Duluth Holdings Inc (DLTH) 2017 Q2 法說會逐字稿

Good afternoon, and welcome to the Duluth Holdings Second Quarter 2017 Earnings Conference Call. (Operator Instructions)

Please note, today's event is also being recorded.

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

Thank you, Jamie, and welcome to today's call to discuss Duluth Trading's second quarter 2017 financial results. Our earnings release, which we issued this afternoon, 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 David 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. Forward-looking statements can be identified by the use of such words as estimate, anticipate, expect and similar words and 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. Duluth Trading expressly disclaims any obligation or undertaking to update or revise any forward-looking statements made today to reflect any change in Duluth Trading's expectations with regard thereto or any other changes in the events, conditions or circumstances on which any such statement is based except as required by law. Please refer to our SEC filings and our Investor Relations website for additional information.

And with that, I'd like to turn the call over to Stephanie Pugliese. Stephanie?

Thank you, Donni, and welcome, everyone, to our second quarter of fiscal 2017 conference call.

Before I begin my remarks, I want to take the opportunity to introduce our new Chief Financial Officer, Dave Loretta. We feel very fortunate to have Dave on our senior leadership team. He has extensive experience in the retail industry, most notably 13 years at Nordstrom and strong experience in treasury, financial planning and analysis, investor relations and corporate development. Aside from his impressive credentials, I can say that Dave has really moved fast quite literally in embracing his role at Duluth. He is hard at work with our finance team, he is ready to participate in today's call and he has moved his family to the Madison area from the West Coast, all since he joined us on July 24.

Now moving on to more good news. I'm pleased to report that net sales for the quarter increased 31% to $86.2 million, which marks our 30th consecutive quarter of increased net sales year-over-year.

In addition, our net income increased 18% to $4.3 million with diluted earnings per share of $0.13. Our adjusted EBITDA increased 27% year-over-year to $9.5 million.

As we discussed on previous calls, total gross profit margin continues to be pressured by a decline in shipping revenue. In the second quarter, our total gross profit margin decreased 240 basis points year-over-year to 56.7%, partly due to the shipping revenue impact. An important note is that our product gross margin increased slightly, in large part due to our favorable mix of higher-margin core products and our team's management of promotional activity. Dave will go into more detail on other factors impacting gross profit margin in his comments.

While we had more free shipping days this quarter compared to the prior year period, at this point, we do not plan to adopt a total free shipping model. We expect that shipping revenues will continue to decline throughout the year as a percent of net sales and in absolute dollars, and we are carefully managing SG&A to help offset its impact on the bottom line. Over the long term, as retail becomes a larger part of our business, shipping revenue is expected to have a less meaningful impact on our overall financials.

Regarding other promotional activity. We had fewer global promotion days year-to-date compared to the same period last year. Also, our product promotions were equivalent to the year-to-date levels of 2016. While we remain competitive and meet customer expectations with free shipping, maintaining product and brand integrity is firmly embedded in our overall promotional strategy. What is very important to us is that our customers are responding to our advertising and our marketing strategies. Our women's business had a very strong quarter, in large part due to the marketing efforts we have deployed this season. Our women's business accounted for 25% of total product sales in the second quarter. While women's continues to grow at a faster pace than our men's business, men's also had a strong showing this quarter, with core products continuing to perform well and our customer responding positively to new product introductions.

Moving on to our 2 business units. Our total direct net sales grew 7% in the quarter. Growth in direct product sales for the quarter was a healthy 10%, offset by the continued decline in shipping revenue. Our retail growth of 138% continues to exceed our expectations, and new store sales once again made a significant contribution to total net sales.

This quarter, we opened 3 new stores: 2 full-line stores, 1 in West Chester, Ohio to serve the Cincinnati market; and the other in Pittsburgh, Pennsylvania. We also opened a store in Red Wing, Minnesota, which is a combination of full-priced goods and outlet merchandise.

Last week, we opened St. Charles, Missouri to serve the St. Louis region. And on this Thursday, September 7, we will open Thornton, Colorado, which will be our 25th store and our first entry into the Western market. Our final third quarter opening will be in October in Avon, Ohio, a suburb of Cleveland.

As we look forward to fall, we are confident in our plans for continued growth of brand awareness and customer acquisition. We will reaccelerate our advertising in men's and women's, including new television ads, digital campaigns and catalog mailing. To further our retail expansion, we will be opening 2 additional stores in the fourth quarter for a total of 5 stores in the quarter and 15 for the full fiscal year. We are pleased to open these 2 additional stores in Waukesha, Wisconsin and Woodbury, Minnesota as building processes move quickly at both locations and we were able to accelerate their opening before the holiday season. Dave will provide more detail on how this impacts our SG&A and CapEx for the fiscal year.

We've been very diligent about executing our retail expansion well, and our consistent and scalable process to open new stores has been very successful. For 2018, we expect the number of new store openings will be comparable to this year. And in today's press release, we are providing some of the projected store openings for the first and second quarters of 2018. We believe that this additional information will help define the impact and timing of our retail expansion on SG&A and CapEx.

