Duluth Holdings Inc. — Q1 FY2018 Form 10-Q
Business context and period. The filing covers the unaudited 13 weeks ended April 29, 2018, compared with the 13 weeks ended April 30, 2017. Duluth sells men’s and women’s apparel, workwear and accessories through direct channels (website and catalogs) and retail stores. At quarter-end, it operated 30 retail stores and three outlets. Fiscal 2018 is a 53-week year ending February 3, 2019.
Financial results and key metrics
| Metric | Q1 FY2018 | Q1 FY2017 | Change |
|---|---|---|---|
| Net sales | $100.2 million | $83.7 million | +19.7% |
| Gross profit / gross margin | $55.9 million / 55.8% | $48.6 million / 58.1% | Margin down 230 bps |
| SG&A / % of sales | $56.2 million / 56.1% | $47.9 million / 57.2% | Expense up 17.3% |
| Operating income (loss) | ($0.3 million) | $0.7 million | Declined |
| Net income (loss) | ($0.7 million) | $0.4 million | Declined |
| Adjusted EBITDA | $2.6 million / 2.6% of sales | $2.7 million / 3.2% of sales | Down 2.2%; margin down 60 bps |
Retail sales rose 70.7% to $34.0 million, driven primarily by 13 more stores than in the prior-year quarter. Direct sales rose 3.8% to $66.2 million. Retail supplied 33.9% of sales, versus 23.8% a year earlier. Sales increased across nearly all product categories and both men’s and women’s business; website visits rose 14%.
Gross margin pressure reflected product mix, higher inventory reserves, increased freight costs associated with retail growth, and slightly lower shipping revenue. SG&A increased by $8.3 million, including higher selling and general and administrative expenses, while SG&A as a percentage of sales improved by 110 basis points. Higher interest expense ($0.8 million versus $0.2 million) was attributed primarily to additional build-to-suit retail stores. The tax benefit was $0.2 million; the effective tax rate related to controlling interest was 25%, versus 39% in the prior period, primarily reflecting U.S. tax reform.
Cash flow, balance sheet and financing
- Operating cash flow was negative $11.0 million, compared with negative $3.5 million. Inventory growth used $10.4 million of cash; management attributed the seasonal working-capital use partly to the larger store base.
- Investing cash flow was negative $14.0 million, primarily for capital expenditures, versus negative $8.4 million a year earlier.
- Financing cash flow was positive $22.0 million, primarily from net line-of-credit borrowing. Cash and restricted cash declined $3.0 million to $4.1 million, comprising $1.2 million cash and $2.9 million restricted cash.
- At April 29, 2018, inventory was $98.0 million, current assets $109.6 million and current liabilities $69.6 million; reported net working capital was $40.0 million. Total assets were $249.0 million and total liabilities $110.6 million.
- Debt totaled $22.7 million, including $21.3 million drawn on the line of credit; $21.3 million was classified as current maturities. Separately, build-to-suit finance lease obligations were $34.2 million. The company reported covenant compliance at quarter-end.
- On May 17, 2018, the company replaced its prior facility with a credit agreement providing up to $80 million of revolving credit and a $50 million delayed-draw term loan. The prior facility’s reported outstanding balance of $27.5 million was repaid with borrowings under the new agreement. The new facility matures in 2023 and has financial covenants and interest rates tied to leverage.
Outlook, commentary and risks
- Management expects fiscal 2018 capital expenditures, net of finance-lease proceeds, of approximately $45–55 million, including $27–32 million for new stores and remodels. It expects to spend about $2 million, plus $0.5 million of starting inventory, to open a store.
- Management expects full-year operating cash flow to be positive, citing normal operations and seasonal working-capital reductions in the fourth quarter. It believes operating cash flow and available credit will fund working capital, planned capital spending and growth for the foreseeable future.
- Growth priorities include brand awareness and customer acquisition, retail expansion, selective expansion of men’s assortments and growth in women’s products. The company opened two stores in the quarter, adding approximately 40,000 gross square feet.
- The business is seasonal, historically generating a significant portion of sales and operating profit in the fourth quarter. Management noted that declining shipping revenue could pressure gross margin and Adjusted EBITDA if shipping expenses do not decline correspondingly.
- The company adopted ASC 606 using the modified retrospective method. It changed direct-sales revenue recognition to shipment, catalog-cost timing, and presentation of estimated inventory-return costs. The filing’s reconciliation shows that, without ASC 606, Q1 reported sales would have been $98.4 million and controlling-interest net loss $2.2 million, versus reported sales of $100.2 million and controlling-interest net loss of $0.7 million. Prior-period figures were not restated.
- The filing states there were no material changes to previously disclosed risk factors and no legal proceedings expected to have a material adverse effect. Management said disclosure controls were effective and there were no material changes in internal control over financial reporting.
Important facts for investors to verify
- How comparable reported growth and profitability are given ASC 606’s effect on current-period results and the unadjusted prior-period comparison.
- Whether retail expansion can sustain sales growth while gross margin declines and direct-segment operating losses increase.
- Inventory levels, cash conversion and seasonal cash-flow assumptions against the planned capital-spending range.
- Borrowings, interest costs and covenant headroom under the new $130 million credit facility, including the delayed-draw term loan terms.
- The lease-accounting adoption timing: the financial-statement notes say adoption is planned for February 4, 2019, while MD&A says the company expected early adoption on January 29, 2018. The filing text does not provide a clear, consistent value for the intended adoption date.