Good morning and welcome to the Duluth Holdings Second Quarter 2018 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I'd now like to turn the conference over to Donni Case, Investor Relations for Duluth Holdings. Please go ahead.

Thank you, Brandon, and welcome to today's call to discuss Duluth Trading's second 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 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 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. 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’d like to turn the call over to Stephanie Pugliese, Chief Executive Officer of Duluth Trading. Stephanie?

Thank you, Donni, and welcome everyone to our second quarter conference call. 2018 is a year of high growth and investment in our future. Our key initiatives for the year center on expanding the brand through our omnichannel initiative and continuing to deepen our relationships with our customers through great product, storytelling, and experiences. I'm very happy to report that we are executing well on all of these goals. We had a strong second quarter with an increased growth rate in our direct business relative to first quarter, healthier product margins and a reduced use of promotions. We opened six new stores in the quarter and we successfully implemented two major infrastructure improvements. In the second quarter, net sales increased 28% to $111 million, which marks our 34th consecutive quarter of increased net sales year-over-year. Retail sales for the quarter delivered a 74% growth rate, largely driven by new stores opened in 2017 and 2018. Our six new stores this quarter opened strong and are meeting our initial expectations. Direct sales grew 5.5%, reflecting a return to more normalized seasonal buying patterns and pent-up demand from the cooler weather we experienced late in the first quarter. We saw growth across all categories in our men's and women's divisions, with men's growing 26% year-over-year and women’s continuing its strong trajectory with 37% growth. Product gross profit rate was up slightly to last year, a result of less reliance on promotional activity and increased initial margin. We got past the drag of clearance merchandise from first quarter, and in second quarter we sold more product at full price than last year as a percent of total sales. Core year-round product and seasonal categories all performed very well and we ended the quarter in a better inventory position than we have seen in…

Thank you, Stephanie and good morning. For the second quarter we reported net sales of $111 million up 28% compared to last year. Sales growth was driven by both our retail and direct segments with retail sales increasing 74% to $49.8 million and direct sales growing 5.5% to $60.8 million. During the quarter, we opened six new stores including three in the State of Texas, which is one of our top three states for the direct business. Revenues from shipping fees were $1.9 million in this quarter, down slightly from $2.1 million last year. Excluding these revenues, the direct product sales increased 6.1% in the second quarter, which reflects a 210 basis point increase sequentially from the first quarter. Additionally, we continue to see direct sales in our established store markets, outpaced markets with no stores or recently opened up stores. Our second quarter gross profit rate was 56.2% of net sales compared to 56.7% last year. The 50 basis point decrease in gross profit was primarily due to the decline in shipping revenues and an increase in freight cost for delivery of products to our growing store base, partially offset by an increase in product margin due to a higher percentage of full price sales as compared to last year. Selling, general and administrative expenses decreased 90 basis points to 47.3% of net sales, compared to 48.2% last year. In dollar terms, the growth in SG&A included $5.8 million in general and administrative expenses, $4.1 million in selling expenses, and an increase of $900,000 in advertising and marketing expenses. Included in SG&A were new store pre-opening expenses of $1.8 million compared to $1.5 million last year. As a percentage of net sales, advertising and marketing costs decreased 310 basis points to 14.3% compared to 17.4% in the second quarter…

[Operator Instructions] Our first question comes from Dan Wewer with Raymond James. Please go ahead.

It was a terrific quarter. Stephanie, I was curious as to how the second quarter sales and earnings actually compared to your internal plan, and if they exceeded your expectations, was there any thought to increasing the guidance for the fiscal year?

So, in terms of second quarter results, we were on plan in a number of places. We exceeded plan in the - we had better expense control in the SG&A side than our internal plan, but from a sales and new store expectation, we were - we're very close to our internal expectations for the quarter. As we look forward for the balance of the year, as I mentioned in my prepared remarks, fourth quarter is the all-important. It's the majority of the sales, it’s certainly the vast majority of our profitability for the year. And right now, we're really pleased with the momentum that we've got coming into the second half of the year, but our focus is on continuing to execute well the plans that we have to get us ready as we get closer and closer to that fourth quarter. So at this point, we're very comfortable with the guidance that we've put out there. The team is executing very well, and we've got big things ahead of us.

