfortunately and to be honest i mean i did equity research for a decade i don't quite understand the dislocation either um i guess it's just a nano cap world but we do know that there's a lot of interest there and given what even broken companies are going for in the private markets there's incredible interest in what we've done and doing and the mass of this location in the reality of our market cap versus our results awesome thank you yeah i just i wanted to reiterate i you know i find such value here in the disconnect and

I fully believe with your guys' position in low debt that, you know, the sky's the limit from here if you guys keep putting up these growth numbers. But thank you. Congrats again.

Yeah, Maya, definitely. And thank you. And by the way, for what it's worth, I do think that was a big piece of it was one of the things that had held back a lot of these discussions was our debt load. And now that that's cleared and the equity hasn't reflected that, at least the equity priced, it's now very interesting because it's just an equity purchase versus having to add all this debt to the transaction and buy it out, which is creating even more of an arbitrage. And I think that's kind of what's been holding those discussions back, which are now no longer holding those discussions back. And I think, you know, we have to think what's best for the shareholders. And if we're getting significantly larger interest and offers at the, at the private level, we have to consider that and we will consider that. And it's definitely a deep, deep discount to reality, in our opinion.

Absolutely. I actually have one more question that that brings up. Are you guys actively looking for more acquisitions? I know once Sundry officially closes up, this is going to be a big one for you guys. But are you guys actively talking to other companies? You know, given the rate environment, I would assume a lot of smaller companies are looking, you know, to get bought out. And I would think that this is a strong position for you guys to capitalize on.

Yes. And in fact, we've seen a lot of that inflow as well. I would say that we think that there's a big opportunity here and we do think it's accretive. I know sometimes people look at it as one is dilutive, but you've got to look at the overall accretion, especially at these levels. Even if you were to issue shares, you know, with Sundry, you're doing, as we've stated, I think they're doing north of 20 and we're north of 30. So you can start to do that math. And it just, there's even more of a dislocation there. And there is, we are seeing more inbound requests than we ever have. Really good companies that are, you know, trying to figure out what to do here and raising capital. Just so you all know in the private market, a lot of times might come with a preferred, which means they're getting multiple amounts of their money back, which is less interesting to a lot of these founders. And additionally, what's happening too is a lot of these, companies have been in business for 10, 12, 15 years and the founders want an exit and they don't want to continue to stay private. So we, we are seeing a lot of deal flow and we do expect, you know, if we do stay in the public markets, we will continue to be acquisitive. But, you know, if we're not also going to get credit for building a 50, 90, $125 million revenue business over the next nine months, there's not really a reason, you know, to be, in the public markets, especially if we're going to trade at, you know, two and a half to three and a half million in market cap. I mean, our market cap is literally probably roughly a little less than half of what our Q1 revenues will be, which is pretty interesting and obviously pretty compelling for a lot of outside people.

Absolutely. Thank you and congrats again.

Thanks. Thank you. Our next question is from Charles Wierzymaski, private investor. Please proceed with your question.

Yes, hi, Bill. Congratulations on the new numbers. I haven't seen anything on the Amazon exposure. Can you talk to us about that?

Yeah, we've been happy with it. It's been slow and steady. It took a while. It warmed up, and it's just been a nice, slow and steady piece. We're learning a lot. We use a third-party agency. There's some things we're looking at from an acquisition candidates that actually specialize in this and have a direct relationship with them. So we believe in it enough that we're actually looking and seeking or even getting inbound requests from Amazon driven companies that have those relationships. The question is for us is, you know, do you put a stateside on there? Do you put a sundry on there? Does it or does not hurt the brand? But we do think the other opportunity is to create some of, our own private label businesses using our current brands under a different brand name and making, you know, maybe more overseas and using that to drive there as well, which we think is a really interesting growth opportunity as well. So take a distilled, like there's no reason we couldn't make the denim in Pakistan and make a lot of the same products be obviously a lower quality product, but also the price point would be significantly less as well. So we're just kind of scraping that data and look and seeing what's working, what's not working. where we can lean in more, and realizing that having potentially an Amazon-based company in our portfolio would really be an interesting play here as we look at these strategies based on the success we've had.

All right. Thank you so much.

Yep. Thanks for the question.

Thank you. Our next question is from Reed Heinwich with Roth Cabral Fund. Please proceed with your questions.

