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DULUTH HOLDINGS INC.

(DLTH)
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DULUTH : Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

06/04/2021 | 11:38am EDT

The following discussion and analysis of the financial condition and results of our operations should be read in conjunction with the financial statements and related notes of Duluth Holdings Inc. included in Item 1of this Quarterly Report on Form 10-Q and with our audited financial statements and the related notes included in our Annual Report on Form 10-K for the fiscal year ended January 31, 2021 ("2020 Form 10-K").

The Company's fiscal year ends on the Sunday nearest to January 31 of the following year. Fiscal 2021 is a 52-week period and ends on January 30, 2022. Fiscal 2020 was a 52-week period and ended on January 31, 2021. The three months of fiscal 2021 and fiscal 2020 represent our 13 week periods ended May 2, 2021 and May 3, 2020, respectively.

Unless the context indicates otherwise, the terms the "Company," "Duluth," "Duluth Trading," "we," "our," or "us" are used to refer to Duluth Holdings Inc.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 that are subject to risks and uncertainties. All statements other than statements of historical or current facts included in this Quarterly Report on Form 10-Q are forward-looking statements. Forward looking statements refer to our current expectations and projections relating to our financial condition, results of operations, plans, objectives, strategies, future performance and business. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as "anticipate," "could," "estimate," "expect," "project," "plan," "potential," "intend," "believe," "may," "might," "will," "objective," "should," "would," "can have," "likely," and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events. For example, all statements we make relating to our estimated and projected earnings, revenue, costs, expenditures, cash flows, growth rates and financial results, our plans and objectives for future operations, growth or initiatives, strategies are forward-looking statements. All forward-looking statements are subject to risks and uncertainties, including the risks and uncertainties described under Part I, Item 1A "Risk Factors," in our 2020 Form 10-K, Part II, and other SEC filings, which factors are incorporated by reference herein. These risks and uncertainties include, but are not limited to, the following: the prolonged effects of the COVID-19 on store traffic and disruptions to our distribution network, supply chains and operations; our ability to maintain and enhance a strong brand and sub-brand image; effectively adapting to new challenges associated with our expansion into new geographic markets; generating adequate cash from our existing stores to support our growth; effectively relying on sources for merchandise located in foreign markets; transportation delays and interruptions, including port congestion; inability to timely and effectively obtain shipments of products from our suppliers and deliver merchandise to our customers; the inability to maintain the performance of a maturing store portfolio; the impact of changes in corporate tax regulations; identifying and responding to new and changing customer preferences; the success of the locations in which our stores are located; our ability to attract and retain customers in the various retail venues and locations in which our stores are located; competing effectively in an environment of intense competition; our ability to adapt to significant changes in sales due to the seasonality of our business; price reductions or inventory shortages resulting from failure to purchase the appropriate amount of inventory in advance of the season in which it will be sold in global market constraints; increases in costs of fuel or other energy, transportation or utility costs and in the costs of labor and employment; failure of our information technology systems to support our current and growing business, before and after our planned upgrades; and other factors that may be disclosed in our SEC filings or otherwise. Moreover, we operate in an evolving environment, new risk factors and uncertainties emerge from time to time and it is not possible for management to predict all risk factors and uncertainties, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statement. We qualify all of our forward-looking statements by these cautionary statements.

We undertake no obligation to update or revise these forward-looking statements, except as required under the federal securities laws.

Overview

We are a lifestyle brand of men's and women's casual wear, workwear and accessories sold primarily through our own omnichannel platform. We offer products nationwide through our website and catalog. In 2010, we initiated our omnichannel platform with the opening of our first store. Since then, we have expanded our retail presence, and as of May 2, 2021, we operated 61 retail stores and three outlet stores.

We offer a comprehensive line of innovative, durable and functional products, such as our Longtail T® shirts, Buck NakedTM underwear, Fire Hose® work pants, and No-Yank® Tank, which reflect our position as the Modern, Self-Reliant American Lifestyle brand. Our brand has a heritage in workwear that transcends tradesmen and appeals to a broad demographic for everyday and on-the-job use.


