Duluth Holdings Inc. (DLTH) Q2 2017 Earnings Report, Transcript and Summary

Good afternoon and welcome to the Duluth Holdings Second Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. Please note today’s event is also being recorded. I would now like to turn the conference 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 Dave Loretta, our 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 risk 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 or 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 would 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 Westcoast, all since he joined us on July 24. Now moving on to more good news, I am 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 strategy. 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 show in this quarter, with core products continuing to perform well and our customer responding positively to new product introductions. Moving onto our two business units. Our total direct net sales grew 7% in the growth. 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 expectation and new store sales once again made a significant contribution to total net sales. This quarter, we opened three new stores, two full line stores, one in West Chester, Ohio to serve the Cincinnati market and the other in Pittsburg, Pennsylvania. We also opened a store in Redwing, 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 re-accelerate our advertising in men’s and women’s including new television ads, digital campaigns and catalog mailings. To further our retail expansion, we will be opening two additional stores in the fourth quarter for a total of five stores in the quarter and 15 for the full fiscal year. We are pleased to open these two additional stores in Waukesha, Wisconsin and Woodbury Minnesota as building processes moved 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 are 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 to find 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 in 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 the opportunity for Duluth in the short and long term. Putting the retail store in a market achieved five important things. First, it increases brand awareness in the market. Second, it is a customer acquisition tool; third, it grows the 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 points 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 end customer’s year-to-date have been acquired through our retail stores. We also continue to closely monitor the performance of our established store market 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 three fold in volume from the revenues they would have contributed in direct to loan. While it is too early to project these growth rates on larger markets that have not yet anniversaried like Chicago, Philadelphia, Washington DC and Boston it certainly gives us confidence in the power of our retail store presence in the market. Lastly, the benefits of having stores in the market are not limited to the 20% plus four-wall EBITDA returns of our stores. In fact, after a store is established in the 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 opened, after approximately one year in the market, the reacceleration of the direct business surrounding a store is over twice the growth rate of the national average for direct end 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 is no doubt that retailers growing from 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 wins, 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 the 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 onto our second quarter results. With our second quarter strong results, our earnings per diluted share were $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 the direct segments 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 seven stores that opened during the first half of 2017 are performing above our expectations. Our retail growth strategy is working and we are 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 increase in gross margin rate was due partly to a 120 basis points decline in shipping revenues and partly due to increasing our inventory reserve to reflect our growing retail base, as well as an increase in freight cost 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 pre-opening 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 and 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 a 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 net sales increased 100 basis points to 14.1% compared to 13.1% end of three months last year. The 100 basis point increase was primarily due to higher retail selling cost 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 two thirds of our inventory considered year round inventory. Our cash used 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 six months of the year was $20.1 million as a result of opening seven new stores in investments and 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 two additional stores in 2017 bringing our total to 15 new stores compared to the previously announced 13 stores. And as Stephanie mentioned, we are opening three stores during the third quarter. During the fourth quarter, we plan to open a total of five 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 pre-opening 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 pre-opening expenses to be in the range of $3 million to $3.5 million and fourth quarter pre-opening expenses to be in a range of $1.5 million to $2 million, compared to the prior third and fourth quarter pre-opening 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 two more stores than originally planned, we have not revised our full year 2017 financial guidance with the exception of capital expenditures since these two 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 50% to 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 segments 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, but we have not encountered any significant issues with the new OMS system. Progress has been slower than we expected. Therefore we feel to 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 Omni channel 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 two 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 have a material impact on next year's financial results. Given the growth of our business we believe the 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 developers 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 to the issuance of interest-bearing credit tenant lease certificate. As of the end of the second quarter the cash use to purchase our portion of these certificates was advanced to the buildings developer to begin construction and as recorded in other assets on the company's balance sheet. We expected 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 two 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 question, 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 effort we're in the process of donating thousands of product like gloves, work pants and other apparel to help the ongoing rescuing 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?

Ladies and gentlemen, at this time we’ll begin the question-and-answer session. [Operator Instructions]. And our first question comes from John Morris from BMO Capital Markets. Please go ahead with your question.

Yes. Thanks. Congratulations everybody on really excellent results. And welcome Dave, glad to have you and super helpful to hear all the transparency and clarity. So ask my question, Dave, maybe if you can talk a little bit about the impact on gross margin. You give us some in terms of the, I guess three different items mentioned. Maybe if you can prioritize and enumerate further, and talk about the expected impact of each of those on a go forward basis, I mean clearly you clearly you're addressing the piece about the shipping revenue, but I wanted to a little bit more about the other parts as well?

Sure. The shipping revenue is certainly the big component. Half of that ship 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 mention 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 taking 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 ship some of our physical counts to the midyear and given the size of it to 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 the one-time entry now and the reserve will be adjusted. Incrementally as retail sales grow or physical count results change.

Sorry, 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 one count for every store.

Okay.

But we’re planning to ship that to the middle part of the year where it's less distracting and actually we save some money on the count process there.

Got it, but reserve quarterly.

Yes. Every quarter the reserve will be reviewed.

Yes. Go ahead.

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 go to the stores reflected in cost of good sold, so that that's a growing component relative to last year and we’ll be ongoing but it's not as large as the reserve component or the shipping revenue component.

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

Yes. It was about a half.

Okay. And that will continue for the next couple 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 in the second quarter as I called out here. So, it will become less material on a year-over-year basis.

Okay. 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 callouts on the quarter and the opportunity ahead for fall from a product perspective?

