Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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 includ
ed in our Annual Re
port on Form 10-K for the
fiscal
year ended January 31, 2016 (“2015 Form 10-K”).
The
three
and six
months of fiscal 2016 and fiscal 2015
represent our 13
and 26-week
periods ended
July 31, 2016
and
August 2, 2015
, 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. and its subsidiary and affiliates on a consolidated basis.
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 or the expected outcome or impact of pending or threatened litigation are forward-looking statements. All forward-looking statements are subject to risks and uncertainties, including the risks and unce
rtainties described under Part
I, Item 1A
“Risk Factors
,
” in our
Annual R
eport on F
orm 10-K
for the
fiscal
year ended January 31, 2016
, which factors are incorporated by reference herein
. 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 rapidly growing lifestyle brand of men’s and women’s casual wear, workwear and accessories sold exclusively through our own direct and retail channels. The direct segment, consisting of our website and catalogs, offers products nationwide and repr
esented 87.6% of our fiscal 2015
net sales. In 2010, we added retail to our omni-channel platform with the opening of our first store. Since then, we
have
expanded our retail pres
ence, and as of
July 31, 2016
, we
operated nine
retail stores and two outlet stores. Net sales for the retail segment
represented 1
8.2
%
and 15.1
% of consolidated n
et sales for the three
and six
months ending
July 31, 2016
respectively, and 16.1% and 12.7
% of consolidated net sales for the three and six months ending
August 2, 2015
, respectively
.
We offer a comprehensive line of innovative, durable and functional product, such as our Longtail T
®
shirts, Buck Naked
TM
underwear, and Fire Hose
®
work pants, 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.
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 have
increased year-over-year for
26
consecuti
ve quarters through
July 31, 2016
;
|
|
·
|
|
Net sales in fiscal 2016 second
quarter increased by
27.4
%
over the prior year second
quarter to
$65.8
million
and net sales in
the first six months of
fiscal 2
016
increased by 23.9
% over the
first six months of the prior year
to
$134.5
million
;
|
|
·
|
|
Net income in fiscal 2016 second
quarter decreased
by
36.5
% over the prior year second
quarter to $3.6
million
and net inc
ome in
the first six months of fiscal 2016
decreased by 18.2
% over th
e
first six months of the prior year
to $6.9
million
;
Adjusted for income taxes, as if we
had been a “C” corporation at a
combined federal, state and local effective income tax rate of 40.0%,
net income in fiscal 2016
second quarter increased by 5.8
% over the prior year second quarter
pro forma net income
and net income in
the first six months of fiscal 2016
increased 36.3
% over the
first six months of the prior year
pro forma net income
;
|
|
·
|
|
Adjusted EBITDA in fiscal
2016 second
quarter
increased
by
13.9
%
over the prior year second
quarter to
$7.5
million
and adjusted EBITDA in
the first six months of
fiscal
2016
increased by 25.1
% over the
first six months of the prior year
to $14.0
million
;
and
|
|
·
|
|
Our retail stores have achieved an average payback of less than two years.
|
See “Reconciliation of Net Income to
EBITDA and EBITDA to
Adjusted EBITDA” section for a reconciliation of our net income
to EBITDA and EBITDA
to Adjusted EBITDA,
both of which are
non-U.S. GAAP financial measure
s
. 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.
Our business is seasonal, and as a result, our net sales fluctuate from quarter to quarter, which often affects the comparability of our results between quarters. Net sales are historically higher in the fourth quarter of our fiscal year due to the holiday selling season.
We are pursuing several strategies to continue our profitable growth, including building brand awareness to continue customer acquisition, accelerating retail expansion, selectively broadening assortments in certain men’s product categories and growing our women’s business.
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 sales are recognized upon customer receipt of the product, while retail sales are recognized at the point of sale.
Comparable Store Sales
Comparable store sales are generally calculated based upon retail stores that were open at least twelve full fiscal months as of the end of the reporting period. Our outlet stores are not included in the comparable store sales calculations.
Comparable store sales allow us to evaluate how our retail store base
is per
forming by measuring the change
in period over-period net sales in stores that have been open for twelve fis
cal months or more. Some of our
competitors and other retailers calculate comparable store sales different
ly than we do; as a result, our
comparable store sales may not be comparable to similar data made available by
other companies. While we have
experienced strong comparable store sales growth to date, we have excluded c
omparable store sales data from this Form 10-Q
due to the limited number of comparab
le
retail stores as of
July 31, 2016
. Although
retail store
expansion is part of our growth strategy,
we expect a majority
percentage of
our net sales to come from our
direct segment for the foreseeable future.