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From our heritage as a catalog for those working in the building trades, Duluth Trading has become a widely recognized brand and proprietary line of innovative and functional apparel and gear. Over the last decade, we have created strong brand awareness, built a loyal customer base and generated robust sales momentum. We have done so by sticking to our roots of "there's gotta be a better way" and through our relentless focus on providing our customers with quality, functional products.

A summary of our financial results is as follows:

?Net sales in fiscal 2021 first quarter increased by 21.4% over the prior year first quarter to $133.4 million;

?Net income of $0.5 million in fiscal 2021 first quarter compared to the prior year first quarter net loss of $(15.2) million;

?Adjusted EBITDA increased to $10.1 million in fiscal 2021 first quarter compared to the prior year first quarter Adjusted EBITDA of $(11.6) million;

See "Reconciliation of Net Income (Loss) to EBITDA and EBITDA to Adjusted EBITDA" section for a reconciliation of our net income (loss) to EBITDA and EBITDA to Adjusted EBITDA, both of which are non-U.S. GAAP financial measures. See also the information under the heading "Adjusted EBITDA" in the section "How We Assess the Performance of Our Business" for our definition of Adjusted EBITDA.

With an emphasis on profitable growth we are pursuing several strategies, including evolving into a portfolio of distinct brands within the Duluth Trading ecosystem, growing sales in existing store and non-store markets, strengthening the core Men's Duluth sub-brand and growing our Women's Duluth sub-brand.

Our management's discussion and analysis includes market sales metrics for our stores, website and catalog sales. Market areas are determined by a third-party that divides the United States and Puerto Rico into 280 unique geographical areas. Our store market sales metrics include sales from our stores, website and catalog. Our non-store market sales metrics include sales from our website and catalog.

COVID-19

In March 2020, a novel strain of coronavirus ("COVID-19") was declared a global pandemic by the World Health Organization. This pandemic has negatively affected the U.S. and global economies, disrupted global supply chains and financial markets, led to significant travel and transportation restrictions, including mandatory business closures and orders to shelter in place.

The ultimate impact of COVID-19 on our operational and financial performance still depends on future developments outside of our control, including the duration and spread of the pandemic and related actions taken by federal, state and local government officials, and international governments to prevent disease spread. Given the uncertainty, we cannot reasonably estimate store traffic patterns and the prolonged impact on overall consumer demand. We continue to actively evaluate all federal, state and local regulations to ensure compliance with store operations.

How We Assess the Performance of Our Business

In assessing the performance of our business, we consider a variety of financial and operating measures that affect our operating results.

Net Sales

Net sales reflect our sale of merchandise plus shipping and handling revenue collected from our customers, less returns and discounts. Direct-to-consumer sales are recognized upon shipment of the product and store sales are recognized at the point of sale. We also use net sales as one of the key financial metrics in determining our annual bonus compensation for our employees.

Gross Profit

Gross profit is equal to our net sales less cost of goods sold. Gross profit as a percentage of our net sales is referred to as gross margin. Cost of goods sold includes the direct cost of purchased merchandise; inventory shrinkage; inventory adjustments due to obsolescence, including excess and slow-moving inventory and lower of cost and net realizable reserves; inbound freight; and freight from our distribution centers to our retail stores. The primary drivers of the costs of individual goods are raw material costs. Depreciation and amortization are excluded from gross profit. We expect gross profit to increase to the extent that we successfully grow our net sales. Given the size of our sales through our direct-to-consumer sales channel relative to our total net sales, shipping and handling revenue has had a significant impact on our gross profit and gross profit margin. Historically, this revenue has partially offset shipping and handling expense included in selling, general and administrative


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expenses. We have experienced declines in shipping and handling revenues, and this trend is expected to continue. Declines in shipping and handling revenues may have a material adverse effect on our gross profit and gross profit margin, as well as Adjusted EBITDA to the extent there are not commensurate declines, or if there are increases, in our shipping and handling expense. Our gross profit may not be comparable to other retailers, as we do not include distribution network and store occupancy expenses in calculating gross profit, but instead we include them in selling, general and administrative expenses.

