Good morning everyone and welcome to the Duluth Holdings fiscal year 2019 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today’s presentation, there will be an opportunity to ask questions.

To ask a question, you may press star and then one on your touchtone telephone. To withdraw your question, you may press star and two. Please also note today’s event is being recorded. At this time, I’d like to turn the conference over to Donni Case, Investor Relations for Duluth Holdings. Please go ahead..

Thank you Jamie, and welcome to today’s call to discuss Duluth Trading’s first quarter fiscal year 2019 financial results. Our earnings release, which we issued this morning, is available on our investor relations website at irduluthtrading.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 to your questions.

Before we begin, I would like to remind you that the 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.

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 SEC filings, as applicable. 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.

With that, I would like to turn the call over to Stephanie Pugliese.

Stephanie?.

Thank you, Donni. We believe that we are well positioned for long term success with our unique brands and the investments that we have made in strengthening our omni-channel model. First quarter results, which were aligned with our expectations coming out of fourth quarter, reflected a continued softness in traffic and customer response.

While indicative of some current challenges that we continue to face through the first weeks of the second quarter, they do not reflect the long term potential that this brand has.

We remain fully committed to building the Duluth Trading brand through multiple touch points with our customers and the fundamental architecture for achieving this is to build an omni-channel model that we control and that responds to the expectations of today’s consumer.

This will allow us to grow and scale our business well beyond what we would have achieved with a direct model alone. Before I turn the call over to Dave’s financial review, I want to address the current state of the business, what’s working, and what we will improve go forward.

You’ve all heard the reports that the retail environment continues to be challenging on a number of fronts, and we are not immune to these macro pressures. While we are cautious about consumer spending behavior and the economic outlook, we are focused on those things within our control.

We have identified four areas of opportunity that the entire Duluth team is focused on for the remainder of this year.

They are improving product selection with deeper inventory and new styles; driving increased traffic to our stores and to our website; refining our investments to improve efficiency and productivity; and testing new ways to expand brand awareness and attract new customers.

Beginning with product, while core product remains the foundation of our sales base, our customers particularly in retail stores are responding positively to new innovative product introductions. The launch of new styles not only widens our audience, it creates more repeat business and improves retention of our existing customer base.

We are making progress here. New product sales penetration doubled in first quarter versus last year and we have increased styles in the women’s plus line from 40 last fall to 85 this year. We are also growing Alaskan Hardgear and will launch an expanded line of Duluth men’s woven bottoms in early fall. But we still have more that we can do.

We know that we disappointed some customers when we ran out of inventory too quickly, for example. To that end, we are increasing our penetration of new styles as we go forward into the latter part of the year and have deepened our inventory purchases to ensure a better customer experience.

We also continue to refine and actively test our marketing spend to most effectively reach new customers and heighten engagement with current ones. We launched a local media campaign in specific store markets earlier this month and have seen some positive early indicators.

We have also seen strong results on our Buy Online Pick-up in Store, or BOPUS initiative with 24% of our customers who used BOPUS making an additional purchase when they reached the store, effectively doubling their original order. On the other hand, we have some work to do on reigniting customer acquisition.

A significant number of our new customers are coming from new store openings, but we know that we have opportunity to do more in the direct segment as well as in our established store markets.

The good news is that we are seeing improved conversion across channels and increased customer spend, indicating strong brand satisfaction by those that cross our threshold. Go forward, we have increased our efforts in localized marketing and across high acquisition media such as social platforms.

This will take some time to gain traction and we expect improvement in the second half of this year. The third area of focus is refining the productivity of our investments.

Our SG&A this quarter was particularly pressured due to the annualizing of some key infrastructure improvements such as the order management system and ecommerce platform that we launched last year. While these were necessary to enable future growth, it is now imperative for the team to improve productivity.

We have made strides already in this area and our variable costs, such as distribution and store labor, showed improvement this quarter year-over-year. Our leadership teams in operations and IT are highly focused on continuing to make progress and we expect that these areas will demonstrate improvement each quarter.

A foundation of our growth has been through innovation and reaching new and existing customers in different ways. As we will announce later today in a separate release, we are opening a concept store in Mall of America.

This store will be a smaller footprint at approximately 1,700 square feet and will carry a limited assortment of top selling products. The Mall of America attracts 40 million annual visitors who come from all over the world and is truly one of the major shopping destinations in the U.S.

Our store, which will open in early fourth quarter, is located in a heavily trafficked corridor, and we believe there is great potential to expand awareness for the Duluth Trading brand. If this new concept store performs well, we will have other stores like this on the drawing board.

As we have shared, we are always evaluating our omni-channel results and making decisions on where to open stores and how many stores to open in a given period. This will give us additional insights into store format which we will use to inform the type and number of stores that we will open in 2020 and beyond.

