Good morning. And welcome to the Duluth Holdings Third Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions [Operator Instructions]. Please note this event is also being recorded. I would now like to turn the conference over to Donni Case, Investor Relations for Duluth Holdings. Please go ahead.

Thank you, Kate. And welcome to today’s call to discuss Duluth Trading’s third quarter 2017 financial results. Our earnings release, which we issued this morning, is available on our Investor Relations Web site at ir.duluthtrading.com under News 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 risk 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 results. Please refer to our SEC filings for additional information. And with that, I would like to turn the call over to Stephanie Pugliese, Chief Executive Officer of Duluth Trading. Stephanie?

Thank you, Donni. And welcome everyone to our third quarter of fiscal 2017 conference call. Our third quarter net sales increased 25% over last year, driven by 101% increase in retail and 4% increase in the direct segment. While our direct segment sales growth was impacted by a continued decrease in shipping revenue, lower growth rates in new store markets and warmer weather in September and October, we were pleased with the overall brand growth and the continued contribution of our retail segment. In the third quarter, our retail stores performed very well, and we saw no slowdown in foot traffic or sales per square foot. In fact, sales on a comp store basis have trended strong as the year has progress. Our new stores are opening with great customer response and we have been on time with all of the grand openings. In addition, the class of 2017 stores are tracking to be at or above our threshold of $450 per selling square foot on an annualized basis. There were several contributing factors to the direct growth rate this quarter. First, product sales growth rates were at 5.2% over last year. That said, we lost 160 basis points of growth to shipping revenue decline, which was in line with its steadily decreasing trend. We also estimate that our direct business lost about 170 basis points of growth to new store markets. In markets with no stores, growth in direct was within the range we set for the full year. We saw positive growth for direct and established store market. However, we had more new store markets this quarter than ever before, which offset the reaccelerated growth rate for direct in established market. That said, we believe the interplay between direct and retail, in both new store and established store…

Thank you, Stephanie and good morning everyone. Today, we reported net sales of $83.7 million, up 25% compared to $67 million last year. This was our 31st consecutive quarter of increased sales year-over-year. Net sales growth was driven primarily by our retail segment, which doubled in sales volume. This 100% growth in retail sales can be attributed to having 12 more stores this quarter as compared to last year, plus a healthy contribution from base stores that were opened during the third quarter of last year. Growth in our direct segment was 4% this quarter, which includes the impact of shipping revenue being down 29% compared to last year. Excluding shipping revenue, direct product sales increased 5% during the quarter. The lower growth rate in our direct channel reflects the combination of factors, including the anticipated shift to retail sales and markets where we’ve recently opened up new stores, as well as weaker Web traffic in September and October due in part to a decline in digital market spend. Moving to the other pieces of the P&L. Gross profit increased 22% to $47.4 million or 56.6% in net sales compared to $38.7 million or 57.8% of net sales last year. The 120 basis point decrease in gross margin rate was due mostly to a 70 basis point decline in shipping revenues with the remaining a combination of increase in freight cost for transporting inventory from our distribution center to our retail stores, and product margins which were up compared to the corresponding prior year due to improved initial mark up and product mix. Selling, general and administrative expenses increased 27% to $48 million compared to $37.9 million last year. This included an increase in $2.3 million in advertising and marketing expenses, $3 million in selling expenses and $4.8 million in…

We will now begin the question-and-answer session [Operator Instructions]. The first question comes from John Morris of BMO Capital Markets. Please go ahead.

I wanted to understand a little bit about the advertising plan, thoughts behind it Stephanie. I am wondering if, during the quarter, did you all decide to shift some dollars out of digital and into TV, and if so. Why? Or just generally, kind of what your thoughts are about the advertising spend, I understand it's down. And what are your thoughts about it currently in Q4 and into next year, that kind of an approach?

Sure. So first of all, in third quarter, John, we did not -- we held the original plan of television and print advertising in terms of the amount of dollars that we had plan to spend and that we actualized. We did spend less so in digital and therefore less overall than we had originally planned to spend. And that was a combination of two things; number one was that we made a decision as we started reading some of the results from digital from earlier in the year to reduce some very non-productive spend in digital overall; the second thing that we did, as it applies to digital for third quarter, is we did some holdout testing in certain areas of the country to understand not only where we could overall put our money in better places, but also to understand the impact that digital has across other metrics in the business. An example of that would be new customer business, would be one metric that we were looking at. And we did that in third quarter because we wanted to be close enough to be fourth quarter, half of the year that we could make some intelligent decisions around how we would deploy digital spend for fourth quarter. Now, all of that testing was third quarter for just a moment. The majority of the leverage that we saw on advertising spend in third quarter was due to the mix of direct versus retail. So I don’t want anyone to think that we’ve pulled back overall spend so significantly, and that’s what impacted that leverage. We did though see some downside if you will to top line in third quarter because of the reduction in that digital spend. The good news is that we learned how to improve the productivity of the digital spend as we went into fourth quarter as we are in fourth quarter today, and we have renormalized that digital spend for fourth quarter and we believe it’s going to be a more productive use of our dollars.

