U.S. Markets open in 8 hrs 9 mins

Edited Transcript of DLTH earnings conference call or presentation 5-Sep-18 1:30pm GMT

Q2 2018 Duluth Holdings Inc Earnings Call

Belleville Oct 15, 2018 (Thomson StreetEvents) -- Edited Transcript of Duluth Holdings Inc earnings conference call or presentation Wednesday, September 5, 2018 at 1:30:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* David Loretta

Duluth Holdings Inc. - Senior VP & CFO

* Donni Case

Financial Profiles, Inc. - MD

* Stephanie L. Pugliese

Duluth Holdings Inc. - President, CEO & Director

================================================================================

Conference Call Participants

================================================================================

* Daniel Ray Wewer

Raymond James & Associates, Inc., Research Division - U.S. Hard Line Goods Analyst

* Dylan Douglas Carden

William Blair & Company L.L.C., Research Division - Analyst

* James Vincent Duffy

Stifel, Nicolaus & Company, Incorporated, Research Division - MD

* Jonathan Robert Komp

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Michael Milton Yuji Kawamoto

D.A. Davidson & Co., Research Division - Research Associate

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good morning, and welcome to the Duluth Holdings Second Quarter 2018 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Donni Case, Investor Relations of Duluth Holdings. Please go ahead.

--------------------------------------------------------------------------------

Donni Case, Financial Profiles, Inc. - MD [2]

--------------------------------------------------------------------------------

Thank you, Brandon, and welcome to today's call to discuss Duluth Trading's second quarter 2018 financial results. Our earnings release, which we issued this morning, is available on our Investor Relations website at ir.duluthtrading.com under Press Releases.

I am here today with Stephanie Pugliese, 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 the 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. 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. Please refer to our SEC filings for additional information.

And with that, I'd like to turn the call over to Stephanie Pugliese, Chief Executive Officer of Duluth Trading. Stephanie?

--------------------------------------------------------------------------------

Stephanie L. Pugliese, Duluth Holdings Inc. - President, CEO & Director [3]

--------------------------------------------------------------------------------

Thank you, Donni, and welcome, everyone, to our second quarter conference call.

2018 is a year of high growth and investment in our future. Our key initiatives for the year center on expanding the brand through our omnichannel initiatives and continuing to deepen our relationship with our customers through a great product, storytelling and experiences. I'm very happy to report that we are executing well on all of these goals.

We had a strong second quarter with an increased growth rate in our direct business relative to first quarter, healthier product margin and the reduced use of promotions. We opened 6 new stores in the quarter and we successfully implemented 2 major infrastructure improvements.

In the second quarter, net sales increased 28% to $111 million, which marks our 34th consecutive quarter of increased net sales year-over-year. Retail sales for the quarter delivered a 74% growth rate, largely driven by new stores opened in 2017 and 2018. Our 6 new stores this quarter opened strong and are meeting our initial expectations.

Direct sales grew 5.5%, reflecting a return to more normalized seasonal buying patterns and pent-up demand from the cooler weather we experienced late in the first quarter. We saw growth across all categories in our men's and women's divisions, with men's growing 26% year-over-year and women's continuing its strong trajectory with 37% growth. Product gross profit rate was up slightly to last year, a result of less reliance on promotional activity and increased initial margins. We got past the drag of clearance merchandise from first quarter. And in second quarter, we sold more product at full price than last year as a percent of total sales. Core year-round product and seasonal categories all performed very well, and we ended the quarter in a better inventory position than we have seen in prior quarters.

Turning now to other progress we have made and what's ahead. First, commitment to our omnichannel strategy guides our execution on all aspects of our operations. As I mentioned a moment ago, we achieved some significant milestones in the past few months. Our order management system went live the last week of May, and our e-commerce platform was launched to customers in the first week of August. Both projects were implemented with minimal disruption to our customers and the team has done a remarkable job on the transitions of both of these major IT systems. In addition, we have upgraded the point-of-sale system in many of our stores. We kicked off our assortment and inventory planning system implementation, and we are well on our way to improving the omnichannel experience for our customers this fall and winter.

We're also hitting our stride in taking an omnichannel view with respect to our marketing, resulting in highly integrated campaigns that focus on promoting key solution-based product initiatives on Summer Solved. This crossed all channels through the timely integration of TV and radio advertising, catalog, digital, billboards and in-store displays. With the continued growth of our retail presence, we are using these learnings to maximize the customers' experiences in each channel and across the enterprise. We know that an integrated marketing campaign amplifies the favorable response of our customers to new offerings, and we've used this approach to make a noticeable impact with our women's plus launch, making our best-selling styles available in sizes up to 3X and 26W.

