Welcome to the Duluth Holdings Fourth Quarter and FY '16 Earnings Conference Call. [Operator Instructions]. Please note this event is being recorded. I'd like to turn the conference over to Donni Case, Investor Relations for Duluth Holdings. Please go ahead.

Thank you, Amy and welcome to today's call to discuss Duluth Trading's fourth quarter and FY '16 financial results. Our earnings release which we issued this afternoon, 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 Mark DeOrio, 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. Forward-looking statements can be identified by the use of such words as estimate, anticipate, expect and similar words and phrases. Forward-looking statements, by their nature, involve estimates, projections, goals, forecasts and assumptions; and are subject to risk and uncertainty 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. Duluth Trading expressly disclaims any obligation or undertaking to update or revise any forward-looking statements made today to reflect any change in Duluth Trading's expectations with regard thereto or any other changes in the events, conditions or circumstances on which any such statement is based, except as required by law. Please refer to our SEC filings and our investor relations website for additional information. And with that, I'd like to turn the call over to Stephanie Pugliese. Stephanie, go ahead.

Thank you, Donni and welcome everyone, to our fiscal fourth quarter and year-end conference call for 2016. I am very pleased to record that for the full fiscal year, net sales increased 24% to $376 million and adjusted EBITDA of $41 million was up 21%, compared to last year. GAAP earnings per diluted share was $0.66, with a strong fourth quarter finish, we were able to exceed the revised full-year guidance we gave on our third quarter earnings call and we met the mid-range of our initial net sales and adjusted EBITDA guidance. It is important to keep in mind that our guidance is based on a high degree of confidence in hitting the midpoint of ranges we give. With the lower visibility we had moving into the all-important fourth quarter, we felt strongly that aligning expectations to what we were experiencing in early December was the right move. We spoke in December about the unseasonably warm weather through November and the fact that there was a distinct shift in consumer purchasing patterns, including customers waiting longer and longer to do their holiday shopping. While these factors created significant headwinds in the first half of the quarter, I am especially pleased and I must say relieved, to report that the latter part of December and January were very strong. Our wear now guys rallied and we saw a pickup in cold weather product sales. In addition, many customers emerged from their shopping hibernation, to provide a holiday and year-end bump. This led to an increase in fourth quarter net sales of 24% to $175 million, with gross margin at 55.4%, despite the highly promotional environment that we experienced throughout the peak season. Now, moving on to highlights from our full fiscal year, how we executed against our 2016 initiatives and…

Thank you, Stephanie. We closed FY '16 on a high note, with fourth quarter net sales of $174.7 million, up 24.4% compared to $140.4 million in the fourth quarter of last year. This was our 28th consecutive quarter of increased sales year over year. Net sales growth was driven by a 14.5% increase in direct net sales and a 105.6% increase in the retail segment. Growth was achieved across all product categories. We're pleased to report that our marketing efforts drove an increase in aided brand awareness year-over-year. In addition, fourth quarter website visits were up 12.8% year-over-year. Gross profit for the fourth quarter increased 22.8% to $96.8 million or 55.4% of net sales, compared to $78.8 million or 56.1% of net sales last year. The $18 million increase in gross profit was primarily due to higher net sales. Gross margins benefited from improved initial product margins and a shift to higher margin products during the quarter. However, these benefits were more than offset by the impact of promotions offered in response to the highly promotional retail environment, resulting in a 70 basis point decline, compared to last year's fourth quarter. Turning to SG&A. Selling, general and administrative expenses increased 23.6% to $73.9 million, compared to $59.8 million in the fourth quarter last year. This included an increase of $6.8 million in advertising and marketing expenses, $4.3 million in selling expenses and $3 million in general and Administrative expenses. As a percentage of net sales, advertising and marketing costs remained flat at 20.1% year-over-year. Selling expenses decreased 30 basis points to 13.7%, compared to 14% in the fourth quarter of last year. Given our lower sales expectations, at the beginning of the fourth quarter and the intensely competitive environment, we aggressively managed our expenses to help protect our margins. In…

[Operator Instructions]. The first question is from Dan Wewer at Raymond James.

Stephanie, I wanted to follow up on your comments about protecting the value of the brand. As I recall, on the last conference call you were concerned that the brand may have become too promotional in the pursuit of 20% direct growth. If you could talk about how you see that changing in 2017 and 2018 and how that may impact the direct revenue growth going forward?

