Digital Brands Group - Q1 2024

Transcript

Operator (participant)

Greetings! Welcome to the Digital Brands Group Q1 2024 conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to your host, John McNamara. You may begin.

John McNamara (Head of Investor Relations)

Thank you, Holly. 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 and contemplated by or underlying the forward-looking statements. In light of these risks and uncertainties, there can be no assurance that the forward-looking statement will prove to be accurate. With that, I'll turn the call over to Hil Davis. Go ahead, Hil.

Hil Davis (CEO)

Hi. 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 a significant operating expense leverage. We expect this operating leverage to continue throughout the year. In fact, this operating leverage, coupled with higher revenues, will result in higher flow-through to our operating and net income.

Regarding the shift in wholesale, we had our fabrics, a majority of our fabrics, get stuck in a shipment container at the LA port due to an X-ray check, where it was in with other products. So we lost two weeks there, which meant January shipped in middle of February, middle of February shipped in middle of March, and majority of March shipped into the April period, which is what impacted revenue, which is pretty significant if you kind of take the current revenue and divide by two. And I think that's really something people need to pay attention to because we will pick that up, and we should ship the majority of June at the end, as the wholesalers have unkinked this based on sell-through rates in their stores, and we do not expect that to happen again.

It was just a one-off 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 we lost two weeks on, and then everything was behind by then. By the way, from our, as we move into the second quarter, not only will we benefit from that shift of March into April, but we'll also benefit 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 where that goes as it continues to grow. As we said before, we're just sending product down there that we already have, so we're not making product for the store, which is just basically no cost on that side.

We also plan to benefit from additional e-commerce strategic decisions in the second half of the year on top of that. So in Q2, you're gonna have the benefit of the store, as well as the shift of March into April, and then you're also going to, 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, as we mentioned, net revenues were negatively impacted by the wholesale shipments from March slipping into April, and then we expect to benefit from that in this, in the second quarter of this year. The gross margin profit increased 48.1%, compared to 45.5% a year ago.

We expect that gross margin number to be higher, as there are significant fixed costs, such as pattern makers, sewer, our fulfillment center, the pick, pack, ship costs are all built in the COGS, in gross profit or cost of goods sold. So as the revenues are higher, so are the gross profit margins. G&A expenses decreased $1 million compared to $4.5 million a year ago. This was 72.7% compared to 100.5% a year ago, and we expect to continue to benefit from these synergies since the Sundry acquisition. Sales and marketing expenses were $700,000 compared to $1 million a year ago, 19.8% versus 22% a year ago. And part of that, too, was the fact that the March e-commerce orders also then slipped into April as well.

So really only two months of e-commerce in the Q1 numbers. Net operating loss was $225,000 compared to $3.7 million a year ago. What's interesting is if you look at what revenues slipped into the April period, we would have actually reported positive net operating income, based on those results. 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 $27.8 per diluted share a year ago, which is a significant improvement. In concluding, as we stated, the company would achieve significant operating leverage as we lap the first year of our Sundry acquisition.... We expect this operating leverage to continue throughout the year on higher revenues, which will increase the flow through to the net and operating income.

Additionally, given our results and given what we expect to achieve in Q2, Q3, and Q4, the board will continue to pursue strategic alternatives, given the continued dislocation between Digital Brands Group, public markets, and the intrinsic value of the company's underlying assets and operating performance. We have several options that we can pursue, all of which should increase shareholder value meaningfully, and we know based on inbound demand, that our what our Nasdaq shell is worth, which is significant. So we will continue to pursue this, especially, like I said, as we know what Q2 is shaping up to be and what Q3 wholesale orders are, the strategic alternatives to explore, et cetera. So thanks everyone for their time. We look forward to the continued momentum, and this concludes our first quarter 2024 earnings call. So let's open it up to Q&A, please.

Operator (participant)

Certainly. At this time, we will be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two 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. Once again, that is star one to ask a question. One moment please, while we poll for questions. As a reminder, if you would like to ask a question, please press star one. Once again, if there are any questions, please press star one. Your first question for today is from Mike Travlos, a private investor.

Speaker 3

Hi there. General broad question, but what is the company's, I could say, 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, you know, opening this one store and pivoting from, you know, e-commerce, so on and so forth?

Hil Davis (CEO)

Yeah, regarding that, I don't-- I wouldn't look at it as one store as pivoting from e-commerce. I think it's one of those things where what we're seeing is you need to have wholesale, you need to have e-commerce, and then if stores work, you also need to have stores. One thing about apparel, unlike like a book or a glass or something along those lines, is that it is physical. Touch, see, feel, fit matters. So I, I would just kind of keep that in mind. I think it's more of you need to be in all the channels if the channels work. With e-commerce, the days of just, you know, rolling out unlimited ad spend is over, and so you're watching ROAS more closely, and you're running a ROAS-based campaign instead of just up into the right, see the meter campaign.

