Duluth Holdings Inc. — Q2 FY2019 Form 10-Q
Business context and period. The company sells branded apparel, workwear and accessories through direct channels (website and catalogs) and retail stores. This filing covers the 13 weeks and six months ended August 4, 2019; comparatives are the periods ended July 29, 2018. Duluth operated 52 retail stores and three outlet stores at quarter-end. Fiscal 2019 ends February 2, 2020.
Financial performance
| Metric | Q2 FY2019 | Q2 FY2018 | Six months FY2019 | Six months FY2018 |
|---|---|---|---|---|
| Net sales | $122.0m | $110.7m | $236.2m | $210.9m |
| Gross profit / margin | $64.8m / 53.1% | $62.2m / 56.2% | $125.7m / 53.2% | $118.2m / 56.0% |
| Operating income (loss) | $3.7m | $9.9m | $(6.4)m | $9.6m |
| Net income (loss), attributable to controlling interest | $1.9m | $6.4m | $(5.6)m | $5.7m |
| Adjusted EBITDA | $9.6m | $13.1m | $4.7m | $15.7m |
| Operating cash flow | Not separately presented by quarter | $(8.0)m | $(12.6)m |
Amounts are in U.S. dollars; financial statement amounts are rounded to the nearest $0.1 million. Adjusted EBITDA is a non-GAAP measure.
Liquidity, debt and cash flow
- At August 4, 2019, cash was $3.5m, restricted cash was $2.7m, working capital was $66.1m, and total assets were $434.1m.
- Current assets were $137.5m and current liabilities were $71.4m. Inventory was $114.8m, up from $97.7m at February 3, 2019.
- Long-term debt, including current maturities, was $28.5m; the line of credit balance was $45.0m. The credit agreement provides an $80.0m revolver and a $50.0m delayed-draw term loan. The exact undrawn availability is not stated clearly in the filing. The company reported compliance with its debt covenants.
- Recognized operating lease liabilities were $111.0m and finance lease liabilities were $27.3m. These lease balances should be distinguished from borrowings.
- For the six-month period, investing cash outflow was $16.7m and financing cash inflow was $27.8m. Capital expenditures were $13.8m, with another $3.0m of contributions toward build-to-suit stores.
Changes versus prior comparable periods
- Q2 sales rose 10.2%; six-month sales rose 12.0%. Retail sales increased 23.8% in Q2 and 31.5% year to date, while direct sales declined 0.9% and 0.8%, respectively. Retail growth was primarily associated with new stores; the company reported four openings in Q2.
- Gross margin fell 310 basis points in Q2 and 280 basis points for the first six months. Management attributed the pressure primarily to promotions and clearance activity, and, for the half-year, slightly lower shipping revenue.
- SG&A increased 16.7% in Q2 and 21.7% for the first six months; as a share of sales it rose to 50.1% and 55.9%, respectively. Higher occupancy, depreciation, equipment and personnel costs associated with store growth and infrastructure investments were significant factors.
- Q2 net income declined to $1.9m from $6.4m; the six-month period moved from $5.7m net income to a $5.6m loss. Six-month Adjusted EBITDA fell to $4.7m from $15.7m.
- Operating cash use improved to $8.0m from $12.6m for the six-month comparison, but inventory growth remained a major cash use. Cash and restricted cash together increased $3.1m during the current six-month period.
Outlook, commentary and risks
- The filing gives no specific revenue or earnings guidance. Management expected full-year fiscal 2019 operating cash flow to be positive, citing expected seasonal working-capital reductions in Q4, and said operating cash flow plus credit availability should cover working capital, planned capital spending and growth needs.
- Fiscal 2019 capital expenditures were projected at approximately $38m–$42m, including $30m–$32m for store expansion and remodels. Management expected capital spending to moderate into 2020, planned store square-footage expansion at 30%–40% below the prior three-year pace, and emphasized improving returns, operating earnings and free cash flow.
- The business is seasonal, with historically significant revenue and operating profit in Q4. Management cited the risk of inventory shortages or excess inventory, intense competition, customer-preference changes, store performance, expansion execution, and higher labor, transportation, energy or other costs. It also noted that declining shipping revenue could pressure gross margin if shipping costs do not decline correspondingly.
- The company adopted ASC 842 lease accounting on February 4, 2019, recognizing right-of-use assets and lease liabilities and recording a $1.9m cumulative reduction to opening retained earnings. Prior periods were not restated. Four build-to-suit leases were reclassified from operating to finance leases during Q2; management said the correction to the prior-quarter presentation was immaterial.
- Management said disclosure controls were not effective as of August 4, 2019 due to an unremediated material weakness involving controls over the new order-management system conversion and timely account reconciliations and analyses. Remediation was ongoing; management stated the financial statements fairly present the reported periods in accordance with U.S. GAAP.
- The company reported no material changes to previously disclosed risk factors, no legal proceedings believed likely to have a material adverse effect, and no material subsequent events requiring disclosure.
Key facts investors should verify
- Whether retail growth and new-store openings can offset continuing weakness in direct sales while maintaining store-level returns.
- Whether promotional and clearance activity abates and gross margin recovers, including the effect of shipping revenue and costs.
- Whether SG&A growth moderates and management achieves its stated capital-spending and free-cash-flow objectives.
- Inventory quality, seasonal cash needs, actual remaining credit availability, and continued compliance with credit covenants.
- Progress in remediating the material weakness and the reliability of controls following the order-management system conversion.
- The effects of ASC 842 and lease obligations when comparing reported results, leverage and cash flows with prior periods.