The second half of our year is historically the strongest. It’s also when some of the initiatives I just talked about will start to kick in and show results. That said, we are just beginning to implement these improvements and we will be acting on the results throughout the remainder of the year.

While we are reiterating our guidance for 2019 at this time, we know that there is much left to do. What we can guarantee is that our entire organization is focused on executing well on our objectives and preparing for our peak selling season. Now I will turn the call over to Dave..

Thank you Stephanie, and good morning. For the first quarter, we reported net sales of $114 million, up 14% compared to $100 million last year. Our direct segment sales were essentially flat to last year at $65.7 million and our retail segment sales grew 43% to $48.5 million.

For the quarter, shipping revenues were down 32% compared to last year at $1.7 million. The growth in retail was primarily driven by our new stores opened up in 2018 and in the first quarter of 2019.

During the quarter, we added five new stores and almost 80,000 gross square feet, with three of them being our first stores in the State of Kansas, Washington and Florida. We ended the quarter with a total of 51 stores compared to the prior year of 33.

As we mentioned on the last call, our sales trends in the direct channel and existing store markets were soft heading into the first quarter. The opportunities to drive stronger year-over-year sales came at the expense of gross margin, which declined 250 basis points to 53.3% for a gross profit of $60.9 million in the quarter.

The decline in margin rate was primarily due to heavier clearance activity in early March and deeper discounts on core product at the end of April. While these events helped mitigate headwinds from a slow start to warmer spring weather, the month of May did not trend better.

We continue to see year-over-year sales declines in the direct channel and expect the second quarter’s results will be impacted by these trends. Many of the product and inventory initiatives that Stephanie articulated won’t become fully annualized or realized until the third and fourth quarters.

Selling, general and administrative expenses increased 26% to $70.6 million compared to $56.2 million last year. This included an increase of $2.5 million in advertising and marketing expenses, $2.9 million in selling expenses, and $9 million in general and administrative expenses.

As a percentage of net sales, SG&A expense increased 570 basis points to 61.8% compared to 56.1% last year. As a percentage of net sales, advertising and marketing costs decreased 50 basis points to 21.1% compared to 21.6% in the first quarter of last year.

The 50 basis point decrease was primarily due to a greater mix of retail net sales partially offset by an increase in catalog expense due to a shift in our women’s and men’s catalogs from late January of Q4 into the first quarter. Selling expenses as a percentage of net sales increased 50 basis points to 16.6% compared to 16.1% last year.

This slight increase is a result of the variable fee structure of our new ecommerce platform that began when we launched the new website last year and will be fully annualized in our third quarter.

General and administrative expenses as a percentage of net sales increased 570 basis points to 24.1% compared to 18.4% last year, largely due to the expenses related to new stores and the depreciation and support costs related to the investments in technology and logistics infrastructure.

I’d like to remind everyone that as of the beginning of the fiscal year, we adopted the new lease accounting standard using the optional transition method. Upon adoption of the new lease standard, we recorded right-of-use assets of $121.8 million and lease liabilities of $115.5 million.

During the first quarter, the new lease standard had a pre-tax expense impact of $200,000 and we expect the full-year pre-tax impact to be approximately $1 million, or $0.02 per diluted share. For the quarter, we reported a net loss of $7.6 million or $0.23 per diluted share compared to a net loss of $700,000 or $0.02 per diluted share last year.

Our adjusted EBITDA was negative $4.7 million compared to $2.6 million last year. Turning to the balance sheet and liquidity, we ended the first quarter with net working capital of $63 million and $39 million outstanding on our line of credit. Inventories increased 6.4% to $104 million compared to $98 million of the comparable period last year.

The increase in inventory is due to having 18 additional stores partially offset by lower outlet and clearance inventory. Coming out of 2018, we have made improvements in the alignment of our inventory and use of the new systems to optimize in-stock positions across the stores and distribution centers.

Our inventory plans for the second and third quarters reflect a higher year-over-year growth rate ahead of the peak selling period. Capital expenditures for the first quarter were $9.8 million compared to $14 million last year, and were primarily for the new store openings. Looking forward, we are reaffirming our 2019 full year financial guidance.

We expect 2019 net sales to be between $645 million and $655 million with mid-single digit growth in direct and the retail channel accounting for up to 45% of total 2019 net sales. We plan to open 15 new stores in 2019.

We expect full-year gross margins to remain flat compared to 2018 and selling, general and administrative expenses as a percentage of net sales to be 50 to 100 basis points over last year primarily from the lease adoption as previous noted, which shifts some lease expense from the interest line item to SG&A.

There will also be increased depreciation expense from investments in stores and related technology and infrastructure projects placed into service during 2018 and 2019. We expect 2019 earnings per diluted share to be between $0.74 and $0.80. This assumes a full year weighted average diluted share count of 32.5 million shares and a tax rate of 27%.

