Duluth Holdings Inc. (DLTH) Q4 2023 Earnings Call Transcript

Good morning, and welcome to the Duluth Holdings Inc Fourth Quarter 2023 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 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 fourth quarter and full year 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. Before I share some details of our business performance and progress on key strategic initiatives, I'd like to first introduce Heena and welcome her to the Duluth family. Heena is joining us as our Senior Vice President and Chief Financial Officer. With more than 20 years of finance and leadership expertise, Heena brings a breadth of experience across different facets of global finance, accounting, and mergers and acquisitions. She was recently with Contour Brands holding the position of Chief Financial Officer for Global Wrangler and Global Contour Supply Chain. We're thrilled to welcome such a seasoned executive to fill the important Chief Financial Officer position at such a pivotal time for Duluth Trading. Heena's extensive experience and strong finance and leadership acumen will play a critical role in the evolution of Duluth's long-range plans as we remain focused on executing the pillars of our Big Dam Blueprint. As a brief review of our fourth quarter performance, net sales increased approximately 2%. The quarter was highlighted by growth in both the Duluth and AKHG brands driven by strong outperformance in our women's business, which registered year-over-year growth of 12%. We were particularly pleased with the continued momentum in our AKHG women's business, posting stellar year-over-year growth of more than 20%. Product performance highlights in our women's business included positive momentum in our newest Hero product, the Heirloom Gardening Bid which we introduced in an aligned version, making it suitable for year-round wear. Flannels and bras also played a significant role in our fourth quarter growth with both categories up strong double digits. In flannels, our improved in-stock position benefited sales during the peak giving period. In bras, the success we are seeing is a testament to our unique product innovation and growing brand loyalty; our TeeLUXE bra was the number one style in its launch season. The broad-based positive trends and exceptional customer responses across our women's business indicate continued growth potential. In the fourth quarter, our men's apparel business was flat. Men's AKHG, first layer, woven tops and bottoms grew as our unique product continued to resonate with our loyal customer base. This was partially offset by softer trends across our cold-weather categories of outerwear, sweaters, and footwear, which was impacted by the warmer weather. Product performance highlights in our men's business included double-digit growth in underwear, Double Flex denim, and flannels. Success with Double Flex denim was driven in part by the introduction of new elevated washes and was brought to market through our monumentally durable campaign. Men's underwear with humorous photoreal prints resonated with consumers, and flannels were bolstered by new pattern designs, color palettes, and a strong in-stock position. During the quarter, the industry saw consumers gravitate towards promotional purchasing. We saw a significantly higher portion of our holiday sales occur during the Thanksgiving through mid-Cyber Week period when we ran our global event. Our Black Friday sales were the strongest in our company's history, and we saw a pull forward of sales from the following weeks. In January, we introduced new product innovation and saw a sequential improvement with our full price sales trend. Let me spend a few moments on our product innovation strategy. Within our core categories as well as our AKHG brand, we introduced more newness than ever before. Most of these introductions came in the form of soft launches, but the successful initial results and consumer excitement highlight our ability to develop, design, and deliver innovative and unique first-to-market fabrications and features that set Duluth apart in the marketplace. Key new offerings late in the fourth quarter included a new addition to our electronic fire hose pant collection featuring the strongest flex work pant fabric on the market with a lighter weight than our original fire hose. This product, we've named Flex Fire Hose HD comes in two styles and truly represents the next generation of workwear. We also expanded our core Buck Naked category by offering men's Buck Smooth, which provides the same comfort and function as the fan favorite Buck Naked, adding a smoother, more vibrant, and patterned construction. Our quick-drying Dry on the Fly technology was expanded into tees and underwear across both men's and women's. And finally, we launched AKHG Fitness, our first-ever fitness apparel offering. The assortment built for Nature's Gym for both women and men includes tanks, shorts, hybrid jackets, and after-sweat sweats. Our fitness apparel includes features and technologies that stretch, wick, breathe, and dry quickly and is offered in sizes up to 3X. AKHG Fitness is off to a great start, and although a small contributor to the business today, we see this as a white space opportunity to build on our unique fabrics, features, and functions to create and support AKHG Fitness as a growing and year-round category. To bring awareness to our innovation and product offerings, our marketing and creative teams ramped up our investments in social influencers, which delivered meaningful engagement and strong growth from new younger consumers. We continue to balance brand awareness and high-converting digital tactics to optimize our return on investment and consistently deliver relevant content to both existing and new consumers with creative concepts across streaming video and audio as well as cable TV. Throughout the year, we strategically retargeted past consumers, leading to an 11% increase in reactivated buyers during the fourth quarter. Personalized content re-engaged lapsed consumers, reinforcing the trust and loyalty they have in our brand. In addition, new buyers grew in Q4 as our high-quality solution-based product appealed to consumers who had not previously purchased from Duluth. Our strategic shift towards targeting a younger consumer is gaining traction as our new consumers are, on average, five years younger than our existing consumers. Our previous investment in replatforming the duluthtrading.com website to the next generation of e-commerce tailored for mobile usability is paying off. Our goal is to enhance accessibility and provide a frictionless shopping experience, and because of our investment, we saw high single-digit direct channel growth driven by higher traffic and conversion in mobile more than offsetting retail softness. In fact, fourth quarter mobile sales increased over 20% from a year ago and mobile now represents our largest channel for consumer interaction and purchases, accounting for over half of our total direct channel sales. Shifting to the foundational drivers of the business, we remain steadfast in our commitment to the pillars outlined in our Big Dam Blueprint. As initially introduced in 2021, the five pillars include one, lead with a digital mindset; two, intensify our efforts to optimize our own DTC channels; three, evolve the company's platform to grow into a multibrand and multichannel business; four, prioritize test and learn to unlock long-term growth; and five, future proof the business through investments in capabilities and infrastructure. I'm extremely proud of the tremendous progress we've made on related key strategic initiatives. The benefits of these investments are reflected in a greater penetration of digital sales, especially mobile, lower variable fulfillment costs, and future gross margin expansion. These investments will also enable us to drive revenue growth opportunities in the future. Let me update you on the progress we made in 2023. First, as mentioned on previous calls, we went live with our new highly automated fulfillment center in October and are achieving our plan to process up to 60% of all online orders and store replenishment volume through this facility. In addition to shortening delivery times to keep pace with evolving consumer expectations, the enhanced automation in this center drove lower variable cost per unit to fulfill an order in this facility, which was 42% of the average cost of our three legacy fulfillment centers during the last four months of the fiscal year. This approximately $55 million investment represented the largest individual capital expenditure in the history of Duluth. I'm proud of the cross-functional team's ability to execute and deliver the results we expected. This step change in logistic capabilities allows us to further optimize our own DTC channels and serves as a significant enabler to future-proof and scale the enterprise. Second, we meaningfully advanced our sourcing and product innovation functions, which we believe is another critical strategic unlock that allows us to bring to market high quality, innovative products more frequently, increase our speed to market, and significantly reduce our product cost. Several team members were onboarded during the year, including our new Vice President of Sourcing during the fourth quarter. Our sourcing and product innovation team is accelerating this initiative and the benefits will begin to materialize in 2024 and continue to build over time. Finally, we made great strides completing several foundational initiatives to execute our technology transformation roadmap, the continuation of which will become the primary focus of our capital expenditure outlays. These initiatives will enable the optimization of the business, focusing on a centralized data repository, customer data and analytics, as well as tools to maximize the logistics network capabilities and strategic planning and assortment decisions. Our focus for 2024 will accelerate the operational improvements of the strategic roadmap by expanding our pipeline of new and innovative products, optimizing our marketing mix, improving gross margin rates, and controlling what we can control by prudently managing expenses and inventories. In closing, I'm proud of the progress we've made on our foundational initiatives and remain steadfast in our strategic roadmap. With that, I'll turn the call over to Heena to discuss Q4 and the full year '23 financials and our 2024 outlook.

Thanks, Sam, and good morning. First, I'd like to express how thrilled I am to have joined the Duluth Trading family. In just shy of four weeks in my new role as CFO, I have had the pleasure of meeting with our Board of Directors and the entire leadership team. I visited several stores and toured our fulfillment centers in Adairsville and Belleville. I'm impressed by the strength of our brands, consumer loyalty, innovative product design, engaging storytelling, and the strategic choice to invest in infrastructure to capitalize on growth opportunities. I look forward to partnering with Sam and the entire leadership team as we further pursue our growth initiatives. I firmly believe Duluth Trading is uniquely positioned to expand its reach, and I am excited to leverage my experience to drive our next phase of profitable growth. Let me begin with a review of our full year 2023 and Q4 financial results. Today, we reported full year 2023 net sales of $646.7 million, adjusted EBITDA of $33.4 million, and EPS of negative $0.28. Our Q4 reported results were net sales of $245.6 million, adjusted EBITDA of $21.1 million, and EPS of $0.21. Starting with the top line. For the full year 2023, net sales were $646.7 million, down 1%. In Q4, we saw a trend reversal from prior quarters as net sales grew 1.6% to $245.6 million powered by acceleration in women's and AKHG. Women's business grew double digits across both Duluth and AKHG brands, driven by flannels, intimates, fitness, and the garden collection. The men's apparel business reversed trend from prior quarters and was flat to last year, with growth in AKHG and growth in core Duluth categories of first layer, bottoms, and woven tops, offset by declines in cold weather categories of outerwear, sweaters, and footwear impacted by warmer winter weather. From a channel perspective, our retail channel sales declined 12%, which was more than offset by our direct channel sales growing 9% through higher conversion and greater penetration of mobile. As Sam mentioned, mobile grew over 20% and moved up to our number one sales channel for the quarter. Moving to gross margin. For the full year 2023, our gross margin contracted 230 basis points to 50.3%. Our fourth quarter gross margin was 48.2%, down 300 basis points as we saw our highest-ever Thanksgiving to mid-Cyber Week sales contribution in the fourth quarter during which we ran our global event. I will provide fiscal 2024 guidance details shortly, but through the acceleration of our sourcing and product innovation initiatives, I want to reiterate that we expect gross margin benefits over the next several years. Now on to SG&A. For full year 2023, SG&A decreased by 1% to $333.8 million and was flat to last year as a percentage of sales at 51.6%. For the quarter, SG&A decreased 3.8% to $108.8 million and leveraged 250 basis points to 44.3% of sales. The Q4 leverage was driven by lower fulfillment costs across the network primarily due to efficiencies from Adairsville, further maximization of our marketing spend, and prudent management of our general and administrative expenses. Full year adjusted EBITDA was $33.4 million or 5.2% of sales. Full year net loss was negative $9.4 million or negative $0.28 per diluted share. EPS was weighed down by non-cash depreciation expenses from infrastructure investments. Q4 net income was $7 million or $0.21 per diluted share compared to net income of $7.5 million or $0.23 per diluted share last year. Fourth quarter adjusted EBITDA was $21.1 million, an increase of 2.4% over last year and expanded slightly as a percent of sales to 8.6%. Moving on to the balance sheet. We ended the year with $32.2 million of cash and no outstanding debt on our credit line, leaving us with liquidity of $232 million. Inventory was down 19% or $29.2 million. Our inventory composition is healthy with 90% in current products and a 30% decrease in clearance items. Our capital expenditures for 2023 of $53.2 million were funded by cash and were primarily used to invest in strategic infrastructure initiatives including our new fulfillment center in Adairsville and digital capabilities as per our IT roadmap. Now turning to our outlook for fiscal year 2024. Our full year net sales guidance is $640 million to $660 million, including the 53rd week, which is worth approximately 150 basis points of growth. We expect the first half to be down low to mid-single digits as we continue to navigate a dynamic macro environment. We expect gross margin for the full year to be up 200 basis points with improvement expected to begin in Q1 and build throughout 2024, driven by our sourcing and product development initiatives. As I mentioned earlier, we expect further improvement in margins in the coming years as we continue to optimize our sourcing. We expect SG&A to deleverage by approximately 100 basis points in the coming years, mainly driven by higher fixed costs and depreciation from strategic investments, partially offset by improvements in variable cost benefits being realized from these investments. Advertising expenses are planned to be in line with sales growth and approximately 11% of sales as we plan to continue to invest behind our brands, support new product innovation, and drive omnichannel sales. Variable expenses or selling expenses, which include outbound shipping costs as well as labor across our contact centers, fulfillment centers, and store fleet will continue to leverage driven by optimizing our logistics and fulfillment center network. Fixed expenses, our general and administrative expenses will increase in 2024 primarily from annualizing depreciation and fixed costs from strategic initiatives. We expect our year-over-year EBITDA improvements to outpace net income and EPS growth, as we bear the depreciation impact of strategic investments in our P&L. With that, our full year adjusted EBITDA guidance is $39 million to $45 million and EPS in the range of negative $0.22 to negative $0.07. This includes estimated diluted shares of approximately $33 million and a tax rate of 25%. Our capital expenditure spend will be reduced by more than half to approximately $25 million, and the primary focus will shift from the logistics network to our strategic technology roadmap, enabling efficiencies and scalability. In closing, we are being prudent in our outlook for 2024 and are beginning to see the benefits from our foundational investments fueling adjusted EBITDA growth. Our capital expenditures are normalizing, and our liquidity remains strong. With that, we'll open the call for questions.

Our first question will come from Janine Stichter of BTIG. Please go ahead.

Good morning, and welcome, Heena. I want to ask a bit about the promotional strategy. If we think about the past few quarters, it's been the fact that consumers are shopping more around the promotions than they have in the past that's been pressuring gross margins. So as you think about the gross margin expanding 200 basis points next year, is that entirely due to the sourcing initiatives? I'm curious what you're assuming for planned promotions and then the consumer shopping behavior around those promotions.

Yes, Janine, I'll start with a high-level overview and then Heena will provide additional insights. We expect to continue facing consumer challenges. Last year was very promotional, and we expect a similar scenario this year. However, we believe that many of the strategic initiatives we've implemented, particularly in product development and sourcing, will begin to yield benefits in the upcoming year. As Heena mentioned, our guidance anticipates a gross margin improvement of 200 basis points throughout the year, but we see potential for further upside. We will maintain a balanced approach to pricing and competitiveness while ensuring brand integrity, and we will rely more on our product development strategy to introduce new products more frequently. As I noted earlier, we have more new products than ever before in the pipeline, which looks very promising as we head into Q4.

Yes. Thanks, Sam. Janine, thanks for your question. Yes, we did see a significantly higher portion of our holiday sales occurred during Thanksgiving through mid-Cyber Week period when we ran our global event, and our sales during this period were the strongest in our company's history. We are evaluating the season's performance and we will continue to monitor the macroeconomic and competitive environment. Our guidance for 2024 assumes AUR to be similar to what we experienced in 2023. We are being prudent in our sales outlook and inventory management for 2024. As Sam mentioned, our sourcing and product development initiatives are enabling greater and more frequent introduction of new products, which positions us to drive more full price sales. Our expectation on top line is to be down low to mid-single digits in the first half and our guidance for the full year reflects gross margin up 200 basis points as said in my prepared remarks, and that is mainly driven by our sourcing and product development initiatives, while maintaining AURs year-on-year. As Sam mentioned, we expect further improvement in margin in the out years as we continue to optimize our sourcing strategy.

And maybe along the lines of some of the sourcing initiatives enabling quicker product development. Can you talk about some of the soft launches that you mentioned in the prepared remarks and how quickly you can chase into a broader launch of those assortments?

Yes. As I said earlier, items like Flex Fire Hose HD we built on our iconic firehose pant program came in and the reception to that was really strong. Buck Smooth is interesting. We've talked about Buck Smooth leading up to Q4 as being a new innovation in fabric that allows us to actually print kind of photoreal print on there. And that was met with overwhelming success. I would also add our intimates program in women's. We've introduced some new bras, TeeLUXE bra being our number one bra in its first season. And then last call, we talked about the excitement around our AKHG fitness category, and that came in the last week or so of December and really came out of the gate strong. We think that across AKHG in total, but specifically AKHG fitness, there’s a long runway. A lot of these are not just about items; they are critical components of the strategic building blocks to some of our other key merchandising initiatives like our strategic focus on growing the women's business. The women's penetration was 30% and it increased by 200 basis points. We've mentioned in the past that we think the women's opportunity is to be a larger business in total and a larger share of our business; we're starting to see some traction in that regard. Women's again, double-digit increase for the quarter, up high single digits for the year. Many of these soft launches are item-driven but critically are also a vital part of the strategic building blocks to some of these other longer-term product initiatives.

The next question comes from Jonathan Komp of Baird. Please go ahead.

I want to follow up. I know there was reference to seeing an inflection in the business during the fourth quarter. If you could just maybe share a little bit more. Are there some underlying metrics or full price selling or anything that you would highlight just because from a reported perspective, still seeing gross profit dollars declining. It's hard to see signs of the inflection. So just hoping you could maybe share more insight there.

Yes, Jonathan. A couple of things I'll say. One is the Black Friday weekend through the midpoint of Cyber Week was the strongest sales results we've seen in the history of the company. During that time period, we ran our global event, and because of the demand, it drove some top-line growth, but the flow-through clearly wasn't what we expected or what we've seen in the past. As we assessed the business both today and during the quarter, we did see a sequential improvement in our regular price sales as a percent of total sales, especially as we started to bring in early new spring goods. January, in particular, saw all those new items that we began to introduce in the last week of December; it moved the needle for us from a regular price perspective in January. While we expect headwinds to remain through the first half of this year, we’re optimistic about the early launched goods and the benefits our product development and sourcing initiatives are bringing us. So, we believe while the top line will be challenged, we are going to see better flow-through over the course of the year.

And just as a follow-up, could you maybe just speak to ideally or from a target perspective what percentage of product would you like to sell at full price? And how far off are you today? And then really a broader strategic question, just what needs to change in sort of the focus? If you look at the guidance here for the year, still not profitable at a net basis even though you're realizing benefits now from some of the multiyear supply chain initiatives. So what needs to change? And if you could share any more insight on the strategic pricing.

Yes, absolutely. The product development and sourcing initiatives, as you know, are about creating more newness and innovation more frequently. We really started this initiative last year, and so this is the first full year based on our order timeline that the work done last year starts to come to retail. We expect as Heena mentioned gross margin improvements. While it's still negative, think about over the last 1.5 years or so; our margins have moved towards a competitive perspective. This becomes a starting point for us to move margins upwards as we move through '24 and beyond. Our new fulfillment center really just got up and running in Q4 of last year; we saw some benefits in metrics related to cost per unit and time to delivery towards the end of Q3, and in Q4, we saw lower variable costs per unit. It's about 42% of the average legacy fulfillment center costs per unit. As we go through this year, we expect to see these variable costs coming down, helping us leverage the total variable costs of our center network. A lot of the things we've invested in are now beginning to show benefits. '24 will be the year where we start to recognize these through the full year, and as we start building on those, you will see incremental improvements in gross margins.

And just last question for me. Would it make sense to change focus instead of targeting top-line growth, and it seems like you're embedding an inflection as the year goes on for total revenue, but would it make sense in the short term to focus back on profits into the revenue in terms of how you're managing the organization? Or just any thoughts there.

Yes. I think it's a combination of both. We have to be focused on the top line, which drives a big part of our product development and sourcing; creating a pipeline of frequent new products also drives greater full price sell-throughs, leading to greater bottom-line profits. The variable costs of our business will continue to improve as we move forward, while our fixed costs will rise due to the investments in strategic initiatives. Our P&L is a bit hampered by depreciation associated with those investments; however, manageable costs and the benefits from these investments are beginning to leverage. We see this inflection point moving forward, particularly as capital expenditures are now less than half of what they were last year, with a focus on enabling efficiencies and scalability. We're managing the business prudently and intentionally without compromising our overall goals.

Yes. I would say our focus for 2024 will be to accelerate the operational improvements that we are seeing from the strategic road map by expanding our pipeline of new and innovative products, optimizing our marketing mix, improving gross margins through our sourcing initiatives, and controlling what we can control by prudently managing expenses and inventories. The other point I would make is, as I said in my prepared remarks, we are seeing capital investment cut in half in '24, and we will continue to see adjusted EBITDA outpace net income and EPS as we navigate through the depreciation from prior capital investments impacting our P&L.

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

Kind of similar line of question a bit. I guess, I'm trying to think about the decline in gross margin over the years, 700 basis points, 600 basis points going back to 2015, 2016. Is that all best understood as an increase in promotion? And then can you quantify or even directionally sort of the margin drag from the retail channel over that same period? You've seen productivity in your stores effectively have. Just taking those two things together to think about how the new glide path back to above the line on profitability, if there's a risk around kind of having your customers now so used to higher promotions, et cetera, and sort of how you maybe get the retail chain back on some firmer footing.

So on your long-term gross margin question, we've made significant progress in advancing our sourcing and product development initiatives. As I mentioned in my guidance, we anticipate 200 basis points of improvement, which we expect will continue to build over the coming years and help us return to our pre-pandemic levels in a few years. So we see a path forward to higher gross margins.

Can I stop you there? Is that the promotional impact? I understand the sourcing benefits; can you quantify how much you expect to embed in terms of returning to a higher price plan compared to what it was before the period?

For 2024, we are being prudent in our outlook and we are not assuming any AUR improvement in our guidance. But we are looking at our seasonal performance, optimizing it, and how our new innovation can drive us to more full price sales. I've visited several of our stores, which provide a unique and engaging experience for consumers. They are part of our omnichannel strategy alongside digital and mobile platforms, creating an ecosystem that helps us reach and retain consumers. They are critical to our strategy going forward. All of our stores are cash flow positive. While we do have an opportunity to improve efficiency and profitability in our stores, we plan to be more rigorous about considering size, format, and assortment depth going forward as we evaluate new locations.

This concludes our question-and-answer session. The conference has now also concluded. Thank you for attending today's presentation, and you may now disconnect.