Digital Brands Group, Inc. Q1 FY2024 Earnings Call

Greetings. Welcome to the Digital Brands Group Q1 2024 Conference Call. Please note, this conference is being recorded. I will now turn the conference over to your host, John McNamara. You may begin.

Thank you. Good morning, everyone, and welcome again to the Digital Brands Group 2024 First Quarter Earnings Conference Call and Webcast. With us on the call this morning from Digital Brands is Hil Davis, Chief Executive Officer. Hil will begin the call with an overview of the quarter, and then we will open up the lines for questions. Please keep in mind 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 identify forward-looking statements speak only as of the date the statement is made. These statements are based largely on the company's expectations and are subject to a number of risks and uncertainties, some of which cannot be predicted or quantified and are beyond the company's control. Future developments and actual results could differ materially from those set forth in contemplated by or underlying the forward-looking statements. In light of these risks and uncertainties, there can be no assurance that the forward-looking statements will prove to be accurate. With that, I'll turn the call over to Hil Davis. Go ahead, Hil.

Thank you, John. Good morning. Despite a timing shift in our wholesale shipments, which shifted revenue from the first quarter to the second quarter, we experienced significant operating expense leverage. We expect this operating leverage to continue throughout the year. In fact, this operating leverage, coupled with higher revenues, results in a higher flow-through to our operating and net income. Regarding the shift in wholesale, we had a majority of our fabrics stuck in a shipment container at the L.A. port due to an X-ray check of other products. So we lost 2 weeks there, which meant January shipments shifted to middle of February, and middle of February shipments shifted to middle of March. The majority of March shipments moved into the April period, which significantly impacted revenue. It's important for people to pay attention to this because we will pick that up, and we should ship the majority of June at the end, as the wholesalers have accounted for this based on sell-through rates in their stores, and we do not expect that to happen again. It was just a one-off incident where U.S. Customs flagged the container we were in. There was nothing we could do; we just had to wait until it went through its X-ray process, which caused us to lose 2 weeks, and then everything was behind thereafter. By the way, as we move into the second quarter, not only do we benefit from the shift of March into April, but we'll also see benefits from our store, which opened in mid-April. We are experiencing healthy week-to-week revenue increases since we first opened the store, and we're excited to see how that grows as it continues to develop. As we said before, we're just sending product down there that we already have, so we're not incurring additional costs on that side. We also plan to benefit from additional e-commerce strategic decisions in the second half of the year. So in Q2, you'll have the benefit of the store in addition to the March to April shift, and then as you move through the second half of the year, our fall bookings are strong, coupled with some strategic e-commerce decisions we've made. So let's discuss the first quarter results. Net revenues were $3.6 million compared to $4.4 million a year ago. Again, net revenues were negatively impacted by the wholesale shipments for March slipping into April, which we expect to benefit from in the second quarter of this year. The gross margin profit increased to 48.1% compared to 45.5% a year ago. We expect that gross margin number to be higher as significant fixed costs are built into gross profit or cost of goods sold. So as revenues increase, so do the gross profit margins. G&A expenses decreased by $1 million compared to $4.5 million a year ago. This was down to 27.2% from 100.5% a year ago, and we expect to continue benefiting from these synergies since the Sundry acquisition. Sales and marketing expenses were $700,000 compared to $1 million a year ago, reflecting 19.8% versus 22% last year. This was also due to the fact that March e-commerce orders were pushed into April. So effectively, we only had 2 months of e-commerce revenue in Q1 numbers. Our net operating loss was $225,000 compared to $3.7 million a year ago. Notably, if you look at the revenues that slipped into the April period, we would have actually reported positive net operating income based on those results. Our net loss was $684,000, or a loss of $0.46 per diluted share, compared to a loss of $6.1 million, or a loss of $27.48 per diluted share a year ago, representing a significant improvement. In conclusion, as we stated, the company will achieve significant operating leverage as we navigate the first year of our Sundry acquisition. We expect this operating leverage to continue throughout the year with higher revenues, which will increase the flow-through to net and operating income. Given our results and our expectations for Q2, Q3, and Q4, the Board will continue to explore strategic alternatives in light of the continued dislocation between Digital Brands Group's public markets and the intrinsic value of the company’s underlying assets and operating performance. We have several options to pursue, all of which should significantly enhance shareholder value. We also know from inbound demand that our Nasdaq shell holds significant value. We will continue to pursue this, especially as we understand what Q2 looks like and what Q3 wholesale orders entail along with our strategic alternatives and store performance. So thanks, everyone, for your time. We look forward to the continued momentum, and this concludes our first quarter 2024 earnings call. Now, let’s open it up to Q&A, please.

