Duluth Holdings Inc. — Q2 fiscal 2017 Form 10-Q
Reporting period: The 13 weeks ended July 30, 2017; comparisons are with the 13 weeks ended July 31, 2016. Six-month figures cover the 26 weeks ended on those respective dates. Amounts are in U.S. dollars; financial statement amounts below are in millions unless otherwise noted.
Business context
Duluth sells branded apparel, workwear and accessories through its direct channels (website and catalogs) and retail stores. At quarter-end it operated 20 retail stores and three outlet stores. The business is seasonal, with historically higher sales and operating profit in the fourth quarter.
Financial performance
| Metric | Q2 FY2017 | Q2 FY2016 | Six months FY2017 | Six months FY2016 |
|---|---|---|---|---|
| Net sales | $86.2 | $65.8 | $169.9 | $134.5 |
| Gross profit / margin | $48.9 / 56.7% | $38.9 / 59.1% | $97.6 / 57.4% | $78.6 / 58.5% |
| Operating income / margin | $7.4 / 8.6% | $6.0 / 9.1% | $8.1 / 4.8% | $11.3 / 8.4% |
| Net income | $4.4 | $3.7 | $4.8 | $7.0 |
| Net income attributable to controlling interest | $4.3 | $3.6 | $4.6 | $6.9 |
| Diluted EPS attributable to controlling interest | $0.13 | $0.11 | $0.14 | $0.21 |
| Adjusted EBITDA (non-GAAP) | $9.5 | $7.5 | $12.1 | $14.0 |
Q2 sales grew 31.0%; direct sales rose 7.1% and retail sales 138.3%, with retail growth primarily reflecting 12 more stores than in the prior-year quarter. Retail represented 33.1% of Q2 sales versus 18.2% a year earlier. For the first half, sales grew 26.4%, while net income attributable to controlling interest declined 32.4%. Website visits increased 19.8% in Q2 and 18.0% for the first half.
Q2 gross margin declined 240 basis points, mainly due to more free-shipping promotions, higher inventory reserves associated with retail growth, and freight costs for transporting inventory to stores. First-half gross margin fell 110 basis points; improved product margins partly offset these pressures. SG&A rose 26.1% in Q2 and 32.9% for the first half. It declined as a share of sales in Q2 but increased 260 basis points for the first half, reflecting retail-related selling, occupancy, equipment and depreciation costs. First-half operating income and adjusted EBITDA fell despite sales growth.
Cash, debt and liquidity
- Cash was $1.4 at July 30, 2017, down from $24.0 at January 29, 2017; restricted cash was $2.5. Working capital was $58.3.
- Operating cash flow was negative $12.2 for the first half, versus positive $1.1 in the prior-year period. Inventory growth used $12.9, while accrued expenses and deferred rent and income taxes payable also declined.
- Investing cash outflow was $27.7, including $20.1 of property and equipment purchases and $6.5 advanced for headquarters construction. Financing provided $17.2, including $11.9 net proceeds from the revolving credit line.
- Total debt and line-of-credit balances were $13.5, including $11.9 drawn on the revolver. The revolver’s capacity increased to $50.0 effective August 1, 2017, and is scheduled to rise to $60.0 in August 2018; it matures July 31, 2019. Its effective interest rate was 2.3% at quarter-end. The company reported covenant compliance.
- Management expected full-year fiscal 2017 operating cash flow to be positive, citing normal operations and seasonal working-capital reductions in Q4. It said cash, operating cash flow and available revolving credit should fund working capital and planned investment.
Outlook, commitments and risks
- No specific revenue or earnings guidance was provided. Management identified brand awareness and customer acquisition, retail expansion, selective expansion of men’s assortments and growth in women’s products as strategies.
- Fiscal 2017 capital expenditures were estimated at $38–$42, including approximately $28–$32 for new retail stores. Management estimated $2.0–$2.6 of capital expenditures and starting inventory per new store.
- On August 18, 2017, the company entered a 30-year lease for a planned Mt. Horeb headquarters, expected to begin November 1, 2018. Initial annual rent is $1.8, increasing 2% annually for 20 years, then resetting to $1.3 and increasing 2% annually. The company also advanced $6.4 to the developer for a planned note investment at 4.95% with a 20-year term; the transaction was expected to close by September 30, 2017.
- Management cited seasonality, shipping-revenue sensitivity, inventory and freight costs, and the costs of retail expansion as factors affecting results. It expected adoption of the new lease accounting standard to significantly affect the financial statements. No material changes to previously disclosed risk factors or material adverse legal proceedings were reported.
Important facts for investors to verify
- Whether retail expansion and sales growth translate into improved full-year operating margins and cash generation, given first-half profit and adjusted EBITDA declines.
- Inventory levels, reserve adequacy, shipping promotions and freight costs, and their effects on gross margin and cash needs.
- Revolver usage, borrowing availability, covenant headroom and compliance as seasonal funding needs increase.
- Capital spending and store-opening execution against the stated fiscal-year ranges, and the financial commitments and completion timing for the headquarters lease and note investment.
- The filing’s reported non-GAAP adjusted EBITDA reconciliation and management’s assumptions behind its full-year positive operating-cash-flow expectation.