It looks like the growth rate slows in revenues in the second half of the year based on where you are year-to-date in reiterating the guidance?

We're still expecting the direct business to be in the mid-single-digit growth, which is where we are year-to-date. Obviously, we picked up some momentum in that part of the business in second quarter, coming off of a tough kind of end to first quarter if you will, so we're expecting that to stay pretty solid. And then the retail numbers are really a function of how we are coming in with new stores and anniversarying stores as the mix that'll change up a little bit as we go into the second half of the year. But we are - as I said, in terms of the top line business, we are pretty much right on target with where we expect it to be.

And just a follow-up question, as you get more experience with the retail model, how will - have you changed your thoughts on how the growing sales contribution from retail will impact Duluth's long-term gross margin rate, expense rate, and operating margin rate?

So when we look at the - I'll start with the gross profit rate, just as the kind of entry point to ultimate profitability. We know that our retail stores are selling more at percent - at full price as a percent of total, so their product margins sit a little bit higher than the direct business. That said, we do have the additional gross margin pressure if you will on retail of the freight, which is part of - which was over half of the 50-basis-point decline in gross profit as Dave had mentioned in his prepared remarks. So, you've got some puts and takes on the gross margin side of things. When you look at operating margin, as we look at it today and as we break it out today, we know it's not the only way to look at it and we know it's probably not the ultimate way to allocate expenses, particularly around overhead and advertising expense. But the retail business as the mix is increasing towards retail is obviously benefiting us on advertising leverage in particular and leverage overall long term. We are anticipating as we go forward over the next several years that that advertising leverage which is the biggest piece of it is going to continue to benefit us and allow for the kind of inflection point if you will of our overall profitability and start to allow us to increase that income contribution on the bottom line. So we’re not seeing any changes to what we’ve been articulating for the past several quarters on that. In fact, it’s playing out the way that we expected.

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

I wanted to maybe start just following up on the direct business and if I could ask just how things trended during the quarter, I think you signaled a pretty good start and just curious how you saw trends play out and any comments kind of seasonally what worked or didn’t work also would be great?

Well I would say the first thing that was wonderful about second quarter is, we didn’t have the last two weeks that we’ve really struggled with like we did in first quarter, so it was nice to not have that unpleasant surprise at the end of this quarter. Second quarter started off well. We did as we mentioned have some pent-up demand coming out of that weekend of first quarter, but really the quarter was quite strong all along. The team pulled together and I mentioned in my prepared remarks integrated marketing campaigns. One of the areas that I didn’t talk about specifically was our campaigns that we had around Mother’s Day and Father’s Day in the quarter, both of those campaigns I thought the team did an excellent job of integrating, messaging across all channels, and those played out very well for us. The other thing that worked well for us was our Summer Solved product, product like Dry on the Fly, Armachillo, Breezeshooter, those products performed very well for us as well. I mentioned in last quarter’s call that coming out of May, because of course at that point we already had the May month kind of under our belt that we felt good about our inventory position for spring and summer product, and that was because we had strength all the way through the quarter. We ended the quarter in an inventory position in that seasonal product in a very good spot. In fact, we were able to continue some of that momentum and net sales through the month of August because our customer is still looking for hot weather product at that point and so we are pleased with that. But I don't want to fail to mention the fact that core products like No-Yank Tanks, Buck Naked Underwear, Flex Fire Hose, those products were strong in first quarter and continue to do well in second. So really from a product perspective I'm very pleased to say that I think the team was just firing on all cylinders in the quarter.

And maybe just a follow-up. More recently, I'm curious with the new website in place and all the new functionality, kind of what you're seeing there both in terms of any improvements in conversion or any of the key metrics that you're tracking and just the overall trends for the online business?

