Duluth Holdings Inc. (NASDAQ:DLTH) Q2 2023 Earnings Call Transcript

Duluth Holdings Inc. (NASDAQ:DLTH) Q2 2023 Earnings Call Transcript August 31, 2023

Duluth Holdings Inc. beats earnings expectations. Reported EPS is $0.06, expectations were $0.01.

Operator: Good morning, and welcome to the Duluth Holdings Second Quarter 2023 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.

Nitza McKee: 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 Dave Loretta, 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 prediction of future events. And with that, I’ll turn the call over to Sam Sato, President and Chief Executive Officer. Sam?

Sam Sato: Good morning, and thanks for joining today’s call. Before I review our second quarter results, I’m thrilled to share an update on two of our key strategic initiatives that are cornerstones to our Big Dam Blueprint. I’ll start with the exciting news that our newest highly automated fulfillment center located in Adairsville, Georgia has, as planned, begun fulfilling customer online orders and replenishing our store inventories. The scheduled ramp-up is on time and gives us confidence that our October target date for being fully operational is achievable. Representing a significant investment to future-proof our business, this upgrade to our logistics network will support meaningful long-term growth, address our customers’ expectations for faster delivery and immediately generate cost efficiencies that will build over time.

I’ll share more about this shortly, but first, I’d like to thank all our team members and vendor partners responsible for delivering on this key milestone. In addition to going live in our highly automated fulfillment center, I’m equally excited to share on the growth of our sourcing and product innovation functions with the onboarding of several new team members that have deep and extensive experience in apparel design and manufacturing. This team accelerates our efforts to develop and bring to market innovative products that serve a purpose or solve a problem for our customers. Duluth has a long track record of bringing first-to-market fabrications and features to our customers, representing a strong price value proposition, supported by cut-through marketing that is fun and memorable.

The sourcing team will augment and strengthen this competitive advantage, allowing us to enhance the pipeline of new products, while improving our speed to market, fueling greater full price selling and sub-brand loyalty while generating significant product cost savings over time. This strategic initiative, coupled with the go-live of our highly automated fulfillment center sets the stage for meaningful and sustainable long-term profitable growth. Now turning to our second quarter performance and the current consumer environment. Customer demand for our offer remains strong as evidenced by continued growth in units sold, increased buyer counts and online visits, all with higher conversion rates. We shipped more orders in the second quarter compared to last year as demand for our spring and summer collections were healthy.

As we navigate what remains a dynamic macro environment in which customers continue to seek value, we are managing the business prudently, controlling what we can control while staying keenly focused on elevating our unique brand and sub-brand positioning. Importantly, our inventory position is in good shape and ended the quarter below prior year levels due to strong seasonal sell-through and our disciplined efforts to appropriately plan our purchases and receipt flow. Total net sales for the second quarter were $139 million, which was down 1.7% last year and can largely be attributed to lower store traffic in the month of May, which subsequently trended flat to slightly positive beginning in June. We were very pleased by our strong online performance, which grew by nearly 2% in the quarter.

Importantly, our second quarter conversion rate improved year-over-year, both in-store and online, as our assortments and marketing efforts resonated with our broadening customer base. Double clicking on our online performance. Visits to our website were up in the quarter, driven by higher volume on mobile traffic, which accounts for nearly 70% of all online visits. Sales transactions through mobile devices increased roughly 8% and accounted for 55% of direct channel sales. We continue to realize the benefits from last fall’s web platform upgrade, which enables faster load times on mobile devices and easier navigation, contributing to an increase of 50 basis points in our mobile conversion rate. With our direct channel representing 62% of the total, an increase of 200 basis points from last year, our results continue to prove that our digital-first strategy balanced with an omnichannel service model is delivering on our customer shopping expectations with Duluth.

Moving down the P&L. We delivered adjusted EBITDA of $8.6 million for the second quarter. And while we’re not satisfied with the bottom line EPS results, the investments we are making now in technology, supply chain and product innovation are keys to unlocking and fueling longer-term profitable growth. Our balance sheet strength with no drawings on our $200 million line of credit at second quarter end and none expected at year-end, supports our multiyear strategy to invest in the key growth drivers of the business while being funded by operating cash flows. We have strategically managed our inventories to support the programs that have momentum and minimize end-of-season clearance, which is in a healthy position and below last year. As I mentioned, demand for our spring and summer collections were strong, and we continue to deliver great results in key collections like Garden and Landscaping and Planting.

