Digital Brands Group(DBGI) - 2023 Q3 - Quarterly Report

PART I. FINANCIAL INFORMATION This section presents the company's financial statements and related disclosures ITEM 1. Condensed Consolidated Financial Statements – Unaudited This section presents the unaudited condensed consolidated financial statements for Digital Brands Group, Inc., including the balance sheets, statements of operations, statements of stockholders' deficit, and statements of cash flows, along with detailed notes explaining significant accounting policies, financial instruments, debt, equity, and other relevant financial information for the periods ended September 30, 2023, and December 31, 2022 Condensed Consolidated Balance Sheets The condensed consolidated balance sheets show a decrease in total assets and total liabilities from December 31, 2022, to September 30, 2023, with a significant improvement in stockholders' equity from a deficit to a positive balance | Metric | September 30, 2023 ($) | December 31, 2022 ($) | | :-------------------------------- | :------------------- | :------------------ | | Total assets | $27,737,807 | $33,738,055 | | Total liabilities | $22,516,462 | $41,191,229 | | Total stockholders' equity (deficit) | $5,221,345 | $(7,453,174) | - Current assets decreased from $8,829,393 at December 31, 2022, to $7,650,080 at September 30, 2023, primarily due to reductions in cash, accounts receivable, and due from factor[8] - Total current liabilities significantly decreased from $40,893,791 at December 31, 2022, to $22,359,678 at September 30, 2023, largely driven by the elimination of contingent consideration liability and a reduction in promissory notes payable[8] Condensed Consolidated Statements of Operations The condensed consolidated statements of operations show improved net revenues and gross profit for both the three and nine months ended September 30, 2023, compared to the prior year, leading to a reduced net loss for the nine-month period, despite an increased net loss for the three-month period | Metric | 3 Months Ended Sep 30, 2023 ($) | 3 Months Ended Sep 30, 2022 ($) | 9 Months Ended Sep 30, 2023 ($) | 9 Months Ended Sep 30, 2022 ($) | | :----------------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Net revenues | $3,257,332 | $2,658,844 | $12,127,135 | $7,937,406 | | Gross profit | $1,703,288 | $958,298 | $6,032,603 | $2,684,464 | | Income (loss) from operations | $(3,422,162) | $(2,438,800) | $676,489 | $(18,562,356) | | Net loss | $(5,435,994) | $(4,894,471) | $(6,528,082) | $(22,261,338) | | Net loss from continuing per common share - basic and diluted | $(14.55) | $(223.83) | $(17.50) | $(1,607.05) | - Net revenues increased by 22.5% for the three months and 52.8% for the nine months ended September 30, 2023, compared to the same periods in 2022[9] - Gross profit increased significantly by 77.7% for the three months and 124.7% for the nine months ended September 30, 2023, compared to the same periods in 2022[9] Condensed Consolidated Statements of Stockholders' Deficit The statements of stockholders' deficit reflect a substantial improvement from a deficit of $(7,453,174) at December 31, 2022, to a positive equity of $5,221,345 at September 30, 2023, primarily driven by significant increases in additional paid-in capital from equity issuances and a reduction in accumulated deficit | Metric | September 30, 2023 | December 31, 2022 | | :-------------------------- | :------------------- | :------------------ | | Common stock shares outstanding | 578,090 | 317,502 | | Additional paid-in capital ($) | $115,496,683 | $96,294,123 | | Accumulated deficit ($) | $(110,275,397) | $(103,747,316) | | Total stockholders' equity (deficit) ($) | $5,221,345 | $(7,453,174) | - The Company issued 5,761 shares of Series C convertible preferred stock in 2023, contributing to the increase in equity[10] - Significant common stock issuances occurred in 2023, including shares for private placements, services, and the H&J Settlement Agreement, increasing outstanding shares and additional paid-in capital[10] Condensed Consolidated Statements of Cash Flows The condensed consolidated statements of cash flows indicate a reduced net cash outflow from operating activities for the nine months ended September 30, 2023, compared to the prior year, and a shift to cash provided by investing activities. Financing activities continued to be a primary source of cash, though at a lower amount than the prior year | Metric | 9 Months Ended Sep 30, 2023 ($) | 9 Months Ended Sep 30, 2022 ($) | | :----------------------------------- | :-------------------------- | :-------------------------- | | Net cash used in operating activities | $(6,457,638) | $(8,689,857) | | Net cash provided by (used in) investing activities | $41,331 | $(5,533) | | Net cash provided by financing activities | $6,207,950 | $8,362,395 | | Net change in cash and cash equivalents | $(208,357) | $(332,995) | | Cash and cash equivalents at end of period | $1,067,259 | $195,399 | - Cash used in operating activities decreased by $2.2 million, primarily due to a lower net loss[11][175] - Investing activities shifted from a net cash outflow of $5,533 in 2022 to a net cash inflow of $41,331 in 2023, mainly due to a reduction of deposits[11][176] - Financing activities provided $6.2 million in cash, primarily from equity offerings and new loans, partially offset by debt repayments[11][177] Notes to Condensed Consolidated Financial Statements The notes provide detailed explanations of the Company's business, significant accounting policies, financial instruments, debt, equity, and other relevant financial information, offering crucial context to the condensed consolidated financial statements NOTE 1: NATURE OF OPERATIONS Digital Brands Group, Inc. (DBG) operates as a curated collection of lifestyle apparel brands, including Bailey 44, DSTLD, Stateside, and ACE Studios, offering products through direct-to-consumer and wholesale channels. The Company has expanded its portfolio through several acquisitions, with the most recent being Sundry in December 2022, and a disposition of Harper & Jones (H&J) in June 2023 - DBG is a curated collection of lifestyle brands (Bailey 44, DSTLD, Harper & Jones, Stateside, ACE Studios) offering apparel through direct-to-consumer and wholesale distribution[13] - Acquisitions include Bailey 44 (Feb 2020), Harper & Jones (May 2021), Stateside (Aug 2021), and Sundry (Dec 2022)[13][14][15][16] - On June 21, 2023, the Company disposed of its membership interest in Harper & Jones (H&J) through a Settlement Agreement, involving a cash payment and issuance of common stock to the former owners[17] NOTE 2: GOING CONCERN The Company's ability to continue as a going concern is in substantial doubt due to a history of net