Duluth Holdings Inc. — Form 10-Q Summary
Business context and reporting period
Unaudited results cover the 13 and 39 weeks ended November 1, 2015, compared with the periods ended November 2, 2014. Duluth sells branded apparel, workwear and accessories through its direct channels (website and catalogs) and retail stores. At quarter-end it operated six stores and two outlets. The business is seasonal, with a significant portion of sales and profit historically generated in the fourth quarter.
Financial performance and liquidity
| Metric | Three months ended Nov. 1, 2015 | Three months ended Nov. 2, 2014 | Nine months ended Nov. 1, 2015 | Nine months ended Nov. 2, 2014 |
|---|---|---|---|---|
| Net sales | $55.3 million | $42.6 million | $163.8 million | $121.7 million |
| Gross profit / margin | $31.6 million / 57.2% | $23.9 million / 56.2% | $94.7 million / 57.8% | $69.7 million / 57.2% |
| Operating income / margin | $1.6 million / 3.0% | $3.1 million / 7.3% | $10.2 million / 6.2% | $10.0 million / 8.2% |
| Net income attributable to controlling interest | $1.5 million | $3.0 million | $9.9 million | $9.7 million |
| Adjusted EBITDA | $2.7 million | $3.6 million | $13.9 million | $11.8 million |
Quarterly diluted EPS attributable to controlling interest was $0.06 versus $0.13; nine-month diluted EPS was $0.41 versus $0.41. The company was an S corporation during the reported periods and recorded no income tax expense. On a pro forma basis using an assumed 40% tax rate, controlling-interest net income was $0.9 million versus $1.8 million for the quarter and $5.9 million versus $5.8 million for the nine months.
- Sales and segments: Quarterly direct sales rose 26.9% to $46.5 million and retail sales rose 48.5% to $8.8 million. For nine months, direct sales rose 30.2% to $141.2 million and retail sales rose 70.4% to $22.5 million. Retail accounted for 15.8% of quarterly sales and 13.8% of nine-month sales.
- Cash flow: Nine-month operating cash use was $17.3 million, versus $14.7 million used a year earlier, primarily reflecting a $31.2 million inventory increase. Investing cash use was $6.6 million; financing provided $16.2 million. Cash declined to $0.2 million from $7.9 million at fiscal year-end.
- Debt and liquidity: At November 1, total debt was approximately $35.4 million, including $30.3 million drawn on the $40 million revolving facility. Reported undrawn availability was $9.7 million, subject to borrowing-base limits. Working capital was $48.5 million. The company reported compliance with debt covenants.
Material changes versus the prior comparable period
- Quarterly sales growth did not translate into higher operating profit: SG&A increased 43.8% to $30.0 million, faster than sales growth of 29.9%. SG&A rose to 54.2% of sales from 48.9%, and quarterly operating income fell by about 47%.
- Quarterly Adjusted EBITDA declined 26.2% to $2.7 million, with margin falling to 4.8% from 8.5%. Nine-month Adjusted EBITDA increased 17.8%, but its margin declined to 8.5% from 9.7%.
- Nine-month gross margin improved by 60 basis points. Management attributed the margin improvement in both comparison periods to product mix and a higher proportion of full-price sales.
- Inventory increased to $73.0 million from $41.4 million at February 1, 2015, consistent with seasonal stocking and business growth. Capital expenditures included new stores and a warehouse management system.
Outlook, management commentary, risks and unusual items
- Management gave no specific sales or earnings guidance in this filing. It expected fourth-quarter and full-year fiscal 2015 operating cash flow to be positive, citing seasonal working-capital reductions, and said cash flow, the credit line and IPO proceeds should fund planned needs.
- Expected capital expenditures for the fourth quarter of fiscal 2015 and full-year fiscal 2016 were $13–14 million, including $8–9 million for new stores. Management estimated $2.0–2.6 million in capital expenditures and starting inventory per new store and cautioned that rapid expansion or slower store payback could pressure cash.
- On November 25, 2015, after the reporting period, Duluth completed its IPO of 7,666,667 Class B shares at $12 per share, receiving approximately $83.7 million in net proceeds. It used $46.3 million to repay a short-term bank note used to fund part of a final distribution to pre-IPO shareholders. The filing estimated that distribution at $51.1 million and said the balance was intended to be funded with cash, the credit line or IPO proceeds.
- The company also converted from S-corporation to C-corporation tax status on November 25, 2015. It recorded deferred tax assets of $1.9 million and deferred tax liabilities of $1.2 million in connection with the conversion; future results will include corporate income taxes.
- Management disclosed a material weakness in internal controls involving revenue cutoff and inventory receipts. It corrected the reported periods: direct revenue is recognized when customers receive products, and inventory and payables for FOB shipping-point purchases are recorded when shipped. Remediation was ongoing; management gave no assurance that it would be fully effective.
- Key risks include seasonality and inventory forecasting, rising marketing and operating costs, execution and funding of store expansion, reliance on e-commerce and suppliers, shipping and fulfillment disruptions, variable-rate borrowing, and the transition to public-company reporting. The filing reported no legal proceedings believed likely to have a material adverse effect.
Important facts for investors to verify
- Whether fourth-quarter holiday sales convert the substantial seasonal inventory and operating cash use into positive full-year cash flow.
- Actual store-opening costs, sales productivity and payback compared with management’s estimates, and the resulting capital and liquidity needs.
- Current revolver availability and covenant headroom after the IPO, shareholder distribution and seasonal borrowing cycle.
- The final amount and funding of the estimated $51.1 million S-corporation distribution, and the effect of C-corporation taxes on future earnings.
- Progress in remediating the material weakness and the effectiveness of controls over revenue and inventory cutoff.