We expect adjusted EBITDA to be between $60 million and $64 million, capital expenditures in the range of $40 million to $45 million, and free cash flow to be positive. With that, I’ll open the line for questions.

Operator?.

[Operator instructions] Our first question today comes from John Morris from DA Davidson. Please go ahead with your question..

Hi everybody, good work on the progress here moving forward. I know it’s been a tough climate. Dave, I think a question for you on directional on gross margin into Q2, if you can give us how to be thinking about it.

I think given the weakness that you’ve cited so far into Q2 on the top line, that would obviously be potentially weighing against gross margin; but on the other hand, I see that inventory looks like it’s actually in really good shape relative to sales growth, and being down in the outlets the context--maybe a little bit about the context of that inventory, but really with an eye towards if you can comment on gross margin direction in Q2.

Would we still expect to see pressure on gross margin contraction, or could it be beginning to level out a little bit vis-à-vis how we did in Q1? That’d be my first question..

Sure John.

Yes, certainly the clearance activity in the first quarter helped clean some of the inventory levels and overall outlet and inventory was down almost 30% to last year at the end of the first quarter, so we’re not going into the second quarter with a lot of inventory that’s not fresh and new, and that’s what gives us confidence that we won’t have additional pressure.

Certainly we don’t have anticipated the kind of clearance activity that we did have in the first quarter, so we’re expecting gross margin to have some pressure but not nearly the degree that we saw in the first quarter.

As we move through the year, that will improve with the expectation that on a full year basis, we’ll get to flat to last year on our gross margin rate..

Okay, good. A quick question for Stephanie on product and product performance.

Maybe if you can drill down a little bit about product performance by category or what the call-outs might be, I think more so with an eye towards what seems to be improving or surprising--or, I guess, improving, we know Q1 had its pressures, so now I’m kind of interested from a product category perspective on what you see improving thus far in the current quarter and really where you think the opportunity also will be for the fall season, in the back half..

Sure. Let me just start with an overall division perspective, because it’s something that we didn’t actually add to our comments, and that is our women’s business continues to be the stronger growth area.

Alaskan Hardgear continues to be a stronger year-over-year growth area for us, very similar to what we’ve been reporting for the past several quarters, where our men’s business has some pockets of strength, which I’ll talk about in just a second, that is the area where we see the opportunity for most improvement overall as we go forward.

As we look at new product across the board, we are seeing more and more strength in terms of the percent of the sales that our new product lines are giving us, things like Breezeshooter knits in women’s, like additional silhouettes in Sol Survivor, and some of our base layer programs are doing quite well.

When we look at men’s, John, as we go forward, while it is the softer division overall in terms of its trends, we have some pockets of strength there, and those are the areas that we are playing into as we go forward.

An example of that would be that we’re launching a new men’s bottoms fit campaign in just about a month or two, and as we go into early fall that’s an area that we’ve seen some strong results of in men’s, and women’s for that matter.

That’s a place that we’re playing into with heavier assortments, heavier inventory as we go forward, so we think we’re going to see some positive--more positive results there. Again though, I would reiterate that what we talked about in our last call is still very true.

It’s about pushing hard on women’s, Alaskan Hardgear, select categories in men’s, and newness overall. We continue to see those trends..

Great, thanks..

Sure, thank you..

Our next question comes from Jonathan Komp from Robert W. Baird. Please go ahead with your question..

Yes, hi. Thanks everyone. First question I wanted to ask, more of a shorter term oriented question, but just given the softness that’s continued and then into the first five weeks of Q2 here, just curious how you’re thinking about the decision to hold the full-year guidance given the softer start.

I know first quarter was in line with what you expected, but any thoughts on the confidence level and the progression in the performance that you need to hit the maintained guidance?.

Yes Jon, I think the biggest thing for us that we know that we’ve had a softer trend than we would like in the first part of the year. We also know that the second half of the year is by far the bigger and the more important in terms of driving through the top and bottom line in the business.

The measures that we’ve put in place as we go forward are really just beginning to take hold and will come to fruition as we get into third and then of course into fourth quarters. Right now, our focus is on improving that top line, managing the expenses so that we’re gaining the productivity that we need that are in line with our guidance.

The one other thing that I would add is over the past several years, whether the business has been slightly ahead of trend or slightly behind trend at this point in time, we know that because so much important business is yet to come, we haven’t adjusted guidance at this point in time for that very reason.

It’s very similar to what we’ve done in the past in terms of how we’re looking at the importance of the second half of the year..

Okay, great. Then maybe a couple of bigger picture questions.

