DULUTH HOLDINGS INC. - Quarter Report: 2016 May (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-Q

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For the quarterly period ended May 1, 2016



OR





For the transition period from             to              



Commission File Number 001-37641

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DULUTH HOLDINGS INC.

(Exact name of registrant as specified in its charter)

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Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☑    No  ☐



Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☑    No  ☐



Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):





Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☑



The number of shares outstanding of the Registrant’s Class A common stock, no par value, as of June 6, 2016 was 3,364,200.

The number of shares outstanding of the Registrant’s Class B common stock,  no par value, as of June 6, 2016, was 29,004,706.

 

 

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DULUTH HOLDINGS INC.

QUARTERLY REPORT ON FORM 10-Q

FOR QUARTER ENDED May 1, 2016 

INDEX

 





 

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PART I. FINANCIAL INFORMATION



Item 1. Financial Statements

DULUTH HOLDINGS INC.

Condensed Consolidated Balance Sheets

(Unaudited)

(Amounts in thousands)





The accompanying notes are an integral part of these condensed consolidated financial statements.

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DULUTH HOLDINGS INC.

Condensed Consolidated Statements of Operations

(Unaudited)

(Amounts in thousands, except per share figures)

 











The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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DULUTH HOLDINGS INC.

Condensed Consolidated Statements of Comprehensive Income

(Unaudited)

(Amounts in thousands)









The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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DULUTH HOLDINGS INC.

Condensed Consolidated Statement of Shareholders’ Equity

(Unaudited)

(Amounts in thousands)

 







The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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DULUTH HOLDINGS INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(Amounts in thousands)











The accompanying notes are an integral part of these condensed consolidated financial statements.

 



 

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1.    NATURE OF OPERATIONS AND BASIS OF PRESENTATION

A.    Nature of Operations

Duluth Holdings Inc. (“Duluth Trading” or the “Company”), a Wisconsin corporation, is a lifestyle brand of men’s and women’s casual wear, workwear and accessories sold exclusively through the Company’s own direct and retail channels. The direct segment, consisting of the Company’s website and catalogs, offers products nationwide. In 2010, the Company added retail to its omni-channel platform with the opening of its first store. Since then, Duluth Trading has expanded its retail presence, and as of May 1, 2016, the Company operated seven retail stores and two outlet stores across South Dakota, Minnesota, Iowa and Wisconsin. The Company’s products are marketed under the Duluth Trading brand, with the majority of products being exclusively developed and sold as Duluth Trading branded merchandise.

The Company has two classes of authorized common stock: Class A common stock and Class B common stock. The rights of holders of Class A common stock and Class B common stock are identical, except for voting and conversion rights. Each share of Class A common stock is entitled to ten votes per share and is convertible at any time into one share of Class B common stock. Each share of Class B common stock is entitled to one vote per share. The Company’s Class B common stock trades on the NASDAQ Global Select Market under the symbol “DLTH.”

On November 25, 2015, the Company converted from an “S” corporation to a “C” corporation for federal income tax purposes under Section 1362 of the Internal Revenue Code, as amended (the “Code”), and the Company completed its initial public offering (“IPO”). Refer to the Company’s consolidated financial statements and notes included in the Company’s annual report on Form 10-K for the fiscal year ended January 31, 2016, for additional information related to the Company’s IPO. During the first quarter of fiscal 2016, the Company paid the remaining $0.2 million balance of its final “S” corporation distribution, which resulted in a total final distribution of $46.6 million from the termination of the Company’s “S” corporation status. 

B.    Basis of Presentation

The condensed consolidated financial statements are prepared in accordance with U.S. Generally Accepted Accounting Principles (“U.S. GAAP”). The accompanying condensed consolidated financial statements include the accounts of the parent, Duluth Holdings Inc., and its wholly-owned subsidiary, Duluth Trading Company, LLC. The Company also consolidates Schlecht Retail Ventures LLC (“SRV”) as a variable interest entity (see Note 4 “Variable Interest Entities”). All intercompany balances and transactions have been eliminated.