losses, negative cash flows from operations, and a significant working capital deficit. Future operations depend on generating sufficient cash flows or securing additional financing, which may dilute existing shareholders - The Company has not generated profits since inception and sustained net losses of $6,528,082 and $22,261,338 for the nine months ended September 30, 2023 and 2022, respectively[18] - As of September 30, 2023, the Company had a working capital deficit of $14,709,598[18] - The Company's ability to continue as a going concern is dependent on generating sufficient cash flows from operations or obtaining additional capital financing, with no assurance of success[19] NOTE 3: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES This note outlines the Company's key accounting policies, including GAAP conformity, retroactive adjustments for reverse stock splits, principles of consolidation, use of estimates, reclassification of prior period financial statements, and fair value measurements. It also details the accounting for contingent consideration, inventory valuation, goodwill impairment, and net loss per share calculations Basis of Presentation The Company's financial statements are prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP) - Financial statements conform to GAAP[21] Reverse Stock Split The Company implemented two reverse stock splits: one-for-100 effective November 3, 2022, and one-for-25 effective August 22, 2023, with all share and per share amounts retroactively adjusted - A one-for-100 reverse stock split became effective on November 3, 2022[22] - A one-for-25 reverse stock split became effective on August 22, 2023[23] - All share and per share amounts in financial statements are retroactively adjusted to reflect these splits[22][23] Unaudited Interim Financial Information The interim financial statements are unaudited, prepared according to SEC rules, and include only normal recurring adjustments. They should be read in conjunction with the Company's audited annual financial statements - Interim financial statements are unaudited and prepared in accordance with SEC rules for interim reporting[24] - Disclosures are condensed or omitted per rules, but adequate to prevent misleading information[24] - Results of operations are not necessarily indicative of the full year ended December 31, 2023[24] Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries (Bailey, H&J, Stateside) from their acquisition dates, with inter-company transactions eliminated. H&J's accounts were no longer consolidated after June 21, 2023, due to its disposition - Consolidated financial statements include the Company and its wholly-owned subsidiaries Bailey, H&J, and Stateside from acquisition dates[26] - All inter-company transactions and balances are eliminated upon consolidation[26] - As of June 21, 2023, H&J's assets, liabilities, revenues, and expenses are no longer consolidated due to its disposition[26] Use of Estimates The preparation of financial statements requires management to make estimates and assumptions, particularly for inventory, impairment of long-lived assets, contingent consideration, and derivative liabilities. These estimates are based on historical experience and market factors, and actual results may differ - Significant estimates include inventory, impairment of long-lived assets, contingent consideration, and derivative liabilities[27] - Estimates are based on historical experience, known trends, and market factors, and are evaluated on an ongoing basis[27] - Actual results could differ from these estimates[27] Reclassification of Previously Issued Financial Statements Certain prior year accounts were reclassified to conform with current year presentation, specifically regarding cost of net revenue, general and administrative expenses, and discontinued operations. These reclassifications had no effect on the reported results of operations - Reclassified $916,693 in general and administrative expenses to net revenues for the nine months ended September 30, 2022, primarily for personnel and warehouse costs[29] - Reclassified H&J's assets and liabilities as of December 31, 2022, on the consolidated balance sheet due to its discontinued operations[30] - These reclassifications had no effect on the reported results of operations[29] Cash and Equivalents and Concentration of Credit Risk The Company defines cash equivalents as highly liquid securities with original maturities under three months. As of September 30, 2023, and December 31, 2022, the Company held no cash equivalents, and its cash in bank accounts may exceed federally insured limits - Cash equivalents are highly liquid securities with original maturities under three months[31] - No cash equivalents were held as of September 30, 2023, and December 31, 2022[31] - Cash in bank deposit accounts may exceed federally insured limits of $250,000[31] Fair Value of Financial Instruments The Company's financial instruments, including cash, prepaid expenses, accounts payable, and various debt, are carried at values representative of their fair market value due to their short maturity. Contingent consideration, previously a Level 3 liability, was valued at $0 as of September 30, 2023 - Carrying values of financial instruments (cash, prepaid expenses, accounts payable, accrued expenses, related party notes, convertible debt) approximate fair value due to short maturity[32] | Liabilities | September 30, 2023 (Level 3) ($) | December 31, 2022 (Level 3) ($) | | :------------------------ | :--------------------------- | :-------------------------- | | Contingent consideration | $0 | $12,098,475 | Contingent Consideration Contingent consideration liabilities, related to stock price guarantees from the Bailey44 and H&J acquisitions, were valued using a Monte Carlo simulation model. As of September 30, 2023, these liabilities were reduced to $0 due to the Norwest Waiver and H&J Settlement Agreement, resulting in significant gains - Contingent consideration liability was related to stock price guarantees from Bailey44 and H&J acquisitions, classified as a Level 3 financial instrument[34] - The Norwest Waiver on June 21, 2023, resulted in a $10,698,475 gain by reducing the Bailey Merger Agreement contingent consideration to $0[39] - The H&J Settlement Agreement on June 21, 2023, reduced the H&J contingent consideration to $0, resulting in a $1,400,000 gain included in discontinued operations[40] | Company | September 30, 2023 ($) | December 31, 2022 ($) | | :-------------- | :------------------- | :------------------ | | Bailey | $0 | $10,698,475 | | Harper & Jones | $0 | $1,400,000 | | Total | $0 | $12,098,475 | Inventory Inventory is valued at the lower of cost or net realizable value, using the weighted average cost