These collections delivered a sales increase of nearly 40% in the second quarter. Our women’s heirloom gardening bib overall was again the number one style for the quarter. Our plans are to make this hero product a year-round item, which we’ve designed with a soft fleece lining option to add warmth and comfort during cooler months. Our total women’s business grew almost 3% during the quarter, with increases in Duluth branded collections like heirloom garden, but also in the base layer unders and the newer AKHG collections. Growing our women’s apparel segment, which now represents 35% of total apparel sales is a key strategic initiative and continues to gain momentum. Success in the women’s business is being derived from a combination of outstanding product design, expansion into relevant categories and our secret sauce of utilizing proven fabrications across styles and uses.

The women’s bra collection was up nearly 50% in the quarter and represents a significant growth opportunity engineered with unique comfort, fabrics and features in a wide range of fits and sizes. We’re seeing great response from the newly released Armachillo TeeLUXE Bra, which is infused with Made-in-the-Jade technology that features soft-touch, seamless comfort and all-around support elements. As we — last year’s launch of women’s AKHG, we’re pleased to see continued interest in demand for our outdoor recreation offering. We saw notable success in our lightweight Access Point collection made for ultimate endurance on the trails and the Stone Run collection, which provides the same functionality with a more structured and durable design. For fall, we’re introducing new soft and cozy cross-layer styles in the AKHG nightwear [ph] and Bamboo programs.

We’re also expanding our use of sherpa and fleece linings within AKHG which broadens our assortment during seasonal transition periods. And our long success in flannel shirts continues as we expand new styles, colors and prints. Overall, the AKHG sub-brand grew 14% in the second quarter, and we expect a similar growth rate in the back half of 2023. AKHG represents a significant growth opportunity for Duluth. We draw so much inspiration and product design ideas from our loyal Wayforger community, sharing their stories of work in play and the apparel they love that helps enable their passion. I encourage you to visit our Duluth Wayforger web page to view the imagery and read about the folks that help shape our brand offering as they embrace and live the true spirit of our family of brands.

We’re pleased with the favorable response to our early fall and winter collections and are particularly enthused about our core men’s Duluth assortment with the recent introduction of new colors and fits in the Longtail T program as well as the increased demand for our Duluth Ballroom Double Flex denim pants, which features new combinations of styles, washes and fits. We expect men’s pants to be a high volume driver for us this fall with the support of robust marketing plans over the next few months. We’ve also recently launched a new men’s collection called Powercord, which strikes the right balance between business casual and job site utility. Designed with abrasion-resistant Cordura nylon twill, the pants combine durability with sharp styling that pair well with button down long sleeve shirts, polos or even a long sleeve henley.

The new Powercord collection is off to a great start and addresses the needs of our customers who are transitioning back to the office more regularly. Excitingly, our pipeline of new and innovative products is full this year, and we still have several key items that we’ll be launching in the fourth quarter. This includes a new addition to our Buck Naked underwear collection that features a soft and smooth fabric, allowing for more extensive pattern printing, including photo images, a new Fire Hose carpenter pant featuring our strongest, most durable Flex Fire Hose fabric to date and a new women’s AKHG fitness apparel assortment launching in January just in time for New Year’s resolutions. We’ve also been busy rolling out new pattern and printed underwear styles for men and women.

Our Buck Naked collaboration with Pabst Blue Ribbon was a customer favorite and is being followed up with several additional collaborations with favorite beer brands dropping in September. Product newness, combined with data-driven marketing strategies are proving to effectively increase customer retention rates and increased brand awareness. Our year-to-date retention rate on prior year customers is up 200 basis points with much of that driven by our longer term and most loyal customers. Our active buyer file overall is up year-over-year and orders per customer is up mid-single-digits, driven by increased purchase frequency. Within the paid social channels, our return on ad spend was up over 60% in the quarter from retained customers and new customer acquisition rates have been on an improving trend all year long.

Our marketing strategy provides nimble and informed shifts when appropriate, and we’re looking to realize efficiency gains in the back half of 2023. New customer acquisition will continue to be a focus, and an expanded reach of new influencers and online content creators will be powerful sources of new buyers. As I mentioned in my opening comments, the go-live of our newest, highly automated fulfillment center in Adairsville, Georgia represents a significant milestone within our strategic road map. This facility is the largest and most efficient within our fulfillment network, and we remain on track to process up to 60% of online customer orders and store inventory replenishment through this new facility by the end of Q3. The efficiency gains will help us realize healthy reductions in cost per unit processing as well as faster delivery times to a greater portion of our direct customer base.

We’re poised to fulfill our customers’ needs and meet the peak demands as it builds towards the holiday selling season. Our inventory is in great shape. We’re accelerating receipt of new product innovation. Our marketing plans are as sharp as ever. And our customer service teams are prepped to deliver superior omnichannel experiences. With the critical investments we’ve made and will continue to make, we’re well positioned to meet the needs of our customers and drive sustainable long-term growth and profitability. I look forward to sharing more on our third quarter call and will now turn it over to Dave to provide more details on our second quarter results and outlook for the year. Dave?

Dave Loretta: Thanks, Sam, and good morning. For the second quarter, we reported net sales of $139.1 million, down 1.7% compared to $141.5 million last year, and brings our year-to-date sales close to flat to last year. Sales in our direct channel were up 1.8% in the quarter, driven by an increase in web visits of roughly 1% and increased conversion of nearly 50 basis points across both, mobile devices and desktop. Sales on mobile devices increased high single digits and continues to become the digital channel of choice for our customers with enhancements made to site speed, navigation and product information. Our retail channel sales were down 7% with store traffic down 2% compared to last year, which is an improvement from the trend — traffic in the first quarter.

The store teams are also continuing to drive increases in the conversion rate on the store visits with outstanding customer service and compelling assortments and targeted offers. As Sam mentioned, the demand for our seasonal and year-round offering was strong, generating positive growth in items sold and orders shipped. The slight decrease in net sales was largely attributed to a lower average retail and order value due to lower levels of full price selling and a higher level of promotional and clearance sales. Our quarter-end inventory position is healthy with spring and summer goods down to high-single-digit penetration to the total from low-teens last year. And clearance is down more than 300 basis points year-over-year to roughly 7% of the total.

As planned, we began to receive and offered new fall and winter seasonal items sooner than last year, and the customer response has been strong. We have also improved the flow of our core year-round items and are experiencing demand build for some of the largest programs, spanning men’s pants, tops and underwear. Total men’s division sales during the quarter were down 3.5%, while women’s was up nearly 3%, with increases for women’s in Duluth, AKHG and the First Layer categories. We drove higher sell-through rates in part through the use of incremental events and targeted offers, enabling us to keep our inventory turning. Our second quarter gross profit margin was 51.4% compared to 53.4% last year and reflects a lower mix of full price sales.

Gross profit dollars declined 5.5% from last year. We did see stabilization in product gross margins relative to last year, near the end of the quarter. Turning to expenses. SG&A for the second quarter increased 1.7% to $72.9 million or 52.4% of sales compared to $71.7 million last year or 50.7% of sales. This included an increase of $2.8 million in general and administrative expenses, an increase of $1.1 million in selling expenses and a decrease of $2.7 million in advertising and marketing expenses. Selling expenses as a percentage of net sales increased 100 basis points to 16% compared to 15% last year and was the result of higher outbound shipping costs from rate increases as well as a greater volume of direct orders shipped with lower average order values.

Within selling expense, costs related to variable labor in our stores and fulfillment centers declined compared to last year and leverage as a percent of sales due to efficiency gains made from scheduling and continuous improvement initiatives across our fulfillment network. Advertising and marketing costs were $11.9 million in the quarter compared to $14.6 million last year and as a percentage of sales decreased 180 basis points to 8.5% compared to 10.3% last year. Our investment in brand awareness through national ad channels and TV streaming was flat compared to last year and our digital media channel spend was reduced along with lower creative costs. We saw stronger results with increased web traffic from organic search and email activities that focused on new product arrivals and clearance messaging that helped drive the increase in retention and reactivation rates.

We also continue to realize high return on media spend through social channels when we highlight product innovation, features and benefits. Overall, customer counts increased mid-single-digits during the quarter, while maintaining roughly flat sales per customer productivity. General and administrative expenses during the second quarter were $38.8 million or 27.9% of net sales compared to $36 million or 25.4% last year. Similar to the first quarter, the increase over last year reflects the incremental fixed cost for the new automated fulfillment center that is now operational and additional personnel expenses associated with the new facility and our corporate functions in the area of product development, sourcing and stock compensation costs.

Adjusted EBITDA for the second quarter was $8.6 million or 6.2% of sales compared to $13.2 million or 9.4% of sales last year. Our net loss per share was $0.06 versus a profit per share of $0.07 in the second quarter last year. Moving to the balance sheet. We ended the quarter with net working capital of $85 million, including $11 million in cash and zero outstanding on our $200 million line of credit. The healthy inventory flow during the second quarter lifted free cash flow and increased our cash balance by $2 million from the end of the first quarter. We remain on target for overall capital expenditures of $55 million this year funded by cash with the lion’s share of that spend associated with the new fulfillment center in Adairsville, Georgia.

As Sam mentioned, we’re pleased to see this project go live and ramp production up over the course of Q3 to begin realizing efficiency gains on our selling costs related to fulfillment center activities as well as faster delivery times to a greater portion of our direct customer base. Our inventory balance ended the quarter down 4.5% from the same period last year and is in a healthy position with a mix of seasonal goods weighted to more fall-winter versus spring-summer, reflecting the strong sell-through on spring-summer and planned earlier receiving on fall-winter goods. Total clearance units on hand are down over 10% from last year as a result of actively managing markdowns during the season to optimize sales and inventory turnover. We are confirming our net sales guidance for the year of $645 million to $660 million, but have reduced the EPS and adjusted EBITDA estimates, reflecting our first half results and a second half outlook in which we see consumers remaining somewhat price sensitive.

We now expect full year adjusted EBITDA of $40 million to $42 million and a loss per share of $0.15 to $0.08. We expect full year gross profit margins will be down 50 to 100 basis points and SG&A to be flat to up 50 basis points. Before I turn it back to Sam, I want to take a moment to address my decision to step down as Senior Vice President and Chief Financial Officer on September 15th. I have accepted an employment opportunity outside the Company, but I want to emphasize that it’s been a privilege and an honor to work alongside Sam and the many talented individuals across this organization. I believe Duluth is well-positioned to execute against the strategic pillars of the Big Dam Blueprint, and I wish the team all the best and continued success in the future.

I’ll now pass it back to Sam.

Sam Sato: Thanks, Dave. I can’t thank Dave enough for his many contributions and leadership at Duluth over the past six years. Under Dave’s leadership, Duluth has elevated and strengthened its finance organization anchored on a deep bench of talent with extensive experience across all finance functions. I have the utmost confidence this will be a seamless transition as we search for a permanent replacement for Dave. I’d like to take this opportunity to welcome Mike Murphy, our current Vice President and Chief Accounting Officer, who will serve as Interim Chief Financial Officer. Mike has been in his current position since 2019. Prior to joining the Company, Mike served for three years as Chief Accounting Officer at First Business Financial Services as well as eight years at KPMG. In closing, it’s been an honor to partner with Dave and I wish him much success in his future endeavors. And with that, we’ll open the call for questions.

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Q&A Session

Operator: [Operator Instructions] Our first question will come from Janine Stichter with BTIG.

Janine Stichter: I was hoping you could elaborate a bit more on the cadence of what you saw throughout the quarter. It sounds like May was the weakest and I think you said you saw some improvement in June. So maybe just some thoughts on what changed there? How much of it’s been maybe some stabilization in the environment versus some of the product initiatives that you spoke to versus just customers shopping around key events like Father’s Day. And I’d love to hear about it both from a top line standpoint and then also from a margin standpoint, where I think you mentioned some product margin stabilization towards the end of the quarter. Thank you.

Dave Loretta: Yes. Hi Janine. This is Dave. So, the quarter did kind of play out with May being the toughest month for us. Both retail and direct were down. But as we entered the June, things were improving. Father’s Day and — was a big event for us and continued to build into July. I’d say July was our best month and we saw positive traffic into the stores as well as a pretty high growth rate in the direct channel. So — but when you blend it together, the results of being down just under 2%, margin pressure was certainly part of the impact as we continue to find ways to drive traffic and transactions into the business, the margin pressure did impact with the 200 basis points down from last year. But as I did call out on my remarks, the — as we came out of July, we’re now starting to comp last year’s period when gross margin pressures were really first starting to impact the business.

And so far, as we look through August, gross margins are up to last year. But the top line is still slightly down. So, top line, we’re seeing kind of a continuing trend, but the margin has stabilized and has started to turn for us in a good way on that front.

Janine Stichter: Great. And then on the promotions or some of the pricing actions that you’ve been taking just to keep the product flowing through, maybe speak to potential for product cost reductions or sourcing benefits as you seem like you might need to keep these more promotional prices in place for longer?

Sam Sato: Yes. Janine, this is Sam. Yes. So, we’re going to be and continue to be targeted with our offers. We try to balance the consumer sensitivity with the integrity of our brand and pricing strategy. So, we’re not going to have a fire sale, so to speak. There’s a balance there. As I said in my prepared remarks, we’ve now onboarded several new members to our sourcing group. And with the intent of — over the long term of creating a structural change to our pricing model and ultimately — gives us more flexibility when business is a bit more challenged. And so, we think the ramp-up will occur over the next couple of years, but certainly see a tremendous opportunity for us to drive increased gross product margins over the long term.

Operator: Our next question will come from Jonathan Komp with Baird.

Jonathan Komp: I want to follow up on the guidance, holding the full year revenue, but lowering the margin again and participating in the promotional environment. Can you just maybe elaborate a little further thoughts on the strategy to participate in the price promotions you’re seeing and why that’s the right move to the brand here?

Dave Loretta: Yes. I’ll start there, Jon. Clearly, there’s pricing pressure that we’re feeling from the consumer out there, yet the demand is still robust. As we said, we shipped more orders, sold more units. But the price point is what the consumers are telling us needs to be a value for them to proceed. So, we’re confident that the brand has got the momentum. And where we’re seeing some of the optimism that keeps us from a top line standpoint confident is in some of the core categories of men’s, while the quarter men’s was down about 3.5%, it’s an improving trend from the last two quarters. And as we’re entering the — in our third quarter here, we’re seeing that play out with newness in some of our styles in the men’s category, innovation and some other items that are bringing to market.

In fact, this back half of the year, we’re really bringing a significant amount of new items to market that we think is going to drive — sustain that top line, which we’re pleased with. But pricing pressures are still keeping the margin impact weighted on the bottom line results.

Jonathan Komp: And maybe just a follow-up, Sam. When I think of the Big Dam Blueprint, this year being a transition year still, you’re not guiding to much profitability in terms of the EBIT dollars. So, can you maybe talk about what’s temporarily impacting the business that might benefit future years? And, are you pursuing the right strategies, growth at the current margin levels that you have today?

Sam Sato: Yes. Thanks, Jonathan. Yes. I mean, as I talked at the beginning of my remarks, two really exciting pillars to the Big Dam Blueprint is our highly automated fulfillment center and our sourcing group. And so when you think about that relative to the structural change of the business and mid- and long-term implication of that from a sustainability in both sales growth and profitability, they are two really critical unlocks. So from a fulfillment perspective, it’s not only about cost efficiencies and being much more efficient from a CPU perspective, but also delivers on the consumers’ expectations, not just from us, but in general, of faster deliveries, especially click to doorbell and the online part of our business is the majority of how we sell products.

And so, that has real application to not only scaling our current business, but as the business continues to grow and we consider other avenues for growth, be it wholesale or anything else, that fulfillment center as the key part of our network becomes an unlock from a delivery and fulfillment perspective. The sourcing piece, last year, we announced the hiring of our first Director of Material Innovations. And as a vertical operation, that’s a critical component, not just in terms of design and product development, and at the core of who Duluth is, it’s about bringing high-quality, well-priced products that are innovative and solve a problem. And so, investing in a more dynamic and experienced sourcing group will also bring a change to our pricing model and allow for longer term greater profits and flow-through.

So yes, I think that in the near term, some of these challenges in the P&L are really related to two things. One is the investment in our enablers, what we’re calling our enablers for the enterprise. And then two, the choppy macro conditions and the sensitivity that consumers are still showing, but we’ve been through these times in the past. And ultimately, our brand loyalty and the affinity consumers have for Duluth ultimately leads back to higher full price selling based on our innovative products and what we bring to market. So, I’m confident that that part will occur. And then, it’s about us ensuring that we’ve got the right infrastructure in place to take advantage of that and scale the business in a more cost-efficient way that’s sustainable.