The Company’s fiscal year ends on the Sunday nearest to January 31 of the following year. Fiscal 2016 is a 52-week period and ends on January 29, 2017.  Fiscal 2015 was a 52-week period and ended on January 31, 2016. The three months of fiscal 2016 and fiscal 2015 represent the Company’s 13-week periods ended May 1, 2016 and May 3, 2015, respectively. 

The accompanying condensed consolidated financial statements as of and for the three months ended May 1, 2016 and May 3, 2015 have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and, in the opinion of the Company, include all adjustments (which are normal and recurring in nature) necessary to present fairly the financial position, results of operations and cash flows of the Company for the interim periods presented. Certain information and note disclosures normally included in consolidated financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such SEC rules and regulations as of and for the three months ended May 1, 2016 and May 3, 2015. These interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s annual report on Form 10-K for the fiscal year ended January 31, 2016.  

C.    Seasonality of Business

The Company’s business is affected by the pattern of seasonality common to most retail apparel businesses. Historically, the Company has recognized a significant portion of its revenue and operating profit in the fourth fiscal quarter of each year as a result of increased sales during the holiday season.

D.    Pro Forma Net Income Information

For the three months ended May 3, 2015, the pro forma net income information gives effect to the conversion of the Company to a “C” corporation on November 25, 2015. Prior to such conversion, the Company was an “S” corporation and generally not subject to income taxes. The pro forma net income, therefore, includes an adjustment for income tax expense on the income attributable to controlling interest as if the Company had been a “C” corporation as of February 4, 2013 at an

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assumed combined federal, state and local effective tax rate of 40%, which approximates the calculated statutory rate for each period. No pro forma income tax expense was calculated on the income attributable to noncontrolling interest because this entity did not convert to a “C” corporation.

For the three months ended May 3, 2015, the pro forma basic and diluted net income per share of Class A and Class B common stock is computed using the pro forma net income, as discussed above.

 

2.    DEBT AND LINE OF CREDIT

Debt consists of the following:





In May 2014, the Company assumed a mortgage note (“Mortgage 2017 Note”) from Schlecht Enterprises LLC (“SE”) in conjunction with the Company’s acquisition of certain related real property from SE, an entity that was previously consolidated through May 21, 2014. The Mortgage 2017 Note had an original balance of $3.8 million. The Mortgage 2017 Note expires in March 2017 and requires monthly payments of $11,900, plus interest at a rate equal to the one-month LIBOR rate plus 1.75 percentage points (effective rate of 2.2% on May 1, 2016), with a final balloon payment due in March 2017. In connection with the Mortgage 2017 Note, the Company entered into an interest rate swap agreement to reduce the impact of changes in the interest rate (see Note 3 “Derivative Financial Instrument”).

During fiscal 2014, the Company entered into a mortgage note (“Mortgage 2019 Note”) with an original balance of $0.6 million. The Mortgage 2019 Note expires in May 2019 and requires monthly payments of $5,300 plus interest at 4%, with a final balloon payment due in May 2019.

The Mortgage 2017 Note and Mortgage 2019 Note are secured by a commercial guaranty from the Company and collateralized by the existing real property owned by the Company in Belleville, Wisconsin. The Mortgage 2017 Note and the Mortgage 2019 Note require that the Company maintain certain financial and non-financial covenants, including a minimum tangible net worth and a minimum trailing twelve month EBITDA.

Schlecht Retail Ventures LLC

SRV entered into a mortgage note (“SRV 2017 Note”) with an original balance of $0.8 million. The SRV 2017 Note expires in September 2017 and requires monthly payments of $3,300 plus interest at 3.1%, with a final balloon payment due in September 2017.

SRV entered into a mortgage note (“SRV 2016 Note”) with an original balance of $0.5 million. The SRV 2016 Note expires in August 2016 and requires monthly payments of $3,400, including interest at 4.5%, with a final balloon payment due in August 2016.