method for DSTLD and FIFO for Bailey, Stateside, and Sundry. It primarily consists of finished goods, raw materials, and work in process, showing a slight decrease from December 31, 2022, to September 30, 2023 - Inventory is stated at the lower of cost or net realizable value[42] - Weighted average cost method is used for DSTLD, and first-in, first-out (FIFO) method for Bailey, Stateside, and Sundry[42] | Inventory Component | September 30, 2023 ($) | December 31, 2022 ($) | | :------------------ | :------------------- | :------------------ | | Raw materials | $1,508,416 | $1,611,134 | | Work in process | $653,412 | $888,643 | | Finished goods | $2,548,499 | $2,622,787 | | Total Inventory | $4,710,327 | $5,122,564 | Goodwill Goodwill and indefinite-lived intangible assets are not amortized but tested annually for impairment. In 2022, the Company recognized a significant impairment loss of $11,872,332 for goodwill and $3,667,000 for brand name assets due to reduced revenues and liabilities exceeding assets for Bailey44 and H&J. Goodwill remained stable at $8,973,501 as of September 30, 2023, after derecognizing $1,130,311 related to the H&J disposition - Goodwill and indefinite-lived intangible assets are tested annually for impairment, not amortized[44] - In 2022, an impairment loss of $11,872,332 for goodwill and $3,667,000 for brand name assets was recorded due to reduced revenues and liabilities exceeding assets for Bailey44 and H&J[45] | Business Combination | September 30, 2023 ($) | December 31, 2022 ($) | | :------------------- | :------------------- | :------------------ | | Bailey | $3,158,123 | $3,158,123 | | Stateside | $2,104,056 | $2,104,056 | | Sundry | $3,711,322 | $3,711,322 | | Total Goodwill | $8,973,501 | $8,973,501 | - The Company derecognized $1,130,311 in goodwill in connection with the H&J disposition[55] Net Loss per Share Net loss per share is calculated by dividing net loss by the weighted-average common shares outstanding. Potentially dilutive securities are excluded if their inclusion would be anti-dilutive, as was the case for all listed potentially dilutive shares as of September 30, 2023 and 2022 - Net loss per share is computed by dividing net loss by weighted-average common shares outstanding, excluding shares subject to redemption or forfeiture[46] - Potentially dilutive securities are excluded from diluted net loss per share if anti-dilutive[46] | Potentially Dilutive Shares | September 30, 2023 (Shares) | September 30, 2022 (Shares) | | :-------------------------- | :------------------- | :------------------- | | Convertible notes | — | 47,092 | | Series A convertible preferred stock | 27,097 | 27,097 | | Series C convertible preferred stock | 321,395 | — | | Common stock warrants | 1,662,096 | 5,285 | | Stock options | 1,558 | 1,558 | | Total potentially dilutive shares | 2,012,145 | 81,032 | - Stock options and warrants were out-of-the-money as of September 30, 2023 and 2022[47] Recent Accounting Pronouncements The Company adopted ASU 2019-04 and ASU 2019-05 (related to Topic 326, Financial Instruments-Credit Losses) on January 1, 2023, which did not materially impact its financial statements. No other recently issued, but not yet effective, accounting standards are expected to have a material effect - Adopted ASU 2019-04 and ASU 2019-05 (related to Topic 326, Financial Instruments-Credit Losses) on January 1, 2023[48] - Adoption of new guidance did not have a material impact on condensed consolidated financial statements[48] - No other recently issued, but not yet effective, accounting standards are expected to have a material effect[49] Unaudited Pro Forma Financial Information Unaudited pro forma financial information is presented as if the Sundry acquisition occurred on January 1, 2022, showing hypothetical net revenues of $23,995,555 and a net loss of $8,405,222 for the nine months ended September 30, 2022. This information is not indicative of actual or future results - Pro forma financial information assumes Sundry acquisition occurred on January 1, 2022[49] | Metric | Nine Months Ended September 30, 2022 (Pro Forma) ($) | | :------------------------ | :--------------------------------------------- | | Net revenues | $23,995,555 | | Net loss | $(8,405,222) | | Net loss per common share | $(29.63) | - Pro forma information is not indicative of actual or future financial results and does not include potential cost savings or operating efficiencies[49] NOTE 4: DISCONTINUED OPERATIONS On June 21, 2023, the Company disposed of Harper & Jones (H&J) through a Settlement Agreement, transferring its membership interest and issuing common stock and cash to the former owners. This transaction resulted in a loss on disposition of business of $1,523,940, and H&J's results are excluded from continuing operations - On June 21, 2023, the Company executed a Settlement Agreement to dispose of Harper & Jones (H&J)[50] - The H&J Settlement involved a cash payment of $229,000 and the issuance of 1,952,580 shares of common stock to D. Jones[50] - The disposition resulted in a loss on disposition of business of $1,523,940[51][52] | Metric (H&J Discontinued Operations) | 3 Months Ended Sep 30, 2023 ($) | 3 Months Ended Sep 30, 2022 ($) | 9 Months Ended Sep 30, 2023 ($) | 9 Months Ended Sep 30, 2022 ($) | | :----------------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Net revenues | $0 | $765,678 | $1,405,482 | $2,658,527 | | Gross profit | $0 | $409,329 | $839,861 | $1,696,765 | | Net loss from discontinued operations | $0 | $(160,432) | $(1,562,503) | $(326,507) | NOTE 5: DUE FROM FACTOR The net amount due from factor decreased significantly from $839,400 at December 31, 2022, to $258,825 at September 30, 2023, reflecting changes in outstanding receivables and advances | Component | September 30, 2023 ($) | December 31, 2022 ($) | | :---------------------- | :------------------- | :------------------ | | Outstanding receivables: Without recourse | $308,918 | $1,680,042 | | Outstanding receivables: With recourse | $29,843 | $65,411 | | Matured funds and deposits | $103,095 | $81,055 | | Advances | $(172,285) | $(632,826) | | Credits due customers | $(10,746) | $(354,282) | | Total Due from Factor, net | $258,825 | $839,400 | NOTE 6: GOODWILL AND INTANGIBLE ASSETS Goodwill remained stable at $8,973,501 as of September 30, 2023, after derecognizing $1,130,311 due to the H&J disposition. Identifiable intangible assets, primarily customer relationships and brand names, totaled $10,701,764, with amortization expense recognized for customer relationships | Business Combination | September 30, 2023 ($) | December 31, 2022 ($) | | :------------------- | :------------------- | :------------------ | | Bailey | $3,158,123 | $3,158,123 | | Stateside | $2,104,056 | $2,104,056 | | Sundry | $3,711,322 | $3,711,322 | | Total Goodwill | $8,973,501 | $8,973,501 | - The Company derecognized $1,130,311 in goodwill and $1,246,915 in intangible assets in connection with the H&J disposition[55][56] | Intangible Asset | Gross Amount ($) | Accumulated Amortization ($) | Carrying Value ($) | | :----------------------- | :----------- | :----------------------- | :------------- | | Amortized: Customer relationships | $9,734,560 | $(4,874,676) | $4,859,884 | | Indefinite-lived: Brand name | $5,841,880 | — | $5,841,880 | | Total Intangible Assets | $15,576,440 | $(4,874,676) | $10,701,764 | - Amortization expense was $719,547 and $537,813 for the three months ended September 30, 2023 and 2022, respectively, and $2,478,824 and $1,613,438 for the nine months ended September 30, 2023 and 2022, respectively[57] NOTE 7: LIABILITIES AND DEBT This note details the Company's various liabilities and debt instruments, including accrued expenses, convertible notes, PPP and SBA loans, merchant advances, and promissory notes. Significant changes include the repayment of December Notes, conversion of the Sundry Note into Series C Preferred Stock, and new March 2023 Notes Accrued Expenses and Other Liabilities Accrued expenses and other liabilities increased to $4,781,632 as of September 30, 2023, from $3,936,920 at December 31, 2022, primarily due to higher payroll-related liabilities, including significant payroll taxes due | Component | September 30, 2023 ($) | December 31, 2022 ($) | | :------------------------ | :------------------- | :------------------ | | Accrued expenses | $489,628 | $668,714 | | Reserve for returns | — | $307,725 | | Payroll related liabilities | $3,792,438 | $2,618,870 | | Sales tax liability | $304,748 | $262,765 | | Other liabilities | $194,817 | $78,845 | | Total Accrued Expenses and Other Liabilities | $4,781,632 | $3,936,920 | - Payroll liabilities as of September 30, 2023, included $1,406,403 in payroll taxes due to federal and state authorities, subject to penalties and interest[58] - Accrued expenses included $535,000 for common stock issuances related to an advisory agreement, expected in Q4 2023[59] Convertible Debt The Company's convertible debt decreased significantly, with $100,000 remaining from the 2020 Regulation D Offering. The $4,000,000 December Notes were fully repaid in February 2023, leading to a $689,100 loss on extinguishment of debt - As of September 30, 2023, $100,000 in outstanding principal remained from the 2020 Regulation D Offering[60] - The $4,000,000 principal of the December Notes was fully repaid in February 2023[63] - A loss on extinguishment of debt of $689,100 was recognized in connection with the December Notes repayment[63] | Convertible Note Summary | December 31, 2022 ($) | September 30, 2023 ($) | | :----------------------- | :------------------ | :------------------- | | Principal | $4,100,000 | $100,000 | | Unamortized Debt Discount | $(1,378,200) | $0 | | Convertible Note Payable, Net | $2,721,800 | $100,000 | Loan Payable — PPP and SBA Loan Bailey had an outstanding PPP Loan balance of $933,295 as of September 30, 2023, and December 31, 2022, which matures in 2026 - Bailey had an outstanding PPP Loan balance of $933,295 as of September 30, 2023, and December 31, 2022[66] - The PPP Loan matures in 2026[66] Merchant Advances The Company obtained merchant advances in 2022 and 2023, secured by future sales transactions. The outstanding principal from 2022 advances was $438,000 as of September 30, 2023, and new 2023 advances from Shopify Capital and another lender totaled $506,728 outstanding - Outstanding principal from 2022 merchant advances was $438,000 as of September 30, 2023, after receiving $2,880,238 in proceeds and making $3,338,572 in repayments during the nine months ended September 30, 2023[67] - In 2023, new merchant advances totaling $902,051 were obtained from Shopify Capital and another lender, with $506,728 remaining outstanding as of September 30, 2023[68] - These advances are generally secured by expected future sales transactions with weekly or daily payments[67][68] Promissory Note Payable Promissory notes payable decreased from $9,000,000 at December 31, 2022, to $4,899,018 at September 30, 2023. The Bailey Note's maturity was extended to June 30, 2024. The Sundry Note was cancelled and converted into Series C Preferred Stock. New March 2023 Notes, totaling $2,458,750 in principal, are currently in default but parties are working on an extension - The Bailey Note principal of $3,500,000 had its maturity date extended to June 30, 2024[69] - The $5,500,000 Sundry Note was cancelled and converted into 5,761 shares of Series C Convertible Preferred Stock in June 2023[70] - March 2023 Notes, with an aggregate principal of $2,458,750, are due September 30, 2023, and are currently in default, though an extension is being negotiated[71] | Promissory Note | September 30, 2023 ($) | December 31, 2022 ($) | | :---------------------- | :------------------- | :------------------ | | Bailey Note | $3,500,000 | $3,500,000 | | Sundry Note | — | $5,500,000 | | March 2023 Notes - principal | $1,399,018 | — | | Total Promissory Note Payable, net | $4,899,018 | $9,000,000 | NOTE 8: STOCKHOLDERS' DEFICIT This note details significant changes in stockholders' deficit, including multiple common stock issuances through private placements and for services, warrant exercises, and the designation and subsequent cancellation of Series A and B Preferred Stock. It also outlines the creation and terms of Series C Convertible Preferred Stock Common Stock Issuances and Warrants The Company issued a significant number of common shares and warrants in 2023 through private placements (January and August), for services, and in connection with the H&J Settlement Agreement, raising substantial capital and increasing outstanding shares - January Private Placement: Issued 1,277,140 common shares (including pre-funded warrant exercises) for $5.0 million gross proceeds ($4.3 million net)[75] - August Private Placement: Agreed to issue 32,000 common shares and 481,875 pre-funded warrants (unexercised as of Sep 30, 2023) for $5.0 million gross proceeds ($3.8 million net)[78] - Issued 1,952,580 common shares for $1,357,043 fair value as part of the H&J Settlement Agreement in June 2023[77] - Exercised warrants for 123,814 common shares for $1,167,566 proceeds after a warrant amendment in August 2023[79] - Issued 63,000 common shares to employees and consultants under the 2023 Stock Purchase Plan, recording $657,090 in stock-based compensation[82] Series A Preferred Stock A single share of Series A Preferred Stock, issued to the CEO in August 2022 for $25,000, carried 250,000,000 votes for reverse stock split and authorized share