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 p
urchased merchandise; inventory
shrinkage; inventory adjustments due to obsolescence, including excess and slo
w-moving inventory and lower of
cost or market reserves; inbound freight; and freight from our distribution ce
nters to our retail stores. The
primary drivers of the costs of individual goods are raw material costs. We expect
gross profit to increase to the
extent that we successfully grow our net sales. Given the size of our direct segment
sales 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 expenses. 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 ex
tent there are not commensurate
declines, or if there are increases, in our shipping and handling expense. Our gro
ss profit may not be comparable
to other retailers, as we do not include
distribution network and store occupanc
y 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 exp
enses 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, catalo
g 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 qu
arters because a portion of the
costs are relatively fixed
.
Our historical sales growth has been accompanied by increased selling, gener
al and administrative expenses.
The most significant components of these increases are advertising, market
ing and payroll costs. While we
expect these expenses to increase as we continue to open new stores, increa
se brand awareness and grow our
organization to support our growing business, we believe these expenses will de
crease 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 (loss) 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 feel Adjusted EBITDA is less susceptible to variances in actual performance resulting from depreciation, amortization and other items.
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.
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Six Months Ended
|
|
|
|
July 31, 2016
|
|
August 2, 2015
|
|
July 31, 2016
|
|
August 2, 2015
|
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct net sales
|
|
$
|
53,841
|
|
$
|
43,343
|
|
$
|
114,166
|
|
$
|
94,698
|
|
Retail net sales
|
|
|
11,982
|
|
|
8,334
|
|
|
20,289
|
|
|
13,786
|
|
Net sales
|
|
|
65,823
|
|
|
51,677
|
|
|
134,455
|
|
|
108,484
|
|
Cost of goods sold
|
|
|
26,901
|
|
|
21,215
|
|
|
55,842
|
|
|
45,359
|
|
Gross profit
|
|
|
38,922
|
|
|
30,462
|
|
|
78,613
|
|
|
63,125
|
|
Selling, general and administrative expenses
|
|
|
32,936
|
|
|
24,707
|
|
|
67,286
|
|
|
54,616
|
|
Operating income
|
|
|
5,986
|
|
|
5,755
|
|
|
11,327
|
|
|
8,509
|
|
Interest expense
|
|
|
37
|
|
|
60
|
|
|
75
|
|
|
112
|
|
Other income, net
|
|
|
60
|
|
|
26
|
|
|
130
|
|
|
75
|
|
Income before income taxes
|
|
|
6,009
|
|
|
5,721
|
|
|
11,382
|
|
|
8,472
|
|
Income tax expense
|
|
|
2,325
|
|
|
—
|
|
|
4,386
|
|
|
—
|
|
Net income
|
|
|
3,684
|
|
|
5,721
|
|
|
6,996
|
|
|
8,472
|
|
Less: Net income attributable to
noncontrolling interest
|
|
|
65
|
|
|
22
|
|
|
136
|
|
|
82
|
|
Net income attributable to controlling interest
|
|
$
|
3,619
|
|
$
|
5,699
|
|
$
|
6,860
|
|
$
|
8,390
|
|
Percentage of Net sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Direct net sales
|
|
|
81.8
|
%
|
|
83.9
|
%
|
|
84.9
|
%
|
|
87.3
|
%
|
Retail net sales
|
|
|
18.2
|
%
|
|
16.1
|
%
|
|
15.1
|
%
|
|
12.7
|
%
|
Net sales
|
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
Cost of goods sold
|
|
|
40.9
|
%
|
|
41.1
|
%
|
|
41.5
|
%
|
|
41.8
|
%
|
Gross profit
|
|
|
59.1
|
%
|
|
58.9
|
%
|
|
58.5
|
%
|
|
58.2
|
%
|
Selling, general and administrative expenses
|
|
|
50.0
|
%
|
|
47.8
|
%
|
|
50.0
|
%
|
|
50.3
|
%
|
Operating income
|
|
|
9.1
|
%
|
|
11.1
|
%
|
|
8.4
|
%
|
|
7.8
|
%
|
Interest expense
|
|
|
0.1
|
%
|
|
0.1
|
%
|
|
0.1
|
%
|
|
0.1
|
%
|
Other income, net
|
|
|
0.1
|
%
|
|
0.1
|
%
|
|
0.1
|
%
|
|
0.1
|
%
|
Income before income taxes
|
|
|
9.1
|
%
|
|
11.1
|
%
|
|
8.5
|
%
|
|
7.8
|
%
|
Income tax expense
|
|
|
3.5
|
%
|
|
-
|
%