We are becoming increasingly confident in our omnichannel strategy and the role that retail stores play it. In addition to the benefits of giving our customers a full expression of the brand and breaking down the barrier of wanting to see product and try it on before purchase, retail stores contribute very solid results and opportunity for Duluth in the short and long term.

Putting a retail store in a market achieves 5 important things. First, it increases brand awareness in a market. Second, it is a customer acquisition tool. Third, it grows a market's overall revenue more quickly than the direct channel alone. Fourth, it is accretive in profitability. And finally, it builds the entire omnichannel model by growing direct segment sales long term.

Now I will take a couple of minutes to share some additional data points that give us a high degree of conviction that markets with retail stores grow faster and stronger than those without stores. When looking at brand awareness, we recently conducted a survey on how brand awareness in a store market compares to that of national brand awareness. In men's, the aided brand awareness in markets with a retail presence was 11 points higher than in markets without a store. The findings in women's are even more dramatic. In women's, there was a 26 point increase in aided awareness in store markets versus those without stores. This, as we know, is the first step in consideration of brand and eventual purchase. And these survey findings support our internal data that in the first year of a store being opened, as many as 50% of the people purchasing in that store are new to the Duluth brand. In addition, 25% of our customers year-to-date have been acquired through our retail stores.

We also continue to closely monitor the performance of our established store markets that have been opened 24 months or more relative to total market growth, and the incremental growth of these markets is clear. The results that we saw in the Twin Cities are consistent across Madison, Wisconsin; Milwaukee, Wisconsin; and Duluth, Minnesota, as we have shown that they have increased threefold in volume from the revenues they would have contributed in direct alone. While it is too early to project these growth rates on larger markets that have not yet anniversaried, like Chicago, Philadelphia, Washington, D.C. and Boston, it certainly gives us confidence in the power of a retail store presence in a market.

Lastly, the benefits of having stores in a market are not limited to the 20%-plus four-wall EBITDA returns of our stores. In fact, after a store is established in a market, direct sales benefit from consistently stronger growth. While we do see a deceleration in direct sales into the low single digits in the first year that a store is open, after approximately 1 year in a market, the reacceleration of the direct business surrounding a store is over twice the growth rate of the national average for direct in markets without stores. Again, retail is a key component of the omnichannel model. And looking forward, we see stores as a profitable part of the growth engine for the overall brand.

In closing, there's no doubt that retail is going through a major secular change that has heated up the competitive environment. Our roots as a direct-to-consumer brand have allowed us to be on the right side of this trend and have created a pathway to growth. Our brand awareness is growing, yet still has a lot of runway. We are successfully tapping into the enormous women's market with our innovative and functional apparel. Our retail expansion is adding yet another level of engaging our customers and attracting new ones, which is at the heart of everything we do.

Now I will turn the call over to Dave for his review of our financial results and operations this quarter. Dave?

Thank you, Stephanie, and good morning -- good afternoon, everyone. Before I begin the financial review, I'd like to say how excited I am to be at Duluth Trading. The company has a track record of great results and has built a brand that extends beyond its current footprint. As we continue to grow and introduce new customers to Duluth, I look forward to supporting the company's commitment to operating excellence and evolving our omnichannel business model while maintaining our unique culture. During my brief time here, I've had the opportunity to meet with many of my new colleagues, and I look forward to working with this talented and dedicated team as well as our key partners and the investment community.

Now on to our second quarter results. With our second quarter strong results, our earnings per diluted share was $0.13, and we remain on track to deliver on our full year financial guidance. We reported net sales of $86.2 million, up 31% compared to $65.8 million last year. This was our 30th consecutive quarter of increased sales year-over-year. Net sales growth was driven by a 7.1% increase in direct -- the direct segment and 138.3% increase in the retail segment. We grew across all product categories and continue to see strong website traffic, with second quarter website visits up 20% year-over-year. The growth in our retail segment was primarily due to having 12 more stores this quarter as compared to last year. Our 7 stores that opened during the first half of 2017 are performing above our expectations. Our retail growth strategy is working, and we're attracting new customers to the Duluth brand with each new store opening.

During the second quarter, new customers to the Duluth brand through our retail channel was up 128% compared to last year. Gross profit increased 25.7% to $48.9 million or 56.7% of net sales compared to $38.9 million or 59.1% of net sales. The 240 basis point decrease in gross margin rate was due partly to 120 basis point decline in shipping revenues and partly due to an increase -- increasing our inventory reserve to reflect our growing retail base as well as an increase in freight costs for transporting inventory from our distribution center to our retail stores.

It's important to note that gross margin on the sale of products was healthy during the second quarter. However, the headwinds from shipping revenue and retail operational impacts will continue for the rest of the year and negatively impact gross margin rate as compared to the prior year roughly 70 to 100 basis points.

