Good morning and welcome to the Duluth Holdings Third Quarter 2021 Financial Results 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 Nitsa McKee, ICR. Please go ahead.

Thank you and welcome to today's call to discuss Duluth Trading 's third quarter financial results. Our earnings release, which was issued this morning, is available on our Investor Relations website at ir.duluthtrading.com under Press Releases. I am here today with Sam Sato, President and 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 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 will turn the call over to Sam Sato, President and Chief Executive Officer. Sam?

Thank you for joining today's call. We're pleased to report strong third quarter results that reflect healthy brand performance, growing customer appetite for our core collections, and nimbleness in our business model that has allowed us to maneuver unprecedented disruptions within the supply chain. Our customers are responding well to our assortment and showing signs of eagerness for seasonal and early holiday shopping. Before I touch on the third quarter results and current holiday trends, I would like to reaffirm our commitment to the strategic framework I outlined on our last call and provide a few updates. Our Big Dam Blueprint represents an outline for Duluth 's future and the foundation we will build on to address where the customers ' expectations are today and where they are heading. The building blocks of the blueprint will inform critical, long-term investments in our business, many of which are underway today and will be embedded in our near-term plans. Importantly, the investments we make will be thoughtful and purposeful, matching the growth and needs of the business. Dave will provide directional insights for fiscal 2022, but it's important to reiterate that we expect to maintain our operating performance objectives of improving operating margins, while growing sales over the next several years. We are focused on investing in efficiency for growth, which will drive operating margin expansion long-term. On our last call, I outlined the 5 pillars of our Big Dam blueprint, those being: Number 1, live with a digital mindset, which is being infused in all aspects of the blueprint and in each pillar. Under this objective, we intend to maximize Duluth 's already deep commitment to the customer with a digitally-led organization, integrating data and digital technology into all areas of our business. As an initial step, we are embarking on…

Thanks, Sam and good morning, everyone. For the third quarter, we reported net sales of $145.3 million, up 7.2% compared to $135.5 million last year and up 21.3% compared to the same period in 2019. Our direct channel sales grew 38% over 2019, while the retail channel was up 3% over 2019, driven largely by a 9% increase in average transaction value in the stores. We experienced a strong uptick in store traffic compared to last year's COVID slowdown and drove a 22.3% increase while direct channel sales were down slightly by 1.4% compared to last year as expected. Growth in visits to our website turned positive in the third quarter, up 8% to last year, compared to declines in the first half as we began strategically increasing the brand awareness marketing, and investing deeper in digital prospecting. This increased marketing fueled a nearly 30% increase in first-time visitors to our website, positioning us well to capture incremental demand during the peak holiday selling season, and setting the stage for longer-term customer file growth. Since mid-September, our Direct Channel sales have been trending up to 2020 in the mid to low single-digit range on higher-quality margin sales and grew roughly 5% on Cyber Monday. For the balance of the year, we expect the retail channel will continue to outperform Direct, as we cycle past the period last year that was impacted by the lower store foot traffic due to COVID. Additionally, with a strategic decision to shift and increase advertising in the back half of the year, we do expect direct channel sales growth to be positive over last year in the fourth quarter. Back to the third quarter. Our results demonstrate the healthy customer demand for our products and effectiveness of our marketing programs that are better informed by…

We will now begin the question-and-answer session. [Operator Instructions] The first question is from Jonathan Comp of Robert W. Baird. Please go ahead.

Hi. Thank you. Maybe first question, if I could just ask a little more directly on some of the recent trends, you're seeing both with respect to the underlying demand in any volatility from the consumer. And then also just the availability of product, how that's flowed and if that's allowing you to capture some of the seasonal sales that you missed last quarter. I know you gave total color on the ranges you expect for fourth quarter, but just hoping for a little more detail behind what you're seeing.

Yeah. Hi, John. We are seeing strong demand from the customer and haven't really seen much of a drop as the quarter has progressed. But as you mentioned, the inventory flow does continue to weigh on our ability to meet all of that demand. So, as we called out in the third quarter that some sales, we think we left on the table continues into the period so far through November. On top of that, we expect in Q4 that not all the sales are going to be totally lost, but it's factored into the outlook that is represented in our sales guidance.