And then wholesale continues to be strong for us. And then as far as the store, you know, we had a lot of, like we said, products from Sundry alone that was just sitting there. So it's in an outlet location. It's, you know, we'll continue to monitor that and see what makes sense, and if it does make sense to open a full, what they call a full retail store, and then if so, we'll pursue it. So we're just learning there. And then we took over a lease, so it's a short lease, so it's only three years. So there's not a lot of obligation or liability there. So in terms of what differentiates us, I would say the big things are, you know, it's just gonna be design and price point with Sundry.

The Q1 of this, of last year was their last really good quarter before the brand kind of rolled over, and we were lapping incredibly easy comparisons in Q2, Q3, and Q4. So we expect to see that improve nicely. What we did there is we sharpened the price point and brought in a new design team. Stateside, we continue to just grow that slow and steady, 20% a year, and that's basically driven on, you know, we're at the best price point at the women's contemporary market, and so that brand just gets more and more awareness and continues to build. Then DSTLD does e-commerce only, and Bailey's is predominantly licensing now. So it's, it's really sharpening the price point so where you're the best product at the best price, and then good design.

We brought in a new designer for both brands, basically fall of last year, so we're starting to see her products hit the store floors and sell through. So that'll benefit. And then I think that's really the big driver is just being smart about it, just not chasing growth, focusing on cash flow as much as you are top line growth. And again, you know, top line growth in Q1 was significantly impacted by basically majority of March shipping in April, and then you've got... And so you get that benefit, plus the store, plus some other things. Does that answer the question? I know it's a little long-winded-

Speaker 3

Yes.

Hil Davis (CEO)

but just wanted to kind of give a broad view.

Speaker 3

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?

Hil Davis (CEO)

Yeah, so that was driven mostly by the Nasdaq sending us a delisting notice because our, at the end of the year, you know, we have to- the auditors go through, and now that accounting is predominantly all theoretical based and not actual based. As an example, you have to take all these non-cash charges. As an example, that was, we had to take a $368,000 non-cash income tax charge because, for GAAP accounting, we could potentially sell any of our brands at any point in the future. Unknown, it could be a millennium from now, it could be a decade from now, it could be a year from now. No one knows, but this is what they say.

Speaker 3

Uh-huh.

Hil Davis (CEO)

And so you, they say, based on that, you need to take a tax consequence for that, which is kind of silly because the one thing I can guarantee is they don't know when, and the number's gonna be wrong, but that they as assigned to it, right?

Speaker 3

Mm-hmm.

Hil Davis (CEO)

So we had a lot of net non-cash charges, which dipped us below. As you'll see, we're above it now. But what they... The Nasdaq looks at two things. One is at the quarter, that's number one. And then number two is what they perceive as their, you know, your ongoing amount of burn and if you can maintain it. So we have our hearing coming up, and basically, based on our conversations with the Nasdaq, we knew we were gonna be in compliance when we reported Q1, but everyone felt that based on their comments and how they're reviewing all these things, that we needed to show that, you know, with our burn and this additional capital, it would take us out of that risk. Because, I don't know, we just, it's one of those things where they said it's a 50/50 weight.

50% is if you're in compliance, and the second is if they deem, so completely subjective, if they deem that your burn will be able to be lower or will continue to maintain that shareholder equity. So that's, that's what's driving that. So it wasn't-

Speaker 3

So you-

Hil Davis (CEO)

driven by being, staying listed on the Nasdaq.

Speaker 3

Oh, 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?

Hil Davis (CEO)

That's right. Yes, sir. That's... unfortunately, that's right. Exactly. And we went through the same thing last year because of this same issue. Now, what's really important, too, is to keep in mind, as you move into the rest of this year, if you look at our interest expense line, you'll see that it's pretty meaningful. That, that, majority, a lot, not a majority, some of it rolls off at the end of Q2 because that, debt's paid back. And then the majority of it, will roll off in Q3 because that date, that debt's paid back. So when you get into Q4 and then next year, that interest expense line is probably 20% of what it is now.

Speaker 3

Mm-hmm.

Hil Davis (CEO)

So when really, when you look at that, that's gonna be pretty significant. And then secondly, next year, we also a $1,000 a quarter in the Stateside depreciation and amortization, no longer running through the books. So we have to amortize the goodwill of, of all our acquisitions. So at the end of the-

Speaker 3

Mm-hmm

Hil Davis (CEO)

Q4 this year, it's $800,000 a year. So $200,000 will come back to the books starting in Q1 next year. So what's interesting is when you look at that, just alone, Q1 next year, you're gonna pick up probably $600,000 just in non-cash ex- or interest expense, which is amortized, as well as the the Stateside goodwill as well. So that'll also be a benefit. Doesn't impact Q1 or Q2, but it does benefit the, as we move forward, starting in Q4 on the interest expense side, in Q1, both interest expense and goodwill.

