Moira Conlon - Investor Relations Stephanie Pugliese - Chief Executive Officer Dave Loretta - Chief Financial Officer.

Jonathan Komp - Baird Dylan Carden - William Blair Jim Duffy - Stifel.

Good morning and welcome to the Duluth Holdings Third Quarter 2018 Earnings Conference Call. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please also note today's event is being recorded.

At this time, I would like to turn the conference call over to Moira Conlon, Investor Relations for Duluth Holdings. Please go ahead..

Thank you, Jamie, and welcome to today's call to discuss Duluth Holdings' third quarter 2018 financial results. Our earnings release, which we issued this morning, is available on our Investor Relations website at ir.duluthtrading.com under Press Releases.

I am here today with Stephanie Pugliese, Chief Executive Officer; and Dave Loretta, Chief Financial Officer. On today's call, management will provide prepared remarks and then we will open the call up to your questions.

Before we begin, I would like to remind you that comments on today's call will include forward-looking statements, which can be identified by the use of 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 risks and uncertainties that could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements.

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. Please refer to our SEC filings for additional information. And with that, I would now like to turn the call over to Stephanie. Stephanie, please go ahead..

Thank you, Moira, and welcome everyone to our third quarter of 2018 conference call. Throughout the year we have continued to execute on key initiatives that prepares for our peak selling season and position us to reach our goal of $1 billion in revenues over the next several years.

In a few minutes, I will talk more about how those efforts are fortifying our omnichannel presence and enhancing our customers' experience.

But first, I’m pleased to report that our team delivered a strong third quarter, achieved through our focus on innovative new and core products, increasing brand awareness through new product marketing and enhancing the customers experience in all channels.

Net sales increased 27% to $107 million, which marks our 35th consecutive quarter of increased net sales year-over-year. Retail sales for the quarter had a 58% growth rate, largely driven by new stores opened in 2017 and 2018. And we opened four new stores this quarter that are now ready for holiday shoppers. Direct sales grew 10.5%.

This number includes the four percentage point impact of revenue recognition. After that adjustment, our direct growth rate grew at 6.5% year-over-year and improved over the first and second quarter growth rate. We’re on track to meet an annualized direct growth rate in the mid-single digits.

We saw strong results across all categories in our men’s and women’s division, with men’s growing 25% year-over-year and women’s growing 35%. Gross profit margin of 57.1% with 50 basis points over last year, driven primarily by less reliance on promotional activity this quarter.

Core year-round product and seasonal categories performed very well and we ended the quarter in a clean inventory position reflecting ongoing efforts to improve terms, while maintaining a 95% or higher fulfillment rate in direct. While we achieved our goals for the quarter, the team also worked through some challenges.

The transition to our new e-commerce platform in August went very well, but there was an expected period of adjustment where we saw a slowdown of direct growth and some increased expenses to monitor and fine tune this halfway.

We have a slower transition than expected when we upgraded our retail replenishment software and implemented new technology in our Belleville distribution center. This caused a temporary flow down in inventory being replenished to existing stores and the delay in our seasonal update for late sell product.

Lastly, we incurred more labor costs in our call center as we continued to refine the order management systems, while maintaining our customers service standard. All of these challenges were identified and improved throughout the quarter and into November. We expect to get those expenses back in line for the fourth quarter.

And as we entered this all important peak season, we’ve improved our ability to reach new customers and serve our existing customers better than ever before. We’ve successfully completed our store expansion plans for the year with the addition of seven new stores opened in the second half of the year.

We have achieved our stated goal of 15 stores for fiscal 2018 and all are meeting or exceeding our initial expectations. Overall, this year was our most ambitious effort to geographically expand the dilutive trading store experience to customers across the country.

We now have 46 stores in 24 states and 37 markets, and we’re coast to coast from Portland, Oregon to Portland, Maine. To this achievement, we have a great deal to the tireless work of Al Dittrich, who built an incredible retail store team from scratch. Now that he has his leadership team in place.

We have promoted Al to Chief Operating Officer oversee all dilutive operations. As we’ve stated before, our omnichannel strategy is at the core of successfully growing our market penetration and can be measured through the combination of retail and direct sales.

While our current established store market base is small, we continue to see positive leading indicators that this strategy is working. We bring new high value customers to the brand. We increase our overall market penetration immediately and our direct channel continues to grow at more than double the growth rate of non-store markets.