increase proposals. It was redeemed in October 2022 and subsequently cancelled on September 13, 2023 - One share of Series A Preferred Stock was issued to the CEO for $25,000 in August 2022[83][84] - It had 250,000,000 votes per share, exclusively for reverse stock split and authorized common stock increase proposals[84][85] - The share was redeemed in October 2022 and the Series A Certificate of Designation was cancelled on September 13, 2023[85][86] Series B Preferred Stock A single share of Series B Preferred Stock was issued to the CEO in May 2023 for $25,000, granting 250,000,000 votes solely for reverse stock split proposals. It had no conversion, dividend, or liquidation rights and was automatically redeemed upon the reverse stock split's effectiveness, with its certificate of designation cancelled on September 13, 2023 - One share of Series B Preferred Stock was issued to the CEO for $25,000 in May 2023[87] - It carried 250,000,000 votes per share, exclusively for reverse stock split proposals[88] - The Series B Preferred Stock had no conversion, dividend, or liquidation rights[89] - It was automatically redeemed upon the effectiveness of a reverse stock split and its certificate of cancellation was filed on September 13, 2023[90][91] Series C Convertible Preferred Stock In June 2023, the Company issued 5,761 shares of Series C Convertible Preferred Stock to Sundry Investors at $1,000 per share, in exchange for the cancellation of promissory notes. These shares are convertible into common stock at a conversion price of $0.717, rank senior to common stock in liquidation, and have voting rights on an as-if-converted basis - Issued 5,761 shares of Series C Convertible Preferred Stock to Sundry Investors on June 21, 2023, at $1,000 per share[92] - Issued in consideration for the cancellation of promissory notes from the Sundry acquisition[92] - Convertible into common stock at a conversion price of $0.717 per share[99] - Ranks senior to common stock in liquidation and has voting rights on an as-if-converted basis[97][98] NOTE 9: RELATED PARTY TRANSACTIONS The Company made net repayments of $218,967 to related parties during the nine months ended September 30, 2023, reducing the outstanding balance to $336,250. These advances are unsecured, non-interest bearing, and due on demand, primarily from current and former executives and a board member - Net repayments to related parties totaled $218,967 for the nine months ended September 30, 2023[101] | Metric | September 30, 2023 ($) | December 31, 2022 ($) | | :---------------------- | :------------------- | :------------------ | | Amounts due to related parties | $336,250 | $556,225 | - Advances from related parties are unsecured, non-interest bearing, and due on demand[101] - Advances from Trevor Pettennude totaling $325,000 in October 2022 were paid off in September 2023[102] NOTE 10: SHARE-BASED PAYMENTS This note details the Company's share-based payment activities, including common stock warrants issued in connection with private placements and merchant advances, and stock options. It also reports the stock-based compensation expense recognized for the periods Common Stock Warrants The Company issued a significant number of common stock warrants in 2023 through private placements and merchant advances, with varying exercise prices and expiration dates. A warrant amendment in August 2023 reduced the exercise price of certain existing warrants, leading to immediate exercises - Granted 51,085 warrants in connection with the January Private Placement, with an exercise price of $9.43 per share[105] - Granted 6,095 warrants for merchant advances with an exercise price of $131.25[106] - Granted 1,027,750 warrants in connection with the August Private Placement, with an exercise price of $9.43 per share[107] - A warrant amendment in August 2023 reduced the exercise price of 196,542 existing warrants to $9.43 per share, leading to the exercise of 123,814 shares for $1,167,566[108] | Warrant Activity | Common Stock Warrants (Shares) | Weighted Average Exercise Price ($) | | :----------------------- | :-------------------- | :------------------------------ | | Outstanding - Dec 31, 2022 | 176,733 | $209.25 | | Granted | 1,641,262 | $14.69 | | Exercised | (155,899) | $27.63 | | Outstanding - Sep 30, 2023 | 1,662,096 | $20.86 | Stock Options As of September 30, 2023, the Company had 1,558 stock options outstanding with a weighted average exercise price of $9,055.50 per share, of which 1,463 were exercisable. Stock-based compensation expense for options was $101,417 and $110,092 for the three months ended September 30, 2023 and 2022, respectively - As of September 30, 2023, 1,558 stock options were outstanding with a weighted average exercise price of $9,055.50 per share[110] - 1,463 options were exercisable as of September 30, 2023[110] - Stock-based compensation expense was $101,417 and $110,092 for the three months ended September 30, 2023 and 2022, respectively[111] - Total unrecognized compensation cost related to non-vested stock option awards was $269,490 as of September 30, 2023, to be recognized over 0.77 years[111] NOTE 11: LEASE OBLIGATIONS The Company extended lease agreements for its corporate office/distribution center and a showroom in Los Angeles in 2023, recognizing new right-of-use assets and liabilities. Total rent expense for the three and nine months ended September 30, 2023, was $140,304 and $401,444, respectively - In January 2023, the Company extended its corporate office and distribution center lease in Vernon, California, recognizing a right-of-use asset and liability of $467,738[113] - In May 2023, a showroom lease in Los Angeles was extended, recognizing a right-of-use asset and liability of $125,397[114] | Metric | 3 Months Ended Sep 30, 2023 ($) | 3 Months Ended Sep 30, 2022 ($) | 9 Months Ended Sep 30, 2023 ($) | 9 Months Ended Sep 30, 2022 ($) | | :----------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Total rent expense | $140,304 | $267,041 | $401,444 | $736,523 | - As of September 30, 2023, the Company had $980,322 and $248,734 in accounts payable for past rents due for the Vernon and Los Angeles leases, respectively[113][114] NOTE 12: CONTINGENCIES The Company is involved in several legal proceedings, primarily vendor lawsuits related to trade payables and a retail store lease dispute. While some matters have been settled or are on payment plans, a $1.5 million retail lease claim against Bailey 44 (updated to $450,968) remains ongoing and disputed. Management believes losses in excess of accrued amounts are not probable - Lawsuits filed by vendors in March and February 2023 for trade payables totaling approximately $43,501 and $182,400, respectively, are included in accounts payable[116][117] - A