Earnings Call Transcript - DBGI Q3 2023

Operator, Operator

Thank you for standing by, and welcome to the Digital Brands Group, Inc. Q3 2023 Earnings Call. I would now like to welcome John McNamara, Investor Relations to begin the call. John, over to you.

John McNamara, Investor Relations

Good afternoon, everyone, and thank you again for joining us on the Digital Brands 2023 Third Quarter Financial Results Conference Call. With us on the line from Digital Brands is Hil Davis, Chief Executive Officer. Hill will begin the call with a brief overview of the quarter, and then we'll open up the lines for questions. As usual, we would remind you 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 which identify forward-looking statements speak only as of the date the statement is made. These forward-looking 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 by the underlying 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. With that, I'd like to turn the call over to Hill Davis. Go ahead, Hill.

Hil Davis, CEO

Thank you, John, and good afternoon, everyone. We are halfway through our fourth quarter and have closed our first quarter 2024 wholesale bookings. Given the current trends in the fourth quarter and our first quarter wholesale bookings, we are pleased to report that Sundry has made a significant turnaround. Sundry reached its lowest point in August and has been steadily increasing every month since. For instance, we have tripled Sundry's first quarter 2024 wholesale bookings compared to the Brand's third quarter 2023 wholesale revenue, which also faced its lowest sales in July and August. Since that time, we have seen a substantial rise. Moreover, Sundry's fall sweater was so popular at wholesale that Anthropologie has requested an exclusive sweater program for next fall and holiday, which should substantially boost our wholesale revenues relative to our first quarter bookings as well as our third and fourth quarter results this year. Other wholesale accounts have indicated they underestimated demand for Sundry this fall and holiday season, as their products have been selling out in just weeks. Recently, we learned that another major retail chain, our largest wholesale account, sold through 57% of Sundry's holiday sweaters in just one week. They are looking to increase their orders for next year. The turnaround for Sundry, alongside the increased revenue from our other brands and cost synergies, has led to significant operating leverage. Based on the growing revenue trends and the decline in our operating expenses, we anticipate being EBITDA-neutral in the first quarter. This assumes current e-commerce trends hold, which have been softer than expected due to a challenging macro environment impacting other retailers and DTC companies as well. This period has been one of the most promotional we have encountered, with promotions starting earlier and featuring higher discounts than in the past. Other retailers that have recently reported earnings, as well as my conversations with private companies, indicate this trend is widespread, including major players like Home Depot, Target, Levi's, and Nike. Despite these weaker e-commerce trends, we generated internal free cash flow in October, which we used to reduce old accounts payable and debt. We expect to continue producing internal free cash flow and will keep improving our balance sheet, as this is highly valued by private investors. We anticipate that our monthly internal free cash flow will rise in April and again in October. The increase in October alone is over $60,000 each month, mainly because our office and distribution center rent will no longer include catch-up payments owed to the landlord from the COVID period during which we didn't pay rent. Specifically, in October, we will see an additional $60,000 of free cash flow simply by reverting to normalized rent payments. We are also in the final stages of securing a lease for an outlet store to replace an existing location, set to open around March 1. The brand at this store currently generates $1.8 million annually, averaging $150,000 a month, with operating costs around $45,000 monthly. Since we possess a substantial inventory of old Sundry products from the acquisition, we expect zero cash cost for our cost of goods sold. This should contribute at least $50,000 to our monthly cash flow if revenues fall to $100,000 a month, which we consider a conservative estimate as we do not expect such a decline. If we maintain our current revenue, the contribution could reach an additional $100,000 monthly. Given our $4.5 million in wholesale bookings, e-commerce revenue, store revenue, wholesale reorders, and licensing income, we project achieving EBITDA neutral to positive in the first quarter. Particularly with the exclusive sweater program from Anthropologie, in addition to feedback from other wholesalers, we should exceed the $6 million revenue mark for the third and fourth quarters. To clarify, a quarterly revenue of $6 million is considered EBITDA neutral. Based on our current bookings for Q1, confirmed purchase orders in our system, e-commerce trends, outlet store revenue, wholesale reorders, and first and second-quarter licensing income, we expect to be at least EBITDA neutral and to see a healthy EBITDA positive for the third and fourth quarters. In summary, we are observing accelerating revenues that should result in a growth of over 50% in the first and second quarters and nearly 100% in the third and fourth quarters. Internal free cash flow is also on the rise, especially by March and September. We anticipate neutral EBITDA in the first half and positive EBITDA in the second half, which is also why our internal free cash flow is set to increase. We believe these fundamental metrics are important, and we will seek investors, whether private or public, who recognize these trends that are currently undervalued in the market. Now, let’s turn our attention to the third quarter results. Net revenues increased by 22.5% to $3.3 million compared to $2.7 million a year ago. These figures exclude revenue from our sale of Harper & Jones for both the third quarter of 2022 and 2023. This illustrates Sundry's lowest wholesale revenue point based on current fourth quarter trends and first quarter bookings, with our Q1 2024 wholesale bookings being triple that of the third quarter revenue. This also reflects the changes we implemented when acquiring Sundry, including a new design team, adjusted pricing, and improved fabric quality. We were not able to implement these changes until September, and we are now seeing favorable results. Gross margin rose 77% to $1.7 million compared to $1 million a year ago. Our profit margins improved significantly to 52.3% from 36% last year and also increased from 52% in the second quarter, indicating we are maintaining and growing gross margin. General and administrative expenses, inclusive of noncash items, rose 25.3% to $3.7 million compared to $3 million last year. Excluding noncash items, G&A expenses decreased 30.8% to $1.6 million compared to $2.3 million a year ago. G&A expenses included $2.1 million in noncash expenses for depreciation, amortization of loan discounts, and stock options. Sales and marketing expenses increased 12.6% to $1.2 million compared to $1 million last year, with the sales and marketing expense ratio at 35.3%, down from 38.5% a year ago. Our net operating loss, excluding noncash charges, was $1.2 million compared to a loss of $2.5 million last year, effectively halving our net operating loss despite revenue that was significantly below our Q1 wholesale bookings alone. The net loss per diluted share attributable to common stockholders was $5.4 million or $14.55 per diluted share compared to a loss of $4.9 million or $223.83 per diluted share a year ago. Excluding noncash expenses, the net loss per diluted share was $2.6 million or $8.92 per share. In conclusion, the Board is currently examining strategic alternatives due to the ongoing discrepancy between Digital Brands Group's public market valuation and the intrinsic value of our operational assets. We believe our first quarter 2024 wholesale bookings and monthly internal free cash flow highlight how significant this disparity has become. We are operating at an $18 million wholesale revenue run rate for 2024, not accounting for any impact from our e-commerce sales, store revenues, or licensing income. We project generating over $6 million in internal free cash flow for 2024. We have several options to pursue which should substantially enhance shareholder value. We are aware of a strong demand for our NASDAQ listing. We take these options seriously, as it is evident we are not receiving recognition for our acquisitions, revenue growth, and the generation of internal free cash flow while anticipating EBITDA positivity in 2024 atop substantial internal free cash flow. As noted, our internal free cash flow should continue to rise as we progress through 2024 due to the outlet store and the normalization of rent payments. Currently, these factors are not resonating with the public markets, prompting us to move forward with our strategic alternative approach. Thank you for your time, and we look forward to sustaining our momentum. This wraps up our third quarter 2023 earnings call, and we are ready for Q&A.