Your first question for today is from Mike Travlos, a private investor.

General broad question, but what is the company's competitive advantage or approach to the retail market? I mean, obviously, retailing is big and fragmented, but what's our angle here that we're playing with opening this one store and pivoting from e-commerce, so on and so forth?

Yes. Regarding that, I wouldn’t look at one store as pivoting from e-commerce. It’s more that you need wholesale, e-commerce, and if stores work, you also need to have stores. One thing about apparel is that physical touch, feel, and fit matter. So I would encourage everyone to keep that in mind. It’s important to be present in all channels if those channels prove successful. With e-commerce, the days of unlimited ad spending are over. You're seeing a closer focus on return on ad spend and running campaigns that are based on returns rather than an open-ended approach. Wholesale continues to be strong for us. As far as the store, we had a lot of product left over from Sundry that needed to be sold. It’s an outlet location, and we’ll continue to monitor it to see what makes sense. If it makes sense to open a full retail store, we’ll pursue that. We’re still learning here. We’ve taken over at least, so it's a short lease of only 3 years, so there’s not a lot of obligation there. In terms of our differentiation, I would say our key areas are product design and price point with Sundry. The first quarter of last year was their last strong quarter before the brand rolled over. We are comparing against easy comparisons in Q2, Q3, and Q4, and we expect to see improvement there. We sharpened our price point and brought in a new design team. Stateside, we continue to grow steadily at approximately 20% a year, driven by having a competitive price point in the women’s contemporary market, which builds our brand awareness. Bailey’s remains predominantly a licensing operation. Focusing on offering a good product at the best price along with good design is key to our strategy. We hired a new designer for both brands in the fall of last year, and we’re starting to see her product reach the store floors and sell-through. That will benefit us moving forward. It’s about being smart and not just chasing growth but focusing on cash flow alongside top-line growth. Again, our top-line growth in Q1 was significantly impacted by the bulk of March shipping occurring in April. Therefore, we’ll benefit from our store's performance, the timing of shipments, and various other strategic initiatives.

No, it does kind of new to the story, so I did want to hear something extensive. Second question, you had come out with a press release in the past somewhat recent about no equity raises in 2024, but you had some equity activity. I don't know if you call it a raise. So what's the situation?

Yes. So that was largely driven by Nasdaq sending us a delisting notice because our auditor needs to review and verify our financials, which has become more complex. For example, we needed to acknowledge a non-cash tax charge of $368,000 for GAAP accounting as we can potentially sell any of our brands at any point in the future. This requirement seems a bit nonsensical. We received a lot of non-cash charges, which pushed us below compliance thresholds. You’ll see that we are currently above it. The Nasdaq monitors two things: compliance at the end of the quarter and their assessment of our ongoing financial burn. We have a hearing coming up, and based on discussions with Nasdaq, we knew we would be in compliance when we reported Q1. Still, everyone felt that in light of their concerns, we needed to raise additional capital to mitigate the perceived risk of delisting.

So you just played it safe and just raised additional capital and if you don't need it, then you don't need it then?

That's right. Yes, sir. Exactly. Unfortunately, that’s the reality. We went through a similar situation last year due to the same issue. It’s also noteworthy that as we look toward the rest of this year, you’ll find that our interest expense is relatively high. However, a significant portion of that will roll off at the end of Q2 and the majority of it will come off in Q3, which is when that debt will be repaid. By the time we reach Q4 and next year, our interest expense could be about 20% of what it is now. When you factor that in, it will make a meaningful difference.

And if you put all that stuff together, you anticipate being at least cash flow positive pretty soon? Not to ask you for guidance, but that's what you're anticipating.

Yes, internally we expect to be cash flow positive soon. As for pure GAAP accounting, we think we would start approaching that as well. While Q4 may be unpredictable due to rigorous auditing processes, we anticipate that by the second half of the year, we will be moving in a positive direction.

So without giving formal guidance that you anticipate being cash flow positive very soon?

Yes, internally cash flow positive. That's right. Exactly. Additionally, from a strict GAAP perspective, we believe we will also begin approaching that point as well. As for Q4, it really depends as auditors are under PCAOB review, and their requests can be quite extensive. This economic environment adds a significant cost to being public. In the first quarter alone, our costs were around $600,000.

And on a thing for the...

