What changed in this filing

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Item 7. Management’s Discussion and Analysis

2023-03-17 compared with 2022-03-25 · 59 added, 66 removed, 194 unchanged (39% of the section changed)

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A summary of our financial results is as follows:

 Net sales in fiscal 2021 increased by 9.4% over the prior year to $698.6 million;

 Net income in fiscal 2021 increased 118.8% compared to the prior year to $29.7 million;

 Adjusted EBITDA in fiscal 2021 increased 41.6% over the prior year to $77.4 million;

 Cash flow from operations in fiscal 2021 increased to $92.0 million and Free Cash Flow increased $43.1 million over the prior year to $81.6 million.

 Net sales in fiscal 2022 decreased by 6.5% over the prior year to $653.3 million;

 Net income in fiscal 2022 was $2.2 million compared to prior year net income of $29.6 million;

 Adjusted EBITDA in fiscal 2022 decreased 43.8% over the prior year to $43.5 million.

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.

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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.

See “Free Cash Flow” section for a reconciliation of Net cash provided by operating activities to Free Cash Flow.

See also the information under the heading “Free Cash Flow” in the section “How We Assess the Performance of Our Business” for our definition of Free Cash Flow.

Our management’s discussion and analysis includes market sales metrics for our stores, website and catalog sales.

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Our non-store market sales metrics include sales from our website, catalog and orders placed through the call center.

Throughout fiscal 2021, the COVID-19 pandemic impacted our business results and operations.

The disruption in the global supply chain due to transportation delays, container shortages and port congestion interrupted the flow of our inventory and added incremental expedited shipping costs.

Despite these disruptions caused by the pandemic, we achieved record revenues for fiscal 2021, which increased 9.4% to $698.6 million, compared to fiscal 2020, with gross margin expansion creating net income of $29.7 million, a 118.8% increase over fiscal 2020.

Our direct business coupled with retail reemerging in fiscal 2021 fueled our growth through the year as we continued to navigate the pandemic.

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, and the availability, safety and efficacy of a vaccine.

Economic Conditions

The United States economy has experienced high inflation during 2021 and 2022 and there are expectations in the market that inflation may remain at elevated levels.

The ultimate impact of higher inflationary periods on our operational and financial performance still depends on future developments outside of our control.

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

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inbound freight;

and freight from our distribution centers to our retail stores.

and freight from our fulfillment centers to our retail stores.

The primary drivers of the costs of individual goods are raw material costs.

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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.

They also include marketing expense, which primarily includes television, digital and social media 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, rent/occupancy and payroll costs.

While we expect these expenses to increase as we continue to increase brand awareness and invest in infrastructure to support our growing business, we believe these expenses will decrease as a percentage of sales over time.

Our shipping and handling expenses increased during the second half of the year because of additional surcharges due to the strained distribution network during our peak selling season.

While we expect these expenses to increase as we continue to increase brand awareness and invest in infrastructure to support our business, we believe these expenses will decrease as a percentage of sales over time.

Our shipping and handling expenses typically increase during the second half of the year due to additional surcharges during our peak selling season.

Adjusted EBITDA

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We use Free Cash Flow to facilitate a comparison of our operating performance on a consistent basis from period-to-period and our ability to generate cash.

We define Free Cash Flow as net cash provided by operating activities less purchase of property and equipment and capital contributions towards build-to-suit stores.

We define Free Cash Flow as net cash provided by operating activities less purchase of property and equipment.

This non-GAAP measure may not be comparable to similarly titled measures used by other companies.

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Fiscal 2022 Compared to Fiscal 2021

Net sales increased $59.8 million, or 9.4%, to $698.6 million in fiscal 2021 compared to $638.8 million in fiscal 2020.

The increase was due to an increase in store market sales partially offset by a decrease in non-store market sales.

Store market net sales increased $67.1 million, or 16.0%, to $486.2 million in fiscal 2021 compared to $419.1 million in fiscal 2020.

The year-over-year sales difference was primarily driven by temporary store closures beginning on March 20, 2020 until they re-opened beginning in the first week of May through the third week of June, coupled with higher conversion as compared to the prior year.