And Stephanie, it sounds like -- I mean I’m thinking about the promotions and the comments that you had about your promotional plan. It sounds like you were able to hold where you -- I’m just confirming this or checking this with you were able to hold where you wanted to be without trying to get more promotional. So I’m wondering if that’s the case. And was that in other product categories in men’s and women’s the way you wanted it to be. And any thoughts about your progress so far about with that, with respect to that in the fourth quarter, which it sounds like you all come back really nicely here in Q4. So I want to check those out with you?

Sure. So, yes you’re correct in terms of the third quarter promotional activity. We did hold the line on -- an example of that was the global promotions I have spoke about at 20% off and not going to a deeper promotion. And as some of you may recall, we were in a similar situation last year in third quarter where we made the decision to not go deeper in promotion, do not expand our promotional activity in the third quarter, because we didn’t wanted to be to the decrement of fourth quarter. And that’s playing out very similarly, if you will, this year. As we’ve entered fourth quarter, the promotional cadence overall fourth quarter tends to be a more promotional quarter for us year-over-year, or quarter-over-quarter from third quarter into fourth quarter. And we’re experiencing pretty much the same thing this year. When you look year-over-year in fourth quarter, we expect to have a similar number of days on key promotions whether that is a global promotion with the percent off or a big buck naked promotion that we just started yesterday for example. And those types of promotions we expect to be fairly comparable in the fourth quarter. Although, one of the things that we’re doing and we talked about it in prior calls, is we are mixing it up a little bit. We want to make sure that the promotional offer is fresh for our customers. So you might not be a daily apples-to-apples comparison as we go through the fourth quarter. But overall, we’re comparable.

The next question comes from Dan Wewer of Raymond James. Please go ahead.

To ask about inventory up 34% year-over-year, continuing to run faster than revenue growth. I understand that it was distorted by the new store openings in 4Q. Can you give us your sense of where the inventory levels will finish at year-end?

Right now, we’re projecting the inventory levels year-end to be coming down a little bit closer to sales growth. At this point, we see them that they still might exceed the sale growth rate, but they’ll be closer. One of the things though that I do want to say about inventory composition, because I think that is important and then thinking a little bit as we go further into 2018 and beyond; when we talk about the composition of the inventory, remember that 70% to 75% of our products carried forward season-over-season. And so while our inventory levels are exceeding the growth rate of sales, we feel very comfortable with the lack of risk, if you will, in the composition. We have year around and core product as a bulk of our inventory right now. And the true clearance markdown inventory that we have on hand is actually less than we have last year. So again, healthy composition although it is a little bit higher than the sales growth right now. As we look forward into 2018, one of the things that we've identified is the need to get our team some better higher level systems to be able to track and buy inventory more closely to the individual locations needs, and that's one system upgrade that we're looking at for 2018, which will start to impact our purchasing for early '19 and beyond.

Second question I have is with concerns of different carriers reaching capacity constraints, concerns about packages not arriving in time for the holidays. How are you thinking about that? Are you concerned that your customer may be reluctant to buy too close to Christmas this year for that reason?

Couple of things on that. The first thing I would say is that it’s another benefit that we've gotten from the decision we made several years ago to engage in third party logistics partners in additional locations, as you know on the eastern part of the U.S. as well as the western part. And so we've got additional capacity and additional contractual capacity in order to be in better position to fulfill the orders. The second thing that I would say is that we are shipping or guaranteeing Christmas delivery with regular shipping through the 18th then we start to upgrade that shipping. So we've got a little bit of cushion, if you will, in terms of the timing of those orders going out. The last thing that I would say is it's also a benefit that now we have 31 retail stores online as opposed to the 16 that we had last year. So obviously, that piece of it won't be impacted by the shipping crunch, if you will. All that said, we're watching it very closely. We have very good relationships with our shippers, and we'll be making sure that we follow it through to the very end.

Then the last question I have, with a 39% effective tax rate, Duluth could be -- looks like one of the biggest beneficiaries with a proposed change in corporate tax rate. Have you and Dave given any thought as to what you'll do with that potential higher net income? Do you increase your reinvestment rate, or do you just anticipate that flows through to the net income?

At this stage if that were to play out and we would realize some additional cash avoidance from taxes, it really just flows down to our free cash flow level and gives us a little shift in how we would fund our capital plans over the coming years. So we haven't identified any changes to our growth plans. But certainly, the avoidance of additional taxes will allow us to fund those capital plans more from our own cash flows versus borrowing or other forms of financing. So that’s the way we are thinking about it right now.