We've strategically timed the launch of the women's plus for the fall season to coincide with the start of our peak selling period. We remain very focused on building continued momentum in our women's line overall not only for its sales potential, but also because women are valuable customers. They tend to shop more often and across more product categories. Our retail stores have been instrumental in breaking down a key barrier to women adopting the brand, namely: the ability to see, feel and try on products.

Women's plus is not all we have planned for this fall, though, we will be also launching several new and innovative lines of apparels including Flexpedition men's and women's pants. This line of bottoms is incredibly flexible and tough while being water-repellent to protect him and her from changing weather conditions. In addition, our new Spit & Polish apothecary line for men and women launched last month with 32 styles of new products. The line uses natural ingredients and universal scents to fight dirt and grime encountered with an active lifestyle. We also expect continued growth in men from Alaskan Hardgear through new styles and additional store-within-a-store concepts in retail.

As we previously mentioned, a critical element of our omnichannel strategy is to enhance the growth of a total market through the addition of retail stores. This quarter, we continue to see that direct sales in established store markets outpace those without stores, supporting our conviction that our market expansion strategy is working. With our larger retail footprint, we have an even greater opportunity to leverage the momentum created by customers who shop across channels and to serve those customers better. That is why we will begin to roll out additional services, like buy online pick up in store; easier returns processes; and ship from store later this year. The endgame is to convert our customer base into high-value multichannel buyers because we know that they shop more often and spend more than double that of single-channel buyers. Omnichannel markets are the best expression of our brand and create the most opportunity for growth and long-term profitability.

Before I turn the call over to Dave, I want to update you on our retail store expansion plans for the fiscal year. As I mentioned earlier, we successfully opened 6 stores this quarter located in Colorado Springs; Portland, Oregon; Columbus, Ohio; and 3 within Texas: Lubbock, Denton and Arlington. Adding to our 8 stores opened this year, we are on target to open 7 more stores which will put our total for the year at 15, as stated in our guidance. The only change to our previously published schedule of store openings is that we are now planning for a new store in Cary, North Carolina rather than Princewood, Texas, which has experienced some construction delays and is now expected to open in early 2019.

In closing, we've done a lot of heavy lifting in the first half of the year: 8 stores and the completion of 2 major IT projects. With these projects behind us and the new initiatives ahead of us that I mentioned earlier, we are looking forward to the balance of the year. Many of you know that the lion's share of our sales and profitability happens in the all-important fourth quarter. To that end, the team is hard at work to ensure that we have a successful year by focusing on ongoing product innovations, engaging storytelling and supporting high-growth areas like women's with incremental digital, television and localized marketing. We also plan to more fully render the omnichannel experience with buy online pick up in store, ship from store and distribution center improvements for the peak season. We are reiterating our guidance for the year and look forward to sharing our progress with you.

Now I will turn the call over to Dave to cover our financial results and the status of our capital project initiative. Dave?

--------------------------------------------------------------------------------

David Loretta, Duluth Holdings Inc. - Senior VP & CFO [4]

--------------------------------------------------------------------------------

Thank you, Stephanie, and good morning.

For the second quarter, we reported net sales of $111 million, up 28% compared to last year. Sales growth was driven by both our retail and direct segments with retail sales increasing 74% to $49.8 million and direct sales growing 5.5% to $60.8 million. During the quarter, we opened 6 new stores, including 3 in the state of Texas, which is 1 of our top 3 states for the direct business.

Revenues from shipping fees were $1.9 million this quarter, down slightly from $2.1 million last year. Excluding these revenues, the direct product sales increased 6.1% in the second quarter, which reflects a 210 basis point increase sequentially from the first quarter. Additionally, we continue to see direct sales in our established store markets outpace markets with no stores or recently opened up stores.

Our second quarter gross profit weight -- rate was 56.2% of net sales compared to 56.7% last year. The 50-basis-point decrease in gross profit was primarily due to the decline in shipping revenues and an increase in freight costs for delivery of products to our growing store base, partially offset by an increase in product margin due to a higher percentage of full price sales as compared to last year.

