Duluth Holdings Inc. Q1 FY2022 Earnings Call

Good day, and welcome to the Duluth Holdings First Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please also note that this event is being recorded. Now, I'd 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 first 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 risk and uncertainties that could cause the 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, Nitza, and thanks for joining today's call. We made tremendous progress on key strategic initiatives over the course of the first quarter, and I'm excited to share some of the details. We know that our customers demand well-designed products that are grounded in durability, functionality, and are solution-based for the intended end use. Our customers take on life with their own two hands and embrace a can-do attitude in both work and play. To address our customers' various needs and attract new customers, we set out to create distinct positions for each of our sub-brands with product assortments that resonate and deliver against their expectations. I'm pleased to highlight that during the first quarter, we introduced our new Duluth by Duluth Trading Company brand logo. The Duluth sub-brand is focused on the lifestyle of Americana workwear. The first quarter also marked the transition of our Alaskan Hardgear brand to AKHG, and we launched our women's collection in April. AKHG is focused on more technical products needed to support outdoor activities as well as the lifestyle of enjoying the outdoors. And importantly, our first layer business has undergone many updates. We've elevated our assortments through the creation of new, innovative products and intensified our focus on growing categories. Collectively, these updates are meaningful steps forward to position our overall Duluth Trading Company business under a common umbrella that will enable each sub-brand to serve our customers' desire for being active in their work and their recreation. I'll share more shortly how we see the evolution of our business and brand positioning to address the growing active lifestyle of our target customers. But first, I'll touch on our recent results. Today, we reported first quarter net sales of nearly $123 million, a net income loss of $1.3 million, and an earnings loss per share of $0.04. These results were better than our internal plan as well as our early projection, and demonstrate our continued operational effectiveness in the face of a dynamic macro environment. With inventories reaching a healthier position at quarter-end, and digital marketing tactics that draw on elevated data analytics, we are meeting the needs of our customers and executing our strategies for long-term brand growth. The efficiency of our omni-channel model is producing a consistently strong gross profit margin, which for Q1 was 54.6%, an increase of 470 basis points over last year. We continue to fund our strategic brand development initiatives with an increase in creative asset investments supporting our Duluth by Duluth Trading Company and AKHG sub-brand launches. The new brand positioning features seasonally relevant items for active outdoor categories in swim, gardening, and hiking. And as our receipts improve, customer response to our overall brand has been strong, leading to high single-digit sales growth in April. With the support of new brand awareness campaigns, the momentum continued through the Memorial Day weekend, with customer demand exceeding last year. Our reported net sales for the first quarter were nearly $123 million and were planned to be down to the prior year due to expected inventory delays and a strategic shift to carry meaningfully lower levels of clearance inventory. In fact, we ended the quarter with clearance goods making up 3% of total inventory, compared to 8% last year. Our overall inventory position at quarter-end is 6% higher than last year, a significant improvement from the beginning of the quarter, where we were down 18%. Importantly, the makeup of our inventory is significantly healthier compared to last year. The positive outcome of our strategic transition in inventory mix is that we are generating significantly higher gross product margins, fueling gross profit dollar growth, while absorbing higher-than-normal transportation costs. Our reported gross profit margin of 54.6% includes the additional expense of roughly $4 million in airfreight costs associated with inbound inventory from last fall. Absent these incremental freight costs, our gross profit margin is as strong as we've seen in the last five years, and a direct result of inventory management and pricing disciplines put in place. Our strategies continue to yield results that support improved operating margins, which Dave will go into further. Our EPS loss for the quarter, of $0.04, reflects the impact of the $4 million in airfreight costs I just mentioned, as well as sound operational expense management. Absent the airfreight costs, our earnings per diluted share in Q1 would have been a positive $0.05. Our business is not immune to the inflationary pressures in fuel, labor markets, and commodity prices. We will continue to make adjustments to our model to keep the momentum going across the business and continue to execute our strategic playbook. Our teams put many actions in place to address some of the headwinds we identified last year. For example, we've been selective in raising retail price points on certain core items and expect further adjustments to prices in our fall and winter assortment. We established early delivery dates from our manufacturers to account for continued supply chain congestion. And we also plan to airfreight orders on certain new fall and winter products to meet key offer dates. We anticipate being well-positioned with merchandise to meet customer demand during the important sales periods, beginning with Father's Day, and into the fall and winter seasons. We were able to flex our variable expenses below last year, and realize expense leverage relative to our plans that support the continued investments we're making in our brand portfolio. These investments take advantage of the broader trends we see in our target customers to live an active lifestyle, and are designed to unlock tremendous growth opportunities while mitigating the impact of near-term macroeconomic factors. To that end, we purposefully held back some customer acquisition dollars in our first quarter marketing spend given the lighter inventory levels. The benefit of being more selective in attracting new buyers is we have seen higher average order size on their first purchase. As receipt flow improved, we dialed up digital prospecting in the back half of the quarter. And as a result, new buyer growth increased with much of the activity driven