Sure. You got that right, Dan, in terms of the commentary around protecting the brand and how we view promotions as a vehicle for not only growth, in terms of the immediate revenue growth that we see obviously, but also in converting new customers into the brand. Because obviously one of the key platforms for our growth, whether that is direct or retail, is making sure that we're bringing new customers into the brand and maintaining the customer base that we have. We look at promotions, in fourth quarter, as you could see, we knew we had a highly promotional environment. We started out the quarter in a disadvantaged situation, if you will, because of weather issues and some of the things we talked about with the consumer shopping a little bit later. So we did use promotions at that point in time to not only do what I just described, but create some momentum. And remember that the deepest discount that we offered in fourth quarter happened over the Black Friday weekend where we did a 30% off plus free shipping offer across the channels and then we moved forward and we stayed in our normal cadence, if you will, of 20% off, with one additional offer at 30% off with shipping being charged, if you will. So the important thing as we looked at fourth quarter and then I'll roll into 2017, was making sure that while we knew we were in a unique situation, that we were doing, we were executing our promotional cadence in a Duluth way, to not go too far down the slippery slope and create some additional expectations. When we look at 2017, we have a number of different types of promotions and types of business drivers in our arsenal. It's one of…

If we're going to see fewer number of global promotion days in 2017 and we're continuing to see initial margins improve and mix improve, would you anticipate that gross margin rate increases in 2017, even though you're forecasting the drop in the EBITDA margin?

We're actually holding, Dan, to what we talked about in the past which is, we do see the initial margins improving. That said, on the direct side of the business, we've got shipping revenue, that we know is declining as a percent of sales, that's definitely going to create some downward pressure on direct. And on the retail side, the retail segment, obviously we don't have that shipping revenue, so our retail product margins are very similar to what we see in direct, but the overall retail margin is lower. And as retail increases as a portion of the business, we're also going to see some downward pressure mitigating the increases in initial margins. So right now, we're projecting gross margin to hold or gross profit rate, I should say, to hold overall, year over year.

And then the last question I have. What was the reason for accelerating the number of new store openings, given these two significant IT projects going online, just before the holiday season?

The significant IT projects are for this year. We've been scoping those projects and designing those projects for about a year now, but we didn't go live with new IT projects with the acceleration of the stores in fourth quarter, so I'm not sure I understand your question.

I was just thinking there could be some execution risk with the order management system and e-commerce platform and what was the reason for pursuing that? Let me back that out. Why accelerate the rate of new store growth, when you had those two big projects that you're having to manage as well?

If you're thinking specifically around 2017 now and the acceleration to the 10 to 12 stores?

Yes.

So the acceleration of the retail stores is a very different team and a different focus, if you will, than the execution of the big projects with IT. I will tell you that the execution of the order management system and the e-commerce platform is a very big focus for a lot of our internal teams, obviously like IT, our customer service area is very heavily involved, but the retail side of the organization actually functions very independently of these systems. Okay, great. Thank you.

The next question is from Jonathan Komp at Robert W. Baird.

I wanted to start with a question about the fourth quarter and Stephanie, not sure how granular you're willing to be. But if I remember, you started the quarter for the direct business, the first five or six weeks maybe trending only slightly positive. So ending up 14%. Clearly you talked about the acceleration and now in the first quarter with all the unusual weather and tax shifts and Easter shift that we have, any comments on the trends you're seeing during the quarter? Both the fourth quarter and the first quarter? And maybe any grasp on the underlying trend for the direct business?

Sure. So let me just start with fourth quarter, Jon. You're right in terms of obviously we reported on December 8 that the first part of fourth quarter was very soft for us. To give you some sense of scale, the growth rate that we saw year over year in the second half of fourth quarter was double that of what we saw in the first half of fourth quarter. So the business turned quite dramatically as we got closer and closer into the holidays and even through January, we saw the business staying pretty strong and that was true both in direct and retail stores. I will tell you that the new retail stores that we opened in late third quarter and into fourth quarter were very strong for us and we were very pleased with the results. Particularly excited about the new East Coast stores we brought online, because obviously that's a new entry into that market. As we entered February, to be totally honest, we did see a little bit of a malaise come through again in the business and there are a number of factors. You mentioned tax refunds, that's something that a lot of retailers have mentioned in terms of the delay there. Did that directly impact our customers' shopping habits? Perhaps. To what degree, quite frankly we don't know. I do think though that the combination of coming off of a very, very promotional fourth quarter for all retailers suddenly caused everybody to pause coming into February. We have seen our trends improve in the first couple of weeks of March and obviously that's a very positive thing for us. The other thing, as we look forward for the balance of the first quarter, that we're looking forward to quite frankly, is that we have shifted our women's advertising campaigns back into first quarter. That campaign actually will go live next week again, so I think we've got some positive momentum that we're going to create again there. We know that was a -- gave us some strong results in women's in fourth quarter, so we're excited about that starting up again. We've got some new products we brought into the business, things like some of our No BS business wear expansions in mens, some new bottoms, woven bottoms programs and knit programs in women's that have been very strong. And I think as the season progresses and we do get into Easter -- and Easter signals spring for most people and I think as we get a little bit further, it will be obviously the last part of the first quarter, we should see some upswing on that as well.