The SRV 2017 Note and SRV 2016 Note are guaranteed by the Company’s majority shareholder and collateralized by certain real property owned by SRV in Mt. Horeb, Wisconsin. The SRV 2016 Note requires that SRV maintain certain financial and non-financial covenants, including a debt service coverage ratio.

Line of Credit

The Company has a  revolving line of credit from a bank with availability of $40.0 million, subject to certain borrowing base limits, which expires July 2018 and bears interest, payable monthly, at a rate equal to the one-month LIBOR rate plus 1.25 

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percentage points (effective rate of 1.7% at May 1, 2016). The revolving line of credit is secured by essentially all Company assets and requires the Company to maintain compliance with certain financial and non-financial covenants, including a minimum tangible net worth and a minimum trailing twelve month EBITDA.

As of May 1, 2016 and for the three months then ended, the Company was in compliance with all financial and non-financial covenants for all debts discussed above.

 





3.    DERIVATIVE FINANCIAL INSTRUMENT

The Company uses an interest rate swap to manage its interest rate risk on the Mortgage 2017 Note. The Company does not hold or issue derivative financial instruments for trading purposes. The interest rate swap agreement has a notional principal amount equal to the outstanding balance on the Mortgage 2017 Note and matures in March 2017. The agreement effectively changes the Company’s interest rate exposure on the entire outstanding balance of the mortgage note to a fixed rate of 3%. The interest rate swap is designated as a cash flow hedge and qualifies for hedge accounting treatment using the shortcut method. Under the shortcut method, there are no gains or losses recognized due to hedge ineffectiveness and the change in the fair value of the interest rate swap is assumed to perfectly offset the change in fair value of the hedged debt. As a result, the Company reports changes in the fair value of the interest rate swap as other comprehensive income or loss in the period of change.

The fair value of the interest rate swap agreement is recorded as a liability included in other accrued expenses on the accompanying Condensed Consolidated Balance Sheets as follows:







4.    VARIABLE INTEREST ENTITIES

Based upon the criteria set forth in ASC 810, Consolidation, the Company has determined that it was the primary beneficiary of one variable interest entity (“VIE”) as of May 1, 2016 and January 31, 2016, as the Company absorbs significant economics of the entity and has the power to direct the activities that are considered most significant to the entity.

The Company leases certain retail store facilities and office buildings from SRV, a VIE whose primary purpose and activity is to own this real property. SRV is a Wisconsin limited liability company that is owned by the majority shareholder of the Company. The Company considers itself the primary beneficiary for SRV as the Company is expected to receive a majority of SRV’s expected residual returns based on the activity of SRV. As the Company is the primary beneficiary, it consolidates SRV and the leases are eliminated in consolidation.

The condensed consolidated balance sheets include the following amounts as a result of the consolidation of SRV as of May 1, 2016 and January 31, 2016:











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5.    EARNINGS PER SHARE

Earnings per share is computed under the provisions of ASC 260, Earnings Per Share. Basic earnings per share is based on the weighted average number of common shares outstanding for the period. Diluted earnings per share is based on the weighted average number of common shares plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding restricted stock. The reconciliation of the numerator and denominator of the basic and diluted earnings per share calculation is as follows:







 



 



6.    STOCK-BASED COMPENSATION

The Company accounts for its stock-based compensation plan in accordance with ASC 718, Stock Compensation, which requires the Company to measure all share-based payments at grant date fair value and recognize the cost over the requisite service period of the award.

Total stock compensation expense associated with restricted stock recognized by the Company during the three months ended May 1, 2016 and May 3, 2015 was $0.3 million and $0.2 million, respectively, and is included in selling, general and administrative expenses on the Condensed Consolidated Statements of Operations.

A summary of the activity in the Company’s non-vested restricted stock during the three months ended May 1, 2016 is as follows:



At May 1, 2016, the Company had unrecognized compensation expense of $2.7 million related to the restricted stock awards, which is expected to be recognized over a weighted average period of 2.3 years.