In addition to building our store base and investing in brands awareness through marketing efforts, we've successfully implemented several major initiatives to build a strong and scalable infrastructure and to support our omnichannel model growth.

To date, we have improved our e-commerce and mobile experience to further develop our ability to personalized content and improve product visibility. We have deployed buy online, pick up in-store in seven retail locations. We are seeing the quick adoption rate by customers and we plan to roll this out to more locations in 2019.

In addition, ship-from-store went live in those stated seven locations and we will be expanding this initiative to stores with advantageous locations and background macro capacity. We have upgraded our POS system across all stores and we now have the ability to issue electronic gift card in time for the holiday season.

Finally, as I mentioned a moment ago, we have completed the upgrade to our distribution centers to create more efficiencies in direct shipping and retail replenishment. We can't thank our team enough for their tremendous and coordinated effort to have these enhanced capabilities in place for our peak selling season.

That said nothing excites customers like innovative product introductions. This quarter, we've launched several new products, including Flexpedition and Agiloft Outerwear. We also introduced our Plus Size line for women through our receptive audience.

We are bringing in new customers, almost a quarter of women who purchased Plus Sizes are new to the brand. And our repeat rate was strong with 10% of customers repurchasing since the launch. We plan to grow this line substantially in 2019. Now I will conclude my remarks with what we see ahead for the holiday season.

First, as I've already mentioned we have a stronger and more capable infrastructure than ever before. We have some new and exciting product launches, including new outerwear and an expanded Alaskan Hardgear collection.

Every year we are getting smarter about our advertising investments across TV catalog and digital that we believe will help us stand out from the noisy crown this holiday season. Our stores are in a strong inventory position. With our new systems in place, we are stocking based on sales forecast, not back selling as in prior years.

We have ramped up our stock base at the distribution centers to avoid bottleneck. And recognizing the customers that have been buying closer to Christmas each year, we believe that having a larger network to reach customers, including almost 50 stores will allow us to capitalize on the later sales opportunity.

We know that we still have a lot to accomplish and we will be monitoring and reacting to customer demand throughout this quarter. We are reiterating our sales and EPS guidance for the year and look forward to a successful holiday season. With that, I will turn the call over to Dave to discuss our financials and operations in more detail..

first, higher spend in women's television advertising for an earlier start to the fall and winter season and to support the women's Plus Size launch; second, a shift to accretive marketing expenses from the second quarter to the third quarter; and third, the impact of recognizing certain catalog costs in the third quarter versus the fourth quarter last year due to the revenue recognition adoption.

Within selling expenses, the 70-basis-point increase was largely due to the higher retail selling costs from additional stores and also the impact of a temporary decline in productivity at our distribution and call centers while adopting the new system.

As a partial offset to this, we continue to realize leverage in shipping expenses as retail sales increase proportionally. Within general and administrative expenses, 120-basis-point increase was due to the additional staff, consulting and depreciation costs related to the new order management and e-commerce platforms.

In addition, higher retail fixed costs from our largest store base contributed to the increase in G&A expenses. Included in SG&A were new store preopening expenses of $2.2 million compared to $2.7 million last year.

For the quarter, we reported a net loss of $3.2 million or $0.10 per diluted share compared to a net loss of $800,000 or $0.03 per diluted share last year. We ended the second quarter with a cash balance of $2.5 million, net working capital of $85 million and $65 million outstanding on our revolving line of credit.

In terms of working capital, we made significant improvements in managing inventory. While sales increased 27% in the third quarter, inventory was only up 1.5% compared to last year. These improvements reflect the enhanced flexibility we built into our supply chain through vendor relationships.

Additionally, our outlet inventories have improved by focusing on selling clearance products through the web and throughout the stores rather than just at the outlet stores. We feel good about our inventory position as we head into the holiday season in terms of both quantities and location.

Also, we expect to benefit -- to realize benefits ongoing from our inventory planning systems that will lead to high returns and positive free cash flow. We’re reaffirming our 2018 outlook for net sales of $555 million to $575 million with the retail segment accounting for up to 40% of total net sales consistent with our plans.

We opened 15 stores this year and expect our direct segment to grow in the mid-single digits. Our full year guidance also assumes the following. Our gross margin rate was flat to down 20 basis points with last year.