Great and that's actually partly related to my next question, but it looks like and a couple moving parts, but it looks like for the initial 2017 revenue guidance, still projecting pretty healthy direct growth. By my math, maybe 10% or low double digits for the year. And I'm just wondering, as you look at the year if that's -- first of all if that's how you're thinking about the growth rate of the business? And then secondly, just a little more detail on some of the drivers. I know you mentioned some of the new product and I'd be curious to hear a little more.

Sure, so a couple of things. The new product, one of the things that we're finding in terms of a common thread around the new product is our men are definitely responding to an extension into new areas of their closets. If you will, Alaskan Hardgear is an example of that, where we've got a much more technical approach to outerwear, with more synthetic types of fabrics and our guy has definitely responded to that increased assortment. And if you'll remember, that's one of our growth strategies, is to reach deeper into his closet. We've also introduced new products around, you could call it the more casual side of his lifestyle and those have been very well received, too. So more on the Duluth side of things, more cotton-based products and he has responded very quickly to that type of product. On the women's side of the business, I mentioned Duluth Unders. That's our base layer underwear, tank, et cetera, part of our business. She is responding in a very healthy manner to those consumables, if you will. And the other thing that is exciting to see in women's is that, because it's a younger part of our brand, if you will, the way that she has received very strongly our problem-solution type of messaging and the products that live underneath that messaging, has been really very encouraging about what we think the long term opportunity overall of the women's brand is. So products like NoGA or Fire Hose Work Pants, our everyday denim, that has details that just make it a little bit more wearable, a little bit more functional, a little bit more durable, all of those types of products, she's received very nicely. Did I answer your question?

You did, but I'm curious, that's very helpful. On the direct business for the year, are you thinking low double digit type growth? Is that in the ballpark of what you're thinking?

Yes, I think that we have seen, as you've noted, a deceleration in the growth rate of direct. I think a lot of that has to do with what I described just a minute or two ago, with the levels of maturity in the various sectors of the direct business, between men's, women's and Alaskan Hardgear were the three that I noted. I do think there is some maturity in direct and that the growth rate is probably going to decelerate a little bit further into 2017. That's the way we're looking at it. The great news though, is that as we look at the retail expansion and the segments within direct that are less mature, we still see very, very healthy growth rates overall.

Okay, great. And last one if you don't mind. Just the question on the margin commentary you had, Mark, for the next 18 or 24 months. And I'm curious, does that imply a further acceleration in the number of retail openings? And after 2018 or after 2017, sorry, I'm just trying to align my thinking with why you'll see some incremental pressure, even in the period beyond 12 months?

Yes. As we know, the retail business is a very profitable business for us. We're continuing to see a payback on our initial store investments of 24 months or less. We're continuing to see EBITDA margins in the mid 20s and so we believe the right thing to do for the business is to scale the retail business up more rapidly. As we do that, we'll see benefits to the profitability of the business as a whole. So we do expect to see a gradual scaling up of the retail store openings. Having said that, consistent with our past practices, we're going to do this in a disciplined way. We're not going to get ahead of ourselves, we're going to make sure that we execute well on all of the store openings as we go and that will inform the pace of that growth in the coming years.

And I would just add to that, Jon, that when we look at 10 to 12 stores this year, we're at a pace of slightly more than one a month and I'd say slightly more, because there are certain months that we're just not going to open a retail store in, right? So there are other months we need to consolidate and open a couple. And that, we're very much ready to do from a management perspective, from an inventory perspective, et cetera. That said, once we go past that one-ish per month, we need to reevaluate systems, improve our processes, improve how we look at the business overall, so that we can ensure once we get past that 12 stores or so, that we again have improved our processes to the point where we can execute well. And that's one of the things that Al Dietrich and his team will be working on this year, to make sure we're ready for that. In addition, obviously to that all-important site selection.

