Good morning, and welcome to the Duluth Holdings Third Quarter Fiscal Year 2019 Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Donni Case, Investor Relations for Duluth Holdings. Please go ahead.

Thank you, Kay, and welcome to today's call to discuss Duluth Trading's Third Quarter Fiscal year 2019 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 Stephen Schlecht, 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 risks and uncertainties that could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements. Such risks and uncertainties include, but are not limited to, those that are described in our most recent annual report on Form 10-K and other SEC filings as applicable. These forward-looking statements speak only as of the date of this conference call and should not be relied upon as predictions of future events. And with that, I would like to turn the call over to Steve. Go ahead, Steve.

Good morning, and thank you for joining us today. Since I assumed the role of Interim CEO last quarter, I've spent a good deal of time meeting with all levels of management throughout our organization. While I never stepped back from my role in shaping strategy, I had to reenter the operational side of the business. Over the last couple of years, we have been undergoing a significant transformation for both our IT systems and distribution infrastructure, which was necessary to support our growth and compete in today's retail environment. As I recently reported to our Board of Directors while we have our share of growing pains, I have high confidence in our people, processes and systems. And collectively, I believe we have a clear road map to growing our company and its profitability. That said, the potential of our investments both in time and money have not been fully realized at this time, yet they are gaining traction and bearing fruit. In fact, I believe we entered the fourth quarter better prepared to serve our customers at any time in the last two years. And here's a quick update on what we have accomplished. We completed the opening of the 15 stores that were planned for fiscal 2019 in time for the holidays. In the third quarter, we opened a new markets, new markets in Birmingham, Alabama; Austin, Texas; and Salt Lake City. Subsequent to the quarter, we launched our new concept store, that exclusively features men's underwear in the Mall of America. We also opened in the new markets of Nashville and Knoxville, Tennessee, which completed our store build out for 2019, bringing us the total count of stores to 61. While we announced last quarter that we were moderating our retail expansion, stores play an important role…

Thanks, Steve, and good morning, everyone. For the third quarter, we reported net sales of $119.8 million, up 12% compared to $106.7 million last year. Our Direct segment sales grew 2.9% compared to last year, and our retail segment sales grew 24%. For the quarter, shipping revenues were $1.5 million compared to $1.6 million last year. The growth in retail was primarily driven by new stores opened in 2018 and 2019. During the third quarter, we added 3 new stores and roughly 47,000 gross square feet. We ended the quarter with a total of 58 stores compared to 43 stores in the prior year. During the quarter, we continue to experience some challenging demand trends, direct product sales were up 2.9% as reported, however, this period benefited the most from the 53rd-week calendar shift. Excluding this, direct sales were down slightly for the quarter. We saw some momentum in August and September, largely driven by increased clearance activity and the Big Dam Birthday sale event. However, a tough October followed, which reraised the gains of the prior 2 months. We are pleased to see that markets where the store opened at least two years, continue to outpace nonstore markets and the direct sales growth. In an effort to drive more sales and web traffic, we took deeper markdowns during sale events and drove a greater amount of clearance activity. As a result, gross margin was down 250 basis points from last year for a gross profit amount of $65.4 million. As a reminder, our exposure to the China tariffs will continue -- will impact our fourth quarter gross profit by $1 million to $1.5 million. Our plans to shift the remaining production to other countries are underway, and we expect minimal margin impact next year. Our women's business continues to…

[Operator Instructions]. The first question comes from John D. Morris of D.A. Davidson.

A question for you on inventory. Can you give us a feel of what the inventory would have been if you were adjusting to the fact that you've got to pull forward to correct, for last year? I just -- I'm just wondering, it looks, even with that, potentially a little bit high, up 39% relative to sales growth. And I wonder if you can give us any comfort there on where you might be expecting that inventory to be, let's say, at the end of fourth quarter? So those two questions.

Yes. Sure. We moved our inventory forward by quite a bit, 3 to 4 weeks, which in this period of time, amounts to a fairly large amount in excess of $20 million of inventory that we pulled in early. Relative to last year, we know that we were late in getting those inventories into our warehouse and out to our stores. So I'd say under normal circumstances, if we come back and repeat, next year, we would expect our inventories to be closer in line to what our sales growth are. At the end of the year, I think we'll also see greater increase in the inventory levels because we're going to repeat that activity in preparation for spring and summer. So we're expecting inventory to be between 20% and 30% higher on a year-over-year basis at the end of the year, reflecting that continued pull forward. And then as we proceed through 2020, get the inventories back in line with sales growth.