November 2022 vendor lawsuit for $50,190 was settled in January 2023 and is on payment plans[118] - Two lawsuits against Bailey's from 2020 and 2021 totaling $96,900 were settled in February 2022 and are on payment plans[119] - A lawsuit against DBG by an investor for $100,000 reimbursement is ongoing and included in short-term convertible note payable[120] - A vendor lawsuit against Bailey 44 for a retail store lease, initially $1.5 million, was updated to $450,968 and is being disputed by the Company[121] NOTE 13: INCOME TAXES The Company uses a discrete effective tax rate method for interim periods due to the unreliability of an annual effective tax rate. A full valuation allowance is required against net deferred tax assets due to cumulative losses and no history of generating taxable income - Uses a discrete effective tax rate method for interim reporting periods due to significant changes in estimated ordinary income affecting the annual effective tax rate[125] - A full valuation allowance is required against net deferred tax assets due to cumulative losses and no history of generating taxable income[126] NOTE 14: SUBSEQUENT EVENTS Subsequent to September 30, 2023, the Company exercised 225,375 pre-funded warrants from the August Private Placement into shares of common stock - Through the issuance date, 225,375 pre-funded warrants from the August Private Placement were exercised into common stock[127] ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides management's perspective on the Company's financial condition and results of operations, highlighting recent developments, business overview, material trends, and a detailed comparison of financial performance for the three and nine months ended September 30, 2023 and 2022. It also discusses liquidity, capital resources, and critical accounting policies Business Overview Digital Brands Group is a curated collection of lifestyle apparel brands, including Bailey 44, DSTLD, Stateside, Sundry, and ACE Studios, operating through direct-to-consumer and wholesale channels. The Company focuses on an omnichannel strategy to acquire and retain customers, leveraging data to optimize inventory and marketing. Recent developments include a reverse stock split to maintain Nasdaq compliance and the disposition of Harper & Jones Recent Developments Recent developments include seeking stockholder approval for a reverse stock split to maintain Nasdaq listing compliance and the disposition of Harper & Jones (H&J) on June 21, 2023, through a settlement agreement involving cash and common stock - The Company filed a definitive proxy statement for a special meeting on August 21, 2023, to seek stockholder approval for a reverse stock split (1-for-2.5 to 1-for-50) to comply with Nasdaq's minimum bid price requirement[133] - On June 21, 2023, the Company disposed of Harper & Jones (H&J) through a Settlement Agreement, making a $229,000 cash payment and issuing 1,952,580 shares of common stock to D. Jones[134] Our Company Digital Brands Group manages a portfolio of lifestyle apparel brands (Bailey 44, DSTLD, Stateside, Sundry, ACE Studios) across direct-to-consumer, wholesale, and retail channels. The Company emphasizes an omnichannel strategy, leveraging digital data for customer insights, inventory management, and marketing to increase 'closet share' and Lifetime Value (LTV) - Digital Brands Group is a curated collection of lifestyle brands (Bailey 44, DSTLD, Stateside, Sundry, ACE Studios) offering apparel through direct-to-consumer and wholesale distribution[136] - The Company employs an omnichannel strategy, blending physical and online channels, to acquire and retain customers and drive high customer lifetime value (LTV)[138][141] - Leverages customer data (contact, browsing, purchase history) to understand preferences, lower inventory risk, and control markdown strategies[139] - Acquired Bailey (Feb 2020), H&J (May 2021), Stateside (Aug 2021), and Sundry (Dec 2022)[142] Material Trends, Events and Uncertainties The Company faces ongoing global supply chain disruptions, leading to increased costs for raw materials, shipping, and labor, as well as extended transit and production times. Its operating results are also subject to seasonality, with stronger performance typically in the second half of the calendar year - Global supply chain disruptions have led to increased costs for raw materials (10-100%), sea/air shipping (25-300%), and labor (5-25%)[143] - Increased transit times via sea or air (two weeks to two months) and longer production times are also impacts[143] - Quarterly operating results vary due to seasonality, with stronger performance historically in the second half of the calendar year[143] Components of Our Results of Operations This section defines the key components of the Company's financial results: Net Revenue (sales less returns/promotions across direct-to-consumer and wholesale channels), Cost of Net Revenue (direct merchandise costs, inventory adjustments, duties, inbound freight), Operating Expenses (general & administrative, sales & marketing, distribution, and changes in contingent consideration fair value), and Interest Expense (from various debt instruments) Net Revenue Net revenue for DSTLD, Bailey, Stateside, and Sundry represents total sales less returns, promotions, and discounts, generated through direct-to-consumer websites, showrooms, and wholesale channels including specialty and department stores - Net revenue for DSTLD, Bailey, Stateside, and Sundry includes sales less returns, promotions, and discounts[144][145] - Products are sold direct-to-consumer via websites and showrooms, and indirectly through wholesale channels (specialty retailers, department stores)[144][145] Cost of Net Revenue Cost of net revenue for all brands includes direct costs of purchased merchandise, inventory shrinkage, adjustments for obsolescence (excess, slow-moving, lower of cost and net realizable value reserves), duties, and inbound freight - Cost of net revenue includes direct cost of purchased merchandise, inventory shrinkage, and inventory adjustments (obsolescence, excess/slow-moving, lower of cost and net realizable reserves)[146] - Also includes duties and inbound freight[146] Operating Expenses Operating expenses encompass general and administrative costs (payroll, professional fees, software, depreciation), sales and marketing (digital advertising, photoshoots, commissions), distribution (third-party logistics, packaging, shipping), and changes in the fair value of contingent consideration. The Company anticipates increased expenses as a public company - General and administrative expenses include payroll, professional fees, insurance, software, and headquarters-related costs[148] - Sales and marketing expenses cover digital