A 50 to 80 basis points increase in SG&A expenses, as a percentage of net sales, reflecting the increased selling and overhead expenses related to our retail expansion and investments in technology, infrastructure and people, which will be partially offset by leverage in advertising, and new store pre-opening expenses of $6.5 million to $7 million compared to $7.5 million in 2017.

We expect 2018 earnings per diluted shares to be between $0.79 and $0.84. This assumes the full year diluted share counts of 32.4 million shares and a tax rate of 26%.

We now expect adjusted EBITDA to be between $53 million and $56 million, primarily due to higher depreciation and interest expense related to the stores and the treatment of our new corporate office building as a capitalized lease. These increases were offset by anticipated savings and marketing and overhead expenses.

In closing, we are excited about the progress we've made in the first nine months of the year. We have a strong foundation in place for the holiday selling season and are on track to meet our full-year financial guidance. With that, I'll open the call to questions.

Operator?.

[Operator Instructions] Our first question today comes from Jonathan Komp from Baird. Please go ahead with your question..

Maybe just a couple of questions on the direct business to start.

Just firs on the accounting change, could you just give a little bit more detail on what that is and any future impacts that we should think about?.

Sure, Jon. The impact relates to the timing of our shipped orders with our recognition of a shipped order being booked as a sale at the time that we shipped the order at the doors. Where in the past, it was based on our estimation as to when customers would actually receive the order in their hands.

And under the new revenue recognition standard, there is the ability for us to determine where the transition of control of that order is.

And so the impact of this means, in the past, we would differ shipped sale at the end of the period into that next fiscal quarter whereas now we've recognized those shipped sales within the quarter that we actually ship the package at the door.

So because this quarter, if you think about at the end of October, our sales are at really their peak period relative to the end of any other quarter, it had a bigger impact within the third quarter and then the other adjustment is the same affect at the front end of the quarter.

On a full-year basis, the impact relates to just about two percentage points in terms of year-to-date direct sales growth. And for the full year, we expect it to have a nominal increase at the backend of the fourth quarter because at the end of January sales were simply at a lower level compared to the end of the third quarter.

So won't be nearly the same level of impact that we have this period..

And then a broader question on the direct business, you said the underlying growth rate accelerated a little bit in the quarter and it sounded like there is some volatility guide for the systems within the quarter.

So maybe you can share a little more color on your confidence in the trajectory, and then, obviously, for the fourth quarter I think we can apply something up roughly mid-single digits for that segment. So any color you had on drivers into the fourth quarter and how things there shake it up would be helpful..

Sure. In terms of third quarter and what happened in direct, we saw from a -- I will start with the system. We saw a slowdown in direct in the first several weeks of August and that was an expected flow down, Jon in a couple of things.

Number one, we expected that we would need as we transition to the ECP sometime to refine some of the pathways for the customers to refine some of the inbound links to make sure that everything was optimized.

The other thing that happened in August as it relates to the transition to the ECP was that we purposefully hold back on some of our digital marketing, some of our heavier promotional activity via email, because we wanted to make sure that the system was working very smoothly for our customers before we build up large traffic volume position, if you will, in terms of advertising or promotional.

So that was part of the direct growth. Traffic in third quarter where we got deeper into the quarter though, we actually had a strong beginning to October. So we have this planned lull in August, September was okay, quite frankly, it was more of a transitional time for us. Beginning of October was very good for us.

And so we view like the direct business overall was where we expected for the third quarter. As we entered into fourth quarter, we had a very strong holiday weekend, the Black Friday through Cyber Monday. Obviously, as I mentioned in my notes, we also see that customers are shopping later and later as it comes into the Christmas time period.

We’re shipping three days longer or later into the Christmas time period this year than we did last year, so we’re anticipating that. And we’re watching the business and reacting every single day. As with any fourth quarter, it's highly competitive.

There are different kinds of shopping patterns as people are, as we have an extra week in between Thanks Giving and Christmas, and people are shopping later et cetera. And so we’re watching the fourth quarter business as we always do very, very closely.

One other thing that I just want to add, when we talk about our systems and very specifically, I feel very, very good about the systems that we put in place. We have had minimal customer disruption with any of our systems. We have had improvement in speed, for example, in our desktop through our mobile sites.

It has cost us a little bit more money than we expected to in fine tuning and refining some of the systems. Some of the costs incurred, for example, were that our customer care representatives, the screens that they are looking at are taking a little bit longer to load than we expected.