 

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7.    PROPERTY AND EQUIPMENT

Property and equipment consist of the following:

 





 



8.    SEGMENT REPORTING

The Company has two operating segments, which are also its reportable segments: direct and retail. The direct segment includes net sales from the Company’s website and catalogs. The retail segment includes net sales from the Company’s retail and outlet stores. These two operating segments are components of the Company for which separate financial information is available and for which operating results are evaluated on a regular basis by the chief operating decision maker in deciding how to allocate resources and in assessing performance of the segments.

Interest expense, income tax expense, and corporate expenses, which include but are not limited to: human resources, legal, finance, information technology, design and other corporate related expenses are included in the Company’s direct segment. Depreciation and amortization, and property and equipment expenditures,  are recognized in each segment. Advertising expenses are generally included in the Company’s direct segment, except for specific store advertising, which is included in the Company’s retail segment.

Variable allocations of assets are not made for segment reporting. The Company does not have any assets outside of the United States. Sales outside of the United States were insignificant.



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Segment information is presented in the following tables:





Segment total assets













 









9.    INCOME TAXES

Prior to November 25, 2015, the Company was taxed as an “S” corporation for federal income taxes purposes under Section 1362 of the Code, and therefore was not subject to federal and state income taxes. On November 25, 2015, the Company’s “S” corporation status terminated, and the Company became subject to corporate-level federal and state income taxes at prevailing corporate tax rates.

The provision for income taxes for the interim period is based on an estimate of the annual effective tax rate adjusted to reflect the impact of discrete items. Management judgment is required in projecting ordinary income to estimate the Company’s annual effective tax rate. The effective tax rate for the three months ended May 1, 2016, was 38.9%.



10.    RECENT 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 beginning after December 15, 2017.  

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Accordingly, the Company will adopt ASU 2014-09 on January 29, 2018, the first day of the Company’s first quarter for the fiscal year ending February 3, 2019, the Company’s fiscal year 2018. The Company has not selected a method for adoption nor determined the potential effects on the Company’s 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, the Company will adopt ASU 2015-11 on January 30, 2017, the first day of the Company’s first quarter for the fiscal year ending January 28, 2018, the Company’s fiscal year 2017. The Company has not determined the impact of this new accounting guidance on the Company’s 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. The Company has adopted ASU 2015-17 as of January 31, 2016 and has reported deferred tax assets and liabilities as noncurrent on the consolidated balance sheets.    

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, the Company will adopt ASU 2016-02 on February 4, 2019, the first day of the Company’s first quarter for the fiscal year ending February 2, 2020, the Company’s fiscal year 2019. The Company has not determined the impact of this new accounting guidance on the Company’s 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 transactions. 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 years, early adoption is permitted. The Company has adopted ASU 2016-09 as of May 1, 2016 and there was no significant impact to the Company’s consolidated financial statements. 







 

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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 31, 2016 (“2015 Form 10-K”).

The three months of fiscal 2016 and fiscal 2015 represent our 13-week periods ended May 1, 2016 and May 3, 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 uncertainties described under Part I, Item 1A “Risk Factors,” in our Annual Report on Form 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 represented 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 presence, and as of May 1, 2016, we operated seven retail stores and two outlet stores. Net sales for the retail segment represented 12.1% and 9.6% of consolidated net sales for the three months ending May 1, 2016 and May 3, 2015, respectively.

We offer a comprehensive line of innovative, durable and functional product, such as our Longtail T® shirts, Buck NakedTM 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:

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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 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 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 performing by measuring the change in period over-period net sales in stores that have been open for twelve fiscal months or more. Some of our competitors and other retailers calculate comparable store sales differently 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 comparable store sales data from this Form 10-Q due to the limited number of comparable retail stores as of May 1, 2016. Although retail store expansion is part of our growth strategy, we expect a significant 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 purchased merchandise; inventory shrinkage; inventory adjustments due to obsolescence, including excess and slow-moving inventory and lower of cost or market 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. 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 extent there are not commensurate declines, or if there are increases, in our shipping and handling expense. Our gross profit may not be comparable to other retailers, as we do not include distribution network and store occupancy expenses in calculating gross profit, but instead we include them in selling, general and administrative expenses.