All right. Yes, that's good to know ahead of time, so we know to expect that. And then, I guess, somewhat or maybe partially connected to that, just trying to understand a little bit better about the expectation for implied sales growth for the fourth quarter. Maybe I missed it because you were kind of going through the full year numbers pretty quickly. But does -- is my math correct, given the window with the full year guided that sales growth in Q4 would be, I guess, low to mid-single digits. And I'm wondering, well, is that correct? And if so, I guess, given the way you're managing the inventory levels, why would that be the case in terms of a de-sell compared to the third quarter growth rate?

Yes. The fourth quarter will have, from a sales growth standpoint, the impact of going against our 53rd week last year. So from a fiscal period standpoint, low mid-single digits is correct. From a 52-week basis, it's going to be a little bit above that in the high mid-single digits. And really, that's what we're managing our inventory flow to is the sales on a week -- same week-over-week basis.

Okay. Great. That's great clarification. Good luck for holiday. The stores look great, especially with that Alaska hard gear.

Great. Thanks, John.

Thank you, John.

The next question is from Jonathan Komp of Baird.

Maybe, Steve, since you're now back kind of deep into the business for a while here. I'm curious, just to start off, kind of, bigger picture, as you've gotten back engaged just kind of any broader thoughts on the state of the business or the brand or anything that surprised you as you've gotten back involved?

Well, there have been no surprises to speak of, John. We've got a lot of talented people here, as I said earlier, we've gone through some growing pains with the rapid store expansion we did with bringing in new systems and new logistic inventory systems that we're using, IT systems. So that created a sort of a drag this last 24 months, and we're coming out of that. So I am fairly well. I feel the brand is solid. I think our systems are in a better place than they ever have been in the last couple of years. We've got a couple to complete yet, but the overall health of the business is good. Challenging environment out there but that's something a little bit out of our control. We're learning a lot about how to work this omnichannel program between the stores and the markets that the stores are in, and our direct business. So probably your next question is on the CEO search. I'll just go ahead and say that, that's something we have planned to initiate probably in the first, if not the second quarter of next year. But we're doing it. We're going to do that carefully. And one of the things I've been trying to do is make sure that we really -- I'm well informed about what the qualities are, the background experiences that we bring, what we're be looking for in our next CEO here.

Okay. Great. And maybe, Dave, a question on the margin performance. On a year-over-year basis, it's the best you've seen in quite a while. And I'm just curious how you're thinking about more of the outlook for margin if you've kind of reached a bottom, so to speak, and see opportunity that more sustainably expand the margin from here? And maybe embedded within that is just your confidence that you have a good handle going forward on the gross margin, since that's been one area that's been less positive or more negative, frankly, as the year has gone on here?

Sure, John. The operating margin improvement, we do expect that to continue. This particular quarter was, I'll say, improved significantly. I don't think we're going to see that degree of improvement every quarter going forward but the goal would be -- with the sales plans, we have the cost structure in place to see improved profitability. As you do know, gross margin is a big part of that. And that's going to come from the improvement in and our sell-throughs and ability to sell at full price. This period we're in right now is the most competitive, and it just continues to be so where we see products really doing well. And in many cases, it's because we've had to meet some pricing that the market has from a deep discount standpoint. And a good part of our gross margin impact in the third quarter did come from our women's side of the business, which I think is going to have a little bit more volatility to it. But that's the nature of continuing to roll out newness in the assortment, some things are going to hit and some things I've missed. But as long as we've got the pipeline of new products, that's going to give us the best chance to see growth and continued productivity. So hopefully, that gives you some color on that question, John.

It does. And maybe that leads to just my last one. As you look forward in terms of some of the sales-driving initiatives, whether it's the marketing messaging in mix or the product pipeline or even getting the customer file in place. Any kind of broader thoughts as you look forward, what the major opportunities to drive the top line that sitting here today you're here looking forward to?