|
|
3.3
|
%
|
|
-
|
%
|
Net income
|
|
|
5.6
|
%
|
|
11.1
|
%
|
|
5.2
|
%
|
|
7.8
|
%
|
Less: Net income attributable to
noncontrolling interest
|
|
|
0.1
|
%
|
|
0.0
|
%
|
|
0.1
|
%
|
|
0.1
|
%
|
Net income attributable to controlling interest
|
|
|
5.5
|
%
|
|
11.0
|
%
|
|
5.1
|
%
|
|
7.7
|
%
|
Pro Forma Net Income Information
(1)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income attributable to controlling interest
before provision for income taxes
|
|
|
|
|
$
|
5,699
|
|
|
|
|
$
|
8,390
|
|
Pro forma provision for income taxes
|
|
|
|
|
|
2,280
|
|
|
|
|
|
3,356
|
|
Pro forma net income attributable
to controlling interest
|
|
|
|
|
$
|
3,419
|
|
|
|
|
$
|
5,034
|
|
|
(1)
|
|
The unaudited pro forma net in
come information for the three
and six months ended August 2
, 2015,
gives effect to an adjustment for income tax expense on the income attributable to controlling interest as if we had been a “C” corporation at an assumed combined federal, state and local effective income tax rate, which approximates our statutory income tax rate, of 40.0%. No pro forma income tax expense was calculated on the income attributable to noncontrolling i
nterest because this entity did
not convert to a “C” corporation.
|
Thr
ee Months Ended
July 31, 2016
Compared to Thr
ee Months Ended
August 2, 2015
Ne
t Sales
Net sales increase
d $14.1
million,
or 2
7.4
%, to $65.8
million
in the
thr
ee months ended July 3
1
, 2016
compared to
$51
.
7
million in t
he three months ended August
2
, 2015
, driven by
gains in both direct
and retail segments of
$
10
.
5 million, or 24.2%, and $3.6
mi
llion, or 43.8
%, respectively,
with gains achieved
across
the majority of
all product categorie
s.
Our
customers continue
d
to respond positively to our marketing efforts
during the quarter
, which resulted in greater e-commerce traffic to our website and sales through our call center. Our website visits increased
19.6
% in the thr
ee months ended July
3
1, 2016
compared to t
he t
hree months ended August 2
, 2015
.
The increase in retail net sales was primarily at
tributable to the opening of
two new retail stores
during the sec
ond quarter of fiscal 2016 along with the opening of a retail store and outlet store in the prior year third and fourth quarters
.
Gross Profit
Gross profit increased $8.5 million, or 27.8%, to $38.9
million in the
thr
ee months ended July 31, 2016 compared to $30.5
million in
the three months ended August 2
, 2015
. As a percen
tage of net s
ales, gross margin increased 2
0
basis points to 59.1
% of net sales in the thr
ee months end
ed July 3
1, 2016
,
compared to
58.9
% of net sales in the three
m
onths e
nded August
2
, 2015
. Th
e increase in gross profit
was primarily driven
by an increase in net sales as discussed above. The increase in gross margin
rate
was pr
imarily attributable to
improved
initial
product costs due t
o increased volume,
a
product
mix
shift to higher margin products
, coupled with strategic management of promotions.
Selling, General and Administrative Expenses
Selling, general and administrative expenses
increased $8.2 million, or 33.3
%, to $32
.9
million in
th
e three months ended July
3
1, 2016
compared to $24.7
million in the three
months
ended August 2
,
2015
.
Selling, general and administrative expenses as a
percentage of net sales
increased 22
0 basis points to
50.0
% in the three months end
ed May 1, 2016, compared to 47.8
% in the
thr
ee months ended August 2
, 2015.
The increase in selling, general a
nd
administrative expenses was
a
tt
ributable to an increase of $3.8
million in adver
tising and marketing costs,
$2.3
million in general and
administrative expenses and $2.1
million in selling expenses.
The
$3.8
million
increase in advertising and marketing costs was primarily driven by
our con
tinued marketing efforts, specifically
in
our women’s advertising
campaign
, which
increase
d
$2.1 million
compared to the
three months ended August 2, 2015
.