Selling, General and Administrative Expenses

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

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

Adjusted EBITDA

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

We define Adjusted EBITDA as consolidated net income (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.

 

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Results of Operations

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





Three Months Ended May 1, 2016 Compared to Three Months Ended May 3, 2015

Net Sales

Net sales increased $11.8 million, or 20.8%, to $68.6 million in the three months ended May 1, 2016 compared to $56.8 million in the three months ended May 3, 2015, driven by gains in both direct and retail segments of $9.0 million, or 17.5%, and $2.9 million, or 52.4%, 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 14.7% in the three months ended May 1, 2016 

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compared to the three months ended May 3, 2015.  The increase in retail net sales was primarily attributable to the opening of two new retail stores and an outlet store during fiscal 2015, coupled with growth in comparable store sales.

Gross Profit

Gross profit increased $7.0 million, or 21.5%, to $39.7 million in the three months ended May 1, 2016 compared to $32.7 million in the three months ended May 3, 2015. As a percentage of net sales, gross margin increased 30 basis points to 57.8% of net sales in the three months ended May 1, 2016, compared to 57.5% of net sales in the three  months ended May 3, 2015. The increase in gross profit of $7.0 million was primarily driven by an increase in net sales as discussed above. The increase in gross margin rate was primarily attributable to improved product costs due to increased volume, coupled with a product mix shift to higher margin products.  

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $4.4 million, or 14.8%, to $34.4 million in the three months ended May 1, 2016 compared to $29.9 million in the three months ended May 3, 2015.  Selling, general and administrative expenses as a percentage of net sales was 50.0% in the three months ended May 1, 2016, compared to 52.7% in the three months ended May 3, 2015. The increase in selling, general and administrative expenses of $4.4 million was attributable to an increase of $0.9 million in advertising and marketing costs, $1.8 million in general and administrative expenses and $1.7 million in selling expenses.

The $0.9 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 310 basis points to 22.0% in the three months ended May 1, 2016, compared to 25.1% in the three months ended May 3, 2015, primarily due to timing of women’s television advertising, coupled with higher net sales.

The $1.8 million increase in general and administrative expenses was primarily due to $1.1 million increase in consulting and professional fees, coupled with $0.3 million increase in building and equipment costs. The increase in consulting and professional fees were primarily due to us becoming a public company. The $0.3 million increase in building and equipment costs were primarily attributable to an increase in retail stores opened during the three months ended May 1, 2016, compared to May 3, 2015, as noted above. As a percentage of net sales, general and administrative expenses increased 30 basis points to 14.2% in the three months ended May 1, 2016, compared to 13.9% in the three months ended May 3, 2015. The prior year three months ended May 3, 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 administrative expenses increased 230 basis points primarily due to the factors discussed above.

The $1.7 million increase in selling expenses was primarily due to an increase of $0.4 million in shipping expenses due to sales growth, coupled with an increase of $0.8 million in third party logistics providers (“3PLs”). As a percentage of net sales, selling expenses increased 10 basis points to 13.8% in the three months ended May 1, 2016, compared to 13.7% in the three months ended May 3, 2015, primarily due to an increase in distribution labor due to our utilization of the 3PLs, which was partially offset by decrease in shipping expenses due to favorable shipping rates as result of being closer to our customers due to the regional 3PLs.

Interest Expense

Interest expense was $0.04 million in the three months ended May 1, 2016, compared to $0.05 million in the three months ended May 3, 2015.  

Provision for Income Taxes

Income tax expense was $2.1 million in the three months ended May 1, 2016 and our effective tax rate was 38.9%. 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 91.5%, to $2.1 in the three months ended May 1, 2016 from $1.1 million in the three months ended May 3, 2015.