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

Operator (participant)

One moment, please, while we reconnect the speaker line. Ladies and gentlemen, please remain on the line while we reconnect the speaker line.

Hil Davis (CEO)

Hi, Holly, I'm back on.

Operator (participant)

Your line is live. Your line is live.

Hil Davis (CEO)

Okay. Sorry, I don't know where I cut off on my last response.

Speaker 3

You had finished talking about the amortization and interest expense.

Hil Davis (CEO)

Yeah, so you'll pick up, you know, probably $400,000 in Q4, and then you'll pick up over $600,000 in Q1, pretty much every quarter going forward, Q1, Q2, and Q3 of next year as well. So it's pretty meaningful as you, as you really think about the earnings shape of the company going forward.

Speaker 3

Mm-hmm

Hil Davis (CEO)

... So given the G&A leverage. So that'll be, that'll be a benefit as well to everything that's going forward.

Speaker 3

So without giving formal guidance, so you anticipate being cash flow positive then, very soon?

Hil Davis (CEO)

Yeah, internal cash flow positive. That's right. Exactly. And then from a pure GAAP perspective, yeah, we would, we would think we'd start approaching that as well, just from a pure GAAP accounting perspective. Q4, you never know because-

... The problem is, all these auditors are getting reviewed by the PCAOB. As an example, like, they were coming back when we were doing our annual, and they were asking, you know, they were asking us to pull 1,000 invoices to prove that a zipper costs $0.05, and you're like, that's not even 1% of the product cost, which is not what they consider a significant event. So hopefully, we're done with all the, our auditors being under PCAOB review, because it also just adds a ton of cost. Also, we-- Yeah, being public costs us $600,000 in the first quarter alone. It's pretty expensive.

Speaker 3

You have Enron to thank for that.

Hil Davis (CEO)

Yeah, that's exactly right. That's exactly right. So, we do think that'll happen, and it'll happen as we move to the second half of the year and then continue going forward.

Speaker 3

Okay, very good. Thank you for the color on that.

Hil Davis (CEO)

Yes, sir.

Operator (participant)

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

Speaker 4

Good morning.

Hil Davis (CEO)

Hi, one second. Let me turn off the, I have the speaker on the computer in the other room.

Okay.

Speaker 4

Pause it. Okay. So 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, like, 1,000%-5,000% increase in revenue in the next two 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?

Hil Davis (CEO)

We don't necessarily look at it that way because, you know, we're wholly. You've got different revenue drivers, and, you know, on the wholesale side, you just don't know. You don't, you know, you, you're showing a couple of months ahead, but the wholesalers, you know, buy based on what's happening in the market right now, so it's more emotional than it is anything else, so it's pretty difficult to predict that.

Speaker 4

Right.

Hil Davis (CEO)

And then as far as e-commerce, it's just steady state and just kind of, especially now that it's ROAS-based, and the stores, you just gotta, you'll have to figure out where they, how they perform. So I think it's probably a little bit harder because my guess is your variability factors will be a lot higher, so all your inputs will have a very high variable factor and, or, you know-

Speaker 4

Right

Hil Davis (CEO)

... standard, wide standard deviations, which would make it harder. But I do think that, you know, we are coming off, you know, the lowest revenue in the second half of last year. We're lapping that. Obviously, as we lap that, we're getting the interest expense back. And then as you move into next year, you get all the Stateside goodwill back, and then you just continue to build the business. And then I think, too, what people often underestimate is when you build small brands and you start building the customer base up, those- as those customers start to repeat, what ends up happening is you start to build a space that gets stairstep function higher. But once you get, start to get to certain levels, that stairstep function starts to become more of a higher slope and less of a stairstep and more-

Speaker 4

Yes.

Hil Davis (CEO)

It's not a hockey stick, per se, but I think-

Speaker 4

The stairstep function. Okay, now you're speaking my language. Yes.

Hil Davis (CEO)

Yeah. So I think that's, and we're still in that stairstep function space because most of our brands are small. But what ends up happening is we're starting to see that stairstep function get, get a higher slope, and I think that's the big difference here, is you're gonna start to can see that. And you see it all the time with brands. Like, I started a brand called J. Hilburn, that went through the same thing. You know, it's just slow and steady, and all of a sudden you get into certain markets and you're a brand, and then it goes up to the right because there's a virality coefficient that happens when you get a certain amount of repeat customers in your customer base.

Every quarter that goes by, you get closer and closer to that moment of virality, basically, based on just the number of customers in your base.

