Digital Brands Group, Inc. Q4 FY2022 Earnings Call

Greetings, and welcome to the Digital Brands Group, Inc. Q4 and Full Year 2022 Earnings Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, John McNamara of Investor Relations. Thank you, Mr. McNamara. You may begin.

Thank you, Kimora. Good afternoon, everybody. On behalf of Digital Brands Group, I'd like to welcome you to the company's 2022 fourth quarter and full year earnings conference call and webcast. With us on the line from Digital Brands is Hil Davis, Chief Executive Officer. Hil will begin the call with an overview of the fourth quarter and the full year, and then we'll open up the lines to questions. We will remind you before we begin that 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 that identify 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, in contemplation or underlying the forward-looking statements. In light of these risks and uncertainties, there can be no assurance that the forward-looking information will prove to be accurate. As Kimora noted, this call is being recorded. And with that, I'd like to turn the call over to Hil Davis, Chief Executive Officer. Go ahead, Hil.

Yes, thank you, John, and good afternoon, everyone. I wanted to start by providing some historical context for where we are and where we have been. The goal of providing this context is to explain three key reasons: first, why the Sundry acquisition is transformative; second, how we have transitioned from a negative working capital cycle model to a positive one; and third, how we anticipate generating over $500,000 in monthly free cash flow starting this fall. Let's begin with some background. We went public in May 2021, which was earlier and smaller than we had hoped. This resulted from having two acquisitions ready to join our company once we were public, which we knew would help us achieve the cash flow and EBITDA positivity necessary for scaling our business. The first acquisition was Stateside, completed in August 2021, and the second was Sundry, which we aimed to close in January 2022. However, coinciding with the SEC's approval to finance the deal, the Federal Reserve announced plans to raise rates multiple times, causing market instability. After the invasion of Ukraine, the situation worsened, and our Sundry acquisition was postponed until December 30, 2022, less than four months ago. This matters because we required both Sundry and Stateside to reach cash flow and EBITDA positivity. With Sundry now acquired, we expect to achieve EBITDA positivity in July or August, which is exciting. The reference to July and August relates to our shipping schedule, so some shipments might fall into the first week of August versus the last week of July, but it's all based on our wholesale orders. A significant change in our working capital cycle model occurred when we began factoring our wholesale orders in October of last year. Factoring enables us to receive upfront cash for 65% of our wholesale orders when we ship them instead of waiting 60 to 90 days to be paid by retailers. This transition allows us to have a positive working capital cycle upon shipment. We ship products most months of the year, enabling us to receive cash immediately versus waiting. Additionally, we can recycle that cash for future production; for example, cash from an April shipment can finance production for June. This cycle creates a powerful positive working capital dynamic. The importance of Sundry's revenues in this process cannot be understated, as it is our largest brand and primarily wholesale-driven. Excluding payments on a weekly MCA that we are servicing to acquire Sundry, our business could generate over $490,000 monthly cash flow. Once the MCA is paid off in October, that cash flow will contribute directly to our balance sheet. This represents a significant shift in cash flow, supplementing our positive EBITDA, which is further enhanced by our ability to factor and recycle cash monthly. In summary, we have three key points: paying off the MCA will free up $490,000; we anticipate positive EBITDA; and we can continuously recycle our cost of goods sold through factoring. Our business has fundamentally changed from 2022. We lost a year due to market conditions that delayed our Sundry acquisition, a critical step toward building a scalable company with positive EBITDA and cash flow. With Sundry now part of our portfolio, we are on track to achieve our initial goals. Now, I will present our fourth quarter and fiscal year 2022 financial results. However, please note that these numbers do not reflect the positive changes anticipated from the Sundry acquisition. Our company has transformed significantly since December 30, 2022. For Q4, excluding any contribution from Sundry, we experienced a net revenue decline of 15.8% to $3.4 million compared to the previous year. This decline was a result of reduced advertising spend focused on launching and promoting our multi-brand site, the Bailey Shop, and a lack of wholesale revenue from Bailey 44, which transitioned to an online-only model in June. The Bailey Shop allowed us to cut back our advertising expenses while cross-promoting our brands to existing customers. Consequently, our sales and marketing expenses dropped to $1 million from $1.4 million a year ago. This represents a sales and marketing expense ratio decline to 7% from 18.5%, indicating margin expansion moving forward. Analyzing our historical return on advertising spend, we estimate we could have driven an additional $800,000 to $1.2 million in Q4 revenue if marketing spend had remained constant year over year. We wanted to understand the strength of the Bailey Shop without inflating results with marketing spend, and this tested strategy proved successful, as we observed significant revenue growth over the weekend when we cross-promoted between brands. In February, we hired a data analytics firm to enhance our advertising efforts following our successful testing. They conducted a 60-day audit, providing us with a strategic roadmap to improve our revenue streams. Our e-commerce metrics continue to show significant improvement week after week as we gather more data and optimize our strategies based on it, resulting in higher revenue with lower customer acquisition costs. We've also reintroduced Bailey's wholesale for this fall, which will add to our Q3 and Q4 revenues. The reduction in our wholesale offerings from 45 to 25 styles has improved profitability, lowering sample costs significantly. Additionally, we have signed a licensing deal with a major off-price retailer for the Bailey's brand, which is projected to bring in $500,000 to $1 million in annual free cash flow starting this fall. Regarding our margins and general and administrative expenses, our gross margin and G&A figures are not normalized due to our audit firm's recommendation to reclassify certain G&A expenses into cost of goods sold. This adjustment reflects a shift in how we categorize production-related salaries, rent, and other costs influenced by the growth of e-commerce. Thus, our Q4 gross margin for 2022 was $642,000, down $1.2 million from the previous year. Our G&A expenses for Q4 were $3.1 million, up from $2.5 million year over year. This demonstrates significant operating leverage; we saw a $6.4 million increase in revenue against an increase of just $646,000 in G&A expenses. We experience continuing leverage in 2023 as we integrate Sundry into our operations. We anticipate higher dollar flow-through from operating cost leverage with Sundry now in our distribution channels and offices. Sales and marketing expenses decreased significantly as we aimed to validate our cross-merchandising strategy without inflating customer acquisition figures. This methodology resulted in meaningful revenue increases, attracting new customers across multiple brands. The net loss attributable to common stockholders in Q4 2022 was $15.8 million or $20.46 per share, compared to $9.7 million or $127.13 per diluted share in the previous year. This figure includes a non-cash impairment charge of $9.7 million and additional interest expenses reflecting our debt. Excluding these charges, we would have posted a net loss of $3.1 million or $4.06 per share. Looking at our fiscal year 2022 results, net revenues increased by 82.4% to $14 million from $7.6 million in 2021. We saw significant improvement in our gross margin from 24.6% to 42.6%. Our G&A expenses decreased even while our revenue grew, showcasing our efficiency. In closing, our fourth quarter and fiscal year 2022 results are historical and do not represent our company’s current state following the Sundry acquisition. The past year’s challenges delayed our progress, but with Sundry integrated, we are moving toward achieving scale, positive EBITDA, and robust cash flow. This transformation from negative to positive working capital cycle is crucial and will significantly enhance our cash flow without external funding needs. Thank you all for your time. We're eager to maintain momentum moving forward and are excited about our growth trajectory. I appreciate your patience during the past year, and we are now seeing our strategies begin to pay off. This concludes our earnings call for the fourth quarter and fiscal 2022. Let's open the floor for questions.