Selling, General and Administrative Expenses

Selling, general and administrative expenses include all operating costs not included in cost of goods sold. These expenses include all payroll and payroll-related expenses and occupancy expenses related to our stores and to our operations at our headquarters, including utilities, depreciation and amortization. They also include marketing expense, which primarily includes television advertising, catalog production, mailing and print advertising costs, as well as all logistics costs associated with shipping product to our customers, consulting and software expenses and professional services fees. Selling, general and administrative expenses as a percentage of net sales is usually higher in lower-volume quarters and lower in higher-volume quarters because a portion of the costs are relatively fixed.

Our historical sales growth has been accompanied by increased selling, general and administrative expenses. The most significant components of these increases are advertising, marketing, rent/occupancy and payroll costs. While we expect these expenses to increase as we continue to open new stores, increase brand awareness and grow our organization to support our growing business, we believe these expenses will decrease as a percentage of sales over time.

Adjusted EBITDA

We believe Adjusted EBITDA is a useful measure of operating performance, as it provides a clearer picture of operating results by excluding the effects of financing and investing activities by eliminating the effects of interest and depreciation costs and eliminating expenses that are not reflective of underlying business performance. We use Adjusted EBITDA to facilitate a comparison of our operating performance on a consistent basis from period-to-period and to provide for a more complete understanding of factors and trends affecting our business.

We define Adjusted EBITDA as consolidated net income before depreciation and amortization, interest expense and provision for income taxes adjusted for the impact of certain items, including non-cash and other items we do not consider representative of our ongoing operating performance. We believe Adjusted EBITDA is less susceptible to variances in actual performance resulting from depreciation, amortization and other items. This non-GAAP measure may not be comparable to similarly titled measures used by other companies.


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Results of Operations

The following table summarizes our unaudited consolidated results of operations for the periods indicated, both in dollars and as a percentage of net sales.


                                                          Three Months Ended
                                                     May 2, 2021       May 3, 2020
(in thousands)
Net sales                                          $       133,419   $       109,917
Cost of goods sold (excluding depreciation
?and amortization)                                          66,876            57,585
Gross profit                                                66,543            52,332
Selling, general and administrative expenses                64,648            71,306
Operating income (loss)                                      1,895          (18,974)
Interest expense                                             1,308             1,350
Other income, net                                               16                59
Income (loss) before income taxes                              603          (20,265)
Income tax expense (benefit)                                   105           (5,086)
Net income (loss)                                              498          (15,179)
Less: Net loss attributable to noncontrolling
interest                                                      (46)              (44)
Net income (loss) attributable to controlling
interest                                           $           544   $      (15,135)
Percentage of Net sales:
Net sales                                                    100.0 %           100.0 %
Cost of goods sold (excluding depreciation
?and amortization)                                            50.1 %            52.4 %
Gross margin                                                  49.9 %            47.6 %
Selling, general and administrative expenses                  48.5 %            64.9 %
Operating income (loss)                                        1.4 %          (17.3) %
Interest expense                                               1.0 %             1.2 %
Other income, net                                                - %             0.1 %
Income (loss) before income taxes                              0.5 %          (18.4) %
Income tax expense (benefit)                                   0.1 %           (4.6) %
Net income (loss)                                              0.4 %          (13.8) %
Less: Net loss attributable to noncontrolling
interest                                                         - %               - %
Net income (loss) attributable to controlling
interest                                                       0.4 %          (13.8) %


Three Months Ended May 2, 2021 Compared to Three Months Ended May 3, 2020

Net Sales

Net sales increased $23.5 million, or 21.4%, to $133.4 million in the three months ended May 2, 2021 compared to $109.9 million in the three months ended May 3, 2020. The increase was due to increases in both non-store and store market sales.

Store market sales increased $22.5 million, or 33.3%, to $89.9 million in the three months ended May 2, 2021 compared to $67.4 million in the three months ended May 3, 2020. The year-over-year sales difference was driven by temporary store closures in fiscal 2020 beginning on March 20, 2020 through May 3, 2020, as well as growth in online sales from both existing customers and new buyers. Non-store market sales increased $0.8 million, or 2%, to $42.0 million in the three months ended May 2, 2021 compared to $41.2 million in the three months ended May 3, 2020.