Understood. And then maybe thinking forward to 2022 and up to 10% top-line growth you mentioned, could you rank order the biggest drivers? You have a lot going on with product innovation, the marketing efficiency and the enhanced targeting and digital effort. So how are you thinking about the contribution from each of those pieces? Neither in absolute, their rank ordered, what could be the biggest drivers as we look to next year?

I think you touched on some of the major points there. The momentum that we are really seeing in some of the ad spend effectiveness and particularly the digital channels, is what's I think a big improvement in the year that we're in right now and that's what we expect will even elevate further because we really had just started to test some of the functionality with our new customer data capabilities and allowing us to direct digital awareness and prospecting and also repeat purchase activity much more targeted and that's just going to continue to grow in 2022. We also have product innovation and product launches, including rolling out women in our Alaskan hard gear line for next year, re-launch of Best Made, and so we've got some exciting things in the product pipeline that will also support that. So, I think those are the 2 top items.

I would add, John, our store productivity continues to improve, although still a little behind 2019 as we both stated in our prepared remarks. We're making really great progress there and we think that 2022 will continue to improve upon our current trends, and so that becomes another driver for us as well.

Great. Maybe the last one if I could. The broader profitability outlook and the 2015 targets for a billion of revenue and back to high single, the low double-digit operating margin, that implies an acceleration in the margin improvement after '22. So, I'm wondering if you could discuss at a higher level how you're viewing the progression along, the operating margin target that you set out to and what are some factors that would cause the progress to come sooner or not, relative to some of the reinvestment opportunities?

Yes, you mentioned 2015. I think you meant 2025.

Yes. Thank you.

The progress we made in operating margins this year is very healthy and I'd say probably greater than the incremental annual improvement that we're going to need over the next 5 years to get to that target. But it's going to be a combination of gross profit, rate improvement from product margin, and just better management of our inventory plans and markdown cadence and productivity of the assortment will come down through the gross profit margin rate, but also leveraging selling expenses with some of the investments we're contemplating in the supply chain, leveraging some of the cost structure in our store infrastructure as the stores are able to grow sales annually over prior years. And while we're talking about investments in our capabilities that hit the G&A line, there are also investments that are a step change now, but not every year. We're going to see leverage in G&A as we progress through the next five years as well. So, I think those are all the opportunities to get us to that operating margin target of high single-digit, low double-digit range, which is where we've been at the past. But as a much smaller Company.

Yeah, that makes sense. Thanks again and best of luck.

Thanks, John.

Thank you.

The next question is from Jim Duffy of Stifel. Please go ahead.

Thank you. Hi, Dave. Hi Sam. Sounds like the team's been hard at work, a lot of encouraging progress. So, congratulations for that.

Thank you.

A couple of near-term questions and then some bigger picture questions. Sam, you mentioned you're in a good stock position to maximize holiday in your prepared remarks. Our visits to the stores, employees were talking about air-freighting product to get it to the stores. Is there inventory available for holiday that isn't reflected in the quarter-end balances that we're seeing with this print?

Jim, your question, we aren't sure how you are asking that question. Can you rephrase?

Where I'm going, Dave, is you have what looks to be very lean inventory balances out of October. We're hearing from people in the stores that there's airfreight product coming in. Is some of that -- are there good amounts of balances that are arriving in November or maybe even early December that can help you capitalize on any holiday demand that's there or is the balance we're looking at in -- at the end of October really what you're dealing with as your stocks for the holiday season?

Inventory continues to flow in, no question, and it will continue through the month here to satisfy. So, as we're selling through these peak periods, we're replenishing, but still below the ideal levels that we want to be at. Most of the airfreight product is already in our hands. Certainly, the holiday items are in place and then some of the core categories that we really wanted to be deeper in are in place. But what we're still chasing is some of our fall, winter seasonal items, outerwear items, and those are coming in day by day here and as soon as we do, we get it into the stores and on our website as quickly as we can.

Okay. Maybe framed another way. Do you think you have inventory positions such that you can deliver upside to that fourth-quarter guidance if the demand is there, or is the inventory to such a gating factor that that's not possible?

Yeah, I think as we stated in our prepared remarks that we've done our best to contemplate the puts and takes into our updated guidance and we remain comfortable with where our current sales guidance is.

