Good morning, and welcome to the Duluth Holdings Inc. Second Quarter 2024 Conference Call. [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 second 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'm here today with Sam Sato, President and Chief Executive Officer; and Heena Agrawal, Senior Vice President and 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. I'm pleased with our second quarter performance as we delivered top-line sales growth of 1.8%, while expanding our gross margin 90 basis points as we began to see the benefits of our sourcing initiatives. The quarter was highlighted by strength in women's and our first layer business, as well as strength in our cooling technologies across Armachillo and Dry on the Fly, keeping consumers cool during the hot summer months. We saw a trend line improvement in both conversion and transactions, coupled with healthy increases over last year in both average order value and units per transaction. Before I review our second quarter results, I'm excited to update you on a key addition to our leadership team. On August 12, Eli Getson joined Duluth Trading Company as our Senior Vice President and Chief Merchandising Officer. Eli has more than 20 years of leadership and expertise. Most recently, Eli served as the Senior Vice President and General Merchandise Manager at Academy Sports and Outdoors, where he was responsible for merchandising, strategic planning and product innovation. Eli brings with him a wealth of experience and knowledge and has hit the ground running. We look forward to sharing his insights on future calls. I'm excited to provide an update on the progress we are making on our key strategic initiatives, including product development and sourcing, logistics network optimization and our retail store portfolio strategy. As mentioned in prior calls, we are seeing the benefits of our sourcing and product innovation efforts. This remains a critical strategic unlock for the business, which is allowing us to bring to market high-quality, innovative products more frequently, increase our speed to market, and significantly reduce our product costs. As Heena will discuss, we remain on track to realize significant product cost…

Thanks, Sam, and good morning. Echoing Sam's comments I am proud of the team for delivering top-line sales growth, coupled with gross margin expansion this quarter in what remains a resilient and value-seeking consumer environment. We not only successfully returned the business to growth with expanding gross margins, but also took important steps towards improving the structural aspects of our business model. As I stated on our first call, our primary focus is to unlock the full profit potential of the enterprise and to strategically deploy capital to unlock growth and white space opportunities. Realizing savings from Phase 2 of the fulfillment center optimization, evaluating the existing store portfolio to increase productivity and profitability and allocating capital to new stores are key steps towards making structural changes to drive sustainable, profitable growth. As Sam mentioned, we started Phase 2 of our fulfillment center network to maximize productivity and capacity. We are leveraging our most efficient and cost-effective Adairsville fulfillment center for a planned exit out of our Dubuque, Iowa facility by the end of October. This will incur restructuring expenses of $7.4 million, with $4.4 million in cash and $3 million in write-offs. The $7.4 million in restructuring expenses will be spread between two quarters with $1.6 million recognized in Q2 and $5.8 million in Q3 this year. We expect to begin realizing savings late in Q4 for a full year annualized run rate savings of $5 million. Adding more color to the progress on our retail store portfolio strategy that Sam spoke about earlier, we have identified priority markets and are on track to open two new sites in the back half of 2025. As it relates to our existing fleet, 15 stores or almost 25% of our current store portfolio are coming up for renewal by 2026. We…

[Operator Instructions] The first question comes from Janine Stichter at BTIG.

Hi, good morning, and congratulations on the progress. I want to start out with some questions around the store fleet. So, I guess, first off, I'd love to hear more about the two sites you're planning for next year, what you look for in terms of site selection. And then as you think about the 25% of the fleet that's up for renewal, how -- maybe some parameters of how these stores look versus the rest of the fleet, either in terms of comp performance or profitability and how we should think about what the range of outcomes might look like for this portion of the fleet?

Yeah. Janine, I'll maybe take the first part of your question, then I'll allow Heena to dive in a little more detail. So, the two LOIs we're excited for their locations. We haven't announced it publicly yet. We keep that pretty close to the vest. But as was stated in our prepared remarks, our primary criteria is obviously location, and we look at adjacencies. It's the size of the opportunity within the market share for our target consumer. And then undoubtedly, we've got some financial criteria that we look at. We stated on our last call that in 2023, our entire fleet was four-wall profitable, and yet we continue to look for improvement and want to ensure that we set appropriate hurdle rates on key metrics so that the store fleet continues to be additive to the company's results, both in terms of sales and profits.