Net Income

Net income increased $0.6 million, or 20.4% to $3.2 million in the three months ended May 1, 2016 compared to $2.7  million in the three months ended May 3, 2015, primarily due to the factors discussed above. Applying a pro forma 40% “C” corporation effective tax rate to the three months ended May 3, 2015, rather than the “S” corporation tax rate that actually

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applied to us, net income increased $1.6 million, or 100.7%, to $3.2 million in the three months ended May 1, 2016 from $1.6 million in the three months ended May 3, 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-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.





As a result of the factors discussed above in the “Results of Operations” section, Adjusted EBITDA increased $1.9 million, or 41.0%, to $6.6 million in the three months ended May 1, 2016 compared to $4.7 million in the three months ended May 3, 2015. As a percentage of net sales, Adjusted EBITDA increased 140 basis points to 9.6% of net sales in the three months ended May 1, 2016 compared to 8.2% of net sales in the three months ended May 3, 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 technology. 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, including 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 starting inventory to open a new store. At May 1, 2016, our working capital was $70.4 million, which includes cash of $30.3 million. 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 May 1, 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.









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Cash Flow Analysis

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



Net Cash 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.

While our cash flow from operations for the three months ended May 1, 2016 is negative, primarily driven by the seasonal nature of our business, we expect cash flow from operations for the full year fiscal 2016 to be positive from normal operating performance and seasonal reductions in working capital during the fourth quarter of our fiscal year, which is consistent with previous full fiscal years.

For the three months ended May 1, 2016, net cash used in operating activities was $3.8 million, which consisted of net income of $3.3 million, non-cash depreciation and amortization of $0.9 million and stock based compensation of $0.3 million, offset by cash used in operating assets and liabilities of $8.3 million. The cash used in operating assets and liabilities of $8.3 million primarily consisted of $2.8 million increase in inventory, due to building up of inventory for the opening of new retail stores in fiscal 2016, which was partially offset by decreases in deferred catalog costs, trade accounts payable and accrued expenses of $1.8 million, $4.6 million and $3.1 million, respectively. The decrease in deferred catalog costs were primarily attributable to the timing and number of catalogs shipped compared to fiscal year end. The decreases in trade accounts payable and accrued expenses were primarily attributable to the timing of payments subsequent to our fiscal year end.  

For the three months ended May 3, 2015, net cash used in operating activities was $4.8 million, which consisted of net income of $2.8 million, non-cash depreciation and amortization of $0.6 million and stock-based compensation of $0.2 million, offset by cash used in operating assets and liabilities of $8.3 million. The cash used in operating assets and liabilities of $8.3 million primarily consisted of $7.7 million decrease in trade accounts payable and accrued expenses, which included a $1.1 million payment related to a portion of the grantees’ tax liabilities associated with the grant of restricted stock, coupled with the 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. 

For the three months ended May 1, 2016, net cash used in investing activities was $3.5 million and was primarily driven by capital expenditures of $1.4 million for the expansion of our Belleville distribution center and $1.7 million for our two new retail stores, which are expected to open during our fiscal second quarter.

For the three months ended May 3, 2015, net cash used in investing activities was $2.5 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 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 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 contributions to Schlecht Retail Ventures LLC.

For the three months ended May 1, 2016, net cash used in financing activities was $0.3  million, primarily consisting of the final $0.2 million distributions to our then shareholders due to our “S” corporation status prior to our IPO and $0.1 million payments on long-term debt.

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For the three months ended May 3, 2015, net cash used in financing activities was $0.3 million, primarily consisting of uses of $6.2 million in tax distributions to our shareholders due to our “S” corporation status, $0.4 million for payments on mortgage notes and $0.2 million for payments on capital leases, offset by proceeds of $1.4 million, net from our revolving line of credit, $0.8 million from new long-term obligations, $4.1 million in 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 from BMO Harris Bank N.A., subject to certain borrowing base limits, which expires July 2018 and bears interest, payable monthly, at a rate equal to the one-month LIBOR rate plus 1.25 percentage points. The revolving line of credit 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 of and for the three months ended May 1, 2016, we were in compliance with all financial and non-financial 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 beginning 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

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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 sheets.