Net sales decreased $45.3 million, or 6.5%, to $653.3 million in fiscal 2022 compared to $698.6 million in fiscal 2021.

Store market net sales decreased $29.8 million, or 6.1%, to $456.5 million in fiscal 2022 compared to $486.3 million in fiscal 2021.

Net sales in non-store markets decreased $14.6 million, or 7.1%, to $191.6 million in fiscal 2022 compared to $206.2 million in fiscal 2021.

The decrease was driven by extended free shipping and higher promotions in the prior year.

Gross profit increased $45.8 million, or 13.8%, to $377.3 million in fiscal 2021 compared to $331.5 million in fiscal 2020.

As a percentage of net sales, gross margin increased to 54.0% of net sales in fiscal 2021 compared to 51.9% of net sales in fiscal 2020.

The increase in gross margin rate was driven by a higher mix of full price sales due to lower clearance inventory and fewer promotional events, as well as improved gross margin rates on both full price and clearance items.

The year-over-year increase was partially offset by expenses associated with increased expedited freight costs in order to combat disruptions within the supply chain.

Gross profit decreased $33.9 million, or 9.0%, to $343.4 million in fiscal 2022 compared to $377.3 million in fiscal 2021.

As a percentage of net sales, gross margin decreased to 52.6% of net sales in fiscal 2022 compared to 54.0% of net sales in fiscal 2021.

The decrease in gross margin rate was primarily due to a lower mix of full price sales, coupled with deeper discounts as a response to the heavily promotional industry environment, particularly during the back half of fiscal 2022.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $4.0 million, or 1.2%, to $337.2 million in fiscal 2022 compared to $333.2 million in fiscal 2021.

Selling, general and administrative expenses as a percentage of net sales decreased in fiscal 2021 to 47.7% of net sales, compared to 48.1% of net sales for fiscal 2020.

The positive leverage was primarily due to shifting to a more efficient digital marketing approach, as well as lower shipping expenses driven in part by a shift in channel mix resulting from higher store traffic during the current year.

The increase in selling, general and administrative expense was primarily caused by increased wages due to Company retail locations being open for the full fiscal year, wage increases at both the stores and distribution centers, new headcount and merit increases, as well as increased depreciation expense associated with investments in technology.

Selling, general and administrative expenses as a percentage of net sales increased in fiscal 2022 to 51.6% of net sales, compared to 47.7% of net sales for fiscal 2021.

The negative leverage was primarily due to lower net sales in the current period compared to the prior period.

The increase in selling, general and administrative expense was primarily caused by increased depreciation expense from continued investments in technology and throughout our fulfillment network.

Interest Expense

Interest expense decreased $1.0 million to $3.7 million in fiscal 2022 compared to $4.7 million in fiscal 2021.

The decrease in interest expense was primarily attributable the full pay-down of Duluth Trading’s bank debt in fiscal 2021 compared to increased borrowings on the revolving line of credit and delayed draw term loan during fiscal 2020 due to uncertainties resulting from the COVID-19 pandemic.

The decrease in interest expense was primarily attributable to the larger amount of long-term debt outstanding in fiscal 2021 compared to fiscal 2022.

Income tax expense was $0.7 million in fiscal 2022 compared to $9.9 million in fiscal 2021.

Our effective tax rate related to controlling interest was 25.0% and 25.5% in fiscal 2021 and fiscal 2020, respectively.

Our effective tax rate related to controlling interest was 23.5% in fiscal 2022 compared to 25.0% in fiscal 2021.

Net Income Attributable to Controlling Interest

Net income attributable to controlling interest was $29.7 million in fiscal 2021 compared to $13.6 million in fiscal 2020, primarily due to the factors discussed above.

Net income attributable to controlling interest was $2.3 million in fiscal 2022 compared to $29.7 million in fiscal 2021, due to the factors discussed above.

Non-GAAP Financial Measures

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Adjusted EBITDA (non-GAAP)

As a result of the factors discussed above in the “Results of Operations” section, Adjusted EBITDA increased $22.7 million, or 41.6%, to $77.4 million in fiscal 2021 compared to $54.7 million in fiscal 2020.

