Good morning and welcome to the Duluth's Holdings Fourth Quarter 2020 and Fiscal Year Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Donni Case, Investor Relations for Duluth Holdings. Please go ahead.

Thank you, and welcome to today's call to discuss Duluth Trading's fourth quarter and fiscal year 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 Steve Schlecht, Chief Executive Officer; and Dave Loretta, Chief Financial Officer. On today's call, management will provide prepared remarks, and then we'll open the call to your questions. Before we begin, I would like to remind you that the comments on today's call will include forward-looking statements, which can be identified by the use of words such as estimate, anticipate, expect and similar phrases. Forward-looking statements by their nature involve estimates, projections, goals, forecasts and assumptions and are subject to 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'll turn the call over to Steve Schlecht, Chief Executive Officer of Duluth Trading. Steve?

Good morning and thank you, everyone, for joining today's call. It was one year ago almost to the date that we announced our first store closings primarily in the northeast due to COVID. At that time, we didn't know just how far-reaching the impact would be, but it was clear that our plans for 2020 were suddenly disrupted. I won't go into all the details of our COVID response as it was pretty much standard procedure for all responsible retailers: protect the staff and customers and protect the financial position. What I think is more important are the lessons we learned from operating in an altered retail reality. First lesson, you don't know if your business model is resilient until it's pressure tested. By the end of March, all 62 of our existing stores were closed due to the pandemic, and we had absolutely no idea when they could reopen. In the prior year, retail store sales accounted for 43% of total revenues, so this circumstance presented a giant mountain to climb to fill that revenue gap. Fortunately, we already had a strong omni direct channel in place that allowed customers who traditionally shopped in stores to shift their buying patterns online. When our stores closed, we also ramped up digital marketing and promotions to draw current and new customers to our website. And it worked. Direct sales closed the retail gap and ended the year accounting for 72% of total 2020 sales. The second lesson was that the currency of the Duluth Trading brand was validated in a difficult retail environment. When your entire organization is dedicated to creating innovative, solution-based, high-quality products and an outstanding customer experience, you have created a lifestyle brand that can prevail in challenging times. Our online activity soared as both established and new…

Thanks, Steve, and good morning, everyone. I'll begin today with a brief overview of our fiscal year results. Then I'll cover our fourth quarter performance and conclude with commentary on our outlook and guidance for 2021. As Steve mentioned in his comments, the Duluth team rose to the challenge and demonstrated agility and resourcefulness throughout a difficult year, the strength of our omnichannel model shining through as many customers shifted to online, while retail stores were closed for up to 10 weeks during the early stages of the pandemic. We delivered net sales of $638.8 million, an increase of 3.8% over the prior year. Our direct fulfillment network, including the role our stores played in shipping orders and expediting BOPIS orders, handled the surge in online sales with minimal disruption as the direct business overall grew to represent 72% of full year sales compared to 57% in 2019. We entered fiscal year 2020 with plans that reflected an emphasis on growing our brand in new and existing markets, leveraging expenses, and expanding bottom line results faster than top line sales. While the pandemic altered our approach, the actions we took coming out of our first quarter to increase financial flexibility enabled us to generate cash flow from operations of roughly $84 million over the 3 quarters. In addition, we grew pretax earnings by close to 12% compared to net sales growth of just over 5% over that same 9-month period. In 2020, we opened only 4 new stores versus an annual pace of 15 store openings in prior years. While new stores have been an effective way to attract new customers, we were very successful in growing brand awareness and reaching new customers through digital channels. In fact, 2020 delivered our largest gain in customer acquisition in recent history, with…

[Operator Instructions] The first question comes from Jonathan Komp of Baird.

Dave, maybe first, just wanted to get your thoughts on the near-term environment. It sounds like you've had a good start to the first quarter. And you're about to cycle, if not already the past few days, pretty significant disruption last year. So how are you thinking kind of the current trajectory and maybe the balance of Q1, Q2? And any thoughts on how that might play out by channel would be appreciated.

