Good afternoon, and welcome to the Duluth Holdings' Fourth Quarter 2018 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 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, Gary, and welcome to today's call to discuss Duluth Holdings' fourth quarter and fiscal 2018 financial results. Our earnings release, which we issued this afternoon, is available on our Investor Relations Web site 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 the comments on today's call which 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. With that, I would now like to turn the call over to Stephanie. Stephanie?

Thank you, and welcome everyone to our fourth quarter and year-end call for fiscal 2018. This past year was one of significant growth and accomplishment for the Duluth's business. Our goals this year were to achieve strong revenue growth, strengthen our omni-channel presence, implement key infrastructure improvements, and reach more customers than we ever have before. We achieved these objectives, and some highlights from the year include: revenue growth of almost $100 million over 2017, a 50% expansion of our store base, ending the year with 46 stores, including three locations in Texas, one of our top three states, market share growth in both new and established store markets. The power of the omni-channel model continues to prove out as evidenced by established store markets consistently achieving direct growth rates at more than double the non-store market rates. Continued double-digit growth in our active customer base along with an improvement in key metrics such as the percent of customer shopping across categories and the average annual spend per customer. Implementation of a large scale infrastructure improvement, including a new order management system, inventory planning system, and the e-commerce platform, and an upgrade to our distribution center in Belleville, Wisconsin; and finally the launch of customer facing omni-programs such as Buy Online Pick Up In-Store or BOPIS, ship from store and e-gift cards. While executing all these important initiatives puts us in a stronger competitive position for the future, our fourth quarter which is the lion's share of our revenues and profitability fell short of our expectations. We began the holiday shopping season with a strong showing on Black Friday and Cyber Monday, and we were on track to deliver higher sales results through the first week of December. As we got closer to Christmas and through January, we experienced a…

Thank you, Stephanie, and good afternoon everyone. In the fourth quarter, we reported net sales of $250.5 million, up 15% compared to $217.8 million last year. This included $7.7 million for an extra 53rd week in 2018 as compared to 2017. Net sales growth was driven by both our retail and direct segments, with retail sales increasing 39% to $86.8 million, and direct sales growing 5.4% to $163.8 million. Excluding the 53rd week, direct segment growth was 2.5% to $159 million, and retail segment growth was 34% to $83.8 million. For the quarter, shipping revenues were $3.4 million, a decrease of 40% compared to the prior year. In retail, we opened a total of three new stores, adding approximately 40,000 gross square feet to our retail footprint. We ended the year with a total of 46 stores and approximately 716,000 gross square feet. As Stephanie mentioned, our holiday business was on trend heading into December but we started to see some mixed results two weeks prior to Christmas. Direct sales were healthy through Christmas with the first eight weeks of the quarter growing 7% over last year. This trend reversed at that point with direct sales lagging last year by close to negative 6%. Our store sales productivity was good through early December but didn't finish the holiday selling season as strong as last year. In January we were up against a very promotional period last year and direct sales growing over 20% in that period. The addition of clearance goods in flash events this year didn't result in enough business to see online gains in January. Gross profit for the fourth quarter was $131.3 million or 52.4% of net sales compared to $116 million or 53.3% in net sales last year. The 90 basis point decrease in gross margin…

Thank you, Dave. Our culture of innovation is not limited to the products that we offer our customers. We did a lot of heavy lifting in 2018 to enhance our omni-channel model and develop a strong platform capable of creating deeper engagement with rapidly evolving customer expectations and technology that is moving faster than ever. While these initiatives created some near-term pressures in our business we generated strong top line growth and maintained profitability in 2018. Looking forward our focus will be on optimizing our investments and maximizing the opportunities we see to enrich brand awareness and engagement across all contact points with the customer. We are intensely focused on the parts of the business with greatest momentum and the greatest opportunity for increased market penetration. These areas include the women's business, Alaskan Hardgear and men's based players. We are introducing proportionately more new product innovations in these areas and we have outsized our marketing efforts to drive growth and awareness. We will continue to expand and refine our omni-channel model with the goal of an additional 15 new stores and holistic efforts to engage customers across channel including the rollout of BOPIS. Regarding BOPIS I can report to you that our trial in seven stores during 2018 exceeded our expectations. 91% of the customers polled indicated that they were likely or very likely to use BOPIS again. We expect to have this slide in all existing stores by the end of this month and we'll make it available in all of our new stores as well. As we see it, BOPIS creates multiple opportunities. It gets product to the customer faster than shipping, it encourages purchases in the store at the time of pickup, and it ensures that we will have the product on hand when customers make the…

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from John Morris with D.A. Davidson. Please go ahead.

