Good day, and welcome to the Duluth Holdings, Inc. Third Quarter 2022 Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Nitza McKee. 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'll turn the call over to Sam Sato, President and Chief Executive Officer. Sam?

Thank you for joining today's call. We are in the midst of our peak season when direct order volume and store traffic are at the highest levels. So I look forward to providing insights on the trends we are experiencing and the great work our teams are doing to deliver against evolving consumer expectations and execute on our strategic playbook. I am also excited to share updates on our brand positioning and critical investments we are making to position our business for long-term growth. We are committed to staying the course on our Big Dam Blueprint initiatives in the phase of many macroeconomic headwinds that we are experiencing today and expect to continue into 2023. While the current environment does pose some near-term challenges for the business, our efforts remains focused on unlocking the company's full potential for sustainable growth. We are all in on the commitment to support scalability and further enable Duluth to deliver long-term growth and profitability. I'll share further detail on some of the key initiatives shortly, but at a high level, we'll continue to execute against our commitments on leading with a digital-first mindset, supported by investments in our logistics and technology infrastructure and in product development and new innovation, while driving brand awareness across our evolving portfolio of sub-brands. But first, regarding our current business, I am pleased to share that we've seen several key trend reversals that point to progress in the areas that have been our focus. Most notably, total net sales for the company grew 1.3% in the third quarter, a sequential improvement of 770 basis points when compared to the first half of the year. Driving that growth was our direct channel, which was up 7% in Q3 versus down 6% in the first half of the year. I'll share…

Thanks, Sam, and good morning. For the third quarter, we reported net sales of $147.1 million, up 1.3%, compared to $145.3 million last year and up 8.6%, compared to the same period in 2020. Our direct channel sales were up 6.8% from last year, which included online sales growth in store markets of low-double-digits and in non-store markets of low-single-digits. Our retail channel was down 6.6% in the quarter representing a significant improvement to the trend in the second quarter of over 500 basis points and benefited from outstanding conversion of the store traffic to sales of over 300 basis points. Traffic to our stores is still below the prior year, but has improved to being down mid-single-digits versus mid-teens in the second quarter. Total net sales growth was strongest in our established Midwest, Southeast and Northeast markets. As we shared on our last call, better supply chain flow and targeting earlier receipt dates on our inbound inventory positioned us well during the third quarter and better supported our transition into the fall and winter season. Sales turned positive in early September and continued through October, up mid-single-digits to last year. As planned, we increased the marketing investments during the quarter to align with the inventory position and focused our messaging on new seasonal products, our women's AKHG launch and driving traffic for our annual Big Dam Birthday sale event and our preseason global sale event in the end of October. As we entered the fourth quarter, holiday shopping was slow to get started relative to last year's industry push to get consumers to buy early. The first two weeks of November during the mid-term elections, sales were down mid-teens. For the last two weeks of November, sales were down high-single-digits to last year, and that trend continued for the…

Thank you. [Operator Instructions] Our first question comes from Jonathan Komp with Baird. Please go ahead.

Yeah, hi. Good morning. Thank you. I want to just maybe gauge your overall sense of the trends you are seeing in your business. I know you highlighted the third quarter, some of the sequential improvement you saw in both channels, but it looks like the fourth quarter, you are embedding the opposite, the return to negative year-over-year performance for both direct and retail. So, what do you make of sort of the trends you are seeing? And then given some of the commentary, do you think it's going to be hard not to still show sales declines going into the first half of next year?

Yeah. Hi, John. Where we were seeing some of the trends that I mentioned on the call coming out of our third quarter, November, the first two weeks, in particular were kind of the toughest and we attribute a portion of that to the early shopping as last year. And so, earlier in November, going up against tougher comps last year, our November, we posted an increase over the prior year of low teens. And so we are comp – it was the toughest month for us to comp. But going into December and January, we're comping easier periods relative to last year, both from the sales trends, shopping behavior and our inventory position was really tough as we move through December. So, as I mentioned, the more near-term trend of down kind of high-single-digits that we saw coming through the back half of November through Cyber Monday is really where we expect some of the rest of the period to play out, but with more upside in the coming weeks than what we felt in the first part of the quarter. But that being said, I think we are looking into next year and we're still planning it. We had inventory issues in the first half of last year in the first quarter in particular. And so I think we'll see some momentum because of that. But the overall consumer backdrop, at least as we're seeing it, isn't going to drive a significant growth over the next few months.

Thanks. That's helpful. And maybe a follow-up then to understand how you're planning the organization. The margin for the business this year will be the lowest that – isn't our model looking backward? And I'm just curious if the sales were not according to your plan and stayed negative, how long would it take or how much pressure would you need to see incrementally on the top-line before you took a different approach to the operating structure or the cost structure of the business, maybe anything more drastic than the current actions you've outlined to slow some of the incremental spend?