As a percentage of net sales, advertising and marketing
costs increased 16
0 basis points to
20.8
% in the three mo
nths ended July
31, 2016, compared to 19.2
% in the
three
months ended August 2, 2015
.
The 16
0 basis point increase in advertising and marketing costs as a percentage of net sales, was primarily driven by
an increase
in television advertising attributable to our women’s advertising campaign, which was partially offset
by a decrease
in catalog costs
primarily
due to our planned
decrease in catalog spend as a percentage of net sales
.
The $2.3
million increase in general and administrative expenses w
as
primarily due t
o $0.9
million increase in
rent expense and related store opening costs
,
coupled with $0.6 million increase in personnel expenses.
The $0.9
million increase in rent expense and related store opening
costs was
primaril
y attributable to an increase of four
retail stores
during the three months ended May 1, 2016, compare
d to May 3, 2015
.
As a percentage of net sales, general and
a
dministrative expenses increased 20 basis points to 16.1% in
the t
hree months ended July 31, 2016, compared to 15.9% in the three months ended August 2, 2015
.
The 20 basis point increase in general and administrative expenses was
primarily
attributable to an increase of 90 basis
points in rent expense and related store opening costs
due to
an
increase in retail stores
,
and an increase of 40 basis points in depreciation, due to capital investments, which was partially offset by a decrease of 60 basis points in personnel and a decrease of 50 basis points in professional fees, which was attributable to higher net sales.
The $2.1
million increase in selling
expenses was primarily due to
$0.7
million
increase
in shipping expenses due to sale
s
growth, $0.5 million increase in distribution costs due the use of two
third party logistics providers (“3PLs”), coupled w
ith
a
$0.5 million
increase
in customer service
primarily attributable to the growth in retail
. As a percentage of net sales, selling expenses increased
40 basis points to 13.1
%
in the three months ended July 31, 2016, compared to 12
.7%
in the three months ended August 2, 2015, primarily due distribution costs and customer service as discussed above.
Interest Expense
Interest expense was $0.
04
million
in the three months ended July
31, 2016, compared to $0.06
million in th
e three months ended
August 2
, 2015
.
Provision for Income Taxes
Income tax expense was $2.
3
million in the three months ended
July 3
1, 2016 and o
ur effective tax rate was 39.1
%.
Prior to November 25, 2015, we had been classified as an “S” corporation for federal and state income tax purposes and therefore, we had not been subject to income taxes. Prior to that date, our shareholders had been subject to
income tax on their distributable
share of our earnings. In connection with our IPO, we converted to a “C” corporation. On a pro f
orma basis, if we had been taxed
as a “C” corporation at an estimated 40% effective tax rate, income taxes would have
been $2.3 million for both the three months ended July 31, 2016 and the three months ended August 2, 2015.
Net Income
Net income de
creased
$2.1 million, or 36.5% to $3.6
million in the thr
ee months ended July 3
1, 2016 compared t
o $5
.7
million in the thr
ee months ended August 2
, 2015
, primarily due to the factors discussed above. Applying a pro forma 40% “C” corpor
ation effective tax ra
te to the three months ended August 2
, 2015
, rather than the “S” corporation tax rate that a
ctually applied
to us
at that time
, net income increased $0.2
million, o
r 5.8%, to $3.6
million in the thr
ee months ended July 31, 2016 from $3.4
million in the thre
e months ended August 2
, 2015.
Six Months Ended July 31, 2016 Compared to Six Months Ended August 2, 2015
Ne
t Sales
Net sales increase
d $26.0
million,
or 23.9%, to $134.5
million
in the
six months ended July 31
, 2016
compared to
$108.5 million in the six months ended August 2
,
2015, driven by gains in both direct and retail segments of
$19.5 million, or 20.6%, and $6.5 million, or 47.2
%, respectively, with gains achieved across virtually all product categories
. The direct net sales gains were due to customers continuing to respond positively to our marketing efforts
, which resulted in greater e-commerce traffic
to our website and
sales through our call center. Our website visits
increased 17.0
% in
the six months ended July 31, 2016 compared to the six months ended August 2
, 2015.
The increase in retail net sales was primarily at
tributable to the
same factors discussed above for the three months ended July 31, 2016 compared
to the three months ended August 2
, 2015
.