As a percentage of net sales, Adjusted EBITDA increased to 11.1% of net sales in fiscal 2021 compared to 8.6% of net sales in fiscal 2020.

As a result of the factors discussed above in the “Results of Operations” section, Adjusted EBITDA decreased $33.9 million, or 43.8%, to $43.5 million in fiscal 2022 compared to $77.4 million in fiscal 2021.

As a percentage of net sales, Adjusted EBITDA decreased to 6.7% of net sales in fiscal 2022 compared to 11.1% of net sales in fiscal 2021.

Free Cash Flow

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(in thousands)

Net cash provided by operating activities

Net cash (used in) provided by operating activities

Purchases of property and equipment

Capital contributions towards build-to-suit stores

Free Cash Flow (non-GAAP)

Free cash flow increased $43.1 million to $81.6 million in fiscal 2021 compared to $38.5 million in fiscal 2020.

The increase was primarily driven by higher net income and lower inventory levels associated with continued in-bound receipt delays.

Free cash flow decreased $110.1 million to ($28.5) million in fiscal 2022 compared to $81.6 million in fiscal 2021.

The decrease was primarily driven by lower net income, higher inventory levels and higher purchases of property and equipment.

Liquidity and Capital Resources

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The most significant components of our working capital are cash, inventory, accounts payable and other current liabilities.

At January 30, 2022 our working capital was $106.5 million, which includes cash of $77.1 million.

We spent $10.4 million in fiscal 2021 on capital expenditures, as well as, $4.7 million of additional investments in software hosting implementation costs, which are included in Prepaid expenses & other current assets on the Company’s Consolidated Balance Sheets.

We expect to spend approximately $57.0 million in fiscal 2022 on capital expenditures, primarily due to investments in logistics optimization, including the introduction of automated fulfillment centers.

At January 29, 2023 our working capital was $107.9 million, which includes cash and cash equivalents of $45.5 million.

We spent $31.5 million in fiscal 2022 on capital expenditures, inclusive of investments in software hosting implementation costs, which are included in Prepaid expenses & other current assets on the Company’s Consolidated Balance Sheets.

We expect to spend approximately $55.0 million in fiscal 2023 on capital expenditures, of which approximately $42.1 million will be related to continued logistics optimization from introducing the new automated fulfillment center in Adairsville, Georgia.

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.

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(in thousands)

Net cash provided by operating activities

Net cash (used in) provided by operating activities

Net cash used in investing activities

Net cash (used in) provided by financing activities

Increase in cash and cash equivalents

Net cash used in financing activities

(Decrease) Increase in cash and cash equivalents

Net Cash Provided by 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 assets and liabilities.

For fiscal 2022, net cash used in operating activities was $5.6 million, which primarily consisted of net income of $2.2 million, non-cash depreciation and amortization of $30.8 million, amortization of stock-based compensation of $2.7 million, which was offset by cash used in operating assets and liabilities of $41.4 million.

The cash used in operating assets and liabilities of $41.4 million primarily consisted of a $32.3 million increase in inventory, primarily due to the pull forward of spring receipts, and a $11.8 million decrease in accrued expenses, partially offset by a $12.7 million increase in trade accounts payable.

For fiscal 2021, net cash provided by operating activities was $92.0 million, which primarily consisted of net income of $29.6 million, non-cash depreciation and amortization of $29.2 million, amortization of stock-based compensation of $2.2 million and cash provided by operating assets and liabilities of $36.1 million.

The cash provided by operating assets and liabilities of $36.1 million primarily consisted of a $26.4 million decrease in inventory, a $10.5 million increase in accounts payable, and a $9.9 million increase in accrued expenses, partially offset by a $4.7 million increase in hosting software implementation costs, a $3.2 million increase in receivables, and a decrease of $2.4 million in prepaid expenses.

For fiscal 2020, net cash provided by operating activities was $50.8 million, which primarily consisted of net income of $13.4 million, non-cash depreciation and amortization of $28.5 million and amortization of stock-based compensation of $1.6 million and cash provided by operating assets and liabilities of $7.2 million.