Operator Instructions

I do have a couple of questions that were emailed in. Sorry, if there are no questions that come from the Q&A, I do have a couple of questions that were emailed ahead of time. Okay, perfect. John, can I move forward with us?

Yes. I am sorry, we were cross-talking. Go ahead with your questions that came in over email.

Yes, the first question was about our data-driven e-commerce and its current status. The transition is progressing smoothly, and we just completed our 60-day audit last week. The data regarding repeat customers, products, and brands is extremely valuable, and we're making progress with it. We're also witnessing a significant daily increase in our e-commerce, with strong cross-merchandising efforts. We are optimistic about what we're observing in terms of collaboration between brands and the Bailey Shop. This channel yields high-margin revenue due to both wholesale and retail markups. Furthermore, there's a clear strategy to generate this revenue at a much lower customer acquisition cost compared to last year, which is significant. We've already noticed improvements since the leadership change in mid-February. Regarding going private, we are still assessing that option. However, as mentioned, the valuations we’re seeing are quite low relative to the free cash flow that will begin to come into the business starting in October. This provides us with numerous opportunities ranging from acquisitions to opening stores and catalogs, as well as potential share buybacks if deemed beneficial for our shareholders. Our goal is to ensure the going private reflects a fair valuation of our free cash flow. Currently, a market cap or acquisition offer between $20 million and $30 million does not accurately represent the free cash flow we anticipate based on the MCA alone and other contributing factors. We have also noted the performance of brands like Solo and Rent the Runway post-transition, which we believe presents opportunities for our investors. Lastly, regarding the potential acquisition of Bonobos and market reactions despite its challenges, we see the long-term value of our company, especially as we approach October and the new free cash flow cycle.

There are no questions in the queue at this time. We have one question from Mike Ripley, who is a private investor. Please proceed with your question.

Yes. Congratulations on an outstanding update on the ER report. Appreciate that. And congratulations on the cross-branding, the product lines. Any projections on percentage of increase in sales with the cross-branding or a percentage of possible revenue?

It's difficult to provide specific numbers at the moment as we are evaluating each brand individually. For the Bailey Shop, we have observed significant increases of 100% and 200%. As an example, over the recent four-day weekend, we launched a curated capsule on the Sundry website, targeting only Sundry customers via email. We noted a substantial increase in e-commerce revenue for Sundry, which had already doubled since our acquisition, rising by an additional 50% on a daily basis so far. We are starting to see some meaningful figures, and we plan to implement similar strategies with a few other brands. We are reviewing our audit to identify which collections and brands could be effectively cross-merchandised. This approach has proven effective, and there is also interest from third parties with whom we could negotiate revenue share deals. This is appealing because it allows us to leverage their email lists for cross-promotion without incurring extra costs. There are numerous exciting opportunities not only for our own brand but also in positioning ourselves similarly to retailers like Revolve or Nordstrom, where we don’t manage inventory but can create curated looks across various categories. For example, we are planning to introduce a third-party shoe brand in the next month or two, and we are also exploring other categories like Vince shorts. The focus is on determining which categories we want to enter and which ones we think can be effectively cross-merchandised. This strategy primarily involves revenue sharing, which is quite impactful and carries no additional inventory costs for the third-party brands. Does that clarify things?

Yes, thank you.

There are no further questions at this time. I would like to turn the floor back over to CEO, Hil Davis, for closing comments.

Well, thanks, everyone for the call. Hopefully everyone is starting to see a picture of what we always thought this would look like, and we're excited to continue to actually execute against it. We're already seeing it show up in our numbers today, and we expect it to only increase going forward. So thanks, everyone, for your time, and we look forward to our Q1 earnings call here just in four to five weeks, I believe. We'll have more updates there too on our growth drivers by channel as well. So thanks, everyone, for their time, and we look forward to discussing again here in a few weeks.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.