Turning to SG&A. Selling, general and administrative expenses increased 26% to $41.5 million compared to $32.9 million last year. This included an increase of $1.3 million in advertising and marketing expenses, $3.5 million in selling expenses and $3.8 million in general and administrative expenses. As a percentage of net sales, SG&A expense declined 180 basis points to 48.2% compared to 50% last year. Our second quarter retail store preopening expenses were roughly flat at $1.5 million compared to $1.3 million last year. As a percentage of net sales, advertising and marketing costs decreased 340 basis points to 17.4% in Q2 compared to 20.8% last year. This included a 220 basis point decline in television advertising attributable to the shift in our women's TV advertising to the first quarter of this year as compared to the second quarter last year and 110 basis point decline in catalog expense as a result of our planned decrease in catalog spend as a percentage of total net sales. Selling expenses as a percentage of sales increased 100 basis points to 14.1% compared to 13.1% in the 3 months last year. The 100 basis point increase was primarily due to higher retail selling costs, partially offset by shipping expenses due to the operating leverage from our increase in the proportion of retail net sales. General and administrative expenses increased 60 basis points as compared -- percent of net sales to 16.7% compared to 16.1% last year due primarily to an increase in retail store occupancy, equipment cost and depreciation expense.

We reported net income of $4.3 million or $0.13 per diluted share compared to $3.6 million or $0.11 per diluted share last year. Adjusted EBITDA was $9.5 million or 11% of net sales compared to $7.5 million or 11.3% of net sales last year.

Referring to our balance sheet and liquidity. We ended the second quarter with a cash balance of $1.4 million and net working capital of $58.3 million. We had almost $12 million outstanding on our $40 million revolving line of credit. Effective August 1, the borrowing availability on our line of credit increased to $50 million.

Inventories increased 27% to $84.7 million compared to $66.9 million at the end of the second quarter last year. Our inventory composition is good, with more than 2/3 of our inventory considered year-round inventory.

Our cash use in operating activities during the first six months of 2017 was $12.2 million, primarily due to an increase in inventory for our peak holiday selling season. Our capital expenditures for the first 6 months of the year was $20.1 million as a result of opening 7 new stores and investments in information technology.

Now I'll take a few minutes to walk through the timing of our retail store openings for the remainder of the year. As announced in our earnings release today, we'll open 2 additional stores in 2017, bringing our total to 15 new stores compared to the previously announced 13 stores. And as Stephanie mentioned, we're opening 3 stores during the third quarter. During the fourth quarter, we plan to open a total of 5 stores. All of which are currently scheduled to open during the month of November and into early December.

We expect to incur $500,000 to $600,000 of preopening expenses per store, with the majority of expenses occurring in the prior month and in the month the store opens. With our remaining 2017 new stores and planned 2018 new stores, we expect third quarter preopening expenses to be in the range of $3 million to $3.5 million and fourth quarter preopening expenses to be in the range of $1.5 million to $2 million compared to the prior third and fourth quarter preopening expenses of $2 million and $700,000, respectively, for last year.

Turning now to our financial guidance. We are reaffirming our outlook for 2017. We expect to report net sales of between $455 million and $465 million, reflecting a 22% growth rate at the midpoint. With the opening of 2 more stores than originally planned, we have not revised our full year 2017 financial guidance with the exception of capital expenditures since these 2 stores are expected to open later in the year and will not have a material impact on our results.

In addition, we still anticipate that more than 60% of net sales and almost 80% of profitability will be in the third and fourth quarters. Given our strong retail performance and continued shipping revenue headwinds in our direct segment, we believe the retail segment could account for close to 30% of total net sales for the fiscal year.

We expect our full year gross margin rate to decline 70 to 100 basis points as compared to prior year, primarily driven by the lower shipping revenue.

We expect advertising expense as a percentage of net sales to be lower than last year in the third and fourth quarters and for the total year, primarily due to the leverage gained by the growth in the retail segment.

We expect full year selling, general and administrative expenses as a percentage of net sales to slightly increase over last year.

We are forecasting earnings per share between $0.66 and $0.71 per diluted share. This assumes a full year weighted average diluted share count of 32.3 million shares and a tax rate of 39% and reflects an increase in net income of 4.2% at the midpoint compared to our 2016 net income.

We expect adjusted EBITDA to be between $47 million and $49.5 million or a 17.8% growth rate at the midpoint.

As mentioned earlier, our plans call for a total of 15 new stores in 2017, which included an outlet store, adding approximately 173,000 additional selling square feet and forecasted to spend approximately $2 million in capital expenditures per store.

Now I'd like to provide an update on our technology and facility initiatives. As reported last quarter, we had anticipated having our Order Management System upgrade completed in August. We have now decided to shift the implementation of both the OMS and the e-commerce platform into the first quarter of 2018. While we have not encountered any significant issues with the new OMS system, progress has been slower than we expected. Therefore, we feel it will be prudent to launch both technology upgrades after our peak selling season. This will give us more time and comfort to complete the testing and stage the integration of the OMS and e-commerce platform, which when combined and fully operational will bring our key technology systems to the forefront of omnichannel retailing. Our existing systems are still sufficient to handle orders for the upcoming holiday season, and we do not expect the delay to affect our 2017 financial results.