The cash provided by operating assets and liabilities of $7.2 million primarily consisted of a $7.7 million increase in accrued expenses and deferred rent obligations due to $3.5 million of deferred payroll taxes afforded by the CARES Act, a $4.2 million increase in income tax payable, a $2.6 million decrease in prepaid expenses, offset by a $1.2 million increase in inventory, a $4.1 million increase in hosting software implementation costs and a $1.5 million decrease in trade accounts payable.

The cash provided by operating assets and liabilities of $36.1 million primarily consisted of a $26.4 million decrease in inventory, a $10.5 million increase in trade accounts payable, and a $9.9 million increase in accrued expenses, partially offset by a $4.7 million increase in hosting software implementation costs, a $3.2 million increase in receivables, and a decrease of $2.4 million in prepaid expenses.

Net Cash Used in Investing Activities

Investing activities consist primarily of capital expenditures for growth related to a new distribution center and information technology.

For fiscal 2021, net cash used in investing activities was $10.2 million, primarily driven by capital expenditures of $10.4 million for a new distribution center and one new retail store, as well as investments in information technology.

For fiscal 2020, net cash used in investing activities was $12.1 million, primarily driven by capital expenditures of $11.7 million, due mainly to the opening of 4 new stores, as well as investments in information technology.

Investing activities consist primarily of capital expenditures related to a new fulfillment center and information technology.

For fiscal 2022, net cash used in investing activities was $22.6 million, primarily driven by purchases of property and equipment of $22.8 million, primarily related to the Adairsville fulfillment center.

For fiscal 2021, net cash used in investing activities was $10.2 million, primarily driven by purchases of property and equipment of $10.4 million for the Salt Lake City fulfillment center and one new retail store, 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 debts, as well as payments on finance lease obligations.

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 fiscal 2022, net cash used in financing activities was $3.2 million, primarily consisting of payments on finance lease obligations.

For fiscal 2021, net cash used in financing activities was $51.4 million, primarily consisting of the full paydown of Duluth’s bank debt.

For fiscal 2020, net cash provided by financing activities was $6.4 million, primarily consisting of proceeds of $28.3 million, net from our term loan and payments of $19.3 million, net from our revolving line of credit to fund working capital.

Credit Agreement

On April 30, 2020, the Company’s credit agreement (the “Credit Agreement”) was amended to include an incremental DDTL of $20.5 million (the “Incremental DDTL”) that was available to draw upon before March 31, 2021, and matured on April 29, 2021, for a total credit facility of $150.5 million.

On May 17, 2018, the Company entered into a credit agreement (the “Credit Agreement”) which provided for borrowing availability of up to $80.0 million in revolving credit and associated swing line (the “Revolver”) and borrowing availability of up to $50.0 million in a delayed draw term loan (“DDTL”), for a total credit facility of $130.0 million.

On April 30, 2020, the Credit Agreement was amended to include an incremental DDTL of $20.5 million (the “Incremental DDTL”) that was available to draw upon before March 31, 2021, and matured on April 29, 2021, for a total credit facility of $150.5 million.

The loan covenants were also amended to allow for greater flexibility during the Company’s peak borrowing periods in fiscal 2020.

The interest rate applicable to the Revolver or DDTL was a fixed rate for a one-, two-, three- or six-month interest period equal to LIBOR (with a 1% floor) for such interest period plus a margin of 225 to 300 basis points, based upon the Company’s rent adjusted leverage.

The interest rate applicable to the Incremental DDTL was also a fixed rate over the aforementioned interest periods equal to LIBOR (with a 1% floor) for such interest period plus a margin of 275 to 350 basis points.

On May 14, 2021, the Company terminated the Credit Agreement, and entered into a new credit agreement (the “New Credit Agreement”), which was treated as a modification for accounting purposes.

The New Credit Agreement matures on May 14, 2026 and provides for borrowings of up to $150.0 million that are available under a revolving senior credit facility, with a $5.0 million sublimit for issuance of standby letters of credit, as well as a $10.0 million sublimit for swing line loans.

