Q2 2019 Earnings Call
Good morning, and welcome to the Duluth Holdings second quarter fiscal year 2019 earnings Conference call. All participants will be in listen only mode should you need assistance. Please signal I conference specialist by pressing the star key followed by zero.
After todays presentation, there will be an opportunity to ask questions to ask a question you May Press Star then one on your Touchtone phone.
Withdraw your question. Please press Star then two please note. This event is being recorded I would now like to turn the conference over to Donnie case Investor Relations for Duluth Holdings. Please go ahead.
Thank you Carrie and welcome to today's call to discuss Duluth trading second quarter fiscal year 2019 financial result.
Earnings release was which we issued this morning.
On our Investor Relations website at <unk> Dot Com under press releases.
I'm here today, with Steve Slacks, founder and Chief Executive Officer, and David <unk>, Chief Financial Officer on today's call management will provide prepared remarks, and then we will open the call to your questions before we begin I would like to remind you that comments on todays call will include forward looking statements, which can be identified by the use of the words, such as estimate anticipate expect and similar phrases.
Forward looking statements by their nature involve estimates projections goals forecasts and assumptions and are subject to risk and uncertainties that could cause actual results or outcomes to differ materially from those expressed in the forward looking statements.
Such risks and uncertainties include but are not limited to those that are described in our most recent annual report on Form 10-K , and other FCC filings as a principal these forward looking statements speak only as of the date of this conference call and should not be relied upon as predictions of future events and with that I'd like to turn the call over to teach Steve <unk>, Chief Executive Officer of Duluth trading equally good morning, and thank you for joining our second quarter 2019 conference call.
We have a fair amount to cover on today's call, but before we again before we begin I want to acknowledge the contributions that Stephanie Pugliese has made to our company.
As CEO , she worked tirelessly and enthusiastically to execute our strategy to build an omnichannel approach to marketing. She led the growth of our successful womens category and oversaw the addition of 50 retail stores.
Her talents and achieve much did not go unnoticed and open the door to a new opportunity with under armour.
Everyone, who is workers, Stephanie we'll measure and we will we wish her the best success in her new endeavor.
Oh in her unanticipated resignation it wasn't easy decision for me to step back into the role of CEO .
As Joe loose founder I'm very proud of what we've accomplished and I'm totally committed to ensuring the continuity of our vision, our culture and our forward momentum.
Well I haven't been to public face in Duluth trading for some time.
I have been actively involved in all aspects of the business.
With our talented and dedicated team we have achieved a smooth transition without any disruption to our business. We remain totally focused on our all important fourth quarter.
That said, we have our work cut out for us.
Our performance in the first half of the year was below our expectations.
And it will definitely pressure the outcome for the full fiscal year.
In response, we have taken down our guidance for 2019.
Dave will address the details of our second quarter financial results.
This revised guidance and the plans we have moving into 2020.
Also I want to recognize that we have had some growing pains over the last year and a half.
I want to see a slow down the pace of our retail expansion in 2020 and focus more on improving asset productivity and thus our operating margin rate.
We have made a number of behind the scene improvements in our business that will bear fruit 2020, which excites me.
We have a strong team in place to execute our plans and to ensure the long term success of the business.
In general our top priorities remain the same.
First is to drive top line growth through new product offerings and targeted marketing that expands our brand awareness.
Second is to leverage our cost structure to drive profitability, while ensuring that we exceed customer expectations.
And third to achieve greater return on our investments.
Our team is well under way to implementing these top priorities and we expect to see signs of improvement in the second half of this year.
Now I will turn the call over to Dave.
Thanks, Dave and good morning, everyone.
For the second quarter, we reported net sales of 122 million up 10% compared to 111 million last year.
Our direct segment sales were essentially flat to last year at 60.3 million.
In our retail segment sales grew 24% to 61.7 million.
For the quarter shipping revenues were 1.6 million compared to 1.9 million last year.
The growth in retail it was primarily driven by new stores opened in 2018 and 2019.
During the quarter, we added four new stores and over 60000 gross square feet with each of them being our first stores in the state of Arkansas, Connecticut, Alabama and Georgia.
We ended the quarter with a total of 55 stores compared to the prior year of 39 stores.
In the second quarter, we continued to experience the challenges we face in the beginning of the year.
Sluggish sales trends in the direct channel and an existing store markets deepened in the second quarter, especially in may with traffic and overall sales volumes falling short of our expectations.
In an effort to drive more store in web traffic, we extended our global promotions and took deeper markdowns on spring and summer products, particularly on core men's items.
As a result, our gross margin for the quarter declined 310 basis points for a gross profit of 64.8 million.
[noise], our women's business continues to outpace men with an overall growth rate of over 20% for the quarter and mid teens growth rate online.
We expect this positive trend will continue in the back half of the year with a greater assortment of new women's items. The launch of our workday wires collection and an increased number of plus sized skews.
To address the more challenging men's business. We also have new product launches and an increased number of new items that we expect will reverse the current trend.
Looking ahead to the second half of the fiscal year, we expect to see gross margins improve but will fall short of making up for the first pass declines.
Two areas of pressure are heavier clearance activity in August and early September .
And the unavoidable impacts of China tariffs.
Which we estimate will negatively impact gross margin by 20 basis points for the full year.
As of now our total source product with exposure to China is less than 15%.
And by 2020, we expect to transition all our apparel goods out of the country will have a small remaining amount of accessories was minimal margin impact.
Selling general and administrative expenses increased 16.7%.
The 61.1 million.
Compared to 52.3 million last year.
This included an increase of 400000 in advertising and marketing expenses 1.3 million and selling expenses and 7.1 million in general and administrative expenses.
As a percentage of net sales SGN, a expense increased 280 basis points to 50.1% compared to 47.3% last year.
As a percentage of that sales advertising and marketing costs decreased 90 basis points to 13.4% compared to 14.3% in the second quarter last year.
Primarily due to advertising leverage gain from a higher mix of retail sales.
Selling expenses as a percentage of net sales decreased 30 basis points to 14.4% compared to 14.7% last year.
The decrease is attributed to improved shipping and fulfillment costs, partially offset by an increase in store labor due to additional stores.
General and administrative expenses as a percentage of net sales increased 400 basis points to 22.3% compared to 18.3% last year, primarily due to an increase in occupancy cost from the growth in the number of retail stores.
An increase in depreciation expense due to investments in technology and corporate facilities.
And an increase in personnel cost due to added headcount to support the growth of the business.
Despite the incremental store costs and associated lease expenses.
We have now mostly cycled past the larger fixed investments in the business from last year.
And the second half of the year, we expect SDMA as a percentage of sales to decrease by over 150 basis points compared with last year and will support the expected growth in earnings going forward.
For the second quarter, we reported net income of 1.9 million or six cents per diluted share.
Compared to net income of 6.4 million or 20 cents per diluted share last year.
Our adjusted EBITDA was 9.6 million compared to 13.1 million last year.
Turning to the balance sheet and liquidity, we ended the second quarter with a cash balance of 3.5 million.
Net working capital of 66 million and 45 million outstanding on our revolving line of credit.
As a side note I'd like to clarify the presentation of debt on our balance sheet.
And the notes of our filings you will see roughly $28 million long term debt related to a third party entity called try.
In accordance with Ace FC topic, 810, which covers the accounting for variable interest entities.
We are required to consolidate this entity as it relates to the development of our corporate offices here, where we are a tenant.
Dilutes holdings is not a guarantor nor are we obligated to repay the slow.
The loan covenants under our bank line of credit exclude this debt.
Moving on.
Inventories increased 12% to 114.8 million compared to 102.4 million for the comparable period last year.
The increase in inventory is due to the additional stores plus slightly higher levels of clearance goods.
As we mentioned on our last call our inventory plans for the back half of the year will result in a higher third quarter ending balance.
This reflects our goal of receiving goods several weeks earlier to mitigate issues, we had last year with the dislocated inventory in our Dcs and store channels.
Our expectation is to have inventory back in line with the expected sales growth by year end.
Capital expenditures for the second quarter were $7 million.
Compared to 12.8 million last year.
And were primarily for the new store openings.
Well, we will complete 2019 with 15, new stores, we expect the pace of capital outlays will moderate going into 2020.
As we rebalance our business model to focus on driving greater returns on the capital invested and driving positive free cash flow.
We plan to continue opening stores in new markets.
But we'll likely plan for expanding square footage by 30% to 40% less than we have over the last few years.
We expect the capital deployed for systems and infrastructure will also moderate as much of the foundational investments needed to scale and support our growing omni channel business are now in place.
Two key initiatives that remain on our technology roadmap include an upgrade to our store Pos systems.
And replatform of our customer data warehouse.
Both are expected to be implemented next year, and while tangible revenue driving benefits.
We will provide further direction on our updated capital expenditure plans when we provide guidance for 2020.
As Steve mentioned, we are adjusting our outlook for the second half of the year based on the first half softness.
We expect to deliver second half year over year sales growth of roughly 10% supported by four main drivers.
First new market expansion what stores, we are on track to open 50, new stores in 2019 and 13 new markets.
Second we anticipate growth rates in online sales in the mid low single digit range supported by continued strong online growth in our established markets.
Third newness will see growth from new products in both men's and women's categories support supported by tighter whole house marketing messages and advertising that drives traffic to stores and our web site.
And lastly, it improved inventory flow in positioning to satisfy our customers' expectation for completing the sale wherever and whenever they want.
In addition to growing topline. We've we've also been keenly focused on expense management, including getting the most out of our advertising spend.
The steps, we've taken to leverage fixed cost and gain variable expense efficiencies are already yielding results.
Now that I've given you some color on the second half of the year, Here's an updated guidance for the full fiscal year 2018.
We expect to deliver sales growth of roughly 10% on a 52 week basis.
Our net sales between 610 million and $620 million in 2019.
We expect gross margins to be down 50 to 100 basis points and selling general and administrative expenses as a percentage of net sales to be in the range of 48% to 49%.
We expect 2019 earnings per diluted share to be between 60, and 66 cents, which compares to 68 cents last year on a 52 week basis.
This assumes a full year weighted average diluted share count of 32.4 million shares and a tax rate of 26.5%.
We expect adjusted EBITDA to be between 51, and 55 million and capital expenditures of roughly $40 million.
But most importantly, we expect the second half of 2019 to be our turning point on growing operating margins and delivering the growth and bottom line results, we've been planning for and investing it.
With that we'll open the line for questions operator.
We will now begin the question and answer session to ask a question you May Press Star then one on your telephone keypad. If you are using a speakerphone. Please pick up your handset before pressing the keys.
Withdraw your question. Please press Star then two at this time, we will pause momentarily to assemble our roster.
The first question will come from Jonathan Komp with Robert W. Baird.
Yes, hi, thank you.
Steve I wanted to maybe start and just ask a broad question.
Given the transition in place in your position back in the leadership role.
Can you just give an update on kind of what you see over time do you expect to initiate any type a search for a permanent replacement or or how long might you be committed to overseeing operations in the current role you are.
Good morning, John well as I told our board I'm all in this and very willing to.
Spend the time that it takes to complete the surge, but also to make sure that we have a very successful fourth quarter. This year and we build the roadmap for 2020.
I really see is starting to search and.
Early 2020, and our focus will be on someone who really has strong brand credentials merchandising marketing.
Retail and direct marketing those would be a lot of things we'll be looking for so.
Hopefully we will have the search completed by mid to late.
2020, John .
Okay, Great. That's that's helpful.
And maybe a question about the comments into 2020 and the decision to moderate the retail growth.
Maybe just.
Bigger picture can talk conceptually, how you're thinking about that moderation is that more of a pause temporarily till that business gets back on.
More of a solid footing from a from an operating margin and earnings perspective, do you think that's how longer term shift and maybe if you could just talk about.
Some of the benefits you expect to accrue from just being able to focus more on the core business and maybe last one on the rapid retail expansion.
Well, yes, it is somewhat of a pause, but we're still committed to the national footprint with our stores in the future.
My objective here is to see us improve our operating ratio and and to do that part of it is to slow down the growth of the business.
