Duluth Holdings Inc. — Q3 FY2019 Form 10-Q
Reporting period: 13 weeks ended November 3, 2019; comparisons are to the 13 weeks ended October 28, 2018. Nine-month comparisons cover the corresponding 39-week periods. Fiscal 2019 ends February 2, 2020. Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions.
Business context
Duluth sells men’s and women’s casual wear, workwear and accessories through its website, catalogs, retail stores and outlets. At quarter-end it operated 55 retail stores and three outlet stores. The business is seasonal, historically generating a significant portion of annual sales and operating profit in the holiday quarter.
Financial performance
| Metric | Q3 FY2019 | Q3 FY2018 | Nine months FY2019 | Nine months FY2018 |
|---|---|---|---|---|
| Net sales | $119.8 million | $106.7 million | $356.0 million | $317.6 million |
| Gross profit / margin | $65.4 million / 54.6% | $61.0 million / 57.1% | $191.1 million / 53.7% | $179.2 million / 56.4% |
| Operating income (loss) | $1.3 million | $(2.6) million | $(5.0) million | $7.1 million |
| Net income (loss), controlling interest | $0.2 million | $(3.2) million | $(5.5) million | $2.5 million |
| Adjusted EBITDA | $7.3 million | $1.0 million | $12.0 million | $16.7 million |
Quarterly sales rose 12.2%; retail sales increased 24.1% and direct sales 2.9%. For the nine months, sales rose 12.1%, led by 28.9% retail growth, while direct sales increased 0.4%. Retail represented 48.6% of quarterly sales versus 43.9% a year earlier. Men’s and women’s sales both increased.
Quarterly gross margin fell 250 basis points, primarily due to promotions and clearance activity. Nine-month gross margin fell 270 basis points, with additional pressure from slightly lower shipping revenue. Quarterly SG&A rose 0.8% to $64.0 million, but declined as a share of sales to 53.5% from 59.5%; lower marketing/catalog costs and operating leverage contributed. Nine-month SG&A increased 14.0% to $196.1 million and rose to 55.1% of sales, reflecting higher general and administrative and selling costs, including store occupancy and depreciation.
Cash flow, liquidity and debt
- For the first nine months, operating cash flow was $(47.6) million versus $(23.5) million a year earlier. The principal working-capital use was an $85.4 million inventory increase, partly offset by a $29.9 million increase in trade payables. Management attributed inventory growth to preparations for peak season and a larger store base.
- Investing cash flow was $(24.5) million, including $20.9 million of property and equipment purchases and $3.7 million of build-to-suit store contributions. Financing cash flow was $73.0 million, including $53.9 million net revolver proceeds and $20.0 million from the delayed draw term loan.
- At November 3, cash was $2.2 million and restricted cash was $1.8 million. Current assets were $204.3 million and current liabilities $95.5 million; reported net working capital was $108.7 million.
- Revolver borrowings were $70.5 million against an $80 million facility. The company also had drawn $20 million of a $50 million delayed draw term loan, available through May 17, 2020. The facility matures in 2023 and is secured by substantially all company assets. The company reported compliance with debt covenants.
- Long-term debt included $28.4 million of TRI-related notes, which are consolidated but for which Duluth is not the guarantor or obligor. Lease adoption resulted in reported operating lease liabilities of $114.6 million and finance lease liabilities of $39.8 million at quarter-end.
Outlook, commentary and notable items
- Management expects full-year FY2019 operating cash flow to be positive, citing seasonal working-capital reductions in Q4, and believes operating cash flow plus revolver availability will cover working capital and planned capital expenditures.
- FY2019 capital expenditures were expected to be approximately $38 million, including approximately $30–32 million for new stores and remodels. Management expects capital outlays to moderate into 2020, plans to pursue store openings with 30–40% less square-footage expansion than in the prior three years, and emphasized improving returns, operating earnings and positive free cash flow.
- No specific revenue or earnings guidance was provided in the filing. Management reported 39 consecutive quarters of year-over-year sales growth and noted that stores had achieved, and were expected to continue achieving, an average payback of less than two years.
- ASC 842 lease accounting was adopted February 4, 2019, adding right-of-use assets and lease liabilities to the balance sheet; prior periods were not restated. The opening adoption adjustment reduced retained earnings by $1.9 million.
- A previously reported material weakness in internal controls was declared remediated after management added resources and enhanced reconciliation controls. Management said disclosure controls were effective. No material changes to previously disclosed risk factors, material legal proceedings, or material subsequent events were reported.
Key facts for investors to verify
- Whether Q4 seasonal sales and cash generation offset the elevated inventory and operating cash outflow.
- Whether promotional and clearance activity continues to pressure gross margin and whether margins recover.
- Inventory quality, turnover and the company’s ability to convert seasonal stock into cash without further discounting.
- Available borrowing capacity, covenant headroom and the impact of lease obligations on fixed-charge coverage and liquidity.
- Progress on moderating capital spending, store returns and management’s stated focus on positive free cash flow.
- The sustainability of the reported internal-control remediation and the effect of lease accounting on comparability with prior periods.