DULUTH HOLDINGS INC. 10-Q

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 included in our Annual Report on Form 10-K for the fiscal year ended January 29, 2023 (“2022 Form 10-K”). The Company’s fiscal year ends on the Sunday nearest to January 31 of the following year. Fiscal 2023 is a 52-week period and ends on January 28, 2024. Fiscal 2022 was a 52-week period and ended on January 29, 2023 . The three months of fiscal 2023 and fiscal 2022 represent our 13-week periods ended April 30, 2023 and May 1, 2022, 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 initiatives, or 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 2022 Form 10-K, and other SEC filings, which factors are incorporated by reference herein. These risks and uncertainties include, but are not limited to, the following: the impact of inflation on our results of operations; the prolonged effects of COVID-19 on store traffic and disruptions to our distribution network, supply chains and operations; our ability to maintain and enhance a strong 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 due to 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, n ew 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 April 30, 2023, we operated 62 retail stores and three outlet stores. We offer a comprehensive line of innovative, durable and functional products, such as our Longtail T ® shirts, Buck Naked TM 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. ‎ 21 Table of Contents 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 increased by 0.7% over the prior year first quarter to $123.8 million;  Net loss of $3.9 million in fiscal 2023 first quarter compared to the prior year first quarter net loss of $1.3 million; and  Adjusted EBITDA decreased to $5.3 million in fiscal 2023 first quarter compared to the prior year first quarter Adjusted EBITDA of $7.9 million. See the “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. 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. Economic Conditions The United States economy has experienced continued high inflation during the first quarter of 2023 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. 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. 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. 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 digital and 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, 22 Table of Contents 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. 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. We also use Adjusted EBITDA as the key financial metric in determining bonus compensation for our employees. This non-GAAP measure may not be comparable to similarly titled measures used by other companies. 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 April 30, 2023 May 1, 2022 (in thousands) Net sales $ 123,759 $ 122,904 Cost of goods sold (excluding depreciation and amortization) 58,108 55,841 Gross profit 65,651 67,063 Selling, general and administrative expenses 70,200 67,994 Operating loss (4,549) (931) Interest expense 934 876 Other income, net 148 46 Loss before income taxes (5,335) (1,761) Income tax benefit (1,458) (438) Net loss (3,877) (1,323) Less: Net loss attributable to noncontrolling interest (8) (29) Net loss attributable to controlling interest $ (3,869) $ (1,294) Percentage of Net sales: Net sales 100.0 % 100.0 % Cost of goods sold (excluding depreciation ‎ and amortization) 47.0 % 45.4 % Gross margin 53.0 % 54.6 % Selling, general and administrative expenses 56.7 % 55.3 % Operating loss (3.7) % (0.8) % Interest expense 0.8 % 0.7 % Other income, net - % - % Loss before income taxes (4.3) % (1.4) % Income tax benefit (1.2) % (0.4) % Net loss (3.1) % (1.1) % Less: Net loss attributable to noncontrolling interest - % - % Net loss attributable to controlling interest (3.1) % (1.1) % 23 Table of Contents Three Months Ended April 30, 2023, Compared to Three Months Ended May 1, 2022 Net Sales Net sales increased $0.9 million, or 0.7%, to $123.8 million in the three months ended April 30, 2023 compared to $122.9 million in the three months ended May 1, 2022. Store market net sales increased $0.3 million, or 0.3%, to $85.4 million in the three months ended April 30, 2023 compared to $85.1 million in the three months ended May 1, 2022. Non-store market net sales increased by $0.6 million, or 1.7%, to $37.4 million in the three months ended April 30, 2023 compared to $36.8 million in the three months ended May 1, 2022. Gross Profit Gross profit decreased $1.4 million, or 2.1%, to $65.7 million in the three months ended April 30, 2023 compared to $67.1 million in the three months ended May 1, 2022. As a percentage of net sales, gross margin decreased to 53.0% of net sales in the three months ended April 30, 2023, compared to 54.6% of net sales in the three months ended May 1, 2022. The decrease in gross margin was primarily driven by a higher mix of promotional and clearance sales during the current period. The lower product margin rate was partially offset by expensing $3.9 million of expedited freight during the first quarter of 2022 compared to $0.1 million during the current quarter, impacting the quarter-over-quarter margin rate variance by 3.1%. Selling, General