Gross Profit
Gross profit increased $15.5 million, or 24.5%, to $78.6
million in the
six months ended July 31, 2016 compared to $63.1 million in the six months ended August 2
, 2015
. As a percen
tage of net sales, gross margin inc
reased 30 basis points to 58.5% of net sales in the six months ended July 31, 2016, compared to 58.2% of net sales in the six
m
onths ended August 2
, 2015
. Th
e increase in gross profit
was primarily driven
by an increase in net sales as discussed above. The increase in gross margin
rate
was primarily due to the factors discussed above for the
second
quarter.
Selling, General and Administrative Expenses
Selling, general and administrative expenses
increased $12.
7 million, or 23.2%, to $67.3
million in the six months ended July 31, 2016 compared to $54.6 million in the six
months
ended August 2
,
2015.
Selling, general and administrative expenses as a percentage of net sales
decreased 30 basis points to
50.0%
in the six months ended July 31, 2016, compared to 50.3% in the six months ended August 2
, 2015.
The increase in selling, general an
d
administrative expenses of $12.7
million was att
ributable to an increase of $4.7
million in advertising and marketing costs
, $4.2
million in general and
administrative expenses and $3.8
million in selling expenses.
The
$4.7
million
increase in advertising and marketing costs was primarily driven by our continued marketing efforts.
As a percentage of net sales, advertising and
marketing costs
decreased 70 basis points to 21.5% in the six months ended July 31, 2016, compared to 22.2% in the six months ended August 2
, 2015. The 70 basis points decline in advertising and marketing costs were
primarily attributable to
a decrease
of 60 and 40 basis points
in catalog and in television advertising, respectively,
primarily due to increased net sales an
d planned decrease in catalog spend as a percentage of net sales
, which was
partially offset by an increase
in web advertising
of 20
basis points
.
The $4.2
million increase in general and administrative expenses was primarily due to $1.
2
million increase in consultin
g and professional fees, $1
.
2
million in
crease in rent expense and related store opening
costs
, and $0.
8
million increase
in depreciation expense
. The increase in consulting and professional fees were primarily due to us becoming a public company
. The $1.2
million in
crease in rent expense and related store opening
costs
and $0.8
million increase in d
epreciation expense
were primarily attributable to
factors discussed above for the three months ended July 31, 2016 compared to the three months ended August 2, 2015.
As a percentage of net sales, general and adm
inistrative expenses increased 2
0 basis points to 15.
1
% in the six months ended July 31, 2016, compared to 14.9% in the six months ended August 2
, 2015.
The
six months ended August 2, 2015
included a $1.1 million payment related to a portion of the grantees’ tax liabilities associated with the grant of restricted stock awards. Excluding this $1.1 million payment, as a percentage of net sales, general and admi
nistrative expenses increased 13
0 basis points primarily due to the factors discussed above.
The $3.8
million increase in selling expenses was prim
arily due to an increase of $1.1
million in shipping expenses due
to sales growth,
and
$1.3 million increase in distribution costs due to the use of two third party logistics providers (“3PLs”)
, coupled with a $0.8 million increase in customer service primarily attributable to the growth in retail
. As a percentage of net sale
s, selling expenses increased 20 basis points to 13.4
% in the six months ended July
31, 2016, compared to 13.2% in the six months ended August 2
, 2015, primarily due to a
n increase in distribu
tion costs and customer service
of 40 and 20 basis points
respectively
,
as discussed above,
which was partially offset by
a
decrease
of 40 basis points
in shipping expenses due to favorable shipping rates as result of being closer to
our customers due to our use of the
3PLs.
Interest Expense
Interest expense was $0.08 million in the six
months en
ded July
31, 2016, compared to $0.1 million in the six months ended August 2
, 2015.
Provision for Income Taxes
Income tax e
xpense was $4.4 million in the six months ended July 3
1, 2016 and
our effective tax rate was 39.0
%. Prior to November 25, 2015, we had been classified as an “S” corporation for federal and state income tax purposes and therefore, we had not been subject to income taxes. Prior to that date, our shareholders had been subject to income tax on their distributable share of our earnings. In connection with our IPO, we converted to a “C” corporation. On a pro forma basis, if we had been taxed as a “C” corporation at an estimated 40% effective tax rate, income taxes would have increased by $1.
0 million, or 30.7
%, to $4.4 in the six months ended July 31, 2016 from $3.4 million in the six months ended August 2
, 2015.