by our enhanced brand messaging and the introduction of the women's collection in AKHG. New buyers who are motivated by the new assortment, focused brand messaging, and product stories are significantly more valuable to us. Net sales in our retail store channel for the first quarter were up versus last year by 0.4%, driven by a higher average transaction value that is up 6% compared to last year. More recently, an improvement in our conversation metrics indicates that our heightened focus on store associate product knowledge training and assisting customers to build their basket along with a better inventory position are paying off. Quarter-to-date sales in the retail channel are trending up compared to last year. Net sales in our direct channel were down for the quarter by 12%, largely reflecting the heavy clearance volume in last year's direction sales but also our purposeful decision to run lighter in working media in February and March. With a better inventory position by April, we leaned into digital advertising, social media, and paid search to accelerate the direct channel growth. In April, direct sales were up low teens over last year. Our rebranding efforts are paying off. We introduced our new Duluth by Duluth Trading Company brand logo and have ramped up the messaging providing a more unified voice across men's and women's segments. The customer response has been amazing. Duluth favorites such as flex Fire Hose pants for men and classic NoGA Performance Stretch pants for women are great examples of product design supporting an active, get-it-done lifestyle with features and durability that stand up to a wide range of work activity. This spring, we built upon the Duluth brand's success we have had in our garden collection by introducing a short version of Women's Heirloom Garden Overall and new styles that leverage other well-known fabrics such as Dry on the Fly, Double Flex Denim, and Fire Hose CoolMax. These are innovative products that are seasonally relevant and provide real benefits such as moisture-wicking, cooling, and comfort. Our brand realignment of AKHG focuses on outdoor recreation for our customers who embrace work and play, addressing their needs for higher performance apparel and gear that stands up to the conditions they face while outdoors. Finally, Alaskan Hardgear has always infused the brand's identity with high-quality innovative clothing and underwear that is functional and allows for comfort and movement as outdoor conditions change. While we know the collection can stand up in these conditions, we also know that most of our customers simply want to trail, hike, or fly fish in the stream. This brand positioning opens up AKHG to a much wider consideration set and expands the brand's potential for the everyday outdoor adventure that may be closer to home. Our rebranding of AKHG coincided with the introduction of our women's collection. Since then, the AKHG women's segment has quickly reached a similar level of penetration as women's has for the Duluth brand, at roughly one-third. The five-star reviews are quickly adding up for the new collection and our live action branding allows for a broader aspirational imagery of women and men together in highly photogenic and real-life settings. We are excited for the long-term potential of AKHG and growing our women's segment. Our first layer products outperformed and remain core to our business. Serving both men and women, we consider our offerings to be America's most comfortable underwear and have collected over 40,000 five-star reviews. That being said, we see greater potential particularly in the women's assortment. Included in this collection is the perennial favorite No Yank Tank. But expansion of our base layer tops and bras for women has seen significant growth of close to 40% in the first quarter. Lastly, within our family of brands is Best Made, which realized a healthy 30% growth rate in the first quarter, albeit still small relative to the other brands. The curated offering within Best Made allows for great storytelling about the source and craftsmanship behind the product but also for the unique individuals that live and work a lifestyle embodied in the Best Made spirit. Our men’s summer collection features women’s tops and bottoms, swimwear, and beach accessories inspired by the Pacific coastline and tropics of Hawaii. In partnership with the iconic brand Kahala, we offered two exclusive Aloha shirt styles. On our last call, we shared details about our capital investment plans for the year in support of our Big Dam Blueprint. I am pleased to report that we are on track with the early stages of our logistic expansion and automation project. And we have kicked off core technology initiatives that serve to advance our internal capability and build the foundation to support long-term growth. Within our existing fulfillment centers, we are implementing capabilities that will be fully operational in advance of our peak season this year. These capabilities increase the speed, accuracy, and capacity of inbound receipts with sortation equipment that expands daily capacity. The quicker we can receive inventory into our system, the faster we can make it available to our customers. In addition, investments are underway to automate sortation and scanning equipment on outbound orders that facilitate quicker replenishment of our store inventory and shipping cost savings through automated carton labeling. The investments we are making in merchandising toolsets will ground our capability to continue driving efficiencies on how we plan, buy, and seamlessly move from one season to the next. The enhanced systems will allow for quicker and more insightful assortment decisions. Ultimately, our merchandised planning tools will generate automated recommendations based on deeper trend analysis and allow our teams to focus on higher value merchandised activities. The utilization of customer insights and data analytics will enable our merchandising strategies and long-range brand growth decisions better. We have been engaging in a number of deeper reviews of our customer base, the interactions we have with them, and measuring the opportunities for greater market and channel penetration. These reviews are informing our plans as well as the technology we are investing in to activate for plans. In summary, despite the external environment posing challenges, we continue to see healthy underlying demand from our customers for products and shopping experiences that meet their needs. We are in a strong financial position with ample access to liquidity, positive cash flow, and earnings power that support our strategic growth plans. With that, I'll turn it over to Dave to provide more details on our first quarter and our outlook for the balance of the year.