Hi, thanks. Hi, Stephanie. Hi, Dave.

Hi, John.

Hi.

Hi. Couple of questions on the product category performance, Stephanie, I know you did mention it, you mentioned it very quickly, so I'm wondering if you can give us a little bit more color on what you saw in terms of the product category performance. For example, I think I heard you say that outerwear didn't perform as well as you wanted it to, and so maybe that also kind of begs the question, if that's the case and/or volunteer your feeling on how whether or whether or not weather impacted you on the quarter, and just generally on the product category performance, both men and women?

Sure. So, first let me start at a slightly higher level on the men's versus women's. Our women's business continues to outpace the overall business and growth and the men's business. We picked up another couple of points of penetration in the women's business overall, and we are definitely seeing an increasing momentum in women's even as we go into the first quarter, particularly around some of our newest product launches, and our Plus Size business, for example, continues to be a very strong part of our business overall. So, in the women's side of things, we certainly had a few products that exceeded expectations, a few that fell a little bit shy, but overall in women's I would say we had some pretty decent momentum throughout the quarter. The struggles that we had specifically on product really were twofold. There were a couple of large scale program that we had that were more weighted towards our men's business in outerwear, there were new launches of product that just didn't meet our expectations overall. We have certain pockets of outerwear that were good, but by and large, our outerwear business fell short. We also saw that the accessories hard goods part of the business didn't meet our expectations, again geared more towards the men's side of things. That said there was also an exacerbation of product performance, in that -- I mentioned in my prepared remarks that we had some later deliveries, some inventory that was misaligned. Specific to that, we had some deliveries that were later than we expected due to some port congestion, a little bit later on into the quarter, and that was -- we added to our problems there in that we had tight deliveries to begin with, and then trying to get some of those goods out to the full network, including all of the stores in time for certain peak selling -- peak parts of the selling season was difficult. So, we found -- we also found that we had some of our inventory that we didn't get out to our DC network fully and completely in time again for some of those peak weeks. So we were taking on more burden in our Belleville, Wisconsin distribution center than we had anticipated which added to cost and slowed down the inventory replenishment to our retail stores. As you may remember, Belleville is the one DC that replenishes our retail stores. So when we get clogged up there on the direct side it tends to impact the whole system. So those were the big things around the product side of things, and what I'd say, John, in terms of the impact of both of those, they're probably both equally weighted in terms of the sales volume impact, but the second thing that I talked about was the inventory misalignment also had expense ramifications as well.

That's a lot of helpful color. I'm wondering, I mean giving the -- I guess, the pace of the slowdown coming so late in the quarter, whether or not you all want to comment on what you're seeing so far top line wise here at the beginning of the first quarter since we're pretty well through it, whether or not you've seen and to what degree you can comment qualitatively on recovery. Dave, I know you gave a fair amount of color on some of the below the top line item things, but I'm wondering if you can comment any kind of a recovery that you've seen so far top line wise.

On the top line side, John, I'll take that one, and then pass it up to Dave for any additional comments. Q1 has been slow for us. We haven't come out of the sluggishness that we saw in Q4, where we're not really seeing a trend reversal at this time particularly on the men's side of the business. That said, our women's customer particularly with new product has been responding more quickly and stronger. So, our women's trend is actually still quite good, but we did come out of fourth quarter with -- you know, because of those issues that I described just a moment ago, with additional end of season clearance inventory, which we took some additional markdowns on in late February and early March to move those goods. We feel good about where we are today on that inventory position. And we feel good about as we keep going deeper into the year, the plans and the new products that we have in place to introduce to the customer, but we really see first quarter sluggish, second quarter perhaps a little bit of recovery but really it's going to be -- and the inflection point as is the latter half of the year for some of the product turnaround as well as some of the marketing efforts that we have in place. The last thing that I would mention to you is we haven't yet seen an all-out kind of spring weather reversal, if you will, with a lot of rain, and obviously not such hot temperatures. So, in terms of really gauging some of our warmer weather product, it's still a little bit too early to tell and call that.