Speaker 4

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

Hil Davis (CEO)

Yeah, I can't comment on that, but I definitely think, you know, we have-

Speaker 4

Right

Hil Davis (CEO)

... the ability to grow revenue, and I think a lot of it is just awareness, too. I mean, when you look at some of these bigger brands that are out there, even ones that aren't performing like Allbirds, or you've got Warby Parker that's starting to perform. A lot of it's just they had a lot of money. They raised, you know, $100,000,000s in the private market, built a ton of brand awareness. They built a customer base that, you know, is basically repeats, and that's, that's really what it is. All they did was take the normal timeline to growth and shrunk it by raising a lot of capital. You know, we're obviously not raising that amount of capital, so our timeline isn't as short as theirs, but it, it's the same path and process.

Speaker 4

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

Hil Davis (CEO)

Yeah, they've done a nice job, and they've raised a lot of money. They have stores. The stores have worked for them. Some have, some haven't, and I think that goes back to the original, where, you know, it's, you know, Warby Parker stores are working better than Allbirds stores, but you never know. And, you know, we look at stores and other brands all the time, and we know that this formula works. You have stores, you have e-commerce, and you have wholesale. And that's, and you kind of want a healthy mix there, and if you have all three of those oars in the water, then you end up building a good business because you're in all the channels. So that's how we kind of think about it.

Speaker 4

Right. 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, this will never work. What garbage? Blah, blah, blah.

Hil Davis (CEO)

Well, I mean, Warby Parker, I think everyone would argue, is a digital company as well, and they have over 170 stores. Allbirds is also a digital company. They have something like 65 stores. Marine Layer, digital company, they're private. I think they have over 40 stores. Buck Mason, also a digital company, has over 27 stores. Like, I can keep naming them, right? There's-- It just-- 'Cause you're digital first, and that's how you were born or what you're doing, doesn't mean you ignore where you can drive revenue. So it's, it's pretty lowbrow thinking or low IQ thinking, and-

Speaker 4

Right.

Hil Davis (CEO)

I think what you have to realize, too, is, like, when I launched J. Hilburn, I was at Citadel Investment Group. I was covering restaurants, retail. I'd covered Amazon and Jeff Bezos forever, and he always said that they struggled in apparel. That was the number one category they struggled in. And if you look at the data today, where they do well in apparel is basics. They don't do well with branded e-commerce, and the reason he always said is that apparel is touch, see, feel, fit. So if Jeff Bezos-

Speaker 4

Yes.

Hil Davis (CEO)

who's probably one of the smartest people-

Speaker 4

Yes

Hil Davis (CEO)

we've ever seen run a business, that can't-

Speaker 4

That is.

Hil Davis (CEO)

That tells you a lot.

Speaker 4

... the methodology. I have a theory that in the future, you know, as time goes on, clothes will generally start to become brandless. People will just say, "You know, I want just the cheapest, coolest denim possible, and I don't care what brand it is." You know, as things start to go more online and online, and more digital in the future, I think that's gonna be a trend. And, I gotta tell you, I regret not buying Amazon stock in the 1990s. I think I had some Musicland stock. Yeah. Wow!

Hil Davis (CEO)

But I think that's, I think that's the key, right? I mean, even look at J.Crew. They were a catalog. They started opening stores. Their revenues just went through the roof, right? Because then you go in, you know, you're, you're this size, you like this product. As long as you continue to keep that fit and make to that product quality, then they go online and buy. So I think what people miss is that in apparel, you acquire in the physical, and you retain in the digital. It's that simple. So the whole point is, you need a good customer acquisition trap, and I think that's where wholesale comes in, and I think that's where stores come in, and then your digital becomes the retention engine, right? And that's your profitability engine, too, because you're not spending as much to acquire a customer.

So I think that's where people miss it, and I, again, I go back to, I think everyone would argue Jeff Bezos is a pretty smart guy, built a pretty big business. He. Go back and read all his K's, his Q's, and his earnings report, and his earnings call, and he will tell you, they couldn't crack retail or apparel. So if they can't crack apparel, and he's spending more money and more time against it than anyone in this room, and if you added all our IQs together, he's probably smarter than all that, too. That tells you a lot, right? So I think that's why you have to have all three. So you can't look at it as, just 'cause you're digital first, doesn't mean you're digital only. You can't be digital only, you can't be wholesale only, and you can't be store only.

You have to have all the oars in the water at once, and that's just the reality of it. The mixes will shift as the consumer shifts, right? I mean, during COVID, there were no stores to go into, so digital was massive. As people have come out of COVID, they wanna shop. So you need to follow the customer. You don't follow a business principle and say, "Nope, we're only digital, and the customer's wrong. They don't. They wanna shop in stores, but we're not gonna do that because we're smarter than them." That's not a good recipe for success. But the problem is that people online are oftentimes, sadly, one standard deviation thinkers. So they only think through that one piece and not like, "Oh, what would...

Like, if you do pull X, what happens in, you know, Y, Z, and A downstream, and how does that impact in what you need to do?

Operator (participant)

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