Duluth Holdings Inc. — Q3 2017 Form 10-Q
Reporting period: 13 weeks ended October 29, 2017; year-to-date covers 39 weeks. Comparisons are with the periods ended October 30, 2016. Amounts below are in millions unless stated otherwise.
Business context and results
Duluth sells branded apparel, workwear and accessories through its website, catalogs and retail stores. At quarter-end it operated 23 retail stores and three outlets. The company is expanding retail while continuing to grow its direct business; fiscal fourth-quarter sales and operating profit are historically higher because of holiday seasonality.
- Q3 net sales: $83.7, up 25.0%. Direct sales rose 3.6% to $54.1; retail sales rose 100.7% to $29.6, primarily reflecting 12 more stores than a year earlier.
- Nine-month net sales: $253.6, up 25.9%. Direct sales rose 5.5% to $175.6; retail sales rose 122.8% to $78.1.
- Q3 gross profit/margin: $47.4 and 56.6%, versus $38.7 and 57.8% a year earlier. Nine-month gross profit/margin: $145.0 and 57.2%, versus $117.4 and 58.3%.
- Q3 operating result: loss of $0.6, versus income of $0.8; net loss was $0.7, or $0.03 per share attributable to controlling interest, versus net income of $0.5, or $0.01 per share.
- Nine-month operating income: $7.5, down from $12.1. Net income was $4.0, down 47.8% from $7.5; earnings attributable to controlling interest were $3.8, or $0.12 per share, versus $7.3, or $0.23 per share.
- Adjusted EBITDA (non-GAAP): $1.9 for Q3, down 24.9% (2.2% of sales versus 3.7%); $14.0 for nine months, down 15.2% (5.5% of sales versus 8.2%).
Cash flow, balance sheet and liquidity
- For the nine months, operating cash flow was negative $35.0, investing cash flow negative $44.6, and financing cash flow positive $56.5. Cash declined $23.1 to $1.0.
- Operating cash use primarily reflected a $57.0 inventory increase ahead of the holiday season and store growth, partly offset by an $18.7 increase in accounts payable. Capital expenditures were $37.5, compared with $21.0 in the prior-year period.
- At October 29, current assets were $145.4 and current liabilities $58.8; reported net working capital was $86.6. Inventory was $129.5, up from $70.4 at fiscal year-end. The reserve for excess and obsolete inventory was $2.9, versus $1.2.
- Long-term line-of-credit borrowings were $50.1 at quarter-end. The facility provided up to $60.0 million from September 29, 2017 through July 31, 2019; an amendment effective November 1 raised availability to $80.0 through December 31, 2017, then $60.0 through maturity. The stated effective interest rate was 2.5% at quarter-end. The facility is secured by essentially all company assets and includes financial covenants; the company reported compliance.
- Other reported debt included $1.5 of SRV mortgage notes and $18.5 of build-to-suit finance lease obligations. Total liabilities were $133.6, compared with $42.2 at January 29, 2017; total assets were $252.9, compared with $156.0.
Material changes, outlook and risks
- Sales growth was led by retail expansion, but profitability weakened: Q3 SG&A rose 26.7% to $48.0 and reached 57.4% of sales; nine-month SG&A rose 30.7% to $137.5 and reached 54.2% of sales. Gross margin also declined.
- Management attributed lower gross margin mainly to declining shipping revenue and higher freight moving inventory from the distribution center to stores, partly offset by improved product margins. Higher SG&A reflected advertising, selling, occupancy, personnel and other administrative costs. Q3 general and administrative expense also included a cost connected with a senior-management retirement.
- Management expected fiscal 2017 capital expenditures, net of finance-lease proceeds, of approximately $42–44 million, including $31–33 million for new stores and remodels. It expected full-year operating cash flow to be positive as seasonal working capital unwinds in Q4, and said cash, operating cash flow and the credit facility should fund working capital, planned capital spending and growth.
- The company gave no specific revenue or earnings forecast in this filing. It cited brand-building, retail expansion, selective men’s assortment expansion and growth in women’s products as strategies. Store payback was stated to average less than two years.
- A 30-year lease for the future Mt. Horeb headquarters is expected to begin November 1, 2018, with initial annual rent of $1.8 million, increasing 2% annually for 20 years before resetting to $1.3 million and continuing to escalate. Management expects adoption of the new lease accounting standard to significantly affect the financial statements.
- Risks include retail and holiday seasonality, inventory and execution demands from expansion, margin pressure, reliance on secured revolving credit and covenant compliance, and the long-term lease commitment. The filing reported no material change to previously disclosed risk factors and no legal proceedings believed likely to have a material adverse effect.
Important facts for investors to verify
- Whether holiday-quarter sales and seasonal inventory reduction convert the year-to-date operating cash outflow into the positive full-year cash flow management expected.
- Whether retail-led growth can improve operating leverage and margins after the declines in gross margin, operating income and Adjusted EBITDA.
- Inventory quality, sell-through and the adequacy of the excess-and-obsolete reserve as inventory has increased substantially.
- Credit-facility borrowing, seasonal availability, interest costs and ongoing covenant headroom; the filing does not state a clear amount of undrawn availability at quarter-end.
- The eventual balance-sheet and expense effects of the headquarters lease, build-to-suit obligations and adoption of the new lease standard.