The next question comes from Brandon Cheatham at BMO Capital Markets.

This is Brandon Cheatham on for John Morris. I was just wondering if you could expand on your advertising campaign. What were some of your learnings, especially on the women's side, that have helped drive those results? And it sounded like this year, women's is growing in a greater portion to men's. Is there a higher ROI there, is that something that really needs to grow, to get that business to where you want it?

Sure. So to start answering your -- with the answer to your question around women's advertising, one of the things that I am most excited about with the new No-Yank Tank campaign in women's is that I think that it's a great Duluth balance, if you will, around not taking ourselves too seriously. Most importantly, featuring a product that is solution-based and it's a solution to a problem that quite frankly is universal. I can't even tell you how many women have written in and said, oh, thank goodness. I've been searching for a product like this for a really long time. And if you look at some of the reviews that we have online, they are actually a lot of fun to read, around the response that we've gotten from women. And I think that the advertising message with this particular ad hits at the heart of the solution base and does it in a very Duluth way. And I'm very proud of the team for creating that ad and creating that messaging around an incredibly important problem, if you will, that we can solve, in a fun and new way. I think that it also, not just the TV advertising but all of the improvements that we've made in women's marketing, whether that is how we message online our products, how we message through our catalogs, our digital advertising, our in-store experience for women, all of that messaging is centering around the Duluth promise of problem-solving products. And the better that we get at that, regardless of if it's women's or men's, but in this case, in a less-established part of our business right now, the better we're long term. We're still at an earlier stage with our women's business, in that at about 21% of the total business, quick math, you can see it's about an $80 million business last year. That's still a small business in the grand scheme of things and we know that we still need to continue to invest in that business in a somewhat disproportionate amount over the next several years to get ourselves continued critical mass. The good news is, on prior calls and in prior conversations, we've talked about the fact that our women's gross profit rate continues to close the gap to men's and we have done that again this year. We continue to improve that gross profit rate by 30 to 50 BPs a year and we saw that again this year and that obviously is the starting point of creating a stronger ROI in women's, overall. So I'm very, very pleased with the growth that we saw in women's and I think that we've got really good investment points go forward.

Just one last one for me, at your analyst day, you mentioned the possibility of outsourcing the tagging to the manufactures. Just wondering, is that still on the table and currently how much of your distribution center capacity is involved in that? I would imagine that's potentially a good margin opportunity.

Yes, we've actually started that process with some of our key programs and so I don't -- off the top of my head I couldn't tell you the percent of the product that is actually being tagged at the manufacturer, but we started the process, we continue to increase the number of products that we're tagging ahead of time. The other things that we're working on is not only the price tagging, but any sort of in-store marketing we need, whether that's size stickers or hang tags also being put on in the manufacturer, that's something that will continue to improve over the next 12 to 18 months. We did, with the DC expansion that went live last summer, one of the things that we did when we built out the additional 75,000 square feet in Belleville, is we allocated that 75,000 square feet for bulk and that freed up some of our original square footage to expand our retail prep area. So we've doubled the amount of space that we've allocated to our retail preparation area in our DC and remember, that our Belleville DC is the only DC that preps retail goods. We have centralized that function and we doubled the amount of retail prep stations, so that we were ready in advance of this retail acceleration this year. So we feel really confident that we'll be able to handle the increased volume there.

[Operator Instructions]. The next question is from Jim Duffy at Stifel.

Congratulations to the team on the stronger execution to close the year. The question is around the strategy evolution. The emphasis of retail, somewhat contrarian. I'm hoping you can share more quantitative details around the factors giving you increased confidence in the retail model. Specifically, what are the trends you're seeing in stores that are open more than a year? Are those stores comping positively? What does the maturity curve of these stores look like? Are you seeing difference in trends by store location types? That would be helpful, thank you.