Thanks, Sam, and good morning. For the first quarter, we reported net sales of $122.9 million, down 7.9% compared to $133.4 million last year and up 11.8% compared to the same period in 2020. The decrease in sales between this year and last was roughly $11 million and was the contributing factor in our sales declining year-over-year. Our direct channel sales were down 12.1% from last year, while the retail channel was up 0.4%, driven largely by a 6% increase in average transaction value in the stores. As we shared on our last call, we anticipated softer sales in the first quarter due to the heavier clearance position we were in last year and continued transportation delays with our new seasonal and core year-round products. Because of these two factors, we focused much of business on selling at regular price and preserving some of the traffic driving media spend until later in the quarter when inventory reached a better position and our new sub-branded collections were enhanced. By April, our customers responded well to the new spring assortment, the new brand messaging, and better in-stock positions on core items. Customer traffic and conversion through both our store and digital channels improved in the back half of the quarter. As Sam mentioned, total net sales for April increased in high single digits, and the momentum has continued with strong customer demand through the Memorial Day weekend. During the quarter, average order value and sales per customer overall increased in mid-single digits, driven by the strong demand of our core offering and being strategically less promotional compared to last year. The higher customer sales productivity is combined with an improving trend in retaining customers who have shopped with us more than once and who were new buyers prior to last year. Buyers who renew and purchase primarily full-price items spent significantly more on their first purchase and are returning more often. Our retention rates in the first quarter are much stronger for these conventional buyers and the spend per customer is higher by roughly 30% versus price-driven buyers. With these insights, we are adjusting our marketing mix and customer segmentation to strategically target the conventional buyer, which leads to a higher customer lifetime value. The amount of clearance inventory was down almost 70% at the beginning of the quarter, relative to last year, driving significant improvement to our product gross margins and an increase of 470 basis points in our reported gross profit margin to 54.6% compared to 49.9% last year. Our first-quarter gross profit amount of $67.1 million compared to last year of $66.5 million included nearly $4 million in expedited freight expense that was spent last year to airfreight certain items to bypass the shipping ports. Those items represent our bestselling year-round core items such as men's fire hose pants and Buck Naked briefs, and where we strive to avoid being out of stock. Absent the incremental freight cost, our first-quarter gross profit margin would have matched a historical high for our first quarter at nearly 58%. We do anticipate some expediting activity this year, although not to the same magnitude as last year, and it is factored into our guidance. Turning to expenses, SG&A for the first quarter increased by 5.2% to $68 million compared to $64.6 million last year. As a percentage of net sales, SG&A expense increased to 55.3% compared to 48.5% last year. This included increases of $2.8 million in general and administrative expenses, $1.1 million in advertising and marketing expenses, and a decrease of $500,000 in selling expenses. Selling expenses as a percentage of net sales increased 80 basis points to 15.8 compared to 15% last year, driven by the higher hourly wage rates implemented across our store fleet and fulfillment center network in the back half of 2021. Additionally, fuel surcharges on our outbound customer shipments contributed to the selling expense de-leverage. We expect to realize a similar de-leveraging selling expense in the second and third quarters before analyzing the wage rate increases and realizing efficiency gains to offset the higher costs. In terms of the fuel charges, we are anticipating the elevated levels will continue throughout the year. As planned advertising and marketing costs as a percentage of net sales increased 160 basis points to 10% compared to 8.4% last year, as a result of the development of creative content for our new brand positioning of Duluth and AKHG. These investments represent roughly 30% of the total cost this quarter and will support brand messaging and feature products in future awareness and customer acquisition campaigns. In addition, we reduced the direct mail catalog portion of our work in media by roughly 50% and continued the strategy to leverage more flexible digital media targeting a higher return on ad spend. Our paid digital media spend represented about 40% of the total advertising spend this quarter, and we expect that to increase to close to 60% in the second quarter, representing the largest component