advertising, photoshoots, and sales commissions[149] - Distribution expenses include costs for third-party logistics, packaging, and shipping to/from customers[151] - Changes in the fair value of contingent consideration and amortization of identifiable intangibles are also included in operating expenses[152] - Additional expenses are expected due to operating as a public company, including compliance, reporting, insurance, investor relations, and professional services[150] Interest Expense Interest expense primarily arises from the Company's outstanding promissory notes, convertible debt, and other interest-bearing liabilities - Interest expense primarily relates to promissory notes, convertible debt, and other interest-bearing liabilities[153] Results of Operations This section provides a comparative analysis of the Company's financial performance for the three and nine months ended September 30, 2023, versus 2022, detailing changes in net revenues, gross profit, operating expenses, other income/expenses, and net loss from continuing operations Three Months Ended September 30, 2023 compared to Three Months Ended September 30, 2022 For the three months ended September 30, 2023, net revenues increased by $0.6 million to $3.3 million, and gross profit rose by $0.7 million to $1.7 million, with gross margin improving to 52.3%. However, operating expenses increased by $1.7 million, primarily due to stock-based compensation and changes in contingent consideration fair value, leading to an increased net loss from continuing operations of $5.4 million | Metric | 3 Months Ended Sep 30, 2023 ($) | 3 Months Ended Sep 30, 2022 ($) | Change ($) | Change (%) | | :----------------------------------- | :-------------------------- | :-------------------------- | :--------- | :--------- | | Net revenues | $3,257,332 | $2,658,444 | $598,888 | 22.5% | | Gross profit | $1,703,288 | $958,298 | $744,990 | 77.7% | | Gross margin (%) | 52.3% | 36.0% | 16.3% | 45.3% | | Operating expenses | $5,125,450 | $3,397,098 | $1,728,352 | 50.9% | | Net loss from continuing operations | $(5,435,994) | $(4,734,038) | $(701,956) | 14.8% | - Revenue increase primarily due to full results from the Sundry acquisition in December 2022[156] - Increase in gross margin due to a shift in sales mix towards higher-margin e-commerce, led by Sundry[159] - Operating expenses increased due to stock-based compensation and change in fair value of contingent consideration[160] Nine Months Ended September 30, 2023 compared to Nine Months Ended September 30, 2022 For the nine months ended September 30, 2023, net revenues increased by $4.2 million to $12.1 million, and gross profit surged by $3.3 million to $6.0 million, with gross margin improving to 49.7%. Operating expenses decreased significantly by $15.9 million, primarily due to a $17.1 million change in fair value of contingent consideration. These factors led to a substantial reduction in net loss from continuing operations, decreasing by $17.0 million to $5.0 million | Metric | 9 Months Ended Sep 30, 2023 ($) | 9 Months Ended Sep 30, 2022 ($) | Change ($) | Change (%) | | :----------------------------------- | :-------------------------- | :-------------------------- | :--------- | :--------- | | Net revenues | $12,127,135 | $7,937,406 | $4,189,729 | 52.8% | | Gross profit | $6,032,603 | $2,684,464 | $3,348,139 | 124.7% | | Gross margin (%) | 49.7% | 33.8% | 15.9% | 47.0% | | Operating expenses | $5,356,114 | $21,246,820 | $(15,890,706) | -74.8% | | Net loss from continuing operations | $(4,965,579) | $(21,934,830) | $16,969,251 | -77.4% | - Revenue increase primarily due to full results from the Sundry acquisition in December 2022[164] - Increase in gross margin due to a shift in sales mix towards higher-margin e-commerce, led by Sundry, and less discounting compared to 2022[167] - Operating expenses decreased primarily due to a $17.1 million change in fair value of contingent consideration[168] Liquidity and Capital Resources As of September 30, 2023, the Company had $1.1 million in cash but a working capital deficit of $14.7 million, raising substantial doubt about its ability to continue as a going concern. Future funding needs are expected to be met through equity offerings, debt financings, or other sources, with no assurance of availability or favorable terms - As of September 30, 2023, the Company had cash of $1.1 million and a working capital deficit of $14.7 million[172] - These factors raise substantial doubt about the Company's ability to continue as a going concern[172] - Future capital funding needs are planned to be met through public/private equity offerings, debt financings, or other sources[172] - No assurance can be given regarding the availability or terms of future financing[172] Cash Flow Activities For the nine months ended September 30, 2023, net cash used in operating activities decreased to $6.5 million, while investing activities provided $41,331. Financing activities provided $6.2 million, primarily from equity offerings and new loans, offset by debt repayments | Metric | 9 Months Ended Sep 30, 2023 ($) | 9 Months Ended Sep 30, 2022 ($) | | :----------------------------------- | :-------------------------- | :-------------------------- | | Net cash used in operating activities | $(6,457,638) | $(8,689,857) | | Net cash provided by (used in) investing activities | $41,331 | $(5,533) | | Net cash provided by financing activities | $6,207,950 | $8,362,395 | | Net change in cash | $(208,357) | $(332,995) | Cash Flows Used In Operating Activities Net cash used in operating activities decreased by $2.2 million to $6.5 million for the nine months ended September 30, 2023, primarily due to a lower net loss, partially offset by non-cash adjustments - Cash used in operating activities decreased by $2.2 million to $6.5 million for the nine months ended September 30, 2023[175] - The decrease was primarily driven by a lower net loss, partially offset by non-cash adjustments[175] Cash Flows Provided By (Used in) Investing Activities Cash provided by investing activities was $41,331 for the nine months ended September 30, 2023, primarily due to a reduction of deposits, partially offset by property purchases and cash disposed in the H&J disposition - Cash provided by investing activities was $41,331 in 2023[176] - Primarily due to a reduction of deposits, partially offset by purchase of property and cash sold in the H&J disposition[176] Cash Flows Provided by Financing Activities Cash provided by financing activities was $6.2 million for the nine months ended September 30, 2023, mainly from $8.1 million in net proceeds from private placements and $5.8 million from loans, offset by $8.8 million in note repayments. This is a decrease from $8.4 million in 2022 - Cash