Okay. And then you saw really nice improvement in average order value in your retail stores in the third quarter. Retail top 2019 levels in the third quarter sounds like traffic trends have been improving. Would that be your expectation that fourth quarter retail could be above the fourth quarter '19 levels as well?

From the average order size, yes. But from a total sales opportunity, I think we're still looking to be close to where we were trending coming out of our third quarter. So, we still expect that the higher conversion of store traffic is going to be continuing right through the fourth quarter compared to 2019, and that's really what's growing the store basis is, capturing a higher conversion rate on slightly lower foot traffic.

Got it. Okay. This next question is set up from my bigger picture question, but can you speak to the full-price percent of sales currently versus what you may have historically run at pre - COVID 2019 and before?

We have seen higher -- slightly higher full-price selling in years past. I'd say going back before 2019. But the ground that we've made up this year has closed a lot of that gap. So, what we're looking forward to is going back to even the historical highs and exceed it even from there. But a big part of that gap has been closed over the last 2 years with the percentage of full-price.

Okay.

Yeah. I think year-over-year, we're running about 800 basis points better than a year ago.

And that's still not to historical peak levels?

That's correct.

Okay. Interesting. So big picture, you've got the market discounting the stock less than 7 times the EBITDA guidance, less than 6 times the implied outlook in '22. That suggests that the market doesn't believe those margins are sustainable or that you can deliver on the growth. Across the industry, promotion's been minimal, margins been making new highs. What gives you guys’ confidence that you can continue to drive the growth in the business at full-price and refrain from reverting back to promotions?

Yeah, I think there's a lot we can do. And certainly, a lot of progress has been made to-date. So, when I think about some of the key drivers, I think about the work we're doing around retaining our very best customers and continuing to acquire new customers. I think about the amount

of knowledge and efficiencies, we're really beginning to gain through our marketing initiatives especially as we shift from more traditional media, to digital media, which is both more flexible, which gives us the opportunity to flex up and flex down based on results we're getting. I think we're in the infancy of really developing our brands beyond the Duluth brand, but really Alaskan Hard Year and Best Made, as Dave mentioned, this spring we are anxious to launch women's in AKHG. And so, we're really at the beginning stages of developing those brands, as well as the continuation of innovative development against the Duluth brand. I think about the amount of effort we're putting into automating our logistics network, which will bring not only efficiencies and leverage from an expense perspective, but will continue to allow us to scale with maybe less constraints around the labor pool as an example. But I think more important than that is meeting the expectation of the customers. We talked already about the percentage of our total business that's being driven by regular price. We think that there's still substantial amount of upside in that regard. And then really, it's the continued investments we're making to help us better manage our inventories both in terms of how we're planning and buying it to the overall amount in total which allows us to become more efficient and ultimately results in less markdowns and less clearance as a percentage of our total.

Excellent. Okay. Thanks so much for that perspective, Sam.

Yeah. You bet. Thanks, Jim.

The next question is from Philip Blee of William Blair, please go ahead.

Hi, everyone. This is Phillip Blee on for Dylan Carden. The expansion of Tractor Supply partnership is encouraging. Do you guys have any plans to continue to expand or launch similar partnerships and how important is this type of sales channel in achieving your longer-term revenue growth target, both from an incremental top-line perspective and just in general from brand awareness and attracting a new customer base? Thank you.

Hi, Philip. We're excited about what's happening with Tractor Supply. As I mentioned in my prepared remarks, we've just recently expanded to their online channel. I think importantly, we're starting to gain some pretty good learnings around what it will take operationally for us to scale this as a longer-term opportunity. We're also testing a couple of things with Danner Boot in 3 of our stores and we're looking at new ways to leverage that partnership as well. And so, all of these things ultimately, are leading us to, I think importantly, where we need to make investments into the future and I think the great news is our current long-range plans really doesn't at this point contemplate this being a substantial part of the business. And so actually, to Jim's earlier question, this becomes another element of growth for us that is not currently part of our long-range plan, and so we think that there's some upside here as well. Well, I think that wraps us up. I just wanted to thank everyone for participating. We look forward to speaking with you at the end of the year and wish you-all happy holidays. And thanks again.

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

Thank you.