Yes. Sure, John. Yes, we are in the middle of a period that's, compared to prior year, going to be significant shifts, right? It was a year ago that we did start to have to close our stores. But our -- so going against those comparables is going to look different than we have as of recently, but the trends overall in the business are very encouraging. Through February, for the month of February, our total business was up 13%. By channel, that represented direct up a little over 40%; and the retail channel still negative, but got little better than the fourth quarter, down minus 20%, 24%. In March, the first 2 weeks of March, we're seeing that improvement continue and remain in the mid- to even slight high teens overall. This past week is when we really start to see our stores comp positively over the prior year as traffic was dwindling and then stores started to close. So when we look at our first quarter, we're expecting the quarter to be in the mid-teens overall for the business. And that means direct is going to be -- it's going to be slightly down from its current trend. Because last year we were very aggressive near the end of March and in April with some promotions, clearance events. So we're not expecting the direct to be as much, by the end of the first quarter, to be as positive. But retail should be significantly higher, 60% to 70% over last year, which -- so the combination of those 2 get you to sort of a mid-teens for the Q1 outlook right now.

Okay. Great. And maybe on margin, the full year gross margin expansion as well, it looks like a little bit of implied G&A leverage for the year. Could you maybe just differentiate some of the drivers for both of those pieces, to the extent you're willing?

Yes, certainly. We do expect that gross margin, we'll see some improvement. Last year we had a significant hit to our gross margin. So we'll see some improvement in the first quarter, likely a little over 100 basis points, and for the full year 50 basis points to 100 basis points improvement in gross margin when we -- based on our promotional plans right now. But yes, our leverage is be coming from selling costs and overhead. The big component of overhead is simply having our stores open and being able to leverage the occupancy and the fixed costs in that channel. But in terms of ad spend, we're expecting to be relatively flat in terms of our percent of sales. We held some back last year, and we're going to shift it around. We'll have significant leverage in the first quarter, but we're just moving dollars into more of the back half of the year. So full year guidance that we gave on earnings growth is sort of what those components will get us to.

Okay, excellent. And just last one on the new pilot selling and Tractor Supply, the handful of stores so far, just any broader thoughts how to shape the strategy, how it's evolving around where you may be willing to sell Duluth product? And I know it's very early, but just given the current margin profile of the business of selling in your own channels, if you did decide to ever meaningfully increase that portion that you might be willing to sell in other channels, any kind of broad-stroke thoughts on what that might mean from a from a margin contribution standpoint? Understanding it's early, any thoughts there would be helpful.

Yes, it is very early. And the product that we picked for that test is our most tried and true, well-known product, and it has -- it carries some of our best margins. So we expect that net, we'll see some accretion in margin overall from this activity if it really takes off the way we hope it will. We don't necessarily need to apply the same level of ad spend on that effort, so you get some benefit there. And then it's -- the partnership is really a one company to another, and it's a well-known company. So we don't have any plans at this point to ramp up a wholesale division or internal costs to really manage a growth in that. But this was simply a first attempt of us to see what our product would look like in other retail places that can gain some customer awareness and pick up new customers.

The next question is from Jim Duffy of Stifel.

So guys, a good year all in all, very good progress on the inventory. After growth in both the second quarter and the third quarter, the inflection of revenue declined, however, in the fourth quarter came as a bit of a surprise. Given the new customers acquired, technology advancements, new products offerings, we would have thought the direct business would have been stronger. What -- was the direct deceleration larger than your expectations in the fourth quarter? Do you guys think that maybe you cut advertising expense too much in the fourth quarter? And then, Dave, I'm curious what's embedded for direct business in the full year outlook?

Well, let me start there, Jim, in terms of our outlook. For the full year, we're not expecting that direct is -- needs to generate much growth at all compared to the prior year. We -- as you saw, from April through November, direct was on a very high growth rate. The deceleration in the fourth quarter truly came in the -- some of the critical weeks in December, and possibly pulling up on ad spend did impact that. But given the dislocation of where the shopping was happening, we -- and the concerns around delays of deliveries from our carrier network. We were concerned that if we stepped on the gas further in that period of time, that we may disappoint customers. And that's something we didn't want to do, having a delivery not made when they expected it. So that's partly why I think we saw some deceleration there. But it really reinvigorated itself when we came into January, so no concerns that there's a channel issue with our direct business. And I think we could be -- my estimate for 2021, but the retail is really where we're expecting the growth in the top line to come in 2021.

Okay. With respect to the direct business, you've greatly tightened up the inventories. It's your intent to be less promotional. There's some inherent tension there between promotion and supporting that direct business. Are you confident that you can stabilize the direct business while being less promotional? Or do you view that less promotional stance as being a headwind, we should consider an estimate?