Hello. First, congrats on a solid quarter. Very excited about 2023 for you guys, most definitely. I would like to piggyback a little bit off of some of the debt conversations here and focus on your agreement with Black Oak Capital. Could you touch on your securities purchase agreement with Black Oak Capital and what that means for your company with some of that debt restructuring?

Yeah, so Black Oak had the first lean position on our debt. which is in the beginning of the call I was talking about how we can start to factor now. That's the reason we can factor because they've converted their debt into preferred equity. And then that preferred equity can get converted into common at up to $500,000 a month. And they're maxed out at that. So that will take about 14 months from when they start selling. I believe their average price per share is roughly $9.31, if I'm not mistaken. So if they were to sell at this level, they would actually be returning less money to their debt holders, which they obviously do not want to do. So I don't think they would sell, and based on conversations, they want to return par or above par level, which would be above 931, based on the conversations that I've had with their managing director. And they're definitely in no hurry. They think this is an incredibly undervalued asset as well. They do – their job is their fund investing company. So they also set valuation. So they're very clear on that's the big reason they converted is they, they, one of the reasons is they saw that there was a massive disconnect and they could actually return significantly more in equity than debt given the dislocation of the valuation. So that's the opportunity there. And that's, so again, they're limited, which is nice. And they were very open to that. They had no problem with it. They don't want to put pressure on, and they do think it's undervalued, which is why they converted it into the equity. And they'll just be very smart about it, but also they're in no hurry, and they think it's incredibly undervalued, and they could make multiples of their debt and return that to their debt holders.

Thank you. That's very important to touch on. I appreciate the clarification there. That was one of the potential flags a while ago that I was seeing, but the more that I've read the filings and then hearing this on the call, it sounds like, you know, it would really make no sense for them to dilute at the current moment. So thank you very much. I appreciate it. Yep.

Definitely. And, and again, like I talked to him probably weekly and they, they definitely feel like there's a much bigger opportunity for their, their holders. And, and, They have some, as all portfolios do, some brands that are underwater, and so this would help offset those as well if they return more than their principal amount that they converted into equity, which is not lost on them.

Exactly. And when they converted it into equity, they were making their decisions right at that point, which I think shows the true colors of what their intentions are anyways. All right. Well, thank you.

Yep, and by the way, I cannot stress enough the ability to factor now, which we have not had. I just can't tell you. We're moving from a negative five-month working capital cycle to a positive three-month working capital cycle. I mean, that is significant, especially as our wholesale continues to grow, especially brands like Stateside, over 50%. I mean, that's being able to use cash from the factor as opposed to having to go to our balance sheet to buy the product and make the product. by the fabric is a massive Delta in our cash needs.

Definitely. That makes perfect sense. Um, yeah, I will just, I'll just add as an institutional investor here and looking for undervalued opportunities, especially with how the markets have been, um, DBGI has been one of my top watches and then I was waiting for, Q3 earnings to come out here, especially going into the end of the year, end of the season. And the most important thing was listening a little bit into your Q1 projected wholesales and orders. That's very important to me as well. So honestly, just congratulations on some good work of recent, and I'll definitely continue being a shareholder. So thank you.

Yep, thank you. Thank you. There are no further questions in the queue at this time. I'd like to hand the floor back to Hill Davis for any closing comments.

Yeah, thanks, everyone, for joining. As you can see, our momentum continues. We're getting leverage on the fixed cost. I'd also say, you know, as you think about different things, you should probably look at the comps. We're also often asked what the comps are. You've got AKA brands out there. You've got Solo brands out there. You've got Warby Parker, which is DTC only. You've got Allbirds. And then you've got ourselves, and I think, you know, going back to what was asked before, there are some dislocations out there. And, you know, all we can do is execute and then make the right decisions for shareholders. But the business is in a really strong state. We're excited. We're excited about the Sundry acquisition and continuing to scale, whether it's in the private or public world. I think we've figured it out, and I think that's why we've got a lot of interest in how to platform these companies, strip out costs, both just from an OpEx perspective, but also from a marketing, DTC, lowering the CAC significantly, driving LTV, which is really critical in the world we're in today. So we're excited about what we see, both in terms of potential pipelines of acquisitions, in terms of the different options that we have at the table, and our continued growth at our brands, both across DTC as well as wholesale. So with that, thanks, everyone, and have a good night.