Operator, Operator

Thank you for your time, and we look forward to the continued momentum. This concludes our 2023 third quarter earnings call, and we will now open the floor to questions and answers.

Hil Davis, CEO

If there are no questions, I have a couple of questions that have come in through email or social media as well.

Operator, Operator

There are no questions at this time, sir.

Hil Davis, CEO

Yes. Let me address a couple of questions we've received. One is whether we expect our gross margins to remain at this level. The answer is yes, we do. There are several reasons for this, the main one being that there are significant fixed costs in our gross margin. For example, when we produce samples for wholesale, we incur costs such as distribution center rent, labor, and costs for sewers and pattern makers, which results in a high fixed dollar amount. As our revenues increase, we gain leverage on these fixed costs. Additionally, we plan to cut another $0.5 million in costs as we move forward, specifically in OpEx line items, which will take effect starting in Q1 and continue on an annualized basis. We do expect our gross margins to maintain this level or possibly increase, especially as we approach Q4, because we will be able to leverage the fixed costs associated with our gross margin. The other question is whether we are frustrated with our current position and whether we are committed to exploring strategic alternatives. The answer is yes to both. It is clear to us, as well as the Board, that we are not being recognized for the progress we have made in our business, the acquisitions we've undertaken, the leverage we've created, the revenue growth, and the internal free cash flow. We are actively pursuing this matter. As many on the call know, we typically do not issue a lot of press releases, but we did release information about this situation intentionally and will continue to pursue it vigorously. We feel that we are not receiving the credit we deserve for what we have built and the results we are achieving. Q1 is a prime example of this, along with the October free cash flow and Q1 wholesale bookings, as well as the positive feedback from our wholesale accounts about how well our products are selling. This reinforces our need to identify the best path for shareholders, which does not currently appear to be through public markets. Those were the major questions I received via email or social media. With that, we can conclude the call.

Operator, Operator

I would like to thank our speakers...

Hil Davis, CEO

Sorry, one more question I just got. Someone asked about the volume today and what's going on and what's happening with the prefunded warrants. And they have been exercising those prefunded warrants. They are almost frame clear of all of them, which I think has been creating a lot of volatility. But as part of the pipe deal we did in early September, as part of it, it was prefunded warrants that they could convert into common, which they've been doing over the last week and at this point, they should be mostly out of those. And I think that has also just created an overhang as I've gotten a lot of questions about that from investors, and that should be done or very, very close to being done at this point.

Operator, Operator

I would like to thank our speakers for today's presentation, and thank you all for joining us. This now concludes today's call, and you may now disconnect.