So we launched the website internally in the middle of July or so, and were able to work out a few kinks that we hadn't seen before we got the employees kind of in there and digging around which was a great kind of strategy to have. Then we went live with customers at the beginning of August. We are - we're really pleased number one, that we haven't seen major disruptions to our customers. And I think that's kudos to the team for really tinkering and working hard on making sure that the website was of high caliber as we launched it to customers. That said, we’re refining certain things, inbound links for example to make sure that the web traffic is coming through to the right places that we’re getting people through to check out seamlessly and those are the things that we expected to be working on in the month of August. So far, we're on track with where we expected the website to be. And as you probably remember, we had talked about the fact that we did expect a time of adjustment if you will for our customers and for some of the kind of plumbing if you will of the website and we're continuing to refine that, but we're really very much on track with where we expected to be very pleased with site speed for example has been an incredible improvement. Our mobile site has seen great improvement around site speed and navigation for our customers. So overall like I said just real pleased with how the launch went over the past few weeks. More to come. We're going to see just what we can do as we get into fall and peak obviously and we’re really focusing right now on how we are linking now these two amazing tools that we’ve just launched in the order management system and the ECP back to more omnichannel experience like the things we mentioned buy online, pickup in store, ship from store, et cetera. So that’s the stuff that the team is focusing on right now. We’re going to be piloting those things over the next couple of weeks. Getting out the kinks of that, so that will be ready for peak.

Maybe last one from me, just on the marketing and advertising expense, I know the first half was down more than 300 basis points for the expense ratio and I’m wondering, if you could give more color just on how much of that is kind of a underlying leverage that you’re gaining versus the - some of the accounting rule changes that are shifting within quarters and just how to think about that expense item for the full year?

Jon, I can give you a little color there. For the second quarter, the improvement over last year is not impacted that material at all by the accounting change. But we did have some planned expenses for the second quarter that are going to push into the third quarter. So some creative projects largely around preparing for some of the future ad campaigns. We had budgeted those to happen in the second quarter, those are getting pushed into the third quarter and that amounts to roughly $800,000. So that gives you a little more feel for what the improvement in second quarter is and what's going to impact third quarter. As we talked about third quarter, just going to see some of that accounting rule impact, not to the same degree we've articulated before, we were saying roughly $2 million of catalog costs were going to be pulled into the third quarter from the fourth quarter. As we look at the timing of some book drops and we made some adjustments there, roughly only half of that we’d really be pulling into the third quarter out of the fourth quarter compared to last year. So a slight adjustment to the timing of the ad but for the full year we still expect to see anywhere from 150 basis points to 200 basis points of leverage on the advertising for the full year.

Our next question comes from Michael Kawamoto with D.A. Davidson. Please go ahead.

Just first off can you talk a little more about what direct growth looks like in markets that have had a store open for two or three years. I think he recently disclosed some of those figures that showed that acceleration you've talked about. So just any incremental color on how those markets are trending would be helpful.

Sure, I can give you, the information we did share a couple of months ago, based on trends through – through 2017, continue at that relative growth rate, where a store market that has been established for upwards of two years is seeing direct growth, at double the pace of the total company growth rate for direct. So that trend year-to-date continues and as we see the store markets start to mature further with the store presence there and the customers shopping both online and in the store, that trend continues with that kind of dynamic. So pleased to see that response and as we see more of our markets become established, we expect that to play out in the back half of the year and into next year as well.

And then on shipping revenue, I think you said it was flattish in 1Q down slightly in 2Q I believe. What are your full-year expectations there, I think you said 20% decline for the full year, is that still kind of what you’re thinking?

Well, 20% at this stage is probably a little extreme. We are year-to-date seeing it to a lesser extent and we don’t anticipate that we’re going to be driving free shipping offers any more incrementally than we did last year. So it’s going to be closer to 10% down year-over-year. You know, the dollars are becoming smaller, so it’s not as big of an impact but for the full year, still – still down year-over-year upwards of a $1 million or roughly 10%, so that's what we expect at this point.

