Business context and reporting period
Duluth Holdings Inc. sells branded apparel, workwear and accessories through its direct channels (website and catalogs) and retail stores. This unaudited 10-Q covers the 13 weeks ended May 1, 2016, compared with the 13 weeks ended May 3, 2015. At quarter-end, the company operated seven retail stores and two outlet stores. Its business is seasonal, with sales and operating profit historically highest in the fourth quarter.
Financial performance and liquidity
- Revenue: Net sales were $68.6 million, up 20.8% from $56.8 million. Direct sales grew 17.5% to $60.3 million; retail sales grew 52.4% to $8.3 million. Retail represented 12.1% of sales, versus 9.6%.
- Profit and margins: Gross profit rose 21.5% to $39.7 million; gross margin increased to 57.8% from 57.5%. Operating income increased to $5.3 million from $2.8 million, and operating margin rose to 7.8% from 4.8%. Net income was $3.3 million versus $2.8 million; net margin was 4.8% in both periods. Net income attributable to controlling interest was $3.2 million versus $2.7 million.
- Adjusted EBITDA: $6.6 million, up 41.0% from $4.7 million; margin increased to 9.6% from 8.2%. This is a non-GAAP measure.
- Taxes and EPS: Income tax expense was $2.1 million, at a 38.9% effective rate; the prior-year reported period had no tax expense because the company was then an S corporation. Reported basic and diluted EPS were $0.10 versus $0.11; the filing gives prior-year pro forma EPS of $0.07 after applying an assumed 40% corporate tax rate.
- Cash flow: Operating cash use was $3.8 million, versus $4.8 million used a year earlier. Investing cash use was $3.5 million, primarily for distribution-center expansion and two planned stores. Financing cash use was $0.3 million. Cash declined $7.6 million to $30.3 million.
- Balance sheet and debt: Working capital was $70.4 million; inventory was $58.2 million. Total debt was $5.0 million, including $3.7 million current maturities. The company had no revolver borrowings and reported $29.1 million of availability under its $40 million facility, subject to borrowing-base limits. It was in compliance with debt covenants.
Material changes and management commentary
Sales growth reflected gains across nearly all product categories, increased website visits, and growth in retail, including stores opened during fiscal 2015 and comparable-store gains. Management attributed the 30-basis-point gross-margin improvement to product cost benefits from higher volume and a mix shift toward higher-margin products. SG&A rose 14.8% to $34.4 million, but declined as a share of sales to 50.0% from 52.7%; increases included marketing, public-company professional fees, selling costs and distribution labor. Prior-year SG&A included a $1.1 million payment related to restricted-stock grantees’ tax liabilities.
Management expects fiscal 2016 capital expenditures of approximately $24–$25 million, including $10–$11 million for new-store expansion. Two new retail stores were expected to open in the second quarter. Management stated that cash on hand, operating cash flow and revolver availability should fund working capital, planned capital spending and growth for the foreseeable future; it expected full-year fiscal 2016 operating cash flow to be positive despite seasonal first-quarter cash use. The filing provides no specific revenue or earnings guidance.
Risks, contingencies and unusual items
- Seasonality makes quarterly results uneven; the company typically uses operating cash in the first three quarters as it builds inventory ahead of the holiday season.
- Growth plans include expanding retail, increasing brand awareness and broadening selected product assortments. Store expansion and marketing require additional spending; management cited shipping revenue and expense as factors affecting gross profit and margins.
- Debt facilities carry financial and non-financial covenants. The company reported compliance at quarter-end and expected continued compliance during fiscal 2016.
- The company consolidates Schlecht Retail Ventures LLC, a variable interest entity owned by its majority shareholder, which owns property leased by the company. The company reported no legal proceedings expected to have a material adverse effect.
- The company became a C corporation and completed its IPO in November 2015. It paid the remaining $0.2 million of its final S-corporation distribution in the quarter. Foreign-currency exposure was described as limited because most merchandise purchases are denominated in U.S. dollars.
Important facts for investors to verify
- Whether sales growth and improved operating margins persist, particularly as the retail footprint expands.
- Inventory levels, seasonal cash requirements and the conversion of earnings into full-year operating cash flow.
- Actual capital spending, store-opening costs and returns compared with management’s stated payback and investment expectations.
- The effect of the post-IPO C-corporation tax burden when comparing earnings and EPS with earlier periods.
- Revolver availability under borrowing-base limits and continued compliance with debt covenants.