No, we demonstrate growth in direct during periods where we're not as promotional. You started with the comment of the file -- the customer file base is much larger. And that's right, it is. So I think in the periods where we are introducing new products that are seasonally right in hitting that sweet spot, then we're going to see nice momentum in direct, but it will be hard to compare to the prior year. But it doesn't mean that we're really going backwards in that channel.

Okay. And last one for me, and I'll let someone else jump in. Just point of clarification on the guidance, Dave, is the Tractor Supply rollout reflected in your commentary about mid-teens growth quarter-to-date? Are you embedding any assumptions about a wholesale revenue contribution in your 2021 outlook?

No, it's not contemplated in the outlook. And the tests that we're in right now involves 3 -- 13 stores of Tractor Supply. It's just our Buck Naked SKU across a few colors and sizes. So it's fairly small and not material at this point. But if things progress well and we expand it to other stores, then we'll obviously refresh our outlook to contemplate that, but it's not in there today.

[Operator Instructions] The next question comes from Dylan Carden of William Blair.

Just curious, you had mentioned kind of the outperformance of hardgear, and it sounds like Best Made Co. is off to a good start. Could you kind of just break down the contribution at this point between kind of plus hardgear, some of these newer categories and brands, as they stand now or maybe as you anticipate them to stand for 2021?

Yes, Alaskan Hardgear is certainly much larger than Best Made and 40 Grit. It's about 5% of our business, but growing at a faster pace. So that's probably more of a meaningful sub-brand that's going to move the needle when it does well. Best Made and 40 Grit today are less than 2% in what they're planned, but we're going to see significant growth in those channels in those brands in 2021; but still relatively small compared to our core men's and our core women's, which are driving most of this volume for us right now.

Great. And then kind of when you talk about sort of this next phase of growth, maybe talking about sort of why CapEx hasn't stepped down a little bit more this year with only one store coming online and kind of what you're putting capital towards now that stores aren't kind of the primary growth engine, is debt paydown kind of anticipated in uses of cash go forward? Anything there would be helpful.

Okay, yes. Certainly, CapEx is a function of the stores. And with one store, then we'll see less spend there. But the other areas that we've got teed up and that we're working on right now include a software implementation, our merchandise lifecycle management tool, that will provide us with tools to allow for assortment planning, forecasting and replenishment. These are basic infrastructure that retail organizations have. And we've gotten by with a patchwork of systems and manual procedures, but it's really due time to have this initiative. So that's going to be several million dollars, $3 million or so million dollars of CapEx to get that initiative stood up. And then the other big spend is going to be in our logistics area. We are going to add some efficiency capabilities in our Belleville warehouse. But more importantly, we're adding a third distribution center in Salt Lake City that will have several million of implementation and fix our cost to get it up and running. And what that will do is it gives us the capacity during the peak period and a closer delivery time to the West Coast as well. But that capacity will give us further confidence during the fourth quarter to step on the gas, like I articulated, and really be confident that we can deliver and meet our customers' expectations. So these are capital spend that are infrastructure-related and are necessary, but we'll get benefit from for the foreseeable future, 3 to 5 years at least. That's kind of the big pieces.

And then the final one I have is just I'm kind of trying to understand guidance here. You're off to kind of a mid-teens pace. Total top line, it sounds like that should theoretically get a little bit better as you lap closures. But it sounds like you're expecting of the 6% to 10% sales outlook for the whole year, there's a first half -- the first half is going to come in kind of towards the lower end of that range, the back half towards the higher end. It sounds like there might be just some volatility between quarters and then stores making up 35% of total for the year. Is there any sort of way that you can kind of contextualize what that looks like front half versus back half, Dave?

Yes. Certainly, first half, we're going to see direct going against some significant volumes in the end of the first quarter and in the second quarter. And we're not anticipating that for a channel growth that we'll see any growth. It will likely be down to prior year in the mid-single digit, but that's going to be offset with retail. That could be up as much as 50%. So that's the rough math to get you to the low end of our sales guidance range for the full year. And then in the back half of the year, we will expect direct to start to grow, especially in the fourth quarter. But for the full back half of the year, it will probably be mid-single-digit. And retail will be closer to 20% to 30% growth as we're going against periods where the stores have been opened, but traffic wasn't as strong last year with the pandemic concern. So we think the back half of the year can combine those 2 to be higher to the high end of that range, the 10% growth.

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