And then to add to that, as we look at the fleet that's coming up, so we have about 15 stores coming up for lease renewal by 2026. And the way we are evaluating it, we are looking at a higher threshold of profitability as the renewals come up for those sites and we are evaluating all options, whether it's remodel, relocate or exit. So that -- as we look at our entire portfolio structurally, we want to make sure that it's improving in profitability overall.

Perfect. And then, I also want to ask about gross margin. So, it sounds like you're really seeing the benefits from the sourcing initiatives. Maybe a bit more color on how that unfolds and it sounds like there's a longer tail on those benefits. So kind of what that looks like over the next year or so? And the,n on the flip side, it sounds like you're seeing consumers continue to gravitate towards clearance. Just more color on what you're seeing from a consumer lens, how you're seeing them dropping and what you're expecting from a promotional standpoint?

Yeah. We talked about the introduction of our product development and sourcing strategic initiative. And in a vertical operation like ours, that's one of the most critical, an important strategic unlocks to allow us to not only compete long term and improve our profitability, but quite frankly, it's about bringing to market high-quality innovative products, importantly, more frequently increase our speed to market, meaning from ideation to actual on the floor, so to speak. And obviously, at the same time, leveraging our size and expertise to improve our profit margins. And as we have now over a handful of quarters started to really build out that team and bring in expertise to help us leverage our relationships. Our team has historically done a really great job within product development. I think this is the next level to that. And based on our time lines, we're now starting to see the benefits of that and see it flow through. In terms of the consumer today, we're being cautious about our outlook as we move forward. At the same time, we've talked a lot about our philosophical approach to ensuring that our inventories remain clean and healthy. And our clearance inventories ticked up a little bit at the end of Q2, and we are swiftly taking action against that and that impact we've contemplated within our guidance. And at the end of the day, we don't want to be carrying pre -- past season's clearance inventory into the next season and certainly not into the next year. And so, we're going to be really, really focused and urging about getting that in line. The great news is although it ticked up a bit, the quality and health of our inventory is in a really good place, nearly 90% of our current inventory is current season's goods. And so, this is a moment in time, we've got to address it and maybe not unlike other times we've had or will have, but we're going to stay focused on turning that inventory and focusing on new product innovation and bringing just great products and stories to market.

Yeah. And just to add on the gross margin piece, Janine, we -- like we said, in Q2, we delivered 90 basis points for the full year, we have line of sight to 150 basis points net of the inventory clearance issue. And as we look ahead, this is a tailwind that is expected to continue for the next four to five years, as we sourced a higher percentage of our products from -- directly from factories. And our goal is to get us back to and ultimately exceed the gross margins that we had pre-pandemic. Just in terms of a little bit more color on where gross margin is going. On the promotion piece, we're going to continue to be flexible and agile. Our approach is to stay competitive, make sure our brand has integrity with our pricing and that we are balancing both sales and margins. And so that's kind of our approach as we are looking at the second half but we feel very good about our second half in terms of all the innovations coming to market that Sam mentioned. And with Eli on board, we are really excited about the disciplined approach he's going to bring to the merchandising.

Perfect. That's helpful color. Thanks so much. I'll pass it on.

Thank you.

The next question is from Jonathan Komp at Baird.

Yeah, hi. Good morning. A couple of questions this morning. Maybe first, following up on the store topic. When you look at the retail stores, I'm curious what you make of the traffic declines that you're seeing. And given the lower traffic, do you still expect the store base, all the stores to be profitable this year? And if you were to consider closing some stores in the future, any sense of what impact that might have on your direct business in those markets?