And rather than try to rush our customer care reps through a transaction with our customers, we are allowing them take the time needed to service our customer well, but it has -- it did cost us extra money in the quarter, and that was part of the additional expenses that I mentioned in my prepared remarks..

And if I could maybe just the last one following up a bit Stephanie, in terms of the omnichannel capabilities you're beginning to rollout tying to some of those systems, I'd be curious just as you look at some of the initial learnings maybe what you think could be most incremental, especially in the next year as you expand the reach of some of those?.

Yes, we're particularly excited about the buy online pick up in-store functionality that we have in the seven stores right now. We do plan to continue to roll that out through the first quarter and then throughout the year.

The -- that kind of goes hand-in-hand with the shipped from store initiatives that we have because when we set up a background for one, it's already set up to be able to handle the other initiative that we have. So we will continue to roll both of those out through the stores as we go through 2019.

Another thing that I'm actually quite excited for and I think we're going to learn a lot over the next several weeks, is with all of the new systems that we put in place, and I mentioned this in my comments earlier, we have the ability now to issue e-gift card, which is something that we weren't able to do with our old system.

We've already seen a nice pick-up on that from our customers. And if that's growing every single week, I think it'll be very interesting and positive for us to see what happens in those last few days, in particular before Christmas when customers are looking for that last-minute gift.

And one of the functionalities that we have see or that we have added to this is an ability to deliver that email e-gift card to a customer at a future date, any time. So it will give our customers a lot of flexibility around gift giving..

Our next question comes from Dylan Carden from William Blair. Please go ahead with your question..

I'm curious on the retail side. By my measure, it looks like sort of store productivity -- sales per store, sales per square foot was down, call it sort of mid-single digits. But in the prepared remarks, if I heard you right, there was maybe some disruption from the new systems as far as sort of store inventory delivery.

I guess can you kind of speak to that and whether or not that might have influence that metric? And then more broadly on inventory management, you're doing a nice job here kind of controlling that. Can you just expand upon some of the tools you're using that allow you to do that? That..

Sure. Let me talk first about the inventory system that we've implemented because that flows through to what happened in the quarter and some of the remarks we've made, and to answer your questions on about what happened in the stores too over third quarter.

So we have most recently implemented Phase 1 of our inventory and assortment planning system, which for this particular timeframe, allows us to pre-inventory stores, in other words, in the past, we would replenish stores based on what they sold the week prior.

So we could be one to two weeks behind in having the inventory there and available for our customers. Today with the system that we put in place, we have the ability to replenish stores based on a sales forecast. So we’re looking forward two to four weeks, anticipating the needs for the stores and inventorying them in advance of those weeks.

We think that’s going to be a really big win for us long-term. The next phase of that system, as an example, will give us additional abilities to localize assortments for our stores, which obviously as we continue to expand our geographic footprint is going to be very important.

So this is a system that we’re really happy that we've taken a step forward and added for our stores and four our inventory team. What happened in third quarter was that we had a timeframe where we were transitioning our distribution center, specifically Belleville, because that's the distribution center that we replenish all of our stores from.

We were transitioning that distribution center with a more automated pick-pack conveyor system. That automation went very well for us. The return to high-yield productivity was slower than the expected. So the transitions, again, the team up and running on that new process that new system, is a little slower than we expected.

We have incurred some additional costs on that. We also, because of that slowdown missed, our original plan for the fall, the late fall transition of goods things like lined pants, based layers, heavier-weight flannel by about a week to 10 days in the stores. We know that that cost us some level of demand.

We don’t have a really accurate and good way of quantifying that, but we know, particularly as I got later into October, that -- and the weather terms that we had some missed demand on that.

And then the last thing that I would just mention is, as we started then implementing the system to look forward, we obviously created a large flow of inventory into the stores, which again, was a little bit of a bubble of lower productivity, cost us a little bit more money.

I’m really very happy though to report that as of early to mid-November, stores were through that kind of overflow of inventory, if you will. They were in great stock position as we enter the Thanks Giving weekend, and they've been in much, much better stock position than they were last year or so.

The inventory overall is up 1.5%, is really a result of our teams working very hard to work with our vendors, to flow our inventory better, to rightsize some of our longest weeks of supply program.

And as we've reached larger and larger scale with some of our core programs, for example, that allows us to flow the inventory more frequently, stay in fulfillment position for our customers and in future..