First Stephanie, just given all that you’ve highlighted in terms of initiatives you’re working on, maybe stepping back, is it too simplistic to think in the last couple of years, maybe you’ve been so focused internally around implementing a lot of systems that now, once you’re past a lot of that, you’re able to shift focus back towards sales, marketing, product, a lot of the drivers you discussed in that, going forward, you should have more capacity to really get back to driving the business versus implementing systems? I’m just curious to hear your thoughts there..

Yes Jon, I think that you said it very well. We knew that the infrastructure improvements were critical to be able to enable the growth for the future, and the truth is that they do put pressure on the focus of the business and ensuring that we executed well those particular programs.

Now there is a renewed strength of how we are going to market, the product, that we’re bringing in new product faster to market, trying new things like additional marketing activities, testing localized marketing, etc.

that’s bringing us back to some of the core foundational ways that this brand has grown over the years, and we’re excited to see those things start to come to fruition and build for the future for us..

Okay, great.

Maybe one more on the retail side, it seemed like, Stephanie, maybe previously the perception was you’re more locked into the strategy of adding 15 standard retail boxes a year, but given some of your opening remarks, it seemed like maybe signaling a little different approach into 2020 and beyond, with different formats and more flexibility.

I’m curious if you can maybe just expand on your thinking behind the test there, and then also how much flexibility you do or do not have in the plans going forward. .

improving brand awareness, bringing new customers into the brand, and then of course creating a physical environment for customers to experience our brand, experience our product. The format that we started with was a downtown kind of historical environment, whether that was Duluth, Minnesota, our first store in Mt. Horeb, Wisconsin.

We evolved that to stores like Bloomington, Minnesota that were renovated existing retail, and then as we went forward beyond that, we realized that there were certain markets that the available real estate might not be the best particular position for our store to be in, and that’s when we opened the opportunity around build-to-suit stores.

So for the past seven or eight years, we have been continuing to explore new types of formats, explore new ways to go to different markets where our customers live, and this is an evolution of that, how do we continue to reach customers in new and different ways, and opening up that flexibility and those opportunities and markets as we go forward.

We will continue to evaluate those formats. We have several of them today. We’ll have a new one in fourth quarter with Mall of America.

We have been opening 15 stores a year for the past couple of years, but we’ve also said that we will continue to evaluate that as we go forward and make sure that we’re making the right decision overall for the omni-channel expansion, and that’s what we’re doing.

In terms of flexibility as we go forward, we have obviously announced the stores that we are moving forward with in 2019. We have not yet signed leases on any 2020 locations, so that is all flexible at this point..

Understood, thanks for all the color..

Sure..

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

Good morning, thanks for taking my questions..

Good morning, Jim..

Just starting on the near term trends, you mentioned the direct business challenges continued through May.

As the weather’s turned, have you seen any bounce in June?.

We’ve really seen the softness, Jim, continue through the first week of June. The one area that has improved more recently, in the past couple of weeks, is our women’s business has gotten stronger; but overall, the softness we’ve seen continue into the first week of June. .

Thanks.

Then on the men’s business challenges, I’m curious - is the difficult trend a function of revenue from existing customers, or is it more a challenge of new customer acquisition?.

It’s more a challenge around new customers, but the customers that we are bringing in, whether that’s crossing the threshold of our stores or coming into our website, we are seeing improvements of conversion and the average spend per customer, so there are some good indicators there. It’s really a traffic problem overall for us..

Okay. Then with respect to direct traffic and conversion trends, are you seeing any benefit to conversion with the new website, and I’m also curious if you can comment on what you’re seeing with respect to the advertising costs for direct.

Is there inflationary pressure there?.

Sure, so the first question around the website, I think the biggest benefit that we have seen so far is specific to our mobile site, and that was one of the key areas that we focused on as we went in and built the new ecommerce platform to be able to capitalize on that traffic that we knew our customers were gravitating to.

You wouldn’t be surprised, it’s pretty common, more than 50% of our traffic is coming through our mobile site, and we have seen conversion improvements there which is very positive thing and a good indicator for us for the future.

In terms of the cost of advertising, we definitely have seen inflation around some specific areas of advertising costs, most specifically in television advertising, and we’re looking at how we blend the mix of networks, how we blend in live sports, etc.

to make sure that we’re being most effective with the use of that money, even considering the inflation..

Okay, thanks. Then Dave, last one from me, for you.

Just looking at the consensus numbers, which are showing earnings improvement year to year in all the remaining quarters of the year, is that consistent with internal expectations?.

Well, that’s consistent when we get to the full year basis. Quarter to quarter, where we’re going to see the biggest improvement is going to be in the third and fourth quarters..

Okay, very helpful. Thank you..

Ladies and gentlemen, that will conclude today’s question and answer session and today’s conference call. We do thank you for attending today’s presentation. You may now disconnect your lines..