Yeah. Jonathan, a couple of things I'll say. As we've discussed in the past, traffic trends in the stores have been challenging, we saw the trends improved sequentially this last quarter. Having said that, we're starting to see where we're getting benefits from a multichannel market strategy, although stores have declined. We're seeing improvements in our online business in those markets. Importantly, we've started to maybe unlock some real local in-store events that are, in fact, driving traffic back to the stores that it's not a price-driven event like this Underwear Trade-Up event. I said in my prepared remarks, and I want to just emphasize this because it's really, I think, important but gives us an optimism around an event like that is, in the first one in April, we had a pretty good response from the female consumer that was actually participating in the trade-up event. And that number in terms of the proportion to total people coming to the stores to trade up the proportion of women's anticipating jumped dramatically. And so, we think that we've now had a couple of those. We've had smaller tests in some other categories that is showing similar results. And so, we believe we've unlocked some really, really valuable and relevant experiences for the consumer. As it relates to the profitability and back to Heena's comments around our store portfolio strategy, we're looking at a combination of new locations as well as rationalizing the current portfolio based on productivity and profitability. And as stores come up for renewal, we've got about 25% of the chain here in the next, call it, year and a half. We're also looking beyond that and engaging our landlords and discussions where we believe we can make some meaningful improvements in the profitability. And in some cases where we just don't believe it's going to meet our thresholds, we're open and prepared to exit those locations. So, our focus is really, really deep on ensuring that the retail portfolio is a profitable contributor to the overall enterprise. At the same time, we recognize the importance of a multichannel ecosystem and the benefits it provides the company from a consumer engagement and sales and transaction perspective.

Got it. And then maybe to follow up on inventory, just to ask a little bit further the sequential dollar increase from the first to second quarter looks pretty substantial, maybe the largest that we've seen in the past for Duluth. So, could you maybe give a little more color? Were there any early receipts? Are there signed some of the new categories aren't resonating? And maybe a broader question about sort of SKU proliferation and how you avoid adding too much in terms of the overall SKU count as you pursue some of these new categories?

Yeah. So, in Q2, we shared in Q1 coming out of -- let me be clear. Coming out of Q4, sold a lot more units in a highly promotional environment. So, we came out of Q4 in a much leaner inventory position than what we had projected when we were placing that spring season orders. And so, one of the areas that we sold through at a higher rate was our core inventory, which had an impact on our Q1 sales. As we ramped up heading into Q2, not only were we able to react to our core products, but the team did go back and react to some areas within the spring/summer collection that they thought we were light on. Those orders weren't receded until April. And so candidly, it cut short our selling window which impacted our sell-throughs and led to higher clearance inventories. And as I said before, we're going to address that here this quarter. We're going to continue to see sequential improvements in our inventory levels, clearance specifically as it relates to the penetration to the total. And largely, I think the health of our inventory, as I said, to Janine, nearly 90% is current season's stock. And so, we feel good about where we are today, and we've got a little bit of this moment in time where inventories are ballooned.

And are you willing to share how much incremental markdown pressure? I know you -- given the outlook on a net basis for the gross margin, but how much incremental discounting pressure are you assuming or any detail there?

Yeah, that's contemplated in that 50 basis points that we took back for the year-end guidance.

Yeah. So Jonathan, just reiterating, we had 200 basis points [indiscernible] cost and sourcing initiatives, and we've layered in 50 basis points to ensure we come out clean and are able to take mitigating actions for clearance inventory in the second half.

Okay. Great. And then, Heena, just one last one, if I could follow up. I know you don't guide quarterly specifically, but third quarter typically is your lowest profitability quarter. So, I'm wondering if you're expecting to be flat or positive on adjusted EBITDA or any other just directional color as we think about modeling the quarters?

Yeah. I think from a top-line perspective, the quarter is expected to follow the seasonality as in prior years. From a margin perspective, I would say, given the clearance inventory, we will see higher pressure in Q3 as we try to clean out of it sooner rather than later.

Okay, great. Appreciate the color. Thanks again.

Thank you.

Thank you.

Our next question is from Dylan Carden of William Blair.

Thanks. I'm curious if you can provide any color on just the range of performance between the stores. And sort of what's the best way to think about the productivity? If you go all the way back to kind of 2017 when you're really ramping the count, it's more or less half since then. So what's -- is that the entire fleet? Is that a factor of sort of an early pop from direct business? I guess -- and the ultimate sort of theme here is just to kind of get a sense of what the potential impact could be as you close or renovate?