Yes. Jonathan, this is Sam. Yeah, so a couple of things. We've got some expense flexibility within OpEx specifically. Our intentions at this stage, while the near-term challenges certainly are impacting our results, we are currently focused on unlocking the company's full potential longer term and as we talked last year, just really beginning the journey of infrastructure and technology investments. And we've got a number of things that are in the works and certainly, we're excited about where we are with Adairsville and what value that will create, the pivot to a different warehouse management system that will allow us to optimize that investment in Adairsville is exciting and in fact, I think it lowered our CapEx spend next year to $35 million or something like that or this year, yeah. And so, as we think about next year, while at a high level, we're going to stay the course on our investment strategy for the long-term. We also recognize the importance to manage the business as well. And so as we've always said, we are acutely focused on managing expenses. We are being highly critical of investments that are outside of kind of the must-haves to deliver our strategic initiatives and as we think about next year and as Dave said, we'll share more on our next call as we're finalizing the plans for 2023. We are going to take a really conservative approach, not just to sales and margins but also expenses, capital, but also not take a short-term look necessarily in our strategic initiatives and what investment requirements will be necessary to unlock that.

Understood. Thanks for sharing the color.

Yes. You bet.

[Operator Instructions] Our next question comes from Jim Duffy with Stifel. Please go ahead.

Hello, thank you. Good morning. Thanks for taking my questions. You guys gave a lot of detail on categories on the call. It sounds like you're having good success with Women. You're having some success with new products. Men's core product however has been a challenge. Sam, can you speak to customer acquisition dynamics? You're turning to promotion to reengage existing customers? Is that improving customer acquisition as well?

Yeah. Hi, Jim, thanks. Yes. So we're obviously excited about the continued traction we are gaining with Women's. Total business was up 10%. Obviously, the success we're starting to see with the introduction of AKHG and we are supporting that with investments like the 20-store reconfiguration we've done in order to give Women's greater space and improved shopping experience. And equally important, as AKHG starts to grow, it requires its own dedicated space in the stores, as well. So those are all good things and our customer acquisition, new customers are reaching this 50-50 point now between men and women, which is exciting for us. Our current female shoppers are at its highest peak that over the last three years and so that's, again, exciting for us. So we remain confident in our product strategy and in our marketing strategy to not only engage the female shopper, but also as we discussed a few calls ago and continue to – our target consumer that 40 to 50-year-old, we're getting traction there, which is a good sign. And we want to be careful that we don't alienate our core consumer who's in their mid-50s, but at the same time, recognize the need to build a business for the future based on a slightly younger consumer that really is in the spending kind of height of their lives and careers. So, both of those elements to our marketing strategies and customer acquisition strategies, we continue to see really good progress there and we are pleased with what we're seeing.

Okay. And then it's a step backwards in promotion from previous strategies, I am curious how you see the balance between promoting the support sales and moving inventory versus conditioning the consumer that the brand is always on sale. Perhaps related to that, I was wondering if maybe this causes you to rethink your pricing architecture. It sounds like you're having success engaging new consumers with core products. But if I interpret your comments, it sounds like new consumers aren't coming back to – or I am sorry, your existing consumer base isn't coming back to core products unless they're on sale.

Yes. So, really important question and so a couple things I'll say. One is, we are always going to balance and take a strategic approach to how we balance price and brand integrity. We want to be really careful about that and in this heightened promotional period we are in, everyone is faced with inflationary issues, and it clearly has taken a toll on the consumer and we're not immune from that. Having said that, we think that the products we build to deliver against solutions and durability needs and expectations that our consumers have, our price value relationship is really good. It's just we are faced with a highly promotional, volatile environment right now and so, while we've got to be more promotional than we are historically, we are also making sure that we're not having a fire sale, so to speak. And I think in certain areas of the business, specifically, again, back to Women's and AKHG and some of the new innovation like our Funk No! men's underwear, the success in those areas continue to show that our brand strength is as good as it's ever been. It's just we're competing with highly promotional activity that now is about share of wallet, and that share of wallet has – the spend has reduced because of inflationary issues. So, I wouldn't say so much that we are rethinking our pricing, our regular pricing strategy. We're going to build products that satisfy the needs of our customers through the lens of durability and performance and solution based. But we also recognize that at times, we've got to be competitive. We've got to make sure that we are strategically taking the appropriate actions to not allow our inventories to back up and then that creates a whole different dynamic as we experienced two years ago. But having said that, we're investing heavily in innovation and we recognize that innovation with the right price value relationship is critical and so our teams continue to think about that and think about other areas of the business whether it's price or adjacent categories that we can continue to innovate into.