Net Income
Net income
decreased $1.5 million, or 18.2
% to $6.9 million in the six months ended July 31, 2016 compared to $8.4 million in the six months ended August 2
, 2015, primarily due to the factors discussed above. Applying a pro forma 40% “C” corporation
effective tax rate to the six months ended August 2
, 2015, rather than the “S” corporation tax rate that actually applied to us, net income increased $1.
8 million, or 36.3
%, to $6.9 million in the six months ended July 31, 2016 from $5.0 million in the six months ended August 2
, 2015.
Reconciliation of Net Income to
EBITDA and EBITDA to
Adjusted EBITDA
The following table
presents reconciliations of net income to EBITDA and EBITDA to Adjusted EBITDA,
both of which are
non-
G
AAP financial measure
s
, 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
|
|
Six Months Ended
|
|
|
July 31, 2016
|
|
August 2, 2015
|
|
July 31, 2016
|
|
August 2, 2015
|
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
3,684
|
|
$
|
5,721
|
|
$
|
6,996
|
|
$
|
8,472
|
Depreciation and amortization
|
|
|
1,082
|
|
|
620
|
|
|
1,951
|
|
|
1,174
|
Interest expense
|
|
|
37
|
|
|
60
|
|
|
75
|
|
|
112
|
Income tax expense
|
|
|
2,325
|
|
|
—
|
|
|
4,386
|
|
|
—
|
EBITDA
|
|
$
|
7,128
|
|
$
|
6,401
|
|
$
|
13,408
|
|
$
|
9,758
|
Non-cash stock based compensation
|
|
|
335
|
|
|
152
|
|
|
615
|
|
|
332
|
Payment of grantees' tax liabilities
associated with grant of
restricted stock awards
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
1,115
|
Adjusted EBITDA
|
|
$
|
7,463
|
|
$
|
6,553
|
|
$
|
14,023
|
|
$
|
11,205
|
As a result of the factors discu
ssed above in the “Results of Operations
” section,
a
djusted EBITDA
increased
$0
.
9 million, or 13.9
%, to $7.5
million in
the
thr
ee months ended
July 31, 2016
compared to $6.6
million in t
he three months ended
August 2, 2015
. As a percen
tage of net sales,
a
djusted EBITDA
decreased 140 basis points to 11.3
% of net sales in the thr
ee months ended
July 31, 2016
compared to 12.7
% of net sales in the thr
ee months ended
August 2, 2015
.
As a result of the factors discu
ssed above in the “Results of Operations” section
,
a
djusted EBITDA
increased $2.8 million, or 25.1
%, to $14.0
million in
the
six months ende
d July 31, 2016 compared to $11.2
million in the six months ended August 2, 2015
. As a percen
tage of net sales,
a
dju
sted EBITDA increased 10 basis points to 10.4
% of net sales in the six
months ended
July 31, 2016
compared to 10.3
% of net sales in the six
months ended
August 2, 2015
.
Liquidity and Capital Resources
General
Our business relies on cash from operating activities as well as cash on hand and a $40 million revolving line of credit as our primary sources of liquidity. Our primary cash needs have been for inventory,
marketing and advertising,
payroll, store leases, capital expenditures associated with opening new stores, infrastructure and information technol
ogy
. The most significant components of our working capital are cash, inventory, accounts payable and other current liabilities.
We expect to spend
approximately $24.0 million to $25.0 million in fiscal 2016
on capital expenditures, inclu
ding a total of approximately $10.0 million to $11
.0 million for new retail store expansion. We expect it will take approximately $2.0 million to $2.6 million in capital expenditures and startin
g inventory to open a new store. At
July 31, 2016
, our
net
working capital was $
62.3
million,
including $23
.3 million of cash
. 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. During the first three quarters of our fiscal year, we typically are net users of cash in our operating activities as we acquire inventory in anticipation of our peak selling season, which occurs in 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
balance as of
July 31, 2016
, combined with cash
flow from operating activities
and
the availability of cash under our revolving line of credit will be sufficient to cover working capital requirements and anticipated capital expenditures and for funding our growth strategy for the foreseeable future.
Cash Flow Analysis
A summary of operating, investing and financing activities is shown in the following table.
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|
|
|
Six Months Ended
|
|
|
July 31, 2016
|
|
August 2, 2015
|
(in thousands)
|
|
|
|
|
|
|
Net cash provided by (used in) operating activities
|
|
$
|
1,072
|
|
$
|
(1,048)
|
Net cash used in investing activities
|
|
|
(15,307)
|
|
|
(3,857)
|
Net cash used in financing activities
|
|
|
(336)
|
|
|
(2,610)
|
Decrease in cash
|
|
$
|
(14,571)
|
|
$
|
(7,515)
|
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, loss on disposal of property, equipment and other assets, stock-based compensation and the effect of changes in assets and liabilities.