Weve digested a lot over the last two years.
Took on a lot of changes and whatnot and I think it's just it's time that we really focus on executing well and continue to build the brand.
Dave you have anything else that you might add to his question at this point.
Yeah John .
We don't have the longer range plans detailed out yet moderating capital growth into next year is combination of.
Focusing on what we've already invested but also you know some cautiousness on on where where the economy, where the industry might be going in and just not getting too far out ahead of ourselves in terms of deploying more capital, but it doesn't mean that we don't think the brand still has the same long term growth opportunity that we've always articulated so.
So nothing is really set in stone on that longer range growth, we're still targeting the the range of.
Our long range objectives, as we always have.
Okay, and maybe maybe just one follow up Dave.
Following up on that and asking a little bit different but when you look at.
Yeah, the ASG in a ratio this year, 48% to 49% would be a high mark for the company.
Is there any sort of longer term vision on where that could be and maybe just any broad stroke comments on the individual pieces, where you could where you could get some leverage over time, especially with less of a focus on.
The capital investment growth in the short term.
John I guess.
Specifically on the S. DNA rate I mean, we we know we've got the opportunity to leverage that and that's going to start to be realized.
This this second half of 2019.
Getting our operating margins back to where they historically were.
In.
Hi single digit low double digit is still our objective.
So.
We think thats.
That's not coming at kind of the expense of more capital as they go hand in hand.
Okay I appreciate the perspective, thank you.
Thanks.
Once again, if you have any questions. Please press star then one at this time.
The next question will come from Jason Carton with William Blair.
Yes, hi, Thank you very much I was wondering either Dave or Steve If you could talk about some of the behind the scenes investments that you alluded to in your prepared remarks, and just sort of how those flow.
Throughout the sort of the balance of the year and into 2020, and one benefits from those or at least from an operating margin standpoint.
Our expected to really take hold.
Yes, just one I guess you know.
What we've talked about from the investments in our infrastructure and logistics I mean, those those have been in place starting last year and the benefits that we're getting from those are materializing in.
And our ability to leverage SDMA.
So I think thats been clear as to how we've articulated where some of the capital spend has been.
If there's a specific area within that that you are curious about yes happy to go deeper with you.
Yes, I guess, maybe then sort of store functionality I know Pos is rolling out next year, but some of the inventory management tools that you've implemented any kind of early signs as to how those.
Our helping sort of drive efficiencies.
Oh sure well, we definitely have the the opportunity within the inventory planning and and flow of goods.
To improve that.
Where where we're going to see in this back half of the year is a better inventory positioning from the planning standpoint and from a from an open to buy so we expect that that's going to be.
Thats already materializing in a better handling.
Better throughput of the inventory.
Better logistics coming down from having inventory in the right locations.
And having the goods in the right place and having them in the stores.
More timely and that comes from both the use of the tools, but also our planning approaches to that so.
Yes, thats whats going to realize in in the benefits.
Great and then sort of I guess falling from that any sort of guidance you can give around the flow of particularly around mens new product into the back half is that mostly a holiday.
Then.
Oh the flow is starting right now I mean, we now have a new.
Pants category that we're really excited about that extend sizing.
And.
And then we have some goods coming in our Alaskan hard gear category thats going to be new.
That will come out in the next in the next month, but we're we are resetting our.
Our store sets right now and so you will see those on the floor.
Starting this week and then more coming out in October .
Great.
And then just last one for me sorry, Thanks for taking all the questions women's now as a percent of the business is there any.
Is there any update to that sort of where that's landed or we'll end the year.
It's still going to be trending a little bit under 30% close to 27, but but it's got a lot of momentum and right and that comes from both the product set that we put together for but also the strong marketing.
Behind it some some of the TV advertising and and coordinated marketing behind women's campaign and upcoming are.
Workday wires collection is is new for us and so there is potential to see that that 27%, where we sit today.
Start to creep higher because.
That opportunity.
Great. Thank you very much.
Thanks, Phil.
And this concludes our question and answer session.
And this also concludes today's conference call. Thank you for attending today's presentation. You may now disconnect your lines have a great day.