Business context and reporting period
Duluth Holdings Inc. sells men’s and women’s apparel, workwear and accessories through its website, catalogs and stores. This unaudited Form 10-Q covers the 13-week second quarter and 26 weeks ended July 29, 2018, compared with the periods ended July 30, 2017. The company operated 36 retail stores and three outlet stores at quarter-end. Its business is seasonal, with historically higher sales and operating profit in the fourth quarter.
Financial performance
Amounts below are in millions except per-share data. Year-over-year comparisons are against the corresponding 2017 periods.
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net sales | $110.7 (+28.3%) | $86.2 | $210.9 (+24.1%) | $169.9 |
| Gross profit / margin | $62.2 / 56.2% | $48.9 / 56.7% | $118.2 / 56.0% | $97.6 / 57.4% |
| Operating income / margin | $9.9 / 8.9% | $7.4 / 8.6% | $9.6 / 4.6% | $8.1 / 4.8% |
| Net income | $6.5 | $4.4 | $5.8 | $4.8 |
| Net income attributable to controlling interest | $6.4; $0.20 diluted EPS | $4.3; $0.13 diluted EPS | $5.7; $0.18 diluted EPS | $4.6; $0.14 diluted EPS |
| Adjusted EBITDA (non-GAAP) | $13.1 (+38.6%); 11.8% of sales | $9.5; 11.0% | $15.7 (+29.6%); 7.5% of sales | $12.1; 7.1% |
Q2 sales growth was concentrated in retail: retail sales rose 74.4% to $49.8 million, while direct sales increased 5.5% to $60.8 million. Retail’s share of sales grew to 45.0% from 33.1%. For the first half, retail sales rose 72.9% to $83.8 million and direct sales grew 4.6% to $127.0 million. Retail segment operating income improved to $8.8 million in Q2 and $10.6 million for the first half; direct segment operating income was $1.1 million in Q2, but a $1.0 million loss for the first half.
Gross margin declined 0.5 percentage point in Q2 and 1.4 points in the first half. Management cited lower shipping revenue and higher freight costs; first-half margin also reflected lower product margin and increased clearance sales. SG&A rose in dollars but declined as a share of sales: 47.3% in Q2 versus 48.2%, and 51.5% for the first half versus 52.6%. The first-half operating margin nevertheless edged down. Interest expense increased to $1.2 million in Q2 and $2.1 million in the first half, mainly due to higher debt and build-to-suit stores. The effective tax rate was 26%, versus 39% in 2017, primarily reflecting U.S. tax reform.
Cash flow, debt and liquidity
For the first half, operating cash flow was negative $12.6 million, compared with negative $12.2 million a year earlier. Inventory growth used $12.1 million of cash, alongside cash use from prepaid assets, tax payments and accrued liabilities. Investing cash outflow was $27.3 million, including $26.8 million of property and equipment purchases. Financing provided $36.4 million, principally through net revolving-credit borrowings of $35.0 million. Cash and restricted cash declined $3.5 million to $3.6 million; unrestricted cash at July 29 was $2.4 million.
At quarter-end, current assets were $116.6 million and current liabilities $42.8 million; inventory was $102.4 million. The company reported $36.5 million of debt, including $35.0 million drawn on its line of credit, and separately reported $40.5 million of build-to-suit finance lease obligations. In May 2018, it replaced its prior facility with an $80 million revolver and a $50 million delayed-draw term loan, both maturing May 17, 2023; the term loan can be drawn through May 17, 2020. The facility is secured by essentially all company assets and contains financial covenants. Duluth said it was in compliance at quarter-end and expected to remain compliant for the rest of fiscal 2018.
Outlook, commentary and risks
- Management expected positive operating cash flow for full-year fiscal 2018, citing normal operating performance and seasonal working-capital reductions in the fourth quarter. It said cash flow and available revolver capacity should cover working capital, planned capital spending and growth for the foreseeable future.
- Fiscal 2018 capital expenditures, net of finance-lease proceeds, were estimated at $45–$55 million, including $27–$32 million for new stores and remodels. The company opened eight stores in the first half, including six in Q2, and added approximately 132,000 square feet in fiscal 2018 to that point.
- Growth priorities include brand awareness and customer acquisition, retail expansion, selected men’s assortment extensions and growth in women’s products. Management reported retail-store payback averaging under two years, and said it expected that performance to continue.
- Management identified continued declines in shipping revenue as a potential drag on gross margin and Adjusted EBITDA if related shipping expenses do not fall correspondingly. Retail expansion also brings higher occupancy, depreciation, payroll and other operating costs.
- The company adopted ASC 606 in fiscal 2018 using the modified retrospective method; prior-year results were not restated. The adoption changed the timing of direct-sales and catalog-cost recognition and affected first-half reported results. The filing’s reconciliation shows first-half net sales of $209.2 million without adoption versus $210.9 million as reported, so reported growth comparisons are not fully like-for-like.
- The company expected to adopt the new lease standard in fiscal 2019 and anticipated a material increase in reported assets and liabilities from recognizing right-of-use assets and lease liabilities.
- A new risk disclosure addresses potential state and local sales-tax collection obligations following the U.S. Supreme Court’s Wayfair decision, including possible tax, penalty and interest exposure on past sales, compliance costs and effects on sales.
- No material change to previously disclosed risk factors was reported apart from the sales-tax issue. The company reported no legal proceeding expected to have a material adverse effect, no significant change in contractual obligations, and no subsequent event requiring disclosure. Disclosure controls were judged effective.
Important facts for investors to verify
- Whether retail expansion can sustain its sales growth and stated store payback while containing occupancy and operating costs; also monitor the first-half direct-segment operating loss.
- How much of reported sales and earnings growth reflects underlying performance versus ASC 606 timing effects; prior-year figures were not restated.
- Inventory levels, seasonal cash conversion, remaining capital-spending plans and liquidity available under the credit facility.
- Debt and lease-related obligations, interest expense, covenant headroom and the terms and usage of the delayed-draw term loan.
- The effect of shipping-revenue declines, freight costs and clearance activity on margins, and the potential consequences of expanded sales-tax collection requirements.