As many of you are aware, our corporate employees in Wisconsin are currently split between 2 locations. For some time, we wanted to bring everyone together in one location. So I'm pleased to announce that in August, we entered into a lease and development agreement to build our future corporate headquarters in Mount Horeb. Construction has already begun, and we expect to move into our new headquarters during the fourth quarter of fiscal 2018. And therefore, we do not expect the headquarters lease to have a material impact on next year's financial results. Given the growth of our business, we believe that consolidating our strategic leadership and administrative functions under one roof will enhance our ability to execute and support this growth.

In conjunction with this project, we entered into an agreement to participate in the developer's financing as an investor and have earmarked $6.4 million to do so. The overall project cost is $30 million for the 108,000 square-foot headquarters building and will be financed by investors through the issuance of interest-bearing credit tenant lease certificates. As of the end of the second quarter, the cash used to purchase our portion of these certificates was advanced to the building's developer to begin construction and is recorded in other assets on the company's balance sheet. We expect this financing transaction to close later this month.

For fiscal 2017, we now expect total capital expenditures to be $38 million to $42 million, reflecting the impact of opening 2 more stores in fiscal 2017 and additional warehouse equipment related to the transition of a third-party distribution center.

In closing, we delivered strong results, and we remain focused on delivering a differentiated customer experience that creates value for our stakeholders, including shareholders, customers and employees.

With that, I'll turn the call back to Stephanie.

Thank you. Before I open the call to questions, I wanted to say that our hearts -- our thoughts and our hearts go out to our customers and our friends in Texas. Duluth is committed to helping those affected by Hurricane Harvey. As part of our efforts, we are in the process of donating thousands of products like gloves, work pants and other apparel to help the ongoing rescue and cleanup efforts in Texas. We will also be raising funds alongside our employees and customers to provide additional needed support to the many people in Houston and the surrounding communities who are in need of assistance.

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

(Operator Instructions) And our first question comes from John Morris from BMO Capital Markets.

Welcome, Dave. Glad to have you. And super helpful to hear all the transparency and clarity. So ask my question. Dave, maybe if you could talk a little bit about the impact on gross margin. You gave us some in terms of the, I guess, 3 different items mentioned. Maybe if you can, I guess, prioritize and enumerate further and talk about the expected impact of each of those on a go-forward basis. I mean, clearly, you're addressing the piece about the shipping revenue, but I wanted to hear a little bit more about the other parts as well.

Sure. The shipping revenue is certainly the big component. Half of that shift this year was related to that, but it's the biggest piece that's going to be a go-forward headwind for us. The other component that I mentioned relates to adding to our inventory reserve for shrinkage, which is something that we decided to take action on at this point given the growth of the retail business and the amount of inventory that's now sitting in retail stores. Historically, we have always taken a shrink adjustment to the P&L at the end of the year, after we've done our physical counts. And it wasn't even that material, but it was a once end-of-year item. This year, we're going to shift some of our physical counts to the midyear. And given the size of it, too, we feel it's more appropriate to have an ongoing reserve on the books versus waiting till the end of the year to book that entry. So that's a onetime entry now, and the reserve will be adjusted incrementally as retail sales grow or physical count results change. But...

Sorry, just -- if I could just ask on that point before you hit on the third one. So are you saying you guys will be doing inventory accounting for shrink twice a year instead of once a year?

No. We'll still just do 1 count for every store, but we're planning to shift that to the middle part of the year where it's less distracting and it's -- and actually, we could save some money on the count process there.

Got it, put reserve quarterly, yes.

Every quarter, the reserve will be reviewed. And then the other component that I called out was additional freight cost. Now that we have a growing store base and freight expense that goes to the store is reflected in cost of goods sold. So that's a growing component relative to last year and will be ongoing, but it's not as large as the reserve component or the shipping revenue component.

And the shipping revenue piece. Did you break down that one piece and said that it was a 122 basis points of the gross margin impact? Did I hear that correctly?

Yes, it was about half.

Okay. And that will continue for the next couple of quarters. But how will that look once you begin to anniversary that, which I believe would be by about the first quarter next year, in diminishing amounts but still ongoing?

Well, certainly in diminishing amounts, yes. We'll anniversary this year's decline in shipping revenue and it will become less of a year-over-year impact. If you recall in the first quarter, we had some headwinds there and the second quarter, as I called out here. So it will become less material on a year-over-year basis.

All right. Great. And just as a quick follow-up for Stephanie to talk a little bit about the product performance. It sounds like your product margins were still very strong and healthy. Are there any particular category performance call-outs on the quarter and the opportunity ahead for fall from a product perspective?