At the Company’s option, the interest rate applicable to the revolving senior credit facility will be a floating rate equal to:

(i) the Bloomberg Short-Term Bank Yield Index rate (“BSBY”) plus the applicable rate of 1.25% to 2.00% determined based on the Company’s rent adjusted leverage ratio, or (ii) the base rate plus the applicable rate of 0.25% to 1.00% based on the Company’s rent adjusted leverage ratio.

The New Credit Agreement is secured by essentially all Company assets and requires the Company

to maintain compliance with certain financial and non-financial covenants, including a maximum rent adjusted leverage ratio and a minimum fixed charge coverage ratio as defined in the New Credit Agreement

The New Credit Agreement originally matured on May 14, 2026 and provided for borrowings of up to $150.0 million that were available under a revolving senior credit facility, with a $5.0 million sublimit for issuance of standby letters of credit, as well as a $10.0 million sublimit for swing line loans.

At the Company’s option, the interest rate applicable to the revolving senior credit facility was a floating rate equal to:

the Company’s rent adjusted leverage ratio.

The New Credit Agreement is secured by essentially all Company assets and requires the Company to maintain compliance with certain financial and non-financial covenants, including a maximum rent adjusted leverage ratio and a minimum fixed charge coverage ratio as defined in the New Credit Agreement.

On July 8, 2022, the Company entered into the First Amendment to the New Credit Agreement (the “First Amendment”), which was treated as a modification for accounting purposes.

The First Amendment amends the New Credit Agreement in order to (i) increase the revolving commitment from $150.0 million to $200.0 million;

(ii) extend the maturity date from May 14, 2026 to July 8, 2027;

(iii) amend the pricing index to replace BSBY with the Term Secured Overnight Financing Rate;

and (iv) to reduce the commitment fee in some instances.

As of and for the fiscal year ended January 29, 2023, we were in compliance with all financial and non-financial covenants.

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The Company currently estimates product return reserve using its own historical sales information.

The Company regularly assesses and adjusts the estimate of accrued sales returns by updating return rates for actual industry and company trends and projected costs.

The Company regularly assesses and adjusts the estimate of accrued sales returns by updating return rates for actual company trends and projected costs.

While returns have historically been within our expectations, future return rates may differ from those experienced in the past.

Changes in these estimates can have a material impact on our financial statements.

We believe the accounting estimate related to product returns is a critical accounting estimate because it requires us to make assumptions about future potential returns and changes in demand, both of which are highly uncertain.

We believe the accounting estimate related to product returns is a critical accounting estimate because it requires us to make assumptions about future potential returns, which are highly uncertain.

Critical Accounting Policies

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Revenue Recognition

Revenue for merchandise that is shipped to our customers from our distribution centers and stores is recognized upon shipment following customer payment, which is when the customer obtains control of the product and has the ability to direct the use of the product, including, among other options, the ability to redirect the product to a different shipping destination.

Revenue for merchandise that is shipped to our customers from our fulfillment centers and stores is recognized upon shipment following customer payment, which is when the customer obtains control of the product and has the ability to direct the use of the product, including, among other options, the ability to redirect the product to a different shipping destination.

Store revenue is recognized at the point of sale.

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Our inventories are composed of finished goods and are stated at the lower of cost or net realizable value, with cost determined using the first-in, first-out method.

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.” The inventory value is adjusted periodically, if needed, to reflect current market conditions, which requires our judgments that may significantly affect the ending inventory valuation, as well as gross margin.

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.” The inventory value is adjusted periodically, if needed, to reflect current market conditions and inventory composition, which requires our judgments that may significantly affect the ending inventory valuation, as well as gross margin.

The estimates used in inventory valuation are obsolescence (including excess and slow-moving inventory and lower of cost or market reserves) and estimates of inventory shrinkage.

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The Company performs its retail store physical inventory counts in July and the difference between actual and estimated shrinkage, recorded in Cost of goods sold, may cause fluctuations, particularly in second fiscal quarter results.

We account for income taxes and the related accounts using the liability method in accordance with ASC Topic 740, Income Taxes (“ASC 740”).

We account for income taxes and the related accounts using the asset and liability method in accordance with ASC Topic 740, Income Taxes (“ASC 740”).

Under this method, we accrue income taxes payable or refundable and recognize deferred tax assets and liabilities based on differences between U.S.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis