Good morning, and welcome to Duluth Trading's Third Quarter 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 Nitza McKee, Senior Associate, IR at 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'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, Nitza, and thank you all for joining today's call. Our third quarter performance did not meet our expectations. We felt the impact of a highly promotional environment and then seasonably warm weather resulting in a net sales decline for the quarter of 8.1% with our direct and retail channels delivering similar year-over-year top-line results. Despite the macro and weather-related impacts, we are pleased to see growth in our average order value and a double-digit increase in digital traffic. That said, these were not enough to offset the year-over-year contraction in transactions. We ended the quarter with inventory levels higher than planned, driven by a combination of early planned receipts of core products to ensure we are in stock for the holiday selling season and cold weather goods in which sales were impacted by warmer weather. As a result, we began taking the necessary actions to increase our unit selling velocity beginning in late October and I'm pleased to report that our top-line trends have meaningfully improved leading into the all-important Black Friday week and continuing through Cyber Monday. As we enter the final peak selling weeks of the holiday season, we are committed to prudently managing our inventory and ending the fiscal year in a clean, high-quality position. In what remains a highly competitive market, we have an unwavering commitment to delivering value to our customers, while also positioning our business for continued success in the future. Looking past fiscal 2024, leveraging our advanced sourcing and product innovation functions and in partnership with our new Chief Merchant, Eli Getson, we are significantly enhancing our go-forward assortment and inventory management. As we look ahead to 2025 and beyond, we are building upon the success of our strategic initiatives, making meaningful progress on structural improvements and embarking on enterprise planning…

Thanks, Sam, and good morning. In the third quarter, we expanded our gross margin by 210 basis points. However, top-line sales declined 8.1%. Unusually warm weather impacted fall-winter seasonal sales, and as a result, our inventory levels increased at the end of the quarter. As Sam mentioned, we are taking swift actions to end the year clean on inventories and as trends have improved, our second half-to-date top line is now tracking at minus 3%. We are pleased with the progress of our strategic initiatives as we saw a second consecutive quarter of gross margin expansion from our sourcing initiative and reduction in fulfillment and transportation costs from the logistics network. Our structural improvements are on track. In Q3, we successfully completed Phase 2 of our fulfillment network optimization and exited one of our legacy fulfillment centers announced last quarter. As stated on the last two calls, our primary focus is to unlock the full profit potential of the enterprise and to strategically deploy capital to unlock growth opportunities. Realizing savings from Phase 2 of the fulfillment network, revitalizing the store portfolio to increase productivity and profitability and allocating capital to omnichannel growth are key steps towards making structural changes to drive sustainable profitable growth. In addition to our strategic initiatives and structural improvements, as Sam mentioned, we have launched Enterprise Planning, an end-to-end cross-functional initiative to significantly enhance our operational and planning processes. Providing an update to Phase 2 of our fulfillment center network, we completed the closure of our Dubuque, Iowa facility at the end of October. This incurred restructuring expenses of $7.7 million which was spread between two quarters with $1.6 million recognized in Q2 and $6.2 million in Q3. We have begun to realize savings in Q4 for a full-year annualized run rate savings of $5…

We will now begin the question-and-answer session [Operator Instructions] The first question comes from Dylan Carden with William Blair. Please go ahead.

Thanks. Sorry if I missed this. You mentioned 25% of the fleet comes due by '26. Do you have a sense of what falls under your new threshold as far as sort of the -- even if it's a range, the magnitude of closures from here?

Hey Dylan, yes. So as we said, we've got about 25% that come due. We have to our process that Heena has been working on recalibrating our hurdle rates for profitability and we're really assessing those store by store as we get into the time frame to renew or renegotiate. So we continue to have our eyes on those 25% and as we get closer to renewal dates, we're vetting those much deeper in anticipation of either renewing, closing or relocating.

Got it. And if I'm looking at the model -- as far -- I appreciate everything you've done on production and distribution efficiencies from a gross margin standpoint. What's sort of the primary driver to get you back above the line from an SG&A perspective?