increase in our marketing mix. Additionally, brand awareness investments designed to develop new customer audiences represent roughly 25% of the total spend and are strategically important to establish momentum in the subsequent quarters. Overall, we expect the second quarter advertising and marketing cost will increase and de-leverage 80 to 100 basis points. General and administrative expenses as a percentage of net sales increased 440 basis points to 29.5% compared to 25.1% last year. The $2.8 million increase from last year represents additional personnel and technology costs, as well as fixed costs for our Cherry Hills, New Jersey store and Salt Lake City fulfillment center that opened last year. We expect additional de-leverage in our second quarter for similar reasons, but to a lesser extent. For the back half of the year, we expect to realize expense leverage in G&A expenses in connection with anticipated sales growth. As of today, our store count stands at 65 with no plans for openings for the balance of the year. As we discussed previously, we are evaluating locations for potential store sites in 2023 and will share more details once we have signed leases. Adjusted EBITDA for the first quarter was $7.9 million, a 17.5% decrease from last year and an 80 basis points of adjusted EBITDA margin contraction. Our net loss was $1.3 million, or a loss of $0.04 per diluted share, compared to a net income of $500,000, or $0.02 per diluted share reported in the first quarter last year. Excluding the expedited freight expense from last year, our EPS would have been a positive $0.05 per diluted share. Moving on to the balance sheet, we ended the quarter with net working capital of $106 million, including $40 million in cash and zero outstanding on our line of credit. Compared to the same period last year, we had $26 million in cash and $17.6 million outstanding on the line. We anticipate minimal borrowings on our available line of credit, which stands today at $150 million. Our inventory level is roughly 6% higher than last year at quarter end and is in a significantly healthier position than where we were at the beginning of the quarter. Spring and year-round receipts that were delayed as of year-end have arrived over the course of the quarter supporting the sub-brand relaunches effectively. Our clearance inventory is at 3% compared to 8% last year, and is at the appropriate level for where we are in the spring and summer season. Our capital expenditures, including the cost of software implementation, are expected to be $40 million in 2022 versus our previous guidance of $57 million. The lower amount represents timing of progress payments for our new fulfillment center facility. On the heels of our lease signing for the building in Adairsville, Georgia, we finalized the contract with our automated storage and retrieval systems provider and have reflected the updated cash flows in our projections. The shift in timing of progress payments will impact early 2023 and benefit our 2022 year-end cash position. We now expect free cash flow for 2022 to be roughly $15 million to $20 million. As we shared, the investments we're planning to make across the business will facilitate expanding and more efficient distribution capacity, product and brand development capabilities, and add to our customer insights and data analytics to better inform our assortment and marketing mix. These investments are all focused on being more digitally led as a business and our key components are a Big Dam Blueprint. To summarize, our outlook for the second quarter and back half of 2022, we expect sales in our direct channel to be up mid-single digits in the second quarter and up low teens in the back half of the year. For retail sales, we expect sales to be mid-single digits in the second quarter and through the back half of the year. We expect gross profit margin to be flat to slightly up in the second quarter and down roughly 50 basis points for the back half of the year. We plan to increase advertising expense by roughly $2 million in the second quarter over last year and spend roughly the same amount in the back half of the year compared to last year. With selling expenses, we expect the second and third quarters to be similar to the first quarter in increase as a percent of sales, and the fourth quarter to be roughly flat to last year as a percentage of sales. Overhead expenses in the second quarter will increase as a percent of sales by 150 to 200 basis points and will be down 50 to 100 basis points in the back half of the year as a percent of sales relative to last year as we gain leverage on sales growth. We are reaffirming our full-year guidance with net sales of $730 million to $755 million, adjusted EBITDA of $84 million to $88 million, and EPS in the range of $0.93 to $1.00 per diluted share. In closing, we are pleased with the great start to the year, particularly given the dynamic environment. Our teams remain focused on the needs of the business and our customers, and executing on our strategic plans. And with that, we'll open the call for questions.

We'll now begin the question-and-answer session. The first question comes from Jonathan Komp with Baird. Please go ahead.

Yes, hi, good morning. Thank you. I wanted to start by following up on the brand realignment. And I think, Sam, you walked through pretty clearly the rationale. But I'm curious if you could share more on the consumer reception so far, and if the differences are being noticed and any feedback you've gathered. And then as you look forward, sort of any changes in brand character or positioning or sort of the product approach as a result of the realignment that you see going forward?

Thank you for the question, Jonathan. At a high level, this was part of our initial efforts within the Big Dam Blueprint, aimed at establishing purposeful and distinct positions for each sub-brand. This approach enables us to focus narrowly on performance and benefit features in product development while allowing our brand marketing team to effectively convey the intended use of these products. From the outset of our strategic planning, creating distinction and a unique position was one of our priorities. Additionally, we have seen impressive responses so far. I would refer you to our prepared remarks regarding AKHG specifically. We have achieved clear separation in what it represents compared to Duluth and Best Made. When we launched the women’s collection in April, it quickly reached a penetration level similar to that of women’s products from the larger Duluth brand. Therefore, the distinct positions in both product development and brand marketing are proving effective and, importantly, helping our customers to understand our offerings clearly.

Great, that's really helpful perspective. And then maybe a follow-up on the full-year outlook. I know you mentioned that Q1 exceeded the internal plans, and you've maintained the outlook for the year. Understanding it's early in the year, but are you baking in any additional conservatism in your outlook for the balance of the year, just trying to understand your thinking and your confidence level after better-than-expected Q1 results?

Yes, I will answer briefly, and then I will let Dave provide more details. One of the key considerations during our planning for this year's receipt flow, partly influenced by the supply chain issues we encountered last year, was to implement deliberate actions like scheduling earlier receipt dates to accommodate delays we faced. We are beginning to see the benefits of this approach in our receipt flow from Q1, and we anticipate it will continue into Q2, as well as during the buildup in Q3 and the peak holiday season in Q4. To recap, last year we noted that our inventories were dropping to about 20% below 2020 levels as we exited Q3, and this trend persisted through Q4. Therefore, our forecast and planning for this year reflect the anticipated demand we missed during Q3 and Q4 due to insufficient inventory.

Yes, that makes sense. And I guess when you look at April specifically, could you maybe further isolate some of the tailwinds that you saw, and maybe relate that to the discussion about some of the marketing reallocations and the strategies for the balance of the year, and whether or not you could carry forward some of the successes that it looks like you may have seen in April?

Yes, I think what has impressed me, since joining the company a year ago, Jonathan, is that the flexibility in our ability to target and increase or decrease purposeful ad spend. And so, this is unlike anything we've experienced in terms of supply chain and its impact on the availability of inventory. And so, the great news is when inventory flow isn't what we need it to be, we could dial that back. And then as we start to see inventory flow in at a higher rate, we can dial that up pretty quickly. And part of that's because we made a strategic shift, over the last couple of years, to a more digital marketing strategy, which is much more flexible than the linear advertising vehicles we would use in the past, where you had to commit to contracts well in advance, and then you're locked in. So, our brand marketing team is doing an unbelievable job of pulling levers throughout the months and the weeks, quite frankly. And so, in the case of April, as inventories started to flow in, and especially things like the AKHG women's launch, that was initially planned to launch in March, and because the receipts weren't here, we pushed it out. And as soon as we saw that stuff start to hit our fulfillment centers, they ramped up their plans on really targeted marketing initiatives. And that drove a lot of business to both the stores and to our digital site.

Yes, Jonathan, I'll just add, the balance of the year is still a lot of business ahead of us. I mean, our first quarter only represents 16% or 17% of the total annual sales. So, quarter-to-date through Memorial Day weekend, where the business is up in the low single-digit range, and obviously needs to continue to accelerate to get to the back-half of the growth rates that we have. So, I think it's just early in the year still, and that's reflective of our guidance that we're reaffirming.

Great, that's helpful color. I'll pass it on. Thanks again.

Thanks, Jonathan.

The next question comes from Jim Duffy with Stifel. Please go ahead.

Thank you. Good morning.

Hi, Jim.

I wanted to ask about some comments you made in your response to the last question. I'm curious about the indications on return on incremental marketing spend. During the first quarter, you pulled back on some marketing. If you had the inventory to do so and set out to scale the business, do you have high ROI initiatives you could invest behind that you believe would drive growth?

Yes, absolutely. As I mentioned, as inventory arrives in line with our planned launches or new collections, we can adjust our marketing spend based on the variability of receipt flow. Currently, we have some fantastic new products launching, and we are excited about them. For example, we have a hunting capsule in collaboration with Mossy Oak, a brand known for introducing a new era of camouflage. We're eager to increase advertising for that as it comes in. Additionally, I noted earlier that bras in the women’s first layer category are experiencing significant growth. We are introducing a new women’s offer called Line Tamer, which is a seamless, line-disguising first layer for women. We have a solid marketing campaign prepared for that. As Dave mentioned in his remarks, we are raising our ad spending in Q2 due to the receipt flow of these new goods and collections. We will continue to adjust our spending based on the receipt flow. We have some truly exciting new products and innovations on the way; we are just navigating the variability in the receipt flow.

Understood. And I want to dig into another level of detail there. Is this established proof of concept with new customer acquisition efforts that you could use to go to the customer file or is this simply compelling product that you're using to reengage the existing customer base?

Yes, I believe there are a couple of factors at play. We have always possessed a wealth of consumer data, and as we've noted in recent calls, our ongoing investment in data insight and customer insight tools is yielding valuable information. We recently appointed a new Director of Customer Insight, who has extensive experience and is already demonstrating how to analyze this data effectively to provide insights on targeting our customer acquisition strategies. He highlighted a key distinction between consumers we acquire mainly through price and what we refer to as conventional spenders—those who come to us over time due to their product needs. Over time, these conventional spenders are significantly more valuable because of both the size of their purchases and the frequency of their engagement with us. Consequently, we are focusing on acquiring similar customers through various channels, primarily through digital acquisition. This approach enhances the effectiveness of our advertising spend, allowing us to be more targeted and selective in attracting and retaining customers.

That's great. Your full-price selling penetration is super encouraging. And I think this dimension of a shift of focus on the conventional buyer versus the price-driven buyer seems powerful. I'm curious, how does that change the addressable market and potential size of the revenue base? Does that narrow the potential size of the revenue base but improve the structural margin opportunity for the business? How do you think about that part?

I don't believe that's the case. Whether we are in inflationary times or a growing market, everyone takes price into account when making decisions. However, I believe that the size of the market we serve, along with our product types, price value, durability, and build quality offer us significant opportunities. We are just beginning to tap into our market potential.

Great. Thank you, guys.

Thanks, Jim.

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

Thanks a lot. Kind of continuing some of this same vein, I guess kind of further up the P&L, you're flirting around sort of peak gross margin or underlying gross margin to back out some of the artificial cost headwinds. And so, I'm curious, you're speaking a lot more towards full-price selling, being more efficient with your promotional cadence, which is something you've long talked about. Is there kind of a structural level of gross margin that sort of underpins the blueprint? And is there any consideration here from a mix shift standpoint for some of these other portfolio brands that's kind of embedded in that kind of recession?

