Duluth Holdings Inc. — FY2017 Form 10-K
Reporting period: Fiscal year ended January 28, 2018, a 52-week period; comparable fiscal 2016 ended January 29, 2017. Fiscal Q4 includes the holiday season. Unless stated otherwise, financial amounts are in U.S. dollars.
Business context and reporting period
Duluth sells men’s and women’s casual wear, workwear, accessories and hard goods under its proprietary brand through its website, catalogs and retail stores. More than 90% of FY2017 sales were proprietary branded products. At year-end it operated 28 retail stores and three outlet stores; direct channels generated 70.2% of sales and retail 29.8%. The company opened 14 retail stores and one outlet during FY2017, including its first Western U.S. store.
Financial performance and liquidity
| Metric | FY2017 | FY2016 |
|---|---|---|
| Net sales | $471.4 million | $376.1 million |
| Gross profit / margin | $261.0 million / 55.4% | $214.1 million / 56.9% |
| Operating income / margin | $37.1 million / 7.9% | $35.0 million / 9.3% |
| Net income attributable to controlling interest | $23.4 million; $0.73 basic EPS | $21.3 million; $0.68 basic EPS |
| Adjusted EBITDA (non-GAAP) / margin | $46.4 million / 9.8% | $41.2 million / 10.9% |
| Cash from operating activities | $29.9 million | $20.3 million |
| Capital expenditures | $46.5 million | $28.7 million |
Sales grew 25.3%. Retail sales rose 111.5% to $140.5 million, driven by new stores and a full year of sales from stores opened in FY2016. Direct sales increased 6.9% to $330.9 million. By product category, men’s sales were $333.5 million (+22.2%), women’s $110.3 million (+36.6%), and hard goods/other $27.6 million (+23.4%). Women’s products represented approximately 23% of total sales.
Profitability growth lagged sales growth: controlling-interest net income rose 9.6%, while operating margin fell 140 basis points and gross margin fell 150 basis points. Management attributed lower gross margin mainly to reduced shipping revenue, slightly higher promotions and higher freight costs moving inventory to stores. SG&A rose 25.0% to $223.9 million; marketing costs declined as a share of sales, but store-related, customer-service, occupancy, depreciation and personnel costs increased. Direct segment operating income declined 45.8% to $13.2 million; retail segment operating income increased 126.0% to $23.8 million.
Fiscal Q4 sales were $217.8 million, 46.2% of annual sales, versus $174.7 million a year earlier. Q4 net income attributable to controlling interest was $19.5 million versus $14.0 million. Q4 gross margin was 53.3%, compared with 55.4% in FY2016 Q4. The business is highly seasonal: FY2017 Q4 generated 83.6% of annual net income attributable to controlling interest.
Cash was $2.9 million at year-end, down from $24.0 million; working capital was $51.5 million, down from $66.1 million. Inventory increased to $89.5 million from $70.4 million. Net cash used in investing was $55.8 million, including $46.5 million of capital expenditures and a $6.3 million investment in an available-for-sale security. Total debt, including current maturities, was $1.5 million; separately, finance lease obligations under build-to-suit leases were $26.6 million. The $60 million revolving facility had no balance outstanding at year-end, carried a 2.8% effective rate, was secured by substantially all company assets and matured July 31, 2019. The company reported compliance with its debt covenants.
Material changes, outlook and risks
- The company planned approximately 15 store openings in FY2018 and forecast capital expenditures of $45–55 million, including $27–32 million for retail expansion. Management said the existing $60 million revolver was expected to be insufficient for its growth plans and intended to refinance it in the first half of FY2018 with greater borrowing capacity and longer-term commitments.
- Management cited average store payback of less than two years and identified approximately 100 potential U.S. store markets. These are company expectations, not guarantees of future performance.
- The Tax Act reduced the U.S. federal corporate rate; FY2017 tax expense included a $1.5 million benefit from deferred-tax remeasurement. Management expected a 21% federal statutory rate for subsequent fiscal years and anticipated a favorable effect on future tax expense and operating cash flows. Excluding the Tax Act impact, management said FY2017 net income increased only 0.8%.
- Key risks include execution and returns on rapid store expansion; seasonal demand and inventory forecasting; continued pressure on shipping revenue and gross margin; reliance on foreign suppliers and concentrated sourcing (one agent accounted for 50% of purchases and another supplier 18%); supply-chain and distribution disruptions; competition and changing customer preferences; and cybersecurity, technology and customer-data risks.
- Substantially all merchandise is sourced from outside the United States. The company also depends on third parties for manufacturing, logistics, delivery and technology services. Its direct channel, including e-commerce, remains a major sales source, while catalogs expose it to postage, paper and printing cost increases.
- Governance and ownership considerations include dual-class shares: the Class A holder, founder Stephen Schlecht, held approximately 67.2% of voting power. The company qualified as a Nasdaq controlled company and could rely on exemptions from certain governance requirements.
- The company reported no legal proceedings expected to have a material adverse effect. The independent auditor issued an unmodified opinion on the financial statements; the auditor did not express an opinion on internal control over financial reporting. Management concluded disclosure controls and internal controls over financial reporting were effective.
Important facts for investors to verify
- Whether the planned 15 FY2018 store openings and $45–55 million capital-spending plan were achieved, and whether new-store economics matched management’s stated payback experience.
- Whether revenue growth translated into improved operating leverage, given declining gross, operating and Adjusted EBITDA margins in FY2017.
- How shipping discounts, freight costs, promotions and catalog expenses affected subsequent gross margin and customer-acquisition economics.
- The actual terms and capacity of the planned revolver refinancing, and liquidity needs through seasonal inventory build and store expansion.
- The final impact of the Tax Act and the adoption effects of new revenue-recognition, restricted-cash and lease-accounting standards; the filing noted that some impacts remained under evaluation.
- Whether supplier concentration, inventory growth and technology-system upgrades created material operational or financial effects.