Yes, I think -- well, a couple of things, I'll say. One is, I'm really pleased with the progress and traction our teams are making on those key initiatives tied to our Big Dam Blueprint. And as you know, some of it is timing in terms of when we start to realize those benefits clearly around our product development and sourcing initiative. We're starting to see that the logistics strategy with Adairsville. I'll take a moment just to celebrate. We're now lapping on about a year since Adairsville came online. It has processed something like 64% more units than a year ago at this time over the Black Friday weekend. And at CPU -- variable CPU costs are actually exceeding what we initially targeted. It's 73% lower than the legacy fulfillment center. So a lot of those things we're starting to see come into play now. It's enabled us to rationalize our fulfillment center network, and we were able to close the buke on that on an annual run rate is about $5 million in savings. So I think over the next -- candidly, over the next handful of years, you'll continue to see the benefits of that work in addition to some of the other structural things that Heena has been charged with. And over the next handful of years, I think you'll see our SG&A come closer into line where we expect it to be. And importantly, allow the benefits of these other initiatives like the product development and sourcing initiatives to really flow through to the bottom line.

Yes. And I would add, in addition to the structural changes, which is around fulfillment center optimization as well as improving overall store portfolio profitability. We are -- our CapEx this year was half of what -- less than half of what it was last year and that's kind of the growing run rate you are looking at, which will also improve the depreciation cost that flow into SG&A. So in addition to the structural, the equilibrium of CapEx to depreciation will help with the overall SG&A costs.

Got it. And also, it also feels like it's a store productivity issue. I think you kind of just bless that there in your comments. I mean where productivity is if you start closing stores, presumably, you get some of the productivity overall fleet productivity to improve and I would think that should help a not a significant amount, given where kind of sales per square foot are at present.

Yes. Like we said, we've established higher hurdle rates or when we renew, which gives us leverage and negotiating for lease renewals with options to either relocate or close as the case might be. And as we do that, it improves the overall health of the portfolio with the new sites, meeting much higher hurdle rates, the older sites that are being renewed also being held to those same standards improves our overall productivity, and our focus on omnichannel marketing for those priority markets to improve traffic to those stores.

Yes. And Dylan, I'll add to that because I want to be clear that you all understand strategically retail stores, as we've always said, are an important part of our omnichannel ecosystem and I think that's really important to understand. Our stores since at the end of 2023, all stores were four-wall profitable. This is really about, to your point, exactly as productivity is within our fleet of stores and as we begin to open new stores, we're holding them to a higher productivity hurdle rate so that we're ensuring that we're getting the returns that we need and that those investments are aligned with our longer-term strategy. So I think in that regard, we're in a really good position because we've got 65 stores today. It's not as though we've got 500 that we've got to rationalize. And we think that we'll make good progress on that front, combined with some of the things I mentioned in my prepared remarks around our go-to-market strategy and localizing some of that. I think that we'll continue to see improvements in our retail store portfolio, both as we kind of renew and/or rationalize some locations in addition to then adding some new locations with higher hurdle rates.

Great. Last one for me. The cool weather gear that you couldn't sell in September October, is any of that, can you pack any of that away or do you have to kind of clearance it by year-end?

Yeah. So part of our strategy is exactly that. And again, I want to make sure that we're clear about what led to the current inventory scenario. And as Heena said, it's really three buckets. There's a timing issue relative to the in-transit bucket that we recognize ownership. That's about a third. There's a third that is tied directly to a planned early receipt of core goods because as you know, we're writing these things further out and last year, we went into Q4 a little lean and came out essentially out of stock and that led to depressed inventory levels throughout Q4. And then the third is really based on our receipt of fall and winter goods. We didn't sell it in third quarter largely because of some weather issues. And so as we look at going through Q4, there's two components that we're focused on. One is ensuring that the seasonal carryover of those receipts don't hurt us into next year, meaning they don't transition into clearance inventory levels. By the way, our clearance inventory levels currently are at about 3% of total, which is 100 bps less than a year ago and sequentially improved from 11% last quarter. But we want to ensure that as we go into next year, this carryover fall-winter doesn't impact our clearance level, which then continues to put further pressure on our margins. And so the seasonal things that are unique to this season, we will mark down and we'll sell through that this quarter. There is core kind of seasonal products like black down puffer jackets that whatever we don't sell through, we're going to pack those away because we buy them every season and it's a small amount of inventory, but inventory nonetheless that we really don't need to mark down as we move into next year. So long answer to your question, but I think important articulation is, yes, there is goods within fall-winter that we will not have to mark down and we'll be able to pack away for a short period of time.

Excellent. Thank you.

This concludes our question-and-answer session and Duluth Trading's third-quarter financial results conference call. Thank you for attending today's presentation. You may now disconnect.