The next question comes from Andrew Burns of D. A. Davidson. Please go ahead.

I wanted to dig into the weather headwind just a bit more. It was a late start to winter last year as well. Was this year worse of the same amount of headwind that you had year-over-year? And then this year there was the initiatives to bring in more swim season product lighter outerwear things of that nature. Were you pleased with the sell-through in that period with the late arrival of weather? Thanks.

So the last year when we talked about weather implications, we have some very obvious quantifiable programs that were either flat year-over-year or down to prior year. Things like heavyweight fleeces or outerwear or some of our super insulated shirt checks, would be an example of those things. This year, we were able to mitigate some of that weather impact because of our transitional product; we brought in lighter weight fleeces; we bought in lighter weight shirt checks; and we did see solid sell through on those products. So we definitely made some good moves in mitigating weather concerns. That said, what we did see is in August where we had a bit of the cooler weather and then as we started to enter November, in particular with the cold snap, the whole business popped. And that’s where we saw some level of weather still impacting our business in September and in early October where we just didn’t have the cool weather. So I guess in summary, not quite to the degree that we saw in 2016, but we did see an overall slowdown, if you will, on some of the fall product in September and early October.

And then just as you look at weather, it seem certainly like November started cooler earlier. Is it fair to call those weather neutral to the business quarter to-date?

I think that’s a fair overall assessment for sure.

The next question comes from Jonathan Komp of Robert W. Baird. Please go ahead.

Stephanie, really just a bigger picture question about the direct side of the business, I know there is moving parts, which you helped clarify on the shipping and some of the new store markets versus existing store markets. But really, bigger picture when you look at a mid single-digit growth rate for that business, so far this year versus double-digits in the past. I am just curious how you’re viewing that in total and how that shakes your view of the growth opportunity going forward? And if you sign that some of the parts of the business are starting to get tougher to scale and continue to grow, or really how you’re viewing it overall?

I think that just to go back Jon you mentioned the mix of the markets, if you will, with the retail stores and the impact on direct. I would say that I feel really good about the long-term view of our direct business. When we get pass some of the noise, quite frankly, that we’re experiencing with new store markets that we particularly experienced in third quarter with more new store markets than we’ve had in the past and bigger markets in the new store grouping. When we look at the rebound or the reacceleration of direct in store markets where we’ve truly put a foothold on that omnichannel model, our direct business is very strong. And even in third quarter, where we had that kind of mix issue impacting overall direct, our established store markets were still at double the growth rate of the non-store markets. So I think really what we’re looking at is that we are moving toward a new model in the business. And it’s a model where we’ve got multiple touch points; direct to loan is important to us, certainly in it’s our heritage and it’s where we came from; but at the end of the day the customers voting loud and clear that the omnichannel model is the one that they are most reacting to. It allow us to not only create a full expression of the brand in the retail store, but then coming off of the retail store you’ve got a direct strength and an opportunity to continue to fulfill those customers orders, once they’ve experienced the brand for the first time. So I guess the way that I would answer it is, yes I think there is some short-term noise in direct, and I think that we’ve got some headwinds with things like the new store markets, as well as shipping revenues that we’ve been talking about for the past couple of quarters. But as we get out beyond that and get more established in our omnichannel model, I think if you want see specifically about direct, we’ve got great opportunity on the direct side of the business as well.

And maybe just a follow on to that but when you think about reaching 15 retail store openings per year, and looking ahead. Do you think that type of retail physical expansion is enough to support ongoing 20% plus total growth from a revenue perspective when you include the direct business?

As we look further out on and we are 15 stores of course becomes less and less a proportion of the total store base that retail growth starts to come down a little bit. That said, one of the things that we’re modeling is what I spoke about just a moment ago and that is as the more and more stores or more and more markets, I should say, become establish store market that reacceleration of direct I think will keep us in a really strong position as we go into the future.

And last one for me just switching over to the margin side at least at the EBIT margin level, you’ve had now a couple of years of pressure on that line. And just wondering as you look ahead, how long you expect the overall business from a EBIT margin perspective to still be under pressure, or at what point some of the current increases in some of the items might start to level off and you get stabilized or start to grow the margin?

Jon. I can address that. As we look out into the next years, some of the big headwinds that we face now aren’t going to be as meaningful, part of that is our preopening expense. We look at this year and its north of $8 million to open up 15 stores. Now, we're still going to have that $8 million next year if we're going to open the same number of stores, but we're going to have significantly more earnings coming off the 31 stores we've got open today. So that goes away to the same degree. And I think also as we rationalize some of the cost pressures to support a balanced retail and direct business, we're going to continue to see leverage on the advertising line given the ad ratio from retail that isn't as great as the peer direct business. So we certainly realize that these last year and this year are more of an investment into the infrastructure into the business to support omnichannel business. And going into next year and the out years we do expect to see more earnings leverage in front of us. So that's what we're planning for.