And then last one here, just maybe a little bit more gross margin pressure now than expected modestly albeit.

Any comments on that Dave as per the new guidance?.

Yes. Slightly more pressure that we’re anticipating in the fourth quarter, not that we set plans to be become more promotional. But that is one of the elements that becomes a bit out of our control as we get through the competitive pricing period.

So in the interest of being cautious, wanted to provide an outlook on that note, but do see that we've offset it with SG&A and largely in the marketing side..

And our next question comes from Jim Duffy from Stifel. Please go ahead with your question..

Couple questions from me. I understand some of the complications really to the systems implementation and inventory flow. I'm curious with the new web platform.

Have you seen any quantifiable benefits to traffic, conversion, any metrics you can share on benefits you've seen from the new web platform development -- implementation?.

Yes, on the immediate front, Jim, we saw a significant improvement, anywhere from 30% to 40% increase in site speed, particularly on our mobile site.

And we know that, that's kind of the -- one of the first entry points to creating a good customer experience, allowing people to get through their shopping process faster and ultimately convert at a higher rate.

We have also seen significant traffic increases year-over-year, driven more than 20% up -- more than 25% up actually in traffic to the website in third quarter, which is a really nice increase. We have not yet seen significant increases in conversion overall. Some of that though have to do with the fact that our traffic has increased so significantly.

And we know that some of that traffic is prospecting traffic in these potential customers. So that's a longer term preposition as they continue to come back to us and get more comfortable with the brand.

The other piece of conversion is that, as with almost every retailer out there right now, our mobile traffic has increased at a faster rate than desktop and tablet, and that traffic does convert at a lower rate. So our mix is continuing to evolve as well.

We have seen, over the past couple of months, improvement in conversion, but we know that that's a longer term proposition, and we will continue to work on that, and fine tuning and improving on that as well. Some of that will also be informed by our marketing mix study that we've shared that we're looking on in prior calls..

Jim, I guess, I'd also add that one of the core elements of being on the new platform is simply having a stability where peak volumes really come into play.

And I know we probably read in a couple other cases in some websites that had troubles with some of the volumes are Black Friday, Cyber Monday weekend volumes were significantly higher to us last year and we didn't realize or see any impact to the customer in that regard. So we're pleased with that as an initial outcome..

And I recognized its early and only in seven stores, but is there any statistics you can share on the uptick of buy online pickup in-store and any impact you are seeing there on retail productivity?.

We have -- what we’ve seen so far -- and you're right Jim, it’s quite early buy. We have seen an increased number of the buy online pick up in-store orders every single week to the stores. Right now, we are seeing a little over 100 buy online pick up in-store orders per store, per week, which is, as I said, ramping up.

We feel really good about that from the standpoint not only at bringing traffic into the store, but also we know from past initiatives with shipped to store that about quarter of those customers come in and purchase something else while they are there, and they tend to double their initial order in terms of the value that quarter of the people that are buying.

So we expect that both as we continue to roll that out will be not only a traffic driver, but an incremental revenue driver for the customers coming in. The other thing that we’ve seen is, and we were out and about to fifth of our stores just last week, and talking to them about the buy online pickup store -- in-store initiative.

One of the things that we found is that customers are using that function as a trip assurance, so they want to make sure that what they want in the store and they're willing to purchase that upfront to have it ready for them.

So as we continue to rollout and get visibility, more visibility, I should say, to in store inventory by location, we think that’s going to be a big win for us. So that’s 2019 for us..

And then on the inventory, clearly very tight, is it where you guys want to be? Or are there some areas of assortment where you're lighter than you would like to be to capture anticipated demand?.

I would say overall is where we wanted to be. The one phrase that we are a little bit light on inventory, quite frankly, is in some of our colder weather goods, lined pants, base layers. And that’s not necessarily a function of tightening up the inventory as much as it is. We've had several really warmth fall and winters the past couple of years.

Now we've gotten some nice cold weather. And the customer demand is a little bit higher than we anticipated. But that’s the one place..

And ladies and gentlemen, with that we will conclude today’s question and answer session. I'd like to turn the conference call back over to Stephanie Pugliese for any closing remarks..

Thank you all for participating in today’s conference call. On behalf of all of us at Duluth, we wish you and your family a wonderful and safe holiday season. And we will see you in a few months..

Ladies and gentlemen, the conference has now concluded. We do thank you for attending today's presentation. You may now disconnect your lines..