Yes, I'll begin with that. The foundational gross profit margin we expect to maintain is generally in the mid-50s over the long term. There is potential for growth in that area, which is driven by a strategically balanced approach to full-price and regular pricing along with appropriate promotional activity. A significant advantage we hope to sustain is managing our inventory levels effectively, which helps avoid the clearance sales we experienced over the last two years. It’s crucial to manage the product mix to support consistent delivery of gross margins. As for product categories and mix shifts, we aim for all sub-brands to achieve comparable gross margins when selling to the end customer. We focus on ensuring that our cost value and price competitiveness allow for consistent initial markups and gross margins. Therefore, we do not anticipate that the growth of sub-brands will adversely affect our gross profit margin opportunities.

Looking at the pre-pandemic history, you've been around mid-50s, and possibly a bit higher, around high-50s. Is it unreasonable to consider that you might achieve a high-50 underlying margin from here, given that the core business still operates at that mid-50s level?

Yes, I mean when I talk about high 50s, our product margins sell at that kind of level. And then we have other costs that are baked into our gross profit margin. So, yes, I think that's definitely achievable to maintain on a kind of rolling 12-month basis.

Okay. And then, across the brands, I guess where are you, Duluth core, Duluth legacy versus sort of the combined portfolio brand from a revenue penetration standpoint? And then the opportunity to cross-sell amongst those brands, are you kind of early days? Are you exploring some of that opportunity? I know the customer profiles are going to be different, but there's got to be some overlap. I'm just kind of curious if there's any commentary there?

At a high level, Duluth, along with AKHG and Best Made, accounts for just under 10% of our business, with Duluth making up the majority. Our strategy is to grow AKHG and Best Made at a significantly faster rate than Duluth, aiming to increase their share over time. Regarding crossover, we are dedicated to establishing distinct roles for each brand to cater to specific consumer needs. We are intentionally minimizing the number of crossover products to maintain this focus. This strategy helps enhance basket size, as customers are not choosing between similar items from Duluth and AKHG, but rather purchasing them for different purposes. We are already noticing improvements in average order value in this context.

Sorry. So, that would mean that there is high customer overlap potential, right? Because if I am buying a flannel shirt for one use case and I am buying a rain jacket for another, my total basket is the combination of both of those and not cannibalize each other, right?

That's correct. Not cannibalizing each other.

And so, you are actively out there kind of marketing to those sorts of distinct customers that might be a customer of one brand and now another, is that sort of something that's yet to come?

Yes, distinct end-use is first and foremost, similar customer. But as we learn more about different consumers and how they are engaging with us, there are opportunities for us to market, for instance, some of those buying primarily AKHG to market some potential consideration items within Duluth or Best Made.

All right, I understand we discussed this a lot on the call, but I'm still a bit confused. I get why you scaled back on marketing due to inventory issues, but it seems marketing actually decreased, if I understood correctly. I'm curious if I heard you right that you've also reduced some of the catalog. I'm trying to grasp the future outlook for marketing; will it remain at that low double-digit percentage of sales?

Yes, we have made some adjustments over the last couple of years by reducing our catalog efforts, although we still see it as a valuable tool for brand building. With our rebranding of Duluth and the repositioning of AKHG, we have a chance to present our messaging in a way that appeals to all genders, particularly during significant occasions like Father's Day. Our Father's Day catalog is set to be released this week, and we plan to use these key moments to share our family-oriented brand stories. Regarding the de-leverage, we may need to clarify that we separate our marketing into two types: working media and nonworking media. Nonworking media focuses on creative brand building. For example, when we launched women's AKHG and repositioned Duluth by Duluth Trading Company, our investments were primarily in developing brand messaging and positioning rather than in direct, commerce-focused marketing.

Got you. That makes more sense. Ultimately, the appropriate level of ad spend should be in the high single to low double digits. I know you might not want to commit to that right now, but just out of curiosity, can I get your thoughts on it?

Historically, it's kind of been this low double-digit range. And I am not comfortable in saying that today we are probably in the range of where we will be as we move forward somewhere in that low double-digit range.

Very good. Thanks guys for taking all the questions. Nice work.

Thanks, Bill. Appreciate it.

This concludes our question-and-answer session, which also concludes today's conference call. Thank you very much for attending today's presentation. And you may now disconnect.