The next question is from Dylan Carden of William Blair. Please go ahead.

Just following on from that last comment there Dave. Is some of that offset next year with new systems investment, is that fair?

You mean systems providing us…

The investments that you're making in the POS and the new platforms coming online in 2018. Does that offset some of the benefit from larger scale so to speak?

Well, you mean the cost to implement the new systems, is largely been incurred and certainly some of it will be in next year. But we'll see the benefits of the new systems near the latter half of next year, certainly with the new Web platform we would expect that to allow us to be much more dynamic and personalized in our e-commerce strategies. So yes, we do expect that to provide some of the benefit for us.

And then two quick ones. Stephanie, the low in between the holiday periods that you called out last year. Is that something that you plan for and are seeing this year? Is there any way to counteract that, or is that just the new reality of the market?

Dylan, when you say the lull are you talking about…

Shoppers shopping closer to need yes, exactly.

I think the shopping closer to need is just the new norm, if you will, for the customer. There's a shipping expectation that's quick. There we obviously, with additional retail stores, are going to feed into the ability to shop closer to in particularly with an extra full weekend of retail sales before Christmas. But I do think that the customer will continue to shop closer to need. And so far we're seeing a fairly similar cadence to that.

And is that anything you can account for with the way you promote or merchandize, or is it just, it's steady year-over-year and really shouldn’t be as much of an impact this year. Is that fair to assume?

Well, we're watching the business every hour at this point with the fourth quarter and the magnitude that it delivers for us. And we're reacting to those that flow of customer desire to shop regardless of a little bit shorter or closer to Christmas or a little bit further out. So it's informing promotional strategy. But I would say honestly the promotional strategy that we have in place is informed, not only with current business but also with prior years and what we're looking to anniversary in the business, as well as competition.

Just one more and I know its early days. But the stickiness -- you had talked previously about half of the customers that are now coming to these newer stores are new to the brand. Do you have any read, either on legacy stores or these sort of newer stores in Chicago and out east, just the stickiness with those customers? Or is that something that’s going to be born out over a longer horizon?

No, we do see that we’ve got a higher retention rate with retail customers than even with our direct customers. And the great news across the board is that our retention rate, even as we’ve grown substantially over the past five years or so, they’ve held steady. So we do have a lot of stickiness with customers. The other thing that I would mention too and I know we’ve mentioned this in prior conversations is that while in our first year, we have about half of the customers coming into our retail stores that are new to the Duluth brand. Even after the first year, we’re still seeing 20% to 25% of customers buying in our stores, are new to the brand. So beyond that first 12 months, our retail stores continue to be strong customer acquisition tool for us.

The next comes from Jim Duffy of Stifel. Please go ahead.

This is Peter McGoldrick on for Jim. I wanted to ask -- so products mix was a driver of product margin expansion. Could you speak to the category performance in the quarter and which categories are supporting product margin expansion and should we expect that to continue into holiday?

So the core products in the business overall, and they’re across the traditional categories, core products being Ballroom jeans, Buck Naked underwear, Longtail Ts, NoGa Pants in women’s, as an example. Those products tend to be our higher margin products and our higher volume products. And as they continue to be the foundation of the business and continue to grow and we feed the brand identity, as well as the growth with those products, we are seeing that that mix is benefiting us from a margin perspective. As we go into fourth quarter, we would expect that to stay fairly similar, because it’s what we’ve seen for the past several years.

And as you attract new customers at retail, are you seeing new merchandising opportunities and assortment opportunities to monetize the traffic within the omnichannel opportunity. Could you speak to any channel distinction between retail and direct?

Overall, I would say that retail and direct, the product mix is very similar; couple of the differences between the two, are that in retail, we do have a higher penetration of women in retain than in men -- than in direct; and in some of our smaller markets, our women’s penetration is well over 30% in those retail stores. So that’s one big difference that we do. We also that we’ve learned about opportunities across size expansion from our retail stores and our ability to sell a fuller range of sizes. And that actually has pushed back into direct as well and built opportunity across both segments. And then the last thing that I would mention is something that’s probably pretty common sense or expected and that is our items like cold weather accessories and our carry items, those more impulse or more pickup type of items, we tend to see have a higher penetration in our retail stores and we continue to build on those as well.

There are no other questions, at this time. This concludes our question-and-answer session. I would like to turn the conference back over to Stephanie Pugliese for closing remarks.

Thank you so much everyone for participating in today’s call. We, at Duluth, wish you all a wonderful holiday season with family and friends and look forward to talking to you in the first quarter.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.