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Gross Profit

Gross profit increased $14.2 million, or 27.2%, to $66.5 million in the three months ended May 2, 2021 compared to $52.3 million in the three months ended May 3, 2020. As a percentage of net sales, gross margin increased to 49.9% of net sales in the three months ended May 2, 2021, compared to 47.6% of net sales in the three months ended May 3, 2020. The increase in gross margin rate was driven a higher mix of full price sales as well as improved gross margin rates on both full price and clearance items.

Selling, General and Administrative Expenses

Selling, general and administrative expenses decreased $6.7 million, or 9.3%, to $64.6 million in the three months ended May 2, 2021 compared to $71.3 million in the three months ended May 3, 2020. Selling, general and administrative expenses as a percentage of net sales decreased to 48.5% in the three months ended May 2, 2021, compared to 64.9% in the three months ended May 3, 2020. The positive leverage was primarily due to shifting to a more efficient digital marketing approach as customer purchasing patterns migrated to online.

The decrease in selling, general and administrative expense was primarily due to decreased traditional advertising, reduced digital prospecting spend, the elimination of third-party logistics, and $1.6 million of non-recurring COVID-19 related expenses during the first quarter of the prior fiscal year. The decrease was partially offset by increased wages due to Company retail locations being open for the full fiscal quarter.

Income Taxes

Income tax expense was $0.1 million in the three months ended May 2, 2021, compared to an income tax benefit of $5.1 million in the three months ended May 3, 2020. The effective tax rate related to controlling interest was 16% for the three months ended May 2, 2021, which was impacted by changes to certain discrete items during the quarter. Excluding these non-recurring discrete items, the effective tax rate related to controlling interest was 25% for both the three months ended May 2, 2021 and May 3, 2020.

Net Income Attributable to Controlling Interest

Net income attributable to controlling interest was $0.5 million, in the three months ended May 2, 2021 compared to a net loss of $(15.1) million in the three months ended May 3, 2020, due to the factors discussed above.

Reconciliation of Net Income (Loss) to EBITDA and EBITDA to Adjusted EBITDA

The following table presents reconciliations of net income (loss) to EBITDA and EBITDA to Adjusted EBITDA, both of which are non-U.S. GAAP financial measures, for the periods indicated below. See the above section titled "How We Assess the Performance of Our Business," for our definition of Adjusted EBITDA.


                                                     Three Months Ended
                                                 May 2, 2021    May 3, 2020
(in thousands)
Net income (loss)                               $         498  $    (15,179)
Depreciation and amortization                           7,274          6,689
Amortization of internal-use software hosting
subscription implementation costs                         369              -
Interest expense                                        1,308          1,350
Amortization of build-to-suit operating leases
?capital contribution                                     199            199
Income tax expense (benefit)                              105        (5,086)
EBITDA                                          $       9,753  $    (12,027)
Stock based compensation                                  371            463
Adjusted EBITDA                                 $      10,124  $    (11,564)

As a result of the factors discussed above in the "Results of Operations" section, Adjusted EBITDA increased $20.7 million to $10.1 million in the three months ended May 2, 2021 compared to $(11.6) million in the three months ended May 3, 2020. As a percentage of net sales, Adjusted EBITDA increased to 7.6% of net sales in the three months ended May 2, 2021 compared to (10.5)% of net sales in the three months ended May 3, 2020.


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Liquidity and Capital Resources

General

Our business relies on cash from operating activities and a credit facility as our primary sources of liquidity. Our primary cash needs have been for inventory, marketing and advertising, payroll, store leases, capital expenditures associated with infrastructure, information technology, and opening new stores. The most significant components of our working capital are cash, inventory, accounts payable and other current liabilities. At May 2, 2021, our net working capital was $73.5 million, including $26.1 million of cash and cash equivalents.

We expect to spend approximately $15.0 million in fiscal 2021 on capital expenditures, inclusive of software hosting implementation costs. Capital expenditures includes a total of approximately $13.0 million related to investments in technology and $2.0 million for one planned new retail store. Due to the seasonality of our business, a significant amount of cash from operating activities is generated during the fourth quarter of our fiscal year. We also use cash in our investing activities for capital expenditures throughout all four quarters of our fiscal year.