Okay. Thank you for that perspective. And maybe one last one, should we interpret your comments on the cautious approach to 2023 to mean that perhaps you're backing away from planned store openings?

Yeah, not necessarily. I would just say, as we laid out in our Big Dam Blueprint, the big chunk of our investments are based on a digital-first mindset, digital-first business and really you think about, for example, our traffic and transactions coming from a mobile device are at their highest levels that they've ever been and we're consistently holding to those levels and in fact continue to grow as a percentage to our total online business. So we recognize that our investments have to be about enabling a digital marketplace, so to speak. Having said that, we recognize stores are really important piece of our omni-channel customer experience and it's about gaining and garnering new consumers. We recognize that. It's a place to provide incredible service opportunities for the consumer, whether it's buy online and pick-up in store or even return or exchange product. We recognize the importance of that. Hence, we just completed a remodel in our St. Charles, Missouri store to a new format which was based on a lot of work we did with the consumer in terms of what they want and expect out of a modern customer experience journey and so we've done that. And so we're going to continue to look for opportunities to open stores, but we're going to be highly opportunistic about that given the backdrop of what we are expecting in 2023 and some of the priorities we have around technology and logistics investments, we want to be really prudent about where our capital outlays go. And again, building for the long-term value and growth benefits of the company.

Understood. Thank you, Sam and best of luck for the team through the holiday season.

Appreciated. Happy holidays, Jim.

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

Thanks. Just a point of clarification. Did you indicate that inventories would be up mid-teens by year-end? Did I hear that right?

That's right, Dylan. That's the estimate.

And so I guess the disconnect there, the spread between kind of the implied guidance for sales or actually the actual guidance for sales would suggest potentially that the gross margin pressures kind of persist into the front half of next year, which I imagine you are not going to blip necessarily, but maybe you will help us out as far as modeling. When does freight at least turn into a tailwind, how are you thinking – you were asked kind of about pricing, but what's sort of the currency of the inventory and the risk of additional promotions kind of into the front half of the year? Anything you can say around that? Thanks.

Yeah, absolutely, while inventories might land up mid-teens compared to last year, it would still be on par, slightly below two years ago and that's really a function of where our inventory was last year, unfortunately, below where it needed to be. So we just – we're getting back to the level that's necessary to enter our spring/summer season. We expect, while clearance levels today are mid-single-digits, we would end up maybe high-single-digits as we look forward to the back to the end of the fourth quarter and that's not unusual for where we end the season. So we don't see that the margin pressure will be there. We do have a tailwind on freight expense in the first quarter of next year that roughly almost $4 million that that will lapse and get the benefit on the gross profit margin for, but product margins will probably still be tougher than they were last year, but not due to an overhang of inventory, but just simply due to competitive pricing environment we are in. So, we're not concerned with the higher inventory levels just compared to prior year.

Awesome. Thank you, Dave. And then, kind of just curious, from an outsiders' perspective here, it seems like the sales from the blueprint aren't necessarily materializing, but the costs are, and sort of pausing the ERP deployment is a little bit telling in that same regard. What's the capacity here to kind of – it sounds like as far as the guidance in the fourth quarter pull back on some of the cost here that maybe we're building out to billion dollars in sales or whatever the ultimate target might land. Is that something where we should see a steeper reduction in SG&A in particular, sort of next year?

Yeah, maybe I'll answer the first part of that Dylan. This is Sam. So, as I said in my prepared remarks, the current environment, it's posing near-term challenges for the business for sure and we're going to prudently focus on managing expenses. Having said that, we are focused on unlocking the full potential long term and so, yeah, there is some flexibility in our OpEx as we move into next year, for sure, but we're not going to necessarily cut our nose off despite our face, meaning there are certain things that we believe we've got to invest in, in order for our business to scale and continue to grow sustainably long term and that's largely around technology and logistics. And so, while we may, depending on what next year looks like, we may extend the timeframe of those capital investments, the investments themselves will ultimately have to be made in order for us to deliver against the longer-term value proposition. Specific to the pause on the ERP, that was really more about as our new CTO came in and looked at our infrastructure and our current course and speed said, we really should prioritize and we would get greater near-term value out of a more optimized warehouse management tool than ERP. And so, he really advised us and made the call as we expected him to give us kind of a re-prioritization through his expert lens on not only where we would get greater value, but importantly, in these conditions, where we could potentially get greater near-term value. And so, I think that was the appropriate call and we eventually are going to replace the ERP system. We're going to have to do that but it's now moved down the priority list, because AJ believes there's other areas that take greater priority and will deliver greater results for us faster.

Thanks, Sam. Appreciate that. That’s good for all.

Sure. Appreciated.

This concludes our question-and-answer session, as well as our conference for today. Thank you for attending today's presentation. You may now disconnect.