Yes. We -- first and foremost, we're very pleased with product gross profit, and that's what we look at very closely to make sure that -- I've talked a lot about product and brand integrity and making sure that we hold on to that, and that's -- obviously, an indicator for us is that product gross profit rate. In terms of where we sold product or products that stood out, core product continues to grow year-over-year as we bring new customers into the brand, as existing customers kind of cross over and try different core products. So those products that you hear a lot about are still the foundation of what we do. That said, we were really pleased with some new product introductions that solved new -- problems for our customers, whether that was products within Summer Solved or new base layer programs particularly in women's had really nice results. We're pleased with some of the transitional items that we introduced in August. As many of you know, one of the strategies that we had for any of the transitional periods was to give him and her wear-now product. And on the one hand, that meant continuing core products like Dry on the Fly a little bit longer into the season. But on the other hand, it was introduction of more seasonless product that allowed him and her to transition into new items without having to be so weather dependent as we have in prior years. And those things have done really nicely for us.

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

First, I wanted to start off, Stephanie or Dave, just asking a different way about the trends you saw on the direct side specifically. It looked like a slight acceleration sequentially both on the sales and your gross and net, plus the customer visits look strong and the new customer acquisition looks strong. So I'm just curious, I know the comparison last year looked pretty difficult. So I'm curious if you could talk about within the quarter some of the drivers and maybe the trend that you saw.

Absolutely. I think -- I'll go back, Jon, to we definitely saw momentum in -- when you look at it from a product assortment perspective, we definitely continue to see momentum in core products. On the women's side of the business, the advertising that we did for No-Yank, that was obviously incremental spend for us in first quarter. We continued to spend into the month of May. And the residual positive effects that we saw on that marketing continued throughout the quarter. She is definitely responding to foundation objects and coming in not only to buy things like No-Yank Tanks, but also responded very well to our second quarter products, things that were like Armachillo or Dry on the Fly products that we've not only repeated some of the core pieces of that assortment, but we've added newness to it year-over-year. On the men's side of the business, one of the campaigns, if you will, that we've had for several years running has been Summer Solved. We added to some of the product offerings there, got a nice response. But as importantly, in men's, one of our strategies going back several years now, has been to expand into different parts of his closet. And we talked on the first quarter call about our Duluth-Built Business Wear with the introduction of ballroom khakis earlier in the season. We launched in May a television advertising campaign around our Wrinklefighter and our customer, particularly in men's, which is a more established part of our business and a longer-running part of our business, they definitely trust us to offer him more aspects of his closet. And that worked really nicely for us.

Okay. And any thoughts about how to think about the direct growth rate going forward? I know, last year, you had some months with a lot of pretty extreme weather volatility, and you saw that in the business. I think in the third quarter, you'll have a similar number of retail store openings year-over-year as in Q2 and then maybe more year-over-year in Q4, just how that lines up. So any thoughts on how you're thinking about the direct growth from here?

Yes. We're still thinking about direct in that 6% growth range for the total year. We had a little bit of an acceleration to 7% overall in second quarter. Obviously, that was impacted on the negative side, if you will, by the shipping revenue that we've articulated. I think that we have -- it's interesting. We do have some difficult weather that we came up against last year, starting around the third week or so of September. So we'll see what happens there. I'll foreshadow and tell you that my closing sentences were wishing for a cold snap. So I've just shared my last sentence with everybody. But I do think that if there's -- if weather is favorable, that's obviously going to be a good thing for us on the direct side of the business, but we have more adequately prepared our assortment for unpredictable weather, if you will, with things like rainwear or extending some of our late summer product a little further into the season. So we'll see. We've still got over 60% of the year to go in sales and more than that on the profit line. We're watching it closely and hoping that it continues to be as strong as we saw in second quarter.

Okay, great. And maybe one last one for me. Apologies, Dave, but kind of a bigger-picture question on the margin. I don't know if you're ready to share any thoughts. But if you look at the overall, operating margin was in the low double digits a couple of years ago and now you're closer to the low 8% range with the retail acceleration. And I'm just curious, kind of big picture how you may be thinking about the right operating margin for this business and how soon in the future you might start making progress on the positive side.

Sure. This is a period with the retail growth that does pressure the operating margin, and that's understandable. And I think we've laid out our strategy over the next couple of years that that's going to be the expectation. But, longer term, we would expect the operating margins to be more in a low double digit, 10% to 12% range, say, and that's probably 2 to 3 years out from here once we get to our store base that's more stable and less impacted by new stores coming on.

Our next question comes from Eric Beder from FBR.

Could you talk a little bit about -- now you're expanding into the West, and the other pieces -- what are you going to have to do in terms of distribution? Is it you're going to have to open up another distribution center? How do you look upon the expansion here and how is it going to affect your distribution needs?