Selling, general and administrative expenses decreased 90 basis points to 47.3% of net sales compared to 48.2% last year. In dollar terms, the growth in SG&A included $5.8 million in general and administrative expenses, $4.1 million in selling expenses and an increase of $900,000 in advertising and marketing expenses. Included in SG&A were new store preopening expenses of $1.8 million compared to $1.5 million last year. As a percentage of net sales, advertising and marketing costs decreased 310 basis points to 14.3% compared to 17.4% in the second quarter of last year. The 310 basis point decline was primarily due to a planned reduction in catalog costs, coupled with greater leverage of web marketing and television advertising expenses due to the growth of retail sales.

Selling expenses as a percentage of net sales increased 60 basis points to 14.7% compared to 14.1% last year. The 60 basis point increase was primarily due to a higher retail selling costs resulting from additional stores, coupled with a short-term increase in call center staffing needed for training on our new order management system. This was partially offset by leverage in shipping expense due to the proportional increase of retail net sales.

General and administrative expenses as a percentage of net sales increased 160 basis points to 18.3% compared to 16.7% last year. This was due to an increase in technology expenses, depreciation and higher store occupancy costs. Bottom line, we reported net income of $6.4 million or $0.20 per diluted share compared to net income of $4.3 million or $0.13 per diluted share last year. Adjusted EBITDA increased 39% to $13.1 million or 11.8% of net sales compared to 11% of net sales last year.

We ended the second quarter with a cash balance of $2 million, net working capital of $74 million and $35 million outstanding on our revolving line of credit. As an area of focus, we continue to rightsize our investment in inventory, and we're able to realize improvements this quarter by growing sales faster than growing inventory levels. Overall, inventories increased $18 million or 21% to $102 million, with roughly half of the increase due to the additional stores compared to the prior year.

Turning to our 2018 financial outlook, which is based on a 53-week period as compared to 52-week period in 2017, we are reaffirming our guidance for the year and expect net sales to be between $555 million and $575 million, with the retail segment accounting for up to 40% of total net sales. The direct segment is expected to grow in mid-single digits as compared to 2017, and we expect to open a total of 15 stores this year, adding 250,000 gross square feet.

As previously discussed, our full year gross profit rate is expected to be flat compared to the prior year and our selling, general and administrative expenses as a percentage of net sales to increase 50 to 100 basis points over last year. The SG&A rate increase is primarily due to an increase in selling and overhead expenses as a result of the growth in retail and investments in technology and our people, partially offset by leverage gained from flexing advertising expenses.

We expect 2018 earnings per diluted share to be between $0.79 and $0.84. This assumes a full year weighted average diluted share count of 32.4 million shares and a tax rate of 26%.

Now I'd like to give an update on our capital expenditure initiatives. At the beginning of the year, we shared with you our capital allocation priorities, which reflected a continued investment in expanding the retail channel and upgrades to the foundational infrastructure systems necessary to execute our omnichannel strategy. As noted previously, the investment in retail stores is on a track for the year with no material changes to the pace and timing of grand openings.

From a systems standpoint, the initiatives break down into 4 core components: first, the complete replacement of our order management system with the implementation of Microsoft's Dynamic AX platform. This is the hub of our network and enables real-time inventory visibility across the chain and serves as a customer order platform, integrating all other critical business feeds. As Stephanie mentioned, we successfully converted to the new system during the second quarter and can now proceed with the other components.

Second, the conversion to a new e-commerce website with the implementation of Salesforce Commerce Cloud platform. This conversion was completed in early August. And in addition to providing our customers with a more agile and consistent experience across multiple devices, the website will enable us to develop more personalized content while enhancing our digital customer service.

Third, the upgrade to our planned sale network in the stores is in process now and will be completed during the third quarter. The critical elements of this upgrade are: completing the integration to our OMS hub for total visibility into customers activities with us across channels, real-time inventory throughout the chain, enabling chip and PIN on card payments and enhancements to our gift card program. In addition, the POS upgrades will allow us to introduce omnichannel functions, including the ability for our customers to place an order online, and then within a few hours, pick up the order in the store; the ability to ship an order from a store to a customers that are in closer proximity; and a more seamless in-store returns processing for our customers. We will begin to test these omniprogram capabilities in a -- this fall in a select number of stores with further rollout to be scheduled for early 2019 based on our learnings from the tests.

The fourth systems component we're embarking on this year is the first phase implementation of an inventory assortment planning, an allocation tool offered by TXT Retail. This tool will allow us to blend state-of-the-art technology with our key item merchandising know-how to better predict, source and supply products for our customers. We will begin our store-level replenishment functions this fall and enable the merchandise forecasting tool and localized assortment planning in 2019.

Lastly, our capital plans this year also include an upgrade to the direct order fulfillment functions in our distribution center in Belleville, Wisconsin, and the move into a new home office facility just down the road in Mount Horeb, Wisconsin. Both projects are on budget and on schedule to be completed during the third quarter.

In closing, we are pleased with the second quarter and year-to-date results as well as the great progress for -- our Duluth teams have made in these critical initiatives. We have good momentum heading into the rest of the year, and we'll continue to execute our near-term plans and expect to deliver on our full year financial guidance.

With that, I'll open the call to questions. Operator?

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question comes from Dan Wewer with Raymond James.

--------------------------------------------------------------------------------

Daniel Ray Wewer, Raymond James & Associates, Inc., Research Division - U.S. Hard Line Goods Analyst [2]

--------------------------------------------------------------------------------

Stephanie, I was curious as to how the second quarter sales and earnings actually compared to your internal plan. And if they exceeded your expectations, was there any thought to increasing the guidance for the fiscal year?

--------------------------------------------------------------------------------

Stephanie L. Pugliese, Duluth Holdings Inc. - President, CEO & Director [3]

--------------------------------------------------------------------------------

Dan, so in terms of second quarter results, we were on plan in a number of places. We exceeded plan in the -- we had better expense control in the SG&A side than our internal plan. But from a sales and new store expectation, we were -- we're very close to our internal expectations for the quarter. As we look forward for the balance of the year, the -- as I mentioned in my prepared remarks, fourth quarter is the all-important. It's the majority of the sales. It's certainly the vast majority of our profitability for the year. And right now, we're really pleased with the momentum that we've got coming into the second half of the year. But our focus is on continuing to execute well the plans that we have to get us ready as we get closer and closer to that fourth quarter. So at this point, we're very comfortable with the guidance that we've put out there. We're -- the team is executing very well, and we've got big things ahead of us [that's still coming] .

--------------------------------------------------------------------------------

Daniel Ray Wewer, Raymond James & Associates, Inc., Research Division - U.S. Hard Line Goods Analyst [4]

--------------------------------------------------------------------------------

It looks like the growth rate slows in revenues in the second half of the year based on where you are year-to-date and in reiterating the guidance.

--------------------------------------------------------------------------------

Stephanie L. Pugliese, Duluth Holdings Inc. - President, CEO & Director [5]

--------------------------------------------------------------------------------

We are still expecting the direct business to be in the mid-single-digit growth, which is where we are year-to-date. Obviously, we picked up some momentum in that part of the business in second quarter coming off of a tough kind of end to first quarter, if you will. So we're expecting that to stay pretty solid. And then the retail numbers are really a function of how we are coming in with new stores and anniversarying stores. It's the mix that will change up a little bit as we go into the second half of the year. But we're -- as I said, in terms of the top line business, we're pretty much right on target with where we expected today.

--------------------------------------------------------------------------------

Daniel Ray Wewer, Raymond James & Associates, Inc., Research Division - U.S. Hard Line Goods Analyst [6]

--------------------------------------------------------------------------------

Okay. And just as a follow-up question, as you get more experience with the retail model, how will -- have you changed your thoughts on how the growing sales contribution from retail will impact Duluth's long-term gross margin rate, expense rate and operating margin rate?

--------------------------------------------------------------------------------

Stephanie L. Pugliese, Duluth Holdings Inc. - President, CEO & Director [7]

--------------------------------------------------------------------------------

So when we look at the -- I'll start with the gross profit rate, just as a kind of entry point to ultimate profitability. We know that our retail stores are selling more at percent -- at full price as a percent of total, so their product margins sit a little bit higher than the direct business. That said, we do have the additional gross margin pressure, if you will, on retail of the freight, which is part of -- which was over half of the 50 basis point decline in gross profit, as Dave had mentioned in his prepared remarks. So you've got some puts and takes on the gross margin side of things. When you look at operating margin, as we look at it today and as we break out -- it out today, and we know it's not the only way to look at it and we know it's probably not the ultimate way to allocate expenses, particularly around overhead and advertising expense. But the retail business, as the mix is increasing towards retail, is obviously benefiting us on advertising leverage in particular, and leverage, overall, long term. We are anticipating as we go forward over the next several years that, that advertising leverage, which is the biggest piece of it, is going to continue to benefit us and allow for the kind of inflection point, if you will, of our overall profitability and start to allow us to increase that income contribution on the bottom line. So we're not seeing any changes to what we've been articulating for the past several quarters on that. In fact, it's playing out the way that we expected.

--------------------------------------------------------------------------------

Operator [8]

--------------------------------------------------------------------------------

Our next question comes from Jonathan Komp with Robert W. Baird.

--------------------------------------------------------------------------------

Jonathan Robert Komp, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [9]

--------------------------------------------------------------------------------

I wanted to maybe start just following up on the direct business and if I could ask just how things trended during the quarter. I think you signaled a pretty good start, and I'm just curious how you saw trends play out. And any comments kind of seasonally, what worked or didn't work, also would be great.

--------------------------------------------------------------------------------

Stephanie L. Pugliese, Duluth Holdings Inc. - President, CEO & Director [10]

--------------------------------------------------------------------------------

Sure. Well, I would say the first thing that was wonderful about second quarter is we didn't have the last 2 weeks that we've really struggled with like we did in first quarter. So it was nice to not have that unpleasant surprise at the end of this quarter. First -- second quarter started off well. We did, as we mentioned, have some pent-up demand coming out of that weak end of first quarter. But really, the quarter was quite strong all along. The team pulled together. And I mentioned in my prepared remarks, integrated marketing campaigns. One of the areas that I didn't talk about specifically with our campaigns that we had around Mother's Day and Father's Day in the quarter. Both of those campaigns, I thought, the team did an excellent job of integrating messaging across all channels. And those played out very well for us. The other thing that worked well for us was our Summer Solved product. Product like Dry on the Fly, Armachillo, Breezeshooter, those products performed very well for us as well. I mentioned in last quarter's call that coming out of May, because, of course, at that point, we already had the May month kind of under our belt, that we felt good about our inventory position for spring and summer product. And that was because we had strength all the way through the quarter. We ended the quarter in an inventory position in that seasonal product in a very good spot. In fact, we were able to continue some of that momentum in net sales through the month of August because our customer's still looking for hot weather product at that point. And so we were pleased with that. But I don't want to fail to mention the fact that core products like No-Yank Tanks, Buck Naked Underwear, Flex Fire Hose, those products were strong in first quarter and continued to do well in second. So really, from a product perspective, I'm very pleased to say that I think the team was just firing on all cylinders in the quarter.

--------------------------------------------------------------------------------

Jonathan Robert Komp, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [11]

--------------------------------------------------------------------------------

Okay. Great. And maybe just to follow up, more recently, I'm curious with the new website in place and all the new functionality, kind of what you're seeing there both in terms of any improvements in conversion or any of the key metrics that you're tracking and just the overall trends for the online business.

--------------------------------------------------------------------------------

Stephanie L. Pugliese, Duluth Holdings Inc. - President, CEO & Director [12]

--------------------------------------------------------------------------------

So we launched the website internally in the middle of July or so and were able to work out a few kinks that we hadn't seen before we got the employees kind of in there and digging around, which was a great kind of strategy to have. Then we went live with customers the beginning of August. We are -- we're really pleased, number one, that we haven't seen major disruptions to our customers. And I think that's kudos to the team for really tinkering and working hard on making sure that the website was of high caliber as we launched it to customers. That said, we're refining certain things, inbound links, for example, to make sure that, that -- that the web traffic is coming through to the right places, that we're getting people through to checkout seamlessly. And those are the things that we expected to be working on in the month of August. So far, we're on track with where we expected the website to be. And as you probably remember, we had talked about the fact that we did expect a time of adjustment, if you will, for our customers and for some of the kind of plumbing, if you will, of the website. And we're continuing to refine that, but we're really very much on track with where we expected to be. Very pleased with site speed, for example, has been an incredible improvement. Our mobile site has seen great improvement around site speed and navigation for our customers. So overall, like I said, just real pleased with how the launch went over the past few weeks. More to come. We're going to see just what we can do as we get into fall and peak, obviously. And we're really focusing right now on how we are linking now these 2 amazing tools that we've just launched in the order management system and the ECP back to more omnichannel experience like the things we mentioned: buy online pick up in store, ship from store, et cetera. That's the stuff that the team is focusing on right now. We're going to be piloting those things over the next couple of weeks, getting out the kinks of that so that will be ready for peak.

--------------------------------------------------------------------------------

Jonathan Robert Komp, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [13]

--------------------------------------------------------------------------------

Okay. Great. And maybe last one for me, just on the marketing and advertising expense, I know the first half was down more than 300 basis points for the expense ratio. And I'm wondering if you could give more color just on how much of that is kind of underlying leverage that you're gaining versus the -- some of the accounting rule changes that are shifting within quarters and just how to think about that expense item for the full year.