Yes. Okay. All the best for spring there, thank you.

Thanks, John.

The next question comes from Jonathan Komp with Baird. Please go ahead.

Yes. Hi, thank you. I wanted to just first follow-up on some of the inventory-related comments, and I want to characterize more of the operations factors that you called out. Just curious, Stephanie, kind of when you think you'll have a good handle on all those factors and does [technical difficulty] any more color on [technical difficulty] as diagnosed some of the operating factors [technical difficulty]?

John, you broke up a little bit for me. So I'll start with what I did hear about commentary on some of the inventory comments that I made as well as where we are today and how we see that evolving and improving. Is that a fair -- is that your question?

[Technical difficulty].

Okay. So we really saw some pretty significant impact on inventory misalignment in fourth quarter, obviously because fourth quarter is such an important part of our year, and every day is a significant amount of volume. So, one or two days of misalignment or missed delivery of an order is very impactful in the fourth quarter, more so of course than any other quarter. That said, the things that we can control, we have found that our deliveries are back to the standard, if you will, in terms of being on-time deliveries, we haven't of late experienced those same types of inventory delays or delivery delays I should say that we experienced in fourth quarter. In addition in fourth quarter, we were just coming off of the transition to our new expansion of our Belleville distribution center, which primarily affects retail replenishment. That was a slow kind of restart at the end of third quarter, stayed impacting us in fourth quarter. So we're past some of those things. The piece that we are still working on from an inventory perspective is we're still fine-tuning the new assortment and inventory planning tool that we put in place in late third quarter, and that is the tool that anticipates sales curves and demand needs in stores ahead of the curve. And while we think that is working well, we definitely think there're opportunities to improve that and to optimize that system. Looking at things like opportunities for highest volume SKUs to be in a never out situation and what type of inventory levels would it take to do that, and we're working with our vendors to be able to fast track some inventory on some of these higher volume items so that we are in better stock position across the entire system. The other thing that we're looking at is as we have -- as I mentioned in the remarks, we are finding more and more that our retail business and our retail customer is responding more disproportionately to new and the new season's goods. And so, we are looking -- we're going back into our placement of orders on those types of goods and ensuring we have the depth of inventory levels to be able to stay in stock in that product across -- now the 50 stores with our Spokane store coming online that we have and making sure that we've got enough inventory to go across the entire system.

Okay. And that [technical difficulty] maybe a question just - some of the drivers talked about units or product marketing initiatives later in the year. Can you talk about your degree of confidence that those [technical difficulty] forward and any results or kind of tests related to some of that or any more color that you could share?

Sure. So, one of the kind of confidence proof points that we have today, I've mentioned it a couple of times in terms of the juxtaposition of women's results versus our men's results right now; women's we have doubled the amount of newness in the floor right now than we have in men's and that business is trending better. The product that we have introduced that is a transitional product as well as some of the early rates that we've gotten in women and remember that our women's customer will shop a little bit more ahead of the season than our men buy now wear now guy is we've seen some very positive indication on some of the early reads even there in summer goods if you will. The other piece that we have seen is that in our men's business where we had small collections of new product, we've gotten actually an early good response, but we haven't been in the inventory position to be able to sustain some of these new kind of trending products. The last piece that -- you asked about confidence as we go forward, I would say that the depth of newness and some of the large scale programs that we have we're introducing a whole new category in women. I'll keep you guys in suspense on that until we get a little bit closer on exactly what that looks like, but that's an important driver of what we've got go forward. We've doubled the skews available in our plus size business, which has proven -- proving itself out. And so I feel really good about where we're going go forward. It's going to take a little bit of time for us to get there, because we're not there yet. The other thing that I would just mention is marketing effort. We have already started some of the test and learn efforts coming off of our first marketing mix indicators that we got in late fourth quarter and we're starting to see indicators of results there. We expect that we'll have the results shortly coming off of fourth quarter and we'll be utilizing that to adjust our marketing investments for third and fourth quarter for the year as well.

Okay, great. And just last one for me, a bit of a follow-up, but when you look at the margin performance of the business given the marketing and model mix changes, maybe you're leveraging some of the systems that are now in place, like how far out do you think you are from stabilizing and maybe starting to improve operating margin again?

Yes. John, we have talked about the second-half of 2019 as a point where we expect some operating margins to start to expand and that that is what we're expected to see. So, I'd kind of cast this as third quarter we expect that trend to begin. And that's what's reflected in our guidance.

Okay, great. Thanks for all of that color.

Yes.

Thanks, John.

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

Thank you. Good afternoon.

Hi, Jim.

Couple of question for me, first, just on trends during December the check showed a more promotional stance on a year-to-year basis that's consistent with your comments on trends across the quarter. Did you find that consumers just weren't responding to promotion like they have in the past?

Yes, I think that there was -- it was partially that, Jim, it was also that we were up against some pretty deep flash sales and while you know we stayed very promotional and increased some of our global you know take X percent of your order promotion in the month of January. We still just didn't see quite the response that we expected. We are attributing some of that quite frankly to some of the things that I've already talked about with having impactful new large scale program that some of them that we had in the customer just didn't react to them at full price or at markdown as well as just some overall slowdown, because we did see that it was enterprise wide if you will that that sluggishness.

Okay. And Stephanie, may be you just answered my next question, but I'm curious the trends across the quarter and the linearity of the quarter was fairly consistent between the direct and the retail business?

Yes. And I would say that they've also been fairly consistent in terms of what we've seen in prior quarters. And what I mean specifically, Jim, about that is that we do consistently see for example that we sell more of a proportion of our sales at full price in retail stores than in direct. Direct is a more promotional segment or channel for us, primarily driven with e-mail as you would imagine. And we saw that consistently but it was all kind of -- there was an umbrella of sluggishness across all aspects.

Okay, helpful. Thanks. And then you have referenced a couple of times the need for more newness in the stores. What are you seeing with respect to store traffic trends? Is that something you can comment on, any help there would be?

Yes. Sure. I would say -- there are two things I can say about that. Number one is when we talk about the quarter that we just came off of and even the continuation into first quarter, we have seen traffic sluggishness across the board. So that's web traffic sluggishness as well as store traffic. In regard to the newness and what we see with that, there are two things. Number one is, as I mentioned just a few minutes ago, we know when we look at the proportion of sales that are driven by core basics versus brand new product versus seasonal new product. And when I mentioned seasonal new that's something like a flannel shirt that might be a repeat of prior year, but it goes away in the spring and summer then comes back again in the fall. That seasonal new and the brand new product is the higher driver of our retail revenues than it is in direct. And we see that and when we deliver at new store set when we deliver a new catalog for example or a new television ad that is featuring either that seasonal product or brand new product we see store traffic increase more quickly and end at a faster stronger pace, if you will, than even the web traffic.

Okay. So it seems like the retail stores are showing some different characteristics in the online which is to be expected I suppose, merchandise assortments you're still getting figured out. I'm curious you know you're adding retail stores, putting new systems in place. Does it make sense to take some time to get your feet underneath you before and tap the brakes on opening stores is that something that's been discussed?

As we're looking at the opening of the stores and the 15 store plan that we have again this year the primary filters, if you will, that we're using are the stores that we are opening even though we're coming off of a sluggish quarter the stores that we're opening are still achieving or exceeding our model goals. All of the things that we talked about a number of times with sales per square foot goals as well as four wall EBITDA projections, the projection of payback on the initial investment. And we are seeing continued strength in the omni model the direct side of the business in our more established longer store market. So there're all the really positive indications around the omni-channel model and the growth there. That said, the other filters if you will that we use and we want to make sure that we always have in place are obviously the capital in place. The second thing would be the available real estate that is right for us, not just there because it's available, and the ability to manage staff and create a customer experience that we expect from our stores. So, if those things are all in place, we expect to keep moving forward with our store expansion. And as far as the system's piece of things, we were obviously still dealing with a refinement of the system and what we sometimes call the tail that flows after the implementation, and we're working on those things. But the very large scale implementations are behind us at this point, and we're really focusing on refining the use of those systems this year as opposed to kind of turning over again.

Very good. Thank you for that.

Thank you.

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

Yes. Hi, thank you very much. I'm curious to trying to understand the wider spread between store productivity and direct business, and how direct was able to kind of pull out of this quarter with some positive momentum which you expect to continue this year. I guess how much of the implementation of new order management systems do you attribute to the decline in the retail channel from a productivity standpoint? And then go forward, any update you can give vis-à-vis kind of the interaction of the two channels one year, two years in customer retention? Of the 50% new customers, how many you are seeing in that second year that comes back to the store? Any sort of second year trend in these newer stores you've now had open from 2017, any kind of data points in and around sort of the aging of the fleet so to speak would be helpful?

Dylan that was a lot of question, so I'm going to try to tick them off one at a time and please let me know if I forget about one okay.

Yes.

So just starting with sales productivity and the retail versus direct and the results that we saw and how OMS and systems might have impacted that. I would say that the impact of the systems implementation overall was three-fold. Specific to your question about was there is an impact to the trend line if you will of retail. We definitely had some impact, it's hard to quantify on the lack of inventory or lack of timely inventory in the stores in the peak season that I've mentioned before with the changeover of both of our DC as well as the new assortment and inventory planning system that we implemented at the end of third quarter that definitely had an impact on our stores where you know people were coming in during the peak season and we didn't have full inventory position particularly in some of our higher volume items. One of the benefits that we have go forward for that will be the boat that's roll-out to all of our stores. But remember in the fourth quarter that was only in seven stores, so it was you know really not impactful at all in terms of the grand scheme of things. The second impact that the systems implementations had were obviously with expenses and that's not necessarily a retail trend line issue but it was certainly very real impact to our bottom issue but it was certainly a very real impact to our bottom line for fourth quarter and for the year. And we've talked I know about some of that in our prepared remarks. The third piece that systems implementation had in terms of an impact was quite frankly there were a lot of our team members that were working through the implementation of those systems as well as…

Yes, you've provided before some handy metrics around sort of in the second year you see direct sales in these new markets to X growth relative to the plea, that's kind of where I was going within.

Yes. So let me talk first about just some quick kind of view of the customer. Our retail customers are they shop more often with us, there's a higher retention rate of retail customers. They spend more on an annualized basis, particularly driven by the visits that occur more often. They also are more likely to buy across categories, across genders and to go back and forth between the channels, kind of what I just explained a couple of minutes ago with back to quarter in basics online. In terms of the overall business and what happens in the market, we are still seeing that, that same dynamics that we've talked about for a little while now which is, we enter a store, a market with a store, we instantly see that market penetration grow substantially with the store volume that we've just added to the market. In the first year, we do see direct growth rates contract to a little bit lower than what the non-store or average market direct growth rates are. As we enter into the second year of that store being in the market, we are still seeing, and even in the slower fourth quarter, we are still seeing direct growth rates in established store markets being double or more so than growth rates in non-store markets. So we're absolutely still seeing that retail has a positive impact on direct growth ultimately. We do see that in the second year of a store being in a market we do see some contraction in four wall store sale, but that's happening we've got a few months where the direct sales are not reignited to a really fast pace and the store sales are kind of hitting up again the grand opening in their 14th, 15th month before the direct starts re-firing to the level where the market is growing again. And so you know, there is that period of a lull, if you will, in that second year of a retail store, but we've consistently seen between direct growth in the retail store being present significant market penetration increase and absolutely an improvement in direct growth rate.

Great. Thank you very much. Can I sneak one last one to hear about on profitability? I'm just curious on the gross margin guidance you know I think it was kind of similar last year and ultimately it was down for the year. I guess sort of confidence level that you're going to go to offset or is it that shipping level shipping threshold should stay more consistent this year given kind of where they trended? And then also on marketing whether or not kind of your plans for the year and what you saw on the fourth quarter gives you some hesitation on leveraging that line item longer turn more aggressively? Thanks.

Yes, Dylan, on the gross margin expectation we do expect that the shipping revenue decline will continue and that's was call out in the comments around 30 basis points of impact to gross margin as a result of that. We do expect that product margin will largely offset that and that will play out through the course of the year similar to last year with the first quarter being a bigger decline in the gross margin rate and then the other periods of the quarter of the year being positive. But in terms of advertising, we also see that the new element that we've got going into 2019 is some learnings from our marketing mix modeling study that we'll apply to our spend already this first part of the year and probably more so in the back part of the year, because we'll have the learnings after this past back half of the year analysis available to us. So we're confident that the advertising leverage will be there, but it'll be more targeted and more focused on the elements that drive the activities that we're looking for. So that's in what's available to us going forward.

Great. Thank you very much.

Yes.

Thanks, Dylan.

This concludes our question-and-answer session, and the conference has also now concluded. Thank you for attending today's presentation. You may now disconnect.