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

Congratulations to the team on the successful systems implementations. Couple of questions around that, first is, is there any way to size any disruption that caused in the second quarter and then Stephanie you mentioned some fine tuning and potential disruption from that, any thoughts around the size of the impact of the business from that?

Jim, we looked at it to give you a couple of specific examples. Some of the disruption that we did see, we had a couple of promotional days where we had mixed visibility to promotional pricing for the customer, so in some cases the promo prices weren't showing up or they were showing up in a couple too many places. That has been worked through over the past four weeks or so. We expect that we lost a little bit of business on those particular days, but it wasn't really material to the quarter particularly given the fact that in most of the cases where it was happening we were able to remedy that within several hours of detecting the problem. So we don't think it was a real material impact over the quarter. In terms of the tinkering, the fine-tuning that we're doing today, those are more things that I would characterize as builds and updates to website that are almost more ongoing types of improvements, that any business would be making to the website. How do we make more efficient the landing pages, that we’re directing people to based-on say prospecting ads. How are - the more that the - if you remember our old website, it was actually two websites coupled together, there were two URLs. Now we're actually three when you consider our mobile site as well. Now, we have one, so we're just making sure that inbound links from organic search from some of the prospecting are all leading into that one URL and not being diverted to some of the old addresses that we had. Those are the fine tuning that we're having, but we're not – we're not expecting that it's material at this point because there really hasn't been major disruption to the customer.

And then with respect to the Microsoft Dynamic AX that real time inventory view has proven a very powerful tool for a lot of other brands and retailers. Do you feel you're successfully leveraging that now to capture sales that might have been lost otherwise just by finding inventory in the system? Is that how we should think about the power of that?

Slightly differently and to first answer your question directly, I don't think we're leveraging that yet. The first kind of stage of leveraging what we believe is the most powerful part of this tool is to be able to do very quick buy online pick up in store. When I say very quick it’s available in a couple of hours instead of available in a few days. And the ship-from-store component where obviously we can only get product to the customer in their home more quickly but we can also leverage inventory where it is. Those are two examples of things that we're piloting in the month of September and we will roll that out to a select group of stores for the peak season and then we'll go from there based on the learnings, based on the learnings and based on the ability for each individual store to be able to handle that type of activity. Some stores just don't have for example a large enough back room. But we'll be rolling it as far as we can to take the maximum advantage of that piece of it. The other thing that I would just mention because I mentioned it in my prepared remarks is the upgrade to our POS system. That was another component to being able to use the real time inventory wisely. That upgrade to the POS system also allowed our POS system to real time - to have real time inventory feeds so that everything was just working in tandem. The biggest thing that we didn't want to do was risk disappointing a customer who ordered something, we thought we had it in a store and then we didn’t for them. So we’ve been very, very cautious if you will, and very diligent on making sure that these systems are working proper before we role it all out.

I know I’m going deep on this but with the new website, the consumer experience is definitely an improvement. Any more you can talk about just kind of the pending unlocks as you leverage some of the new capabilities of the website, are you expecting improved conversion, does personalization become a feature? Any help there would be great. Thanks, Stephanie.

And Jim, I think you hit on a word that is something we’re talking a ton about and that's the personalization part of it. I would categorize where we are today from a systems perspective as we have now built the infrastructure to augment all of the data that we already had. Now we've got the infrastructure to be able to action on that data and we're now putting in place the testing, the resources that we need to action the data that we have and now the systems that will enable that personalization. So we're envisioning personalized emails, our personalized landing pages based on prior search, being able to direct our customers to where they want to go in a much more facilitated and easy fashion for them. In addition to all of the other things like you can buy something online and pick it up on your way home from work from your local store, those types of things that really - they're technology-enabled but at the end of the day they're just amazing customer service. So we're right now at that crossroads of super data rich, infrastructure technology in place now let’s action on it. So we expect over the next 12 months to really start ratcheting up a lot of that, that action, if you will, to engage the customer more fully. And that goes not only from customer groupings but also markets. So how are we differentiating customer communications on the website, if you're in a market with a store versus a market without a store, things like that that we think are going to be really interesting go forward.

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

Just curious as far as sort of saying expectations around particularly direct sales growth and gross margin given some of the choppier comparisons in the back half of the year and sounds like product tailwinds, very real product tailwinds they start ramping in fall, is there anything that you’re kind of expecting in your own internally that you can share?

Are you talking Dylan differently - different from the mid-single digits of direct?

Yes, exactly. I mean, it’s a harder comparison in the fourth quarter, which is a more important quarter for you. Gross margin kind of moves around a little bit. It sounds like you have some new product flow coming in fall and there won’t be as much of a drag, maybe from some shifts in revenue 4Q versus 3Q. Just as far as sort of saying expectations heading into the individual quarters?

Yes, I mean what I’d say is, we’re still very much focused on that kind of mid-single digit marker and reason being that, you articulated some reasons why we might have some tougher comparisons, but also some positives on new product offerings et cetera. We've got a lot of puts and takes in direct right now things that we’ve articulated in the past and perhaps some new things. On the upside if you will. We’ve got I think strong new product launches in the pipeline not only some of the things that we’ve already launched, but some things coming into late third quarter into fourth quarter. We have the new website capabilities, where it’s brand new right now, but there the idea is that we would continue to benefit from the investments that we’ve made, as early - potentially as early as late fourth quarter. But we’re still learning on that. On the flip side though we’ve got the headwinds if you will on the direct growth from some of the new store markets. We’ve opened in some big markets this year, particularly when you think about Texas. And so we’ve got a drag on the direct growth in those types of markets. We had a strong growth rate in fourth quarter last year, but we did so to - at some cost to margin and with promotional activity. Our team is - as I mentioned in the prepared remarks, we had less promotional activity in the second quarter. We think that's obviously a positive for the brand long term. So we're looking at how we balance that growth rate with the gross profit rate ultimately. So that’s a bunch of different examples on why as we have to look at it, and look down the road, we're saying mid-single digits is the place that we're comfortable with right now, and what we're basing our estimates on for the second half of the year.

And if I could just ask on the inventory management in the quarter. It sounds like you're kind of seen some better discipline ahead of benefit of new systems, new order management and in inventory view. Is that correct, and I guess what's - has what has changed internally as far as your sort of approach to inventory versus just sort of wanting to have things available for sale?

Well, there are a couple of things. First, I have to give credit to our internal team and to our manufacturing partners. We've said over time that we have a great base of partners in our manufacturing area, partners that have been with us for 6, 7, 10, 12 years, and as we worked with them and said, we need more flexibility with how we deliver goods. We need your partnership in reducing lead times, for example, flowing goods more often. They really stepped up and have partnered very well with our team. So I have to really give them kudos for that. The other thing that we're looking at is as we're getting smarter about retail and direct, and how they're working together and how we can flow that inventory and how much we need to keep in each individual location, in addition to now having visibility to inventory across the enterprise in a much clearer way, we have the confidence that we can run on some lower weeks of supply, doesn't necessarily mean really low, but lower than we've been in the past and still be able to fulfill our customers' expectations. So you know this quarter was the first quarter where we really saw that lower inventory growth and sales growth, and I’m very, very happy about that and I'm very pleased with what the team has done. And as we go forward, we expect that that's going to actually improve even further. And then when we get some of our assortment and inventory planning tools fully in place that we mentioned earlier, we think that will help us improve that even more.

This concludes our question-and-answer session. I would like to turn the conference back over to Stephanie for any closing remarks.

I just want to say thank you, all for joining our call today. Thank you for the questions. We look forward to sharing our third quarter results in just a few months with all of you. Thanks.

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