Sure. So talking first of all about just some of the overall trends that we're seeing in the retail expansion, if you will. We're very excited about the fact that what we saw in initial small market, if you will, stores, the stores that we opened six years ago, four years ago, three years ago, where we saw a payback of our initial investment in that 24-month range and we saw post pre-opening expenses, a four-wall EBITDA of the mid 20s. That trend has continued as we've moved into larger markets, as we've moved into more expensive locations from the standpoint of build-out costs or labor costs. We continue to see those paybacks happen at 24 months or even less in the case of some of our larger stores. The other thing that we see is that we're expecting that mid 20s four wall EBITDA in our larger stores, now some of them haven't obviously hit that 12-month mark yet, but with the trends that we're seeing, we're expecting that number will continue, as well. Even with higher occupancy rates, as an example. The third thing that I would say is, we've talked about the fact that price of admission, if you will, for as we look at a store, is at about a $400 per square foot on the sales side. We have met or exceeded that on all of the stores that we've opened, not only in the beginning, but just recently, as well. The other thing that we're seeing on the omnichannel perspective from the retail expansion, is that we're building brand awareness with our stores. We're seeing that the markets that our stores are in, the customers are shopping much more frequently across all of the channels, so we're building that omnichannel expectation and interaction with…

So with legacy stores becoming a larger portion of the model, what's a good comp progression to think about, as we model going forward?

There's still going to be a fairly small portion, Jim, of what we're doing, since we're accelerating the number of stores that we're opening. But I -- when we're seeing the level of maturity curves, I would say the low single-digits is pretty consistent.

Okay and then last question on for me, still on the retail. With the accelerated pace of retail expansion, Stephanie, can you talk a little bit about what you're doing internally for talent development, to support the accelerated growth of the stores?

Sure. I will, I have to give great credit to Al and his store team, for gosh, well over a year ago now, identifying the need to create a management and training program. And they started that program last year and it is a program where we bring in people that we have identified as having the experience and the talent to ultimately go into a newly-opened store as an Assistant Manager, sometimes as a Manager and we bring them on board anywhere between four and six months in advance of a new store opening and we have them live in existing stores. So they are working in those stores as a functional member of the team. They are learning the Duluth culture. They are learning the Duluth processes and it creates a base of knowledge and a base of experience, that automatically opens a new store for us. And I think that's a critical piece to how, not only we execute well, any sort of opening schedule that we have on the stores, whether it's accelerated or not. But also, more importantly, it ensures that we deliver an exceptional customer experience, whether you are in downtown Mount Horeb or you're in Philadelphia, Pennsylvania. And that's critical to us and has been a real focus, particularly as we get further and further away from the Madison area. And we know that we need to rely on our people to be the face of Duluth and create that experience. I'm very proud of the fact that if you go on to the review sites, like Yelp, that talks about our stores, our customer experience is rated incredibly highly. And we get stories every day, we have a Companywide e-mail system called Trading Tales, that we hear about customer experiences both through direct and retail and our team is very much delivering on that promise. In terms of the, I'll call it the centralized staff, if you will, as I mentioned, we expanded the square footage in our DC around how we prep retail goods. We've obviously increased the staff and the leadership in that area, to make sure that we're inventorying our stores and getting the goods out in a timely fashion. We've increased our internal staff, that's looking at how we message to the stores, how we visually merchandise the stores and how we plan for the stores and we'll continue to add resources as needed to that expansion. Does that answer your question?

The next question is from Dylan Carden at William Blair.

Just a quick one on advertising leverage, it looks like you got about 60 basis points of leverage in the full year. Is that and I get there's going to be margin pressure from new openings and pre-opening expense, but what's the underlying rate that you're seeing, that you can expect even moving out past that 24 month period, where you're seeing that margin pressure?

Dylan, are you asking about--

The advertising--

Ad ratios? Sorry.

Yes the ad ratio. That's right, the operating expense. The advertising and operating line, when you can start leveraging that.

Our expectation is that in the direct segment, we will maintain advertising expense as a percentage of net sales going forward. We want to do that because we continue to believe that the advertising drives the growth of the business, drives customer acquisition. So where the leverage will come in the overall business is as the retail segment grows, you may recall we've talked about the fact that the ad spend in the retail segment is quite a bit lower than in the direct segment, so that will create sort of a natural leveraging for the business as a whole.

And Dylan, are you also asking about bottom line leverage as we look out past the 18 to 24 months? I thought I heard you ask that. Did we lose you, Dylan?

Sorry, just one moment.

Okay thank you.

Looks like his line is disconnected.

Okay.

There was another question in the queue but that person has also removed themselves from the queue. So this does conclude the question-and-answer session. I'm sorry.

That's okay. Well, I will just jump in, because I know we've reached our hour mark. I just want to say thank you on behalf of the entire Duluth team for joining our call today. We wish you all a great official start to the Spring season and we all look forward to presenting our first quarter results to you all in early June. Thank you so much.

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