Yes. Certainly, looking forward, as you mentioned, one of our biggest initiatives that we're working on now and will go into effect next year as a re-platform of our customer data warehouse system. And that's going to give us the ability to, very much, in a kind of nimble way, personalize our marketing approach to customers based on preferences, based on their shopping habits or even just browsing habits online. And it will also give us the ability to tailor some of the pricing that's relevant to the customer. So we're not as blanketly putting out global promotions, but we can be more targeted. That's going to improve the full price selling. But we also think, capture some of that business of sales growth because it's going to be more relevant and tied to the customers' preferences. That's an initiative that's going to be in place. Our goal is, by this time next year so in place for our fourth quarter. And we'll get some early learnings on it in the third quarter likely, but that's a critical component. I'd say the other thing is really around marrying that with omnichannel capabilities in our stores, which will come with an upgrade to the POS system next year as well and supplement what we've got already with BOPIS and ship from store but make the experience even better in the store. So we know that a conversion of store traffic is key to seeing some store productivity improve. And that's 1 of our major initiatives is seeing the traction in the store level traffic as well.

The next question is from Jim Duffy of Stifel.

A couple of questions for me. I just wanted to start big picture. Steve, you mentioned potential from new system's not fully realized. Maybe there's a little bit of overlap with Jonathan's question here, but can you guys talk about some of the opportunities still on the common and the expected financial benefits as you begin to realize the power of these new systems.

I'm going to let Dave handle that.

Yes. Jim, as we've talked about, the infrastructure that needed to be in place with order management, a new website, logistics infrastructure was really a catch-up from prior years that -- and also to support the future growth. The financial benefits, we're already starting to see that in the logistics side compared to last year's savings from having the inventory flow better in the right place. So we minimize the amount of backorders and split shipments, which adds to cost and thus, handling time on our call center is improved, which streamlines the efficiency of our call center operations. So those financial benefits are -- we benefited from that in the third quarter, and we continue to benefit from it right now. The systems that I just talked about for next year are going to be very much of, sort of, top line driving initiatives and get to selling productivity and margin, gross margin improvement. So those are the 2 systems that we think are going to have the biggest financial impact.

Okay. Great. And then more near-term line of questioning. Dave, could you talk about growth expectations for the direct business in the fourth quarter. You have a very concentrated selling window here. I'm curious, are there any throughput limitations? And is there incremental expenses associated with servicing demand in that concentrated window?

No. We do not anticipate any throughput issues. We got well in front of it this year. Inventory is already been fully received, and our replenishment to stores after a very vibrant Black Friday weekend is smooth and in progress. So from a system standpoint, we have been very stable, knock-on-wood and got through Cyber Monday, which was again, one of our biggest days ever from a online order standpoint. So no concerns from -- hiccups from the infrastructure to kind of satisfy the demand. Direct is with the ships and weekly cadence between Thanksgiving and Cyber Monday being a week earlier. Last year, it does compress. And we're going to expect that the web business is going to be positive on a full quarter basis, similar to the third quarter. Now we are missing a week and that does detract from it but on a true kind of week-over-week basis, we're expecting it to be positive growth. And in fact, as I mentioned, the period between Black Friday and Cyber Monday was up year-over-year compared to those same events last year. So to us, that's a good indication that things are working.

Great. And last one for me, more housekeeping question, I suppose. But you mentioned the third quarter benefited the most from the 53rd week. Can you just explain that nuance, please?

Yes. Sure. With last year having the 53rd week in the fiscal year, it pushed the beginning of our fiscal year this year from 2019 and pushed it forward 1 week. So when you think about the beginning and the end of a quarter, we began the third quarter at the beginning of August, which sales volumes are going to be lower than they would be at the end of the quarter, which is at the end of October. So by pushing it forward, our fiscal period picks up that higher volume week than what we had last year. Now when we go back and we say, let's align the weeks on a similar week-over-week basis, that's a better true measure of the performance of the business, and that's what I called out in terms of the difference in growth rates as you think about it. Now we have the benefit in a fiscal quarter this year or in the third quarter, we'll give a little of that back at the end of the fourth quarter. Because we come down the slope of high sales down to a lower sales period. But really, the bigger impact is missing a 53rd week there.