For the six months ended July 31
, 2016
, net cash provided operating activities was $1.1
million, which
primarily
consisted of net income of $7.0
million, non-cash depre
ciation and amortization of $2.0
million and stock based compensation of $0.
6
million, offset by cash used in operating
assets and liabilities of $8.
3
million. The cash used in operatin
g assets and liabilities of $8.
3
mil
lion primarily co
nsisted of
$10.9
million
increase in i
nventory
,
due to building up of inventory
for
our peak season, coupled with plans for
opening of new retail stores
in fiscal 2016,
$2.8 million decrease in accrued expenses,
which w
as partial
ly offset by an increase of $5.6
in
trade accounts payable primarily attrib
u
table to the timing
.
For the six
months ended
August 2, 2015
, net cash use
d in operating activities was $
1
.
0
million, which consisted of net
income of $8.5
million, non-cash dep
reciation and amortization of $1
.
2
million and
stock-based compensation
of $0.
3
million, offset by cash used in operatin
g assets and liabilities of $11.0
million. The cash used in operating assets and liabilities of $
11.0
mil
lion primarily consisted of $6.1 million increase in inventory and $4.5 million decrease in accrued expenses. The increase in inventory was due to seasonality and growth of our business. The $4.5 million decrease in accrued expenses, was due to a $1.1 million payment related to a portion of the grantees’ tax liabilities associated with the grant of restricted stock, coupled with timing of payments subsequent to our fiscal year end.
Net Cash Used in Investing Activities
Investing activities consist primarily of capital expenditures for growth related to new store openings, information technology and enhancements for our distribution and corporate facilities
, coupled with changes in restricted cash,
which is
related to a
retail store lease agreement
.
For the six
months ended July
3
1, 2016
, net cash used in inves
ting activities was $15.3
million and was primarily driven by capital expenditures
of $14.5
million
for the
expansion of our Belleville distribution cente
r and additional
new retail stores.
For the six
months ended
August 2, 2015
,
net cash used
in investing activities was $3.9
million and was primarily driven by capital expenditures for the opening of a new store and the implementation of a new warehouse management system.
Net Cash Used in
Financing Activities
Financing activities consist primarily of borrowings and payments related to our revolving line of credit and other long-term debts, as well as distributions to
the individuals and entities that were
our shareholders
prior to our IPO
and holders of noncontrolling interest in variable interest entities and capital con
tributions to
Schlecht Retail Ventures LLC.
For the six
months
ended July 31
, 2016, net cash used in financing activities was $0.
3
m
illion, primarily consisting of
the final $0.2 million
distributions to
our then share
holders
due to our “S” corporation status prior to our IPO and $0.1 million payments on long-term debt.
For the six
months ended
August 2, 2015
, net cash
used
in financing activities was $2.6
million, pri
marily consisting of uses of $9.9 million in tax distributions to our then shareholders due to our “S” corporation status prior to our IPO, $0.5 million for payments on mortgage notes and $0.3 million for payments on capital leases, offset by proceeds of $5.9 million, net from our revolving line of credit, $0.8 million from new long-term obligations, $1.0 million change in bank overdrafts and $0.3 million for capital contributions to variable interest entities.
Line of Credit
We
have
a $40.0 million revolving line of credit
(“LOC”)
f
rom
BMO Harris Bank N.A., subject to certain borr
owi
ng base limits, which
expire
s
in
July 2018 and bears
interest, payable monthly, at a rate equal to the one-month LIBOR rate plus 1.25 percentage points. The
LOC agreement is
secured by essentially
all Company assets and requires
that we maintain certain financial and non-financial covenants, including a
minimum tangible net worth
and a minimum trailing twelve month EBITDA. As o
f and for the six
months ended
July 31, 2016
, we were in compliance with all financial and non-financ
ial covenants
, and we expect to be in compliance with all financial and non-financial covenants for the remainder of fiscal 2016
.
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, 2016.
Off-Balance Sheet Arrangements
We are not a party to any off-balance sheet arrangements, except for operating leases
.
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 Annual Report on Form 10-K for the
fiscal
year ended January 31, 2016
.