Yes, that's exactly right. We do believe that will happen as we advance to the second half of the year and continue into the future.

Your next question is from Chris Werny, a private investor.

Okay. I have a PhD in statistics from Moscow State University. And I'm really excited because I've been analyzing the revenue and I think you could have a 1,000% to 5,000% increase in revenue in the next 2 years or so based on all the data I’m looking at. Are there any plans to develop a statistical probability model based on probability theory to actively analyze revenue?

We don’t necessarily look at it that way because we’ve got different revenue drivers in play. On the wholesale side, predicting sales is quite challenging due to the emotional factors driving orders at the moment, which can vary a lot. E-commerce tends to exhibit steady behavior but is increasingly focused on return on ad spend. The stores need further analysis based on their performance. So I think a statistical model would be more complicated because the variability factors in our inputs will be high. However, we are at a point of coming off our lowest revenue quarter from last year, which leads to a situation where, as we recover, interest expense will revert, and we’ll receive goodwill from our acquisitions to enhance our performance. What’s often underestimated is that building smaller brands gradually builds up a customer base. As those customers begin to repeat purchases, the growth trajectory starts to shift from gradual increases to sharper escalations.

Okay. Now you're speaking my language.

Yes. So I think we are still in the stair-step growth function. Our brands are still small, but once you reach a critical mass of customer base, things change significantly. You see it regularly with brands similar to a company like J.Hilburn, which started slow and suddenly gained traction in key markets, leading to significant growth. This growth correlates with establishing a customer base that can lead to trending upwards more rapidly after a certain threshold of repeat customers is reached.

Wow. Awesome. I honestly, I'm going to increase my personal price target in the next 2 to 3 years to probably a 10,000% revenue increase?

Yes. I can't comment on that, but I definitely believe we have the capacity to grow revenue significantly. A lot of it also hinges on brand awareness. When looking at bigger brands, many of which are performing inconsistently, they have benefitted from heavy funding and extensive brand-building efforts. We clearly aren't raising as much capital, which affects our growth timeline compared to theirs, but the underlying business development processes remain relatively similar.

Wow. I'm definitely a fan of Allbirds. I've heard from them, and I really like their shoes. I think they're very forward-thinking and very unique functional and cool.

Yes, they've done a nice job, raising substantial capital and operating stores. Some have performed well while others have not. We often analyze other brands' performances, knowing that our formula also works. You need to employ both online and physical strategies alongside wholesale to maintain a healthy business balance. Having all three distribution channels engaged gives you a better chance of success. We think about this in terms of the customer’s shifting preferences and behaviors over time; during COVID, the absence of physical stores drove tremendous online sales, but now consumers are returning to shopping in-store. So it’s essential to adapt to the customer's preferences rather than rigidly sticking to a single business principle.

Now what would you say to all the ridiculous haters who say, "Oh, you're a digital company and you're opening up physical stores. This will never work. This is garbage blah, blah, blah."

I mean, many would argue that Warby Parker is a digital company, and they operate over 170 stores. Likewise, Allbirds, a digital origin brand, has around 65 stores. Furthermore, brands like Marine Layer and Buck Mason, also digital, maintain quite a number of stores. Just because you start digital doesn’t mean you should disregard physical retail's revenue potential. Dismissing this approach displays low-level thinking. Remember that when launching J.Hilburn, I was at Citadel Investment Group, covering restaurants, retail, and Amazon. Jeff Bezos himself noted struggles with apparel sales, which remain the most challenging category for them. Customer engagement with apparel often involves tactile experiences, such as touch, feel, and fit. Even prominent digital companies can benefit from broader engagement strategies. The success formula includes exposure through stores, wholesale channels, and online presence. You lose out on potential revenue by not embracing all channels.

That is the methodology. I have a theory that as time goes on, clothes will generally become brandless. People will want just the cheapest, coolest denim possible, and won't care about brands. As things become more digital, I believe that will become a trend. I regret not buying Amazon stock in the '90s. I think I had some Musicland stock.

But I think that’s the key. Even looking at J.Crew, which started as a catalog retailer, once they opened stores, their revenues surged. When a customer can physically interact with their size and preferred product, they are more likely to return to the online store to make future purchases. In apparel retail, acquiring customers through physical outlets while retaining them digitally is essential. The main goal should revolve around acquiring customers efficiently while ensuring digital channels offer strong retention. A solid multi-channel strategy is essential for maximizing profitability. Customers’ preferences shift over time, and the business must be responsive and adaptable to those changes.

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.