So just to remind everybody, the retail stores are currently being inventoried and replenished exclusively out of our Belleville, Wisconsin distribution center. We expect that to continue for the foreseeable future. And the reason that we do that is twofold. Number one is that within the Belleville distribution center, that allows us to carry 100% of the SKUs in that DC and be able to allocate from there. We've actually done -- made a number of improvements on how we process goods in addition to allocating some more square footage to our retail prep area. And what I mean by that is we've added technology within the distribution center to improve efficiencies. But more importantly, we have continued to expand the number of items that are coming into the DC already retail-ready from our vendors. And that will allow us more capacity, if you will, to fill more retail stores. Now all of that said, we do have 2 third-party logistics partners, 1 on the East Coast, 1 on the West Coast, as we've mentioned. They are both very capable and have the capacity to fill retail stores -- to fulfill retail stores in the future if we should choose to do that. But right now, we are focusing those 2 locations on distributing -- shipping goods directly to our customers because the purpose of those locations is to allow us that scalability on the direct side of the business and be closer to those customers so that shipping times are faster.

Okay. You opened a hybrid outlet, full-priced store. Could you talk a little bit about that? Is that kind of a one-off? Or is that something you look forward down the road? I know the outlets only come in certain waves. Are you looking for any outlets to open next year?

So to answer the question about Red Wing, which is the hybrid store that we mentioned, that is our second hybrid store that we have within our outlet group. We opened Oshkosh last year, and that store was our first store that had the hybrid of full-priced core merchandise plus the outlet. Interestingly, once we opened that store, we had a number of customers who had been to both our Belleville outlet, which was our original outlet, and the Oshkosh store, and we've got a lot of requests to start bringing in full-priced merchandise into the Belleville outlet as well. So when a customer is coming in to us, they're appreciating the Duluth brand and they are very ready to cross over between full-priced merchandise and outlet. The difference in Red Wing is the actual physical layout of the store allowed us to do a floor of full-priced merchandise and then a floor of outlet merchandise. So there's a cleaner distinction between the 2. And that store is working very, very nicely for us. As we look forward, the number of outlets that we are opening is really determined by the growth in direct and the amount of returns that we feel should be outlet merchandised as opposed to first quality returns. So that number will flex as we go forward. We're not actively pursuing another outlet location right now, but that may come either towards the end of next year or into the following year.

Our next question comes from Dan Wewer from Raymond James.

First question I wanted to ask is if you could walk through, I guess, the discovery process on your IT projects and what led you to the conclusion that we need to delay the implementation of the OMS until next year.

Sure. So we started this project -- these projects because the OMS and e-commerce platform project kind of go hand in hand from the beginning. We started this over a year ago. And the -- as we continued to move forward with OMS specifically, it is the biggest project that we have embarked on from an IT infrastructure improvement to date. And we -- as we were going through and continue to more fully understand how many connection points there are with OMS and other systems that we have within the organization, it went a little bit slower than we originally anticipated. As we went through on the last -- our last call, I know that we talked about moving ECP out because our OMS was taking a little bit longer than we anticipated and we didn't want the e-commerce platform to go live too close to our peak period. As we've come from over the past several months and been more heavily involved in the testing of OMS, we have, as you would expect, discovered some things that we needed to fix along the way in the testing process. But most importantly, we didn't find things that were no-go, showstopper types of things that worried us to the point of saying this OMS couldn't go live. The problem with that it was taking longer and getting too close up to the peak season. And as we've talked about before, one of the things that we hold very dear culturally is executing well and making sure that we can guarantee that the customer experience stays solid. And quite frankly, we got worried that we couldn't guarantee that promise and we couldn't fulfill that promise as we got closer and closer to high-volume weeks and months.

When you say that it was going slower than anticipated, was that an issue with the vendor that you're using? Or do you think Duluth needs to invest more in people who work in IT projects? Or...

I would say -- I can't say that it was a vendor issue or an internal issue. It was the process overall, Dan, that this project was new to Duluth. This scale of product -- project was new to the organization. And we chose ultimately to make the conservative, customer-right decision as opposed to forcing through the project "on time" but risking that we would have ramifications after go-live that could really be more negatively impactful than just delaying it until early first quarter. And it all just comes back to being ready.

Okay. And then just the other question on IT. Is the plan now to simultaneously launch the new OMS and the website? Or do you think that it would make sense to perhaps delay the website so that you don't have 2 projects going live simultaneously?

Yes. There will be a -- our goal is to launch OMS very early in the first quarter, and then there will be a 4- to 6-week gap between that go-live and the ECP because once we launch the Order Management System, we'll want to make sure that the connectivity to the new ECP is solid before we then launch the ECP.

That makes sense. And then the last question I have I know that your product margins were holding up well year-over-year. Do you see your competitors getting more promotional and that Duluth has been able to avoid that because of your differentiation? Or do you think the industry itself is not getting more promotional, and that's contributing to the better product margin?

I think that the industry is definitely more promotional. We haven't seen an easing of that. We've seen some competitors be even more promotional than they used to be. And if you think about the success that many off-price retailers have had, the idea of getting a deal, I think, is stronger than ever for customers. That said, for us, it all goes back to the ownership of our distribution channels and the fact that the only place to get Duluth product is through Duluth website stores, et cetera. And we have made a name for ourselves on people wanting Armachillo, wanting Buck Naked. And so they do come to us, and it does give us some level of protection. That said, the world is more promotional than it ever has been.

Our next question comes from Dylan Carden from William Blair.

First, I just want to make sure I heard 2 things right. One, the -- of the 2 stores, the last stores that you're going to open this year, will those be in early December? Did I hear that right?

Yes.

Okay. And then it's 15 stores is sort of the rough outlook for next year?

Yes.

Okay. And then just sort of -- if that's the case, going back to maybe comments that you made earlier in the year about sort of hitting some constraints from just a human capital side on new store openings sort of above the 1 per month range. Are you adding talent here? And is there any sort of margin impact to think about? And then sort of along with that, how is the SG&A -- what do you pulling from SG&A to kind of manage some of the near-term gross margin headwinds?

So to start with the cadence of store openings and the team that we have in place. I'll start with a real simple reiteration. The 2 things that we've talked about in terms of making sure that we recognize potential constraints around store openings are the logistics of being able to inventory the stores and then the people. I think I talked a little bit about how we're improving efficiencies and processing goods to get them out to the stores. So kind of turning over to the people part, I continue to be incredibly impressed with our store teams, the leadership that are -- is in each specific store as well as the leadership that is overseeing a couple of stores and our district managers that are overseeing a number of stores. We added earlier this year a director of store operations role that is helping us to improve processes in the stores, so that our people can be more in -- and talking to customers as opposed to focusing on tasks. And within the stores that we have, the great thing of having a larger store base is that we're developing more internal talent to be able to move from an assistant manager role to a store manager role, for example, in our new stores. So I have to give great kudos to our store field team for really developing the pipeline of internal talent for our stores. In terms of the SG&A, I'll talk a little bit about it, and then, Dave, if you have anything that you want to add, please do. When we look at the SG&A pressure around opening similar number of stores next year to this year, I think it really falls in line with what we've talked about over the past couple of calls, which is this year is the heaviest downward pressure, if you will, to profitability because of new store openings as a relative to the store base we have. So we're almost doubling the number of stores that we have this year. When you -- when we're opening next year approximately that 15 stores, we're adding 50% to the base. So while this year and next year are going to be the more pressured years for SG&A around preopening expenses, next year will be a little bit better than it is this year. And then the year after that will better still. So that kind of cadence really hasn't changed in terms of directionally what we've talked about in the past. And then, Dylan, I think you had one other question, and I'm -- I want to make sure I answer it. Did I get everything that you wanted?

No, that was more or less it. I'm just trying to think through the nuances, what's sort of going on and better SG&A and some of the gross margin headwinds in, I guess, the current period but -- I mean, to the extent that you can kind of speak to that.

Sure. So the SG&A kind of offset, if you will, to what's going on with gross profit, there are a number of things we're doing across the board. Overall, every process that we have, whether that is preopening expenses or how we're getting goods out to customers on the direct side of the business, we're always looking for more efficiencies. In fact, one of those places is something I already mentioned. In our Belleville distribution center, for example, we've added some automation that we tested it last year, worked very well for us in terms of increasing the productivity of our pick, pack and shipping departments. And so we've expanded on that program this year and we've gained some efficiencies there, as an example. We're always looking at our advertising and making sure that we're placing our dollars in the most productive places. So we've shifted things, as we always do, quite frankly, to be more productive on ad spend. So those are a couple of the things that we're doing to offset some of the -- particularly the shipping revenue pressure that we're seeing.

Excellent. And then the last one I have is the -- you're opening more stores in the fourth quarter than you have historically. Is there any risk that you kind of foresee to that and any mitigating factors that you're sort of putting in place just given that, that's such a big quarter for you guys?

We -- the risks that would kind of come up in the -- in opening stores close together would kind of fall along 3 lines. Building, you know, or build-out and is that on time, we feel really good about that. The -- and that's actually why 2 of those stores are opening earlier than we expected is that process has gone very smoothly and more quickly than we anticipated. The second thing would be, do we have the people in the pipeline? And I just talked about that. We've got a lot of confidence there. And then the third would be having the inventory to furnish those stores. And the team has worked very -- first of all, we've got inventory in place in our core products. We've talked a lot about that in prior quarters with making sure that we're -- we own that product. So we've got the product to stock the stores there. And the team has done a really nice job in seasonal product, where we've needed to augment to add to those stores. So overall, I feel really good. We're well on -- down the path of opening those stores. And I feel like they're going to be a nice win for us. And it gets us ahead of 2018 with those extra stores.

Our next question comes from Jim Duffy from Stifel.

A few questions for me. First off, I look forward to visiting the Thornton store later this week. We're excited to have you come into Colorado.

Oh, good, we'll see you there.

Yes, great. The retail line -- very strong growth from retail, can you guys offer some perspective on how that splits between new door productivity and the year-to-year improvement in doors opened more than a year? Very strong growth, I guess, I'm just curious whether it's the new stores outperforming or you're seeing good growth across the store base.

Overall, we're -- Jim, we're really pleased with both new stores and the existing store base. We have not reported comps at this point mostly because there are 7 stores of the 25-ish, I'm saying ish because the 25th is Thornton, that we have out there. But we're very happy with what our existing stores are doing. And most importantly, we're very happy with what those markets are doing. Because as I mentioned in my prepared remarks, the direct business surrounding our established stores is growing at a very healthy rate overall. That -- all that said, to be very clear, that increase of more than double last year was primarily driven by those new stores. And the fact that our new stores continue to open stronger and stronger, they're exceeding our expectations, a lot of that has to do with some of the stuff I've been talking about with improved processes. And that includes site selection. We're learning more and more with every store that we open. It also has to do with the fact that our brand awareness is increasing. With all of the efforts that we've put forth in direct over the -- a number of years, that continues to build brand awareness nationwide. And so when we enter a market, we're much more well known today than we were 7 years ago when we opened our first store. And that has certainly helped the success of retail.

Stephanie, are you seeing any variance as you open doors in larger markets versus smaller metropolitan areas? Or is there not necessarily a distinct pattern?

Variance in what sense, Jim?

Just door productivity, return on the investment, so forth.

Yes -- no, they're actually very similar. The one -- so when -- what we're looking at when we see the first 12 months of a store, we are looking at four-wall EBITDA. That's very similar. We're looking at obviously sales per square foot, that's falling within the range of our expectations and feels really good so far. The one thing we have not yet experienced, although all indicators are that it should be very similar, is, as you know, starting really right now through the end of the year is when we will start to anniversary our biggest markets. The markets like Chicago, like King of Prussia or Philadelphia, like Washington, D.C. market. And we're going to learn a lot over the next 6 months or so as those stores start to get into their year plus, if you will, of opening. And I think that will be very interesting and very informative for future large markets.

Okay. Very good. Dave, question on the operating cash flows. With the incremental stores, where would you expect to see operating cash flows for the fiscal year and use of the line of credit at year-end?

Sure. I -- on operating cash flows, there's not a really large impact given the payable support that we'll have on the inventory. But the -- I'm sorry, what was the second part? Oh, line of credit.

Use of the line of credit, yes.

Yes. I mean, we will likely have a balance on the line of credit at the end of the year unlike prior years, given the larger number of stores we've got but also the $6 million that we've invested in for our headquarter building. Typically, we do pay down the line of credit by the end of the year, but I would expect to see likely a balance at the end of this year. Not a large one, but one that's there.

Okay. And then my last question. With the systems projects and the headquarters for next year as well as the additional stores, any preliminary thoughts on CapEx for next year?

I think it's a little early for us to talk about that at the moment. Most of the information technology spend is going to be incurred this year, and that's already factored in as well as the amount for our distribution center growth. But the new store, I think we've given you some guidance as to per store amounts that you can probably get pretty close to it. But we'll come out with a forward guidance number on that in subsequent calls.

(Operator Instructions) Our next question comes from Andrew Burns from D.A. Davidson.

Just to follow up on Dan's earlier one on promotional activity. In-store promotion strategies can be very different than online strategies as your retail fleet gets built out and you have much more data and experience. How was your promotional strategy evolving online versus in-store? Are they feeding off each other? Are you able to keep them well aligned? Clearly, driving store traffic in this retail environment is challenging for a lot of people.

Yes. So the -- I would say to sum it up, we are getting more and more aligned each season. If we look back a year or 2 years ago, we had a lot of direct promotions that we did not mirror in retail stores. And we heard loud and clear from our retail store associates and obviously our customers that they were looking for more alignment. So over the past year or so, Andrew, we've done a much better job of -- on big promotions. So when we have a big Buck Naked promotion, for example, or a global promotion, that we align both retail and online. That said, the one place that we continue to differ, if you will, on a regular basis is with email promotions and those, what we call, temporary promotions or product promotions that is a very short lived, maybe 1 or 2-day specific product marked down $5, $10, that sort of thing. And there are 2 reasons why we are not fully aligned on that. First of all, those are fast-moving promotions. And to try to sign and flip those promotions in a retail environment can be very challenging. The second thing is we encourage our customers to sign up for email because that's the way that they can get those special deals, and a lot of customers have already done that. All of that said, though, if there is a customer that comes into a retail store with an email on their phone or a printout of that email, we absolutely honor that email promotion in the store. That's kind of how we're looking at promotions across all of our channels.

And, ladies and gentlemen, at this time, we'll conclude today's question-and-answer session. I'd now like to turn the conference call back over to Stephanie Pugliese for any closing remarks.

So I just want to thank you all for joining our call today. We do look forward to reporting back to you on our third quarter results. And once again, I'm going to mention that fingers crossed for the cold snap to fall. Thank you, everyone, and have a good evening.

Ladies and gentlemen, the conference has now concluded. We do thank you for joining today's presentation. You may now disconnect your lines.