Duluth Holdings Inc. — Q3 FY2016 Form 10-Q
Reporting period: 13 weeks ended October 30, 2016; nine-month comparisons are against periods ended November 1, 2015. Financial statements are unaudited. Duluth sells branded apparel and accessories through its direct channel (website and catalogs) and retail stores. At quarter-end it operated 12 retail stores and two outlets.
Financial performance
| Metric | Q3 FY2016 | Q3 FY2015 | Nine months FY2016 | Nine months FY2015 |
|---|---|---|---|---|
| Net sales | $67.0m | $55.3m | $201.5m | $163.8m |
| Gross profit / margin | $38.7m / 57.8% | $31.6m / 57.2% | $117.4m / 58.3% | $94.7m / 57.8% |
| Operating income / margin | $0.8m / 1.2% | $1.6m / 3.0% | $12.1m / 6.0% | $10.2m / 6.2% |
| Net income attributable to controlling interest | $0.5m | $1.5m | $7.3m | $9.9m |
| Adjusted EBITDA | $2.5m | $2.7m | $16.5m | $13.9m |
| Net cash used in operating activities | Not presented quarterly | $(26.8)m | $(17.3)m |
Q3 sales grew 21.2% (direct +12.3%; retail +68.4%), while nine-month sales grew 23.0% (direct +17.8%; retail +55.4%). Retail represented 22.0% of Q3 sales and 17.4% of nine-month sales, versus 15.8% and 13.8%, respectively, in the comparable periods. Website visits rose 16.7% in Q3 and 16.9% year to date.
Q3 adjusted EBITDA declined 7.9%, and its margin fell to 3.7% from 4.8%; nine-month adjusted EBITDA increased 18.8%, although its margin eased to 8.2% from 8.5%. Q3 diluted EPS was $0.01 versus $0.06; nine-month diluted EPS was $0.23 versus $0.41. Prior-year reported earnings benefited from S-corporation tax treatment; on a pro forma C-corporation basis, prior-year controlling-interest net income was $0.9m for Q3 and $5.9m for nine months. On that basis, current-period net income declined 49.0% for Q3 but rose 23.3% year to date.
Liquidity, debt and cash flow
- Cash was $0.2m at October 30, 2016, down from $37.9m at January 31, 2016. Net working capital was $69.5m.
- Operating cash outflow was $26.8m, principally reflecting a $40.9m inventory build ahead of the peak season, partly offset by higher accounts payable. Investing cash outflow was $22.5m, including $21.0m of capital expenditures. Financing provided $11.6m net; cash decreased $37.7m.
- Debt totaled $14.0m, including $13.2m drawn on the revolving credit facility. The amended facility provides availability of up to $40m through July 2017, increasing to $50m and then $60m in subsequent annual periods through July 2019. The rate was 1.8% at quarter-end; undrawn availability was $26.8m. The facility is secured by essentially all company assets and includes financial and nonfinancial covenants; the company reported compliance.
- Management said it expected positive operating cash flow for full-year FY2016 as seasonal working capital unwinds in Q4, and considered available cash, operating cash flow and credit availability sufficient for foreseeable needs.
Material changes, outlook and risks
- Gross margin improved, primarily from better initial product costs and a higher-margin product mix. SG&A rose faster than sales in Q3, driven by general and administrative costs, store openings, personnel and marketing; Q3 SG&A was 56.6% of sales versus 54.2%.
- Management said Q3 sales fell short of expectations due to unseasonably warm weather and a highly promotional retail environment late in the quarter and into early Q4. The business is seasonal, historically generating a significant share of sales and operating profit in Q4.
- FY2016 capital expenditures were estimated at $25m–$26m, including approximately $13m–$14m for new retail stores. Estimated capital expenditure and initial inventory per new store was $2.0m–$2.6m. No specific revenue or earnings guidance was provided.
- Growth priorities include brand awareness and customer acquisition, retail expansion, selectively broadening men’s assortments and growing the women’s business. Management reported average retail-store payback of less than two years.
- The company had paid off two mortgages in August 2016 and terminated the related interest-rate swap. It also recorded $2.0m of property and equipment and a corresponding liability for build-to-suit lease transactions.
- No material changes to previously disclosed risk factors were reported. The company disclosed no legal proceedings believed likely to have a material adverse effect and stated disclosure controls were effective. Key risks include seasonality, inventory and promotional exposure, execution of store expansion, and variable-rate credit borrowing.
Important facts for investors to verify
- Whether Q4 sales, margins and operating cash flow met management’s seasonal expectations following the warm-weather and promotional pressures.
- Inventory quality and sell-through, given the $40.9m year-to-date inventory cash use and increased inventory balance.
- Whether store expansion generates expected returns while SG&A and store-related costs rise.
- Revolver utilization, covenant compliance and liquidity as the seasonal inventory build unwinds.
- Comparability of reported earnings across periods, considering the prior-year S-corporation tax status and the current C-corporation tax expense.