We believe that our cash flow from operating activities and the availability of cash under our credit facility will be sufficient to cover working capital requirements and anticipated capital expenditures for the foreseeable future.

Cash Flow Analysis


A summary of operating, investing and financing activities is shown in the
following table.

                                                          Three Months Ended
                                                    May 2, 2021        May 3, 2020
(in thousands)
Net cash provided by (used in) operating
activities                                         $       12,423    $      (33,491)
Net cash used in investing activities                     (1,974)            (4,102)
Net cash (used in) provided by financing
activities                                               (31,616)             44,653
(Decrease) increase in cash, cash equivalents
and restricted cash                                $     (21,167)    $         7,060


Net Cash Provided by (Used in) Operating Activities

Operating activities consist primarily of net income adjusted for non-cash items that include depreciation and amortization, stock-based compensation and the effect of changes in operating assets and liabilities.

For the three months ended May 2, 2021, net cash provided by operating activities was $12.4 million, which consisted of net income of $0.5 million, cash provided by operating assets and liabilities of $4.8 million, non-cash depreciation and amortization of $7.3 million, and stock based compensation of $0.4 million. The cash provided by operating assets and liabilities of $4.8 million primarily consisted of a $4.9 million decrease in inventory and a $6.5 million increase in trade accounts payable, partially offset by a $6.8 million decrease in accrued expenses.

For the three months ended May 3, 2020, net cash used in operating activities was $33.5 million, which consisted of net loss of $15.2 million and cash used in operating assets and liabilities of $25.4 million, partially offset by non-cash depreciation and amortization of $6.7 million and stock based compensation of $0.5 million. The cash used in operating assets and liabilities of $25.4 million primarily consisted of a $27.2 million increase in inventory. The quarter-end inventory position, although primarily consisting of core non-seasonal products, reflected a higher balance than historical levels due to purchase commitments made prior to scaling back new store openings and a general slowdown in sales growth over the prior 18 months. Net cash used in operating activities was partially offset by a $5.1 million increase in accrued expenses and deferred rent obligations, a $3.4 million decrease of income taxes payable and a $1.0 million decrease in deferred catalog costs.

Net Cash Used in Investing Activities

Investing activities consist primarily of capital expenditures for growth related to investments in infrastructure, information technology, and new store openings.

For the three months ended May 2, 2021, net cash used in investing activities was $2.0 million and was primarily driven by capital expenditures of $2.0 million for new investments in information technology.


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For the three months ended May 3, 2020, net cash used in investing activities was $4.1 million and was primarily driven by capital expenditures of $4.1 million for new retail stores, as well as investments in information technology.

Net Cash (Used in) Provided by Financing Activities

Financing activities consist primarily of borrowings and payments related to our revolving line of credit and other long-term debt, as well as payments on finance lease obligations.

For the three months ended May 2, 2021, net cash used in financing activities was $31.6 million, primarily consisting of payments of $30.6 million on long-term debt.

For the three months ended May 3, 2020, net cash provided by financing activities was $44.7 million, primarily consisting of proceeds of $29.7 million, net from our term loan and proceeds of $15.7 million, net from our revolving line of credit to fund working capital.

Contractual Obligations

There have been no significant changes to our contractual obligations as described in our Annual Report on Form 10-K for the fiscal year ended January 31, 2021.

Off-Balance Sheet Arrangements

We are not a party to any material off-balance sheet arrangements.

Critical Accounting Policies and Critical Accounting Estimates

The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses, as well as the related disclosures of contingent assets and liabilities at the date of the financial statements. We evaluate our accounting policies, estimates, and judgments on an on-going basis. We base our estimates and judgments on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions and conditions and such differences could be material to the consolidated financial statements.

As of the date of this filing, there were no significant changes to any of the critical accounting policies and estimates described in our 2020 Form 10-K.

Recent Accounting Pronouncements

See Note 12 "Recent Accounting Pronouncements," of Notes to Condensed Consolidated Financial Statements included in Part 1, Item 1, of this quarterly report on Form 10-Q for information regarding recent accounting pronouncements.

© Edgar Online, source Glimpses

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