Yeah. So, Dylan, maybe I can just give more of how we are thinking about the store portfolio. The stores play a critical role as we think about our omnichannel strategy. Our customers that come to the stores and shop online, they, on average, have a higher transaction or higher order value, plus they shop more than twice with more than twice the frequency compared to single channel. So, stores remain a critical part of our overall omnichannel strategy. They play off each other. They also offer a lot of services like buy online, pick up in store returns, et cetera. So, they are a critical component of offering that seamless consumer experience. In terms of profitability of the fleet, like any fleet, there is a normal curve. So, some stores are in the top 15, some are in the bottom. And that's why we are -- we have a three-pronged approach. One is -- to address one of the things that was asked earlier on store traffic. One prong is making the brand awareness and store awareness for the entire fleet, higher by having locally targeted efforts on marketing and experiential events. The other one is rationalizing our current fleet and holding them to a higher standard of profitability as we come up for renewals naturally, whether it's through remodel, exit or relocate. And then, the third one is adding new sites to gain market share with our target consumer in the context of the omnichannel market. So that kind of how I would look at the overall portfolio, the goal is really to grow that entire portfolio profitability.

So, I guess as you think about square footage growth over the next five years then as these leases come through, between openings and rationalization, is the goal to kind of maintain a flat overall square footage to more productive level? Is that sort of broad strokes what we're talking about here?

We will give you more specifics on those as we get deeper into especially the renewal portfolio. Like we said earlier, we are on track to open two new stores in the back half of '25 and our goal is to maintain a healthy level of stores that are growing and profitable.

Let me try another one. So, if you're -- it seems like you've got a better handle on sort of line of sight into a lot of really nice cost efficiencies here. I'm curious as you kind of roll those through when you might expect to kind of get back to a level of more consistent profitability. Is that something that you think -- you kind of mentioned four years there on at least sort of the gross margin side. Is this going to be a sort of relatively slow process, or do you think this model can inflect relatively quickly kind of the next year?

Yeah. I think Dylan, Heena has brought some incredible rigor and insight into how we're going about both our benchmarking studies as well as then the application of those findings, evidenced in part with the announcement we made to close one of our legacy fulfillment centers through the lens of the investment we made in the Adairsville and the efficiency gains we're getting out of that. And so, I think that that's an example of where -- there's some real-time benefits that we will continue to look for as well as ensure that we have visibility to what the longer-term implications are. That, coupled with some of the benefits we're starting to see from some of these other initiatives like our product development and sourcing initiative. I think we're getting some benefits on the margin line. We're getting some benefits in the SG&A line, this legacy fulfillment strategy, the capacity and optimization strategy, it's leading to Q4 benefits of this year. And then, on an annual basis, a new baseline run rate of about a $5 million reduction in our SG&A line and that's real money. And so, we believe that, that benefit is actually not coming at the cost of us doing more business for flowing through greater profitability. So, it's a combination of the different line items that are attached to our different strategic initiatives. And I think this is an ongoing focus of ours, there's really no end in sight in terms of us continuing to look for ways to optimize our costs and get ourselves into a place where our investment strategies really are driving greater top-line and flow through.

Very good. And just -- I just want to be sort of crystal. The comment that you can get gross margins above pre-pandemic, are you talking about getting back to, if not, above the 57%, just so we're using real numbers?

Yeah, I would just -- I would say directionally, our goal and what we're marching towards is getting gross margins at or better than pre-pandemic levels.

Okay. And then I had one more that's escaping me, apologies. Freight. And maybe I missed it, but is there any contemplation of higher freight rates in the guide, or is it that given how you turn inventory that, that's more like 2025 story that we can kind of wait for?

Yeah, that's more of a '25 impact versus the '24 impact, but yeah, we've contemplated the various headwinds and tailwinds in our guide.

Excellent. Thanks a lot.

Thanks, Dylan.

Thank you, Dylan.

This concludes the question-and-answer session and concludes the conference. Thank you for attending. You may now disconnect the conference call.