and Administrative Expenses Selling, general and administrative expenses increased $2.2 million, or 3.2%, to $70.2 million in the three months ended April 30, 2023 compared to $68.0 million in the three months ended May 1, 2022. Selling, general and administrative expenses as a percentage of net sales increased to 56.7% in the three months ended April 30, 2023, compared to 55.3% in the three months ended May 1, 2022. The increase in selling, general and administrative expense was partially due to higher occupancy costs from the new automated Southeast fulfillment center, coupled with increased amortization of software hosting implementation costs from continued capital investments. Income Taxes Income tax benefit was $1.5 million in the three months ended April 30, 2023, compared to income tax benefit of $0.4 million in the three months ended May 1, 2022. The effective tax rate related to controlling interest was 27% for the three months ended April 30, 2023 compared to 25% for the three months ended May 1, 2022. Net (Loss) Income Attributable to Controlling Interest Net loss attributable to controlling interest was $3.9 million, in the three months ended April 30, 2023 compared to net loss of $1.3 million in the three months ended May 1, 2022, due to the factors discussed above. Reconciliation of Net (Loss) 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-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 April 30, 2023 May 1, 2022 (in thousands) Net loss $ (3,877) $ (1,323) Depreciation and amortization 7,413 7,520 Amortization of internal-use software hosting subscription implementation costs 1,270 633 Interest expense 934 876 Income tax benefit (1,458) (438) EBITDA $ 4,282 $ 7,268 Stock based compensation 990 618 Adjusted EBITDA $ 5,272 $ 7,886 24 Table of Contents As a result of the factors discussed above in the “Results of Operations” section, Adjusted EBITDA decreased $2.6 million to $5.3 million in the three months ended April 30, 2023 compared to $7.9 million in the three months ended May 1, 2022. As a percentage of net sales, Adjusted EBITDA decreased to 4.3% of net sales in the three months ended April 30, 2023 compared to 6.4% of net sales in the three months ended May 1, 2022. 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 and information technology. The most significant components of our working capital are cash, inventory, accounts payable and other current liabilities. At April 30, 2023, our net working capital was $88.7 million, including $9.2 million of cash and cash equivalents. We expect to spend approximately $55.0 million in fiscal 2023 on capital expenditures, inclusive of software hosting implementation costs, primarily due to investments in logistics optimization, including investments in the fulfillment network and information technology. 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 April 30, 2023 May 1, 2022 (in thousands) Net cash used in operating activities $ (13,973) $ (31,717) Net cash used in investing activities (21,348) (3,843) Net cash used in financing activities (1,017) (1,121) Decrease in cash and cash equivalents $ (36,338) $ (36,681) Net Cash 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 April 30, 2023, net cash used in operating activities was $14.0 million, which primarily consisted of cash used in operating assets and liabilities of $17.1 million. The cash used in operating assets and liabilities of $17.1 million was primarily due to a $21.1 million decrease in trade accounts payable partially offset by a $10.0 million decrease in inventory. For the three months ended May 1, 2022, net cash used in operating activities was $31.7 million, which primarily consisted of a net loss of $1.3 million and cash used in operating assets and liabilities of $38.6 million. The cash used in operating assets and liabilities of $38.6 million primarily consisted of a $29.6 million increase in inventory and a $17.5 million decrease in accrued expenses offset by a $10.4 million increase in trade accounts payable. Net Cash Used in Investing Activities Investing activities consist primarily of capital expenditures for growth related to investments in infrastructure and information technology. For the three months ended April 30, 2023, net cash used in investing activities was $21.3 million and was primarily driven by new investments in the fulfillment network and information technology. 25 Table of Contents For the three months ended May 1, 2022, net cash used in investing activities was $3.8 million and was primarily driven by capital expenditures of $3.9 million for new investments in information technology. 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 debt, as well as payments on finance lease obligations. For the three months ended April 30, 2023, net cash used in financing activities was $1.0 million, primarily consisting of payments on finance lease obligations. For the three months ended May 1, 2022, net cash used in financing activities was $1.1 million, also primarily consisting of payments on finance lease obligations. 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 29, 2023. 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 2022 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.