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 transactions. 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 years, early adoption is permitted. We have adopted ASU 2016-09 as of May 1, 2016 and there was no significant impact to our consolidated financial statements. .

 

Item 3.    Quantitative and Qualitative Disclosures About Market Risk

Interest Risk Factors

We are subject to interest rate risk in connection with borrowings under our revolving line of credit, which bears interest at a rate equal to the one-month LIBOR rate plus 1.25 percentage points as of May 1, 2016. As of May 1, 2016, no balance was outstanding under the revolving line of credit. As of May 1, 2016, the undrawn borrowing availability under the revolving line of credit, subject to certain borrowing base limits was  $29.1 million. Based on the average interest rate on the revolving line of credit during the first three months of fiscal 2016, and to the extent that borrowings were outstanding, we do not believe that a 10% change in the interest rate would have a material effect on our consolidated results of operations or financial condition. 

Impact of Inflation

Our results of operations and financial condition are presented based on historical cost. While it is difficult to accurately measure the impact of inflation due to the imprecise nature of the estimates required, we believe the effects of inflation, if any, on our results of operations and financial condition have been immaterial. We cannot assure you our business will not be affected in the future by inflation.



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Foreign Exchange Rate Risk

We source a substantial majority of our merchandise from various suppliers in Asia and the vast majority of purchases are denominated in U.S. dollars. We do not hedge foreign currency risk using any derivative instruments, and historically we have not been impacted by changes in exchange rates.



Item 4.    Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Section 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), requires management of an issuer subject to the Exchange Act to evaluate, with the participation of the issuer’s principal executive and principal financial officers, or persons performing similar functions, the effectiveness of the issuer’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act), as of the end of each fiscal quarter. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting

There was no change in our internal control over financial reporting (as defined in Rule 13a-15(d) and 15d-15(d) under the Exchange Act) that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect our internal control over financial reporting. 



PART II. OTHER INFORMATION

Item 1.    Legal Proceedings

From time to time, we are subject to certain legal proceedings and claims in the ordinary course of business. We are not presently party to any legal proceedings the resolution of which we believe would have a material adverse effect on our business, financial condition, operating results or cash flows. We establish reserves for specific legal matters when we determine that the likelihood of an unfavorable outcome is probable and the loss is reasonably estimable.

Item 1A.   Risk Factors

We operate in a rapidly changing environment that involves a number of risks that may have a material adverse effect on our business, financial condition and results of operations. For a detailed discussion of the risks that affect our business, please refer to the section entitled “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended January 31, 2016. There have been no material changes to our risk factors as previously disclosed in our Annual Report on Form 10-K.



Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds

On November 25, 2015, we closed our IPO, in which we registered and sold 7,666,667 shares of Class B common stock at a price of $12.00 per share. The aggregate offering price for shares sold in the offering was approximately $92.0 million. The offer and sale of all the shares in the IPO were registered under the Securities Act pursuant to a registration statement on Form S-1 (File No. 333-207300), which was declared effective by the SEC on November 19, 2015. We raised approximately $83.9 million in net proceeds after deducting underwriting discounts and commissions of approximately $6.4 million and other offering expenses of approximately $1.7 million.

Through May 1, 2016, the net proceeds from our IPO have been applied as follows: $46.3 million to pay in full a short term note previously borrowed from a bank to pay a portion of the distribution of 100% of the cumulative undistributed taxable earnings to our then existing shareholders from the date of our formation through the date of termination of our “S” corporation status, $1.9 million for infrastructure and technology, $1.7 million for retail stores, and $0.3 million for our final “S” corporation distribution. With regards to the remaining proceeds, there has been no material change in the planned use of proceeds from our IPO as described in the final prospectus filed with the SEC pursuant to Rule 424(b)(4).

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Item 6.    Exhibits

Please refer to the Exhibit Index.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.





 

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EXHIBIT INDEX





 

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