Recently Issued Accounting Pronouncements
Revenue from Contracts with Customers
In May 2014, the FASB issued Accounting Standards Update No. 2014-09,
Revenue from Contracts with Customers (Topic 606)
(“ASU 2014-09”), which supersedes the revenue recognition requirements in ASC Topic 605,
Revenue Recognition
. ASU 2014-09 requires revenue recognition to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new revenue recognition model requires identifying the contract, identifying the performance obligations, determining the transaction price, allocating the transaction price to performance obligations and recognizing the revenue upon satisfaction of
the performance obligations. ASU 2014-09 also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and change in judgments, and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 can be applied either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the update recognized at the date of the initial application along with additional disclosures. On July 9, 2015, the FASB deferred the effective date of ASU 2014-09 for one year. ASU 2014-09 is effective for annual
and interim
reporting periods begin
ning after December 15, 2017
. Accordingly, we will adopt ASU 2014-09 on January 29, 2018, the first day of our first quarter for the fiscal year ending February 3, 2019, our fiscal year 2018. We have not selected a method for adoption nor determined the potential effects on our consolidated financial statements
.
Simplifying the Measurement of Inventory
In July 2015, the FASB issued Accounting Standards Update No. 2015-11,
Simplifying the Measurement of Inventory (Topic 330)
(“ASU 2015-11”), which changes the measurement principle for inventory from the lower of cost or market to the lower of cost and net realizable value. Net realizable value is defined as the “estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation.” ASU 2015-11 eliminates the guidance that entities consider replacement cost or net realizable value less an approximately normal profit margin in the subsequent measurement of inventory when cost is determined on a first-in, first-out or average cost basis. The provisions of ASU 2015-11 are effective for public entities with fiscal years beginning after December 15, 2016, and interim periods within those fiscal years, with early adoption permitted. Accordingly, we will adopt ASU 2015-11 on January 30, 2017, the first day of our first quarter for the fiscal year ending January 28, 2018, our fiscal year 2017. We have not determined the impact of this new accounting guidance on our consolidated financial statements
.
Balance Sheet Classification of Deferred Taxes
In November 2015, the FASB issued Accounting Standards Update No. 2015-17,
Balance Sheet Classification of Deferred Taxes (Topic 740)
(“ASU 2015-17”), which requires the classification of all deferred tax assets and liabilities as noncurrent on the balance sheet instead of separating deferred taxes into current and noncurrent amounts. In addition, an allocation of valuation allowances between current and noncurrent deferred tax assets is not required, because the allowances will be classified as noncurrent. The provisions of ASU 2015-17 are effective for public entities with fiscal years beginning after December 15, 2016, and interim periods within those fiscal years, with early adoption permitted. We have adopted ASU 2015-17 as of January 31, 2016 and have reported deferred tax assets and liabilities as noncurrent on the
consolidated
balance sheet
s
.
Leases
In February 2016, the FASB issued Accounting Standards Update No. 2016-02,
Leases
(Topic 842) (“ASU 2016-02”), which requires lessees to recognize most leases on the balance sheets, but recognize expenses on the income statements in a manner which is similar to the current lease standard. The provisions of ASU 2016-02 are effective for public entities with fiscal years beginning after December 15, 2018, and interim periods within those years, with early adoption permitted. Accordingly, we will adopt ASU 2016-02 on February 4, 2019, the first day of our first quarter for the fiscal year ending February 2, 2020, our fiscal year 2019. We have not determined the impact of this new accounting guidance on our consolidated financial statements.
Improvements to Employee Share-Based Payment Accounting
In March 2016, the FASB issued Accounting Standards Update No. 2016-09,
Compensation – Stock Compensation
(Topic 718):
Improvements to Employee Share-Based Payment Accounting
(“ASU 2016-09”), which is intended to improve the accounting for share-based payment transac
tions. ASU 2016-09 changes certain
aspects of the accounting for share-based payment award transactions, including: (1) accounting for income taxes; (2) classification of excess tax benefits on the statement of cash flows; (3) forfeitures; (4) minimum statutory tax withholding requirements;
and
(5) classification of employee taxes paid on
the statement of cash flows when an employer withholds shares for tax-withholding purposes
.
The provisions of ASU 2016-09 are effective for public entities with fiscal years beginning after December 15, 2016, and interim periods within those year
s, early adoption is permitted. We have
adopted ASU 20
16-09 as of May 1, 2016 and
there was no significant impact to our consolidated financial statements
.
.