Next question is from Dylan Carden of William Blair.

Great. Dave, sorry, just continuing on that sort of last thought. So I get that sort of on an apples-to-apples basis, you're looking at a gain here of growth similar to, it sounds like, the third quarter in your direct business. But as reported, is that sort of come down closer to flat? Or what's the right way to think about it? What's actually going to be printed?

For the fourth quarter, flat to slightly up. Low single digits is what we expect will be reported. That's what would tie to the full year guidance.

And then as you sort of had a thought there about -- you mentioned that stores or markets where stores have been opened over 2 years are seeing outsized growth in the direct businesses. Is there any color you can add to that as per when that really kicks in? How big of a difference that is? Is there sort of high volatility amongst markets? How it's aging in some of your older markets? Any additional detail you can provide would be helpful.

Yes. We continue to see that once a store's been in a market after its first full year, the direct business is growing at a faster pace. And in cases where we've got the most established markets, largely around the Midwest here in Minnesota and Wisconsin. We saw direct in the third quarter in the high single digits, in terms of growth in those markets year-over-year. So that's what translates into supporting the market growth. Despite the store contraction in that second year that we know we see because of the shift in some of the customer activity. So in the third quarter, in markets that we've been operating in for at least two years with a store, we were largely positive in terms of the sales growth in those markets when you combine the store business with the direct business. And that continues to play out that way.

I guess, where does that imply that the bigger packs of weakness are then in the direct business, in markets where you don't have a store? And is that sort of largely a newness of inventory issue or so?

Well, it is in markets where we don't have a store, but it's also in markets where we just opened up a store. So those that we opened up this year in 2019 or at the end of 2018 that are still kind of feeling the cannibalization of that new store. So those markets have direct growth rates, which are lower or negative in some cases. In markets where we don't have a store, that has been softer for us, and that's where we're only reliant on our marketing from a national brand standpoint or catalog prospecting. And we have dialed back some of that prospecting because we see that at the end of the day, it's not the most highest value of advertising. But we do think that, that product newness will help within those markets. But it's been the softer part of our business for the last 6 to 9 months for sure.

Great. And then it sounds -- are you expecting to be able to sort of -- I guess, where should we expect back half ad leverage to come in? And related to that, it sounds like what you're saying for fourth quarter is that you're expecting promotional activity to be in line with last year. Are you seeing that already this year? Or is that sort of largely expected as you enter sort of some of the more core selling periods now ahead of Christmas? And then what is, I guess, the shipping impact that you've seen and will continue to see.

Well, the advertising, we do expect to get a little bit of leverage in the fourth quarter there. Although we've added some dollars to the period we're in now to be more nimble and strategic in some of the digital spend that we've got flexibility on in the short term, and it's also a very high return. So we'll -- we expect it to be a minor amount of leverage from advertising in the fourth quarter, not -- certainly not similar to the third quarter. In terms of -- I'm sorry, Dylan, what was the other part of your question there?

Yes. I thought that the comment was that the expectation for 4Q is going to be, call it, stable promotional cadence or depth or maybe even pull back on debt. Just what the expectation is for how promotional you're going to be versus what you've already seen thus far in the quarter?

Yes. From a discount of the product and setting our promotions, where we're going to be a little bit different is, last year, we were doing a lot of flash sales on individual items on different days of the week. And while we found that we -- with the kind of spike the business, it was at a pretty steep discount that didn't really play out in a productive way for us. So we're not going to be doing the daily flatters is nearly as much last year. And some of our sale events are going to be tailored to some items at a 20% discount, some at a 30% and the combination of some temp promo with the global promos, gets us to net roughly the same amount of discounting last year but absent those flash sales. So we expect that we're going to be able to hold gross margin in this quarter, and we already are seeing that in November. Our gross margin year-over-year is up quite a bit to last year. And so we're hoping that, that's going to be in place for the balance of the fourth quarter. But this is the most competitive and critical time for us, and we also are going to be nimble. So we'll react to kind of capture the business. But we're not going to be as steep as you see other retailers. So I think that's my point.

[Operator Instructions]. There are no other questions at this time. This concludes our question-and-answer session and also our conference. Thank you for attending today's presentation. You may now disconnect.