provided by financing activities was $6.2 million for the nine months ended September 30, 2023[177] - Cash inflows included $8.1 million from private placements and $5.8 million from loans and notes[177] - Cash outflows were primarily due to $8.8 million in repayments of notes[177] - In 2022, cash provided by financing activities was $8.4 million, including $7.3 million in equity proceeds and $3.8 million from convertible notes and loans[178] Contractual Obligations and Commitments As of September 30, 2023, the Company had $7.0 million in outstanding principal on debt, primarily from promissory notes (Bailey44 Sellers, March 2023 Notes), PPP, and merchant advances. All outstanding loans, excluding non-current SBA obligations, have maturity dates through 2024 - As of September 30, 2023, the Company had $7.0 million in outstanding principal on debt[179] - Debt primarily includes promissory notes (Bailey44 Sellers, March 2023 Notes), PPP, and merchant advances[179] - All outstanding loans, except non-current SBA obligations, have maturity dates through 2024[179] Critical Accounting Policies and Estimates The Company's financial statements rely on management's estimates and assumptions, particularly for assets, liabilities, costs, and contingent items. These estimates are based on historical experience and market factors, and actual results may differ from these assumptions - Preparation of financial statements requires estimates and assumptions affecting reported amounts of assets, liabilities, costs, and contingent items[180] - Estimates are based on historical experience, known trends, and market factors, and are evaluated continuously[180] - Actual results may differ from these estimates under different assumptions or conditions[180] Emerging Growth Company Status The Company is an emerging growth company and has elected to use the extended transition period for complying with new or revised accounting standards, which may result in financial statements not being comparable to those of other companies - The Company is an emerging growth company under the JOBS Act of 2012[181] - Elected to use the extended transition period for complying with new or revised accounting standards[182] - Financial statements may not be comparable to those of companies that comply with new accounting standards earlier[182] Off-Balance Sheet Arrangements The Company did not have any off-balance sheet arrangements during the periods presented and does not currently have any, as defined by SEC rules and regulations - The Company did not have any off-balance sheet arrangements during the periods presented[183] - Currently, the Company does not have any off-balance sheet arrangements as defined by SEC rules[183] ITEM 3. Quantitative and Qualitative Disclosures about Market Risk As a smaller reporting company, Digital Brands Group, Inc. is not required to provide quantitative and qualitative disclosures about market risk - The Company is a smaller reporting company and is not required to provide quantitative and qualitative disclosures about market risk[184] ITEM 4. Controls and Procedures This section addresses the effectiveness of the Company's disclosure controls and procedures and internal control over financial reporting. Management concluded that disclosure controls were not effective as of September 30, 2023, due to material weaknesses, but has initiated remediation efforts. No material changes in internal control over financial reporting occurred during the nine months ended September 30, 2023 Evaluation of Disclosure Controls and Procedures Management, including the CEO and CFO, concluded that the Company's disclosure controls and procedures were not effective as of September 30, 2023, due to material weaknesses in internal control over financial reporting. Remediation efforts are ongoing, including hiring financial personnel/consultants, assessing accounting policies, and identifying a unified accounting system - Disclosure controls and procedures were not effective as of September 30, 2023, due to material weaknesses in internal control over financial reporting[186] - Remediation efforts include hiring additional financial personnel/consultants with public company and technical accounting expertise[187] - Assessment of accounting basis, revenue recognition, and cutoff procedures led to necessary adjustments to convert from cash to accrual basis[189] - The Company is in the process of identifying a single, unified accounting and reporting system[189] - Despite ineffective controls, supplementary procedures were employed to ensure fair presentation of financial statements[188] Limitations on Effectiveness of Controls and Procedures Management acknowledges that control systems provide only reasonable assurance and can be subject to inherent limitations, such as faulty judgments, simple errors, circumvention by individuals or collusion, and management override. Despite material weaknesses, management believes they did not affect financial results - Control systems provide only reasonable, not absolute, assurance and are subject to inherent limitations[191] - Limitations include faulty judgments, simple errors, circumvention by individuals or collusion, and management override[191] - Management believes the material weaknesses did not have an effect on financial results[192] Changes in Internal Control over Financial Reporting No change in the Company's internal control over financial reporting occurred during the nine months ended September 30, 2023, that has materially affected, or is reasonably likely to materially affect, its internal control over financial reporting - No material changes in internal control over financial reporting occurred during the nine months ended September 30, 2023[193] PART II. OTHER INFORMATION This section covers legal proceedings, risk factors, and other regulatory disclosures ITEM 1. Legal Proceedings The Company is involved in several legal proceedings, primarily vendor lawsuits for trade payables and a retail lease dispute against Bailey 44. While some claims have been settled or are on payment plans, a $450,968 retail lease claim remains ongoing and disputed. Management believes losses in excess of accrued amounts are not probable - Lawsuits filed by vendors in March and February 2023 for trade payables totaling approximately $43,501 and $182,400, respectively, are included in accounts payable[196][197] - A November 2022 vendor lawsuit for $50,190 was settled in January 2023 and is on payment plans[198] - Two lawsuits against Bailey's from 2020 and 2021 totaling $96,900 were settled in February 2022 and are on payment plans[199] - A vendor lawsuit against Bailey 44 related to a retail store lease, initially $1.5 million, was updated to $450,968 and is being disputed by