--------------------------------------------------------------------------------

David Loretta, Duluth Holdings Inc. - Senior VP & CFO [14]

--------------------------------------------------------------------------------

Yes. Sure, Jon. I can give you a little color there. For the second quarter, the improvement over last year is not impacted that materially at all by the accounting change. But we did have some planned expenses for the second quarter that are going to push into the third quarter. So some creative projects largely around preparing for some of the future ad campaigns. We had budgeted those to happen in the second quarter. Those are getting pushed into the third quarter. And that amounts to roughly $800,000. So that gives you a little more feel for what the improvement in second quarter is and what's going to impact third quarter. As we talked about, third quarter is going to see some of that accounting rule impact not to the same degree we've articulated before. We were saying roughly $2 million of catalog costs were going to be pulled into the third quarter from the fourth quarter. As we look at the timing of some book drops and we made some adjustments there, roughly only half of that would really be pulling into the third quarter out of the fourth quarter compared to last year. So a slight adjustment to the timing of the ad. But for the full year, we still expect to see anywhere from 150 to 200 basis points of leverage on the advertising for the full year.

--------------------------------------------------------------------------------

Operator [15]

--------------------------------------------------------------------------------

Our next question comes from Michael Kawamoto with D.A. Davidson.

--------------------------------------------------------------------------------

Michael Milton Yuji Kawamoto, D.A. Davidson & Co., Research Division - Research Associate [16]

--------------------------------------------------------------------------------

Just first off, can you talk a little more about what direct growth look like in markets that has had a store open for 2 or 3 years? I think you recently disclosed some of those figures that -- maybe to show that acceleration you've talked about. So just any incremental color on how those markets are trending would be helpful.

--------------------------------------------------------------------------------

David Loretta, Duluth Holdings Inc. - Senior VP & CFO [17]

--------------------------------------------------------------------------------

Sure. I can give you -- the information we did share a couple of months ago based on trends through 2017 continue at that relative growth rate, where a store market that has been established for upwards of 2 years is seeing direct growth double the pace of the total company growth rate for direct. So that trend year-to-date continues. And as we see the store markets start to mature further with the store presence there and the customers shopping both online and in the store, that trend continues with that kind of dynamic. So pleased to see that response. And as we see more of our markets become established, we expect that to play out in the back half of the year and into next year as well.

--------------------------------------------------------------------------------

Michael Milton Yuji Kawamoto, D.A. Davidson & Co., Research Division - Research Associate [18]

--------------------------------------------------------------------------------

Got it. And then on shipping revenue, I think you said it's flattish in 1Q, down slightly in 2Q, I believe. What are your full year expectations there? I think you said 20% decline for the full year. Is that still kind of what you're thinking?

--------------------------------------------------------------------------------

David Loretta, Duluth Holdings Inc. - Senior VP & CFO [19]

--------------------------------------------------------------------------------

Well, 20% at this stage is probably a little extreme. We are year-to-date seeing it to a lesser extent, and we don't anticipate that we're going to be driving free shipping offers anymore incrementally than we did last year. So it's going to be closer to 10% down year-over-year. The dollars are becoming smaller so it's not as big of an impact. But for the full year, still down year-over-year upwards of $1 million or roughly 10%. So that's what we expect at this point.

--------------------------------------------------------------------------------

Operator [20]

--------------------------------------------------------------------------------

Our next question comes from Jim Duffy with Stifel.

--------------------------------------------------------------------------------

James Vincent Duffy, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [21]

--------------------------------------------------------------------------------

Congratulations to the team on the successful systems implementations. A couple of questions around that. First, is there any way to size any disruption that caused in the second quarter? And then Stephanie mentioned some fine-tuning and potential disruption from that. Any thoughts around the size of the impact to the business from that?

--------------------------------------------------------------------------------

Stephanie L. Pugliese, Duluth Holdings Inc. - President, CEO & Director [22]

--------------------------------------------------------------------------------

Yes. Jim, we looked at it. To give you a couple of specific examples, some of the disruption that we did see, we had a couple of promotional days where we had mixed visibility to promotional pricing for the customer. So in some cases, the promo prices weren't showing up or they were showing up in a couple too many places. That has been worked through over the past 4 weeks or so. We expect that we -- we lost a little bit of business on those particular days, but it wasn't really material to the quarter, particularly given the fact that in most of the cases where it was happening, we were able to remedy that within several hours of detecting the problem. So we don't think it was a real material impact over the quarter. In terms of the tinkering, the fine-tuning that we're doing today, those are more things that I would characterize as builds and updates to a website that are almost more ongoing types of improvements that any business would be making to the website: How do we make more efficient the landing pages that we're directing people to based on, say, prospecting ads? How are -- the more that the -- if you remember our old website, it was actually 2 websites coupled together. There were 2 URLs. Now we're a -- well, actually 3 when you consider our mobile site as well. Now we have 1. So we're just making sure that inbound links from organic search from some of the prospecting are all leading into that 1 URL and not being diverted to some of the old addresses that we had. Those are the fine-tuning that we're having. But we're not expecting that it's material at this point because there really hasn't been major disruption to the customer.

--------------------------------------------------------------------------------

James Vincent Duffy, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [23]

--------------------------------------------------------------------------------

Good to hear. And then with respect to the Microsoft Dynamic AX, that real-time inventory view has proven a very powerful tool for a lot of other brands and retailers. Do you feel you're successfully leveraging that now to capture sales that might have been lost otherwise just by finding inventory in the system? Is that how we should think about the power of that?

--------------------------------------------------------------------------------

Stephanie L. Pugliese, Duluth Holdings Inc. - President, CEO & Director [24]

--------------------------------------------------------------------------------

Slightly differently. And to first answer your question directly, I don't think we're leveraging that yet. We -- the first kind of stage of leveraging, what we believe is the most powerful part of this tool, is to be able to do very quick buy online pick up in store. And when I say very quick, it's available in a couple of hours instead of available in a few days and the ship-from-store component, where obviously we cannot only get product to the customer in their home more quickly, but we can also leverage inventory where it is. Those are 2 examples of things that we're piloting in the month of September, and we will roll that out to a select group of stores for the peak season, and then we'll go from there based on the learnings, based on the learnings and based on the ability for each individual store to be able to handle that type of activity. Some stores just don't have, for example, a large enough backroom. But we'll be rolling it as far as we can to take the maximum advantage of that piece of it. The other thing that I would just mention because I mentioned it in my prepared remarks is the upgrade to our POS system. That was another component to being able to use the real-time inventory wisely. That upgrade to the POS system also allowed our POS system to real-time -- to have real-time inventory feeds so that everything was just working in tandem. The biggest thing that we didn't want to do was risk disappointing a customer who ordered something we thought we had it in a store and then we didn't for them. So we've been very, very cautious, if you will, and very diligent on making sure that these systems are working properly before we roll it all out.

--------------------------------------------------------------------------------

James Vincent Duffy, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [25]

--------------------------------------------------------------------------------

Okay. I know I'm going deep on this, but with the new website, the consumer experience is definitely an improvement. Any more you can talk about just kind of the pending unlocks? As you leverage some of the new capabilities to the website, are you expecting improved conversion? Does personalization become a feature? Any help there would be great.

--------------------------------------------------------------------------------

Stephanie L. Pugliese, Duluth Holdings Inc. - President, CEO & Director [26]

--------------------------------------------------------------------------------

Sure, sure. And Jim, I think you hit on a word that is something we're talking a ton about next to the personalization part of it. I would categorize where we are today from a systems perspective as we have now built the infrastructure to augment all of the data that we already had. Now we've got the infrastructure to be able to action on that data and we're now putting in place the testing, the resources that we need to action the data that we have and now the system that will enable that personalization. So we're envisioning personalized e-mails, personalized landing pages based on prior search, of being able to direct our customers to where they want to go in a much more facilitated and easy fashion for them in addition to all of the other things like you can buy something online and pick it up on your way home from work from your local store. Those types of things that really -- they're technology-enabled, but at the end of the day, they're just amazing customer service. So we're right now at that crossroads of super data-rich infrastructure technology in place. Now let's action on it. So we expect, over the next 12 months, to really start ratcheting up a lot of that action, if you will, to engage the customer more fully. And that goes not only from customer groupings but also markets. So how are we differentiating customer communications on the website if you're in a market with a store versus a market without a store. Things like that, that we think are going to be really interesting go forward.

--------------------------------------------------------------------------------

Operator [27]

--------------------------------------------------------------------------------

Our next question comes from Dylan Carden with William Blair.

--------------------------------------------------------------------------------

Dylan Douglas Carden, William Blair & Company L.L.C., Research Division - Analyst [28]

--------------------------------------------------------------------------------

Just curious as far as sort of setting expectations around particularly direct sales growth and gross margin given some of the choppier comparisons in the back half of the year and the, sounds like, product tailwinds, very real product tailwinds that start ramping in fall. Is there anything that you're kind of expecting in your own internally that you can share?

--------------------------------------------------------------------------------

Stephanie L. Pugliese, Duluth Holdings Inc. - President, CEO & Director [29]

--------------------------------------------------------------------------------

Are you talking, Dylan, differently -- different from the mid single digits of direct?

--------------------------------------------------------------------------------

Dylan Douglas Carden, William Blair & Company L.L.C., Research Division - Analyst [30]

--------------------------------------------------------------------------------

Yes. Exactly. I mean, it's a higher comparison in the fourth quarter, which is a more important quarter for you. Gross margin kind of moves around a little bit. It sounds like you have some new product flow coming in fall and there won't be as much of a drag maybe from some shifts in revenue 4Q versus 3Q. Just as far as sort of setting expectations heading into the individual quarters.

--------------------------------------------------------------------------------

Stephanie L. Pugliese, Duluth Holdings Inc. - President, CEO & Director [31]

--------------------------------------------------------------------------------

Yes. I mean, what I'd say is we're still very much focused on that kind of mid-single-digit marker. And reason being that -- you articulated some reasons why we might have some tougher comparisons but also some positives on new product offerings, et cetera. We've got a lot of puts and takes in direct right now, things that we've articulated in the past and perhaps some new things. On the upside, if you will, we've got, I think, strong new product launches in the pipeline not only in some of the things that we've already launched, but some things coming into late third quarter into fourth quarter. We have the new website capabilities where -- it's brand-new right now, but their -- the idea is that we would continue to benefit from the investments that we've made as early -- potentially, as early as late fourth quarter, but we're still learning on that. On the flip side though, we've got the headwinds, if you will, on the direct growth from some of the new store markets we've opened in some big markets this year, particularly when you think about Texas. And so we've got a drag on the direct growth in those types of markets. We had a strong growth rate in fourth quarter last year, but we did so to -- at some costs to margin and with promotional activity. Our team is -- as I mentioned in the prepared remarks, we have less promotional activity in the second quarter. We think that's obviously a positive for the brand long term, so we're looking at how we balance that growth rate with the gross profit rate ultimately. So that's -- there's -- that's a bunch of different examples on why as we look at it and look down the road, we're saying mid single digits is a place that we're comfortable with right now and what we're basing our estimates on for the second half of the year.

--------------------------------------------------------------------------------

Dylan Douglas Carden, William Blair & Company L.L.C., Research Division - Analyst [32]

--------------------------------------------------------------------------------

That's great. And if I could ask on the inventory management in the quarter. It sounds like you're kind of seeing some better discipline ahead of benefit of new systems, new order management and inventory view. Is that correct? I guess what's -- what has changed internally as far as your sort of approach to inventory versus just sort of wanting to have things available for sale?

--------------------------------------------------------------------------------

Stephanie L. Pugliese, Duluth Holdings Inc. - President, CEO & Director [33]

--------------------------------------------------------------------------------

Sure. Well, there are a couple of things. First, I have to give credit to our internal team and to our manufacturing partners. We've said over time that we have a great base of partners in our manufacturing area, partners that have been with us for 6, 7, 10, 12 years. And as we work with them and said, "We need more flexibility with how we deliver goods. We need your partnership in reducing lead times, for example, flowing goods more often." They really stepped up and have partnered very well with our team. So I have to really give them kudos for that. The other thing that we're looking at is as we're getting smarter about retail and direct and how they're working together and how we can flow that inventory and how much we need to keep in -- each individual location in addition to now having visibility to inventory across the enterprise in a much clearer way, we have the confidence that we can run on some lower weeks the supply doesn't necessarily mean really low, but lower than we've been in the past and still be able to fulfill our customers' expectations. So this quarter was the first quarter where we really saw that lower inventory growth than sales growth. I'm very, very happy about that. I'm very pleased with what the team has done. And as we go forward, we expect that that's going to actually improve even further. And then when we get some of our assortment and inventory planning tools fully in place that we mentioned earlier, we think that will help us improve that even more.

--------------------------------------------------------------------------------

Operator [34]

--------------------------------------------------------------------------------

This concludes our question-and-answer session. I would like to turn the conference back over to Stephanie for any closing remarks.

--------------------------------------------------------------------------------

Stephanie L. Pugliese, Duluth Holdings Inc. - President, CEO & Director [35]

--------------------------------------------------------------------------------

I just want to say thank you all for joining our call today. Thank you for the questions. We look forward to sharing our third quarter results in just a few months with all of you. Thanks.

--------------------------------------------------------------------------------

Operator [36]

--------------------------------------------------------------------------------

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.