Yes. We first and foremost were very pleased with product gross profit, and that’s what we look at very closely to make sure that. You know, I talked a lot about product and brand integrity and making sure that we hold on to that, and that’s an obviously an indicator for us is that product gross profit rate. In terms of where we sold product or the 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 crossover 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 were then some were solved or new base layer programs particularly in women had really nice result. 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 the new item without having to be so weather dependent as we had in prior years, and those things have done really nicely for us.

Yes. We saw that it look great. Thanks. Good luck for fall.

Thanks.

Our next question comes from Jonathan Komp from Robert W. Baird. Please go ahead with your question.

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

Absolutely. I think I’ll go back John to – we definitely saw momentum, and when you look at it from a product assortment perspective, we definitely continue to see momentum in core products. On the women side of the business the advertising that we did for No-Yank that was obviously incremental spend for us in first quarter. We continue 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 Tank, but also responded very well to our second quarter product things that were like Armadillo or Dry in the Fly products that we’ve not only repeated some of the core pieces of that assortment, but we’ve added new to it year-over-year. On the men 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 offering 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 talk in 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 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 very 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 the third quarter you’ll have a similar number of retail store opening 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 -- its 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 sense is we’re wishing for a cold snap. So I’ve just shared my last sentence with everybody. But I do think that if there's you know if whether it 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 well with things like rainwear or extending some of our late-summer product a little further into the season. So we’ll see. We still got 60% of the year to go in sales and more than that on the profit lines. We are 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 from 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 closer to the low 8% range with the retail acceleration. And I'm just curious kind of big picture, how you maybe 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 years, 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 two to three years out from here once we get to our store base that's more stable and less impacted by my new stores coming on.

Okay. Very helpful. Thank you.

Our next question comes from Eric Beder from FBR. Please go ahead with your question.

Hey, guys. This is Eric Beder. How are you are you doing today?

Good. How are you, Eric?

Great. Great quarter. Could you talk a little bit about – now you’re expanding into the West, any other pieces. What you’re going to have to do in terms of distribution? Is it you're going to open up another distribution center? How do you look upon the expansion here and how it’s going to affect your distribution needs?

So, just to remind everybody, the retail stores are currently being inventoried and replenished exclusively at our Belleville with content distribution center. We expect that to continue for the foreseeable future. And the reason that we do that is two folds. Number one is that within the Belleville distribution center that allows us to carry 100% of the SKUs in the DC and be able to allocate from there. We've actually done – made a number of improvements on how we process good 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 continue to expand the number of items that are coming into the DC, already retail ready retail from our vendors. And that will allow us more capacity if you will to sell more retail stores. Now, all of that said, we do have two third-party logistics partners. One on the east coast, one on the West coast as we’ve mentioned, they are both very capable and have the capacity to sell retail stores to fulfill retail stores in the future. If we should choose to do that but right now we are focusing those two 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 to be closer to the 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 price core merchandise plus the outlet. Interestingly, once we open 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 got a lot of request to start bringing in full priced merchandise into the Belleville outlet as well. So when a customer 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 the floor of outlet merchandise, so there’s a cleaner distinction between the two, 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 merchandise 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.

Great. Good luck for the holiday season.

Thank you.

Our next question comes from Dan Wewer from Raymond James. Please go ahead with your question.

Thanks. Hello, Stephanie and welcome Dave.

Hi, Dan.

First question I want to ask, 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 as we continue to move forward with OMS specifically, it is the biggest project that we have embarked on from an IT infrastructure improvement to-date. And 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 and 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 live too close to our peak period. As we’ve come from over the past several months and then more heavily involved in the testing of OMS, we have as you would expect discovered some things that we needed to fixed along the way in the testing process. But most importantly we didn't find things that were no-go showstopper type of thing that worried us to the point of saying this OMS couldn’t go live, the problem was that it was taking longer and getting too close up to the peak season. And as we 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 can 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 need to invest more and people who work in IT projects or..?

I would say -- I can't say it was a vendor issue or an internal issue. It with 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 quote on time, but risking that we would have ramifications after go live that could really be more on negatively impactful than just delaying it until early first quarter.

And just one other question on IT…

It all comes exactly…

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 would make sense to perhaps delay the website, so that you don't have two 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 four to six week gap between that go-live and 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.

Okay. 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 they 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 distributional channel. 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.

Okay. Thank you very much.

Thanks, Dan.

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

Hi. How are you? Thanks for taking the question. First, I just want to make sure, I heard two things right. One, the – of the two 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 its 15 stories 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 the human capital side on new store openings sort of above the one per month range. Are you adding talent here and there's a sort of margin impact to think about? And sort of along with that how is the SG&A, what do you plan for SG&A to kind of manage some of that 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 the real simple reiteration. The two things that we 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 in 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 team, 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 assisted 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 take a little bit about it and then Dave, if you have anything that you want add, please do. When we look at the SG&A pressure around opening a 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 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 pressure 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 be better still. So that kind of cadence really hasn’t changed, in terms of directionally what we’ve talked about in the past.

Okay.

And then Dylan [ph] I think you had one other question and I want to make sure I answer it. Did you get everything that you wanted?

No, that was more or less, - I was just trying to think to the new answers [ph], so what's sort of going on in better SG&A and some of the gross margin headwinds in I guess, the current period. But I mean, these and if you can kind of speak to that?

Sure. You know 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 are doing across the board. You know overall, every process that we have whether that is pre-opening expenses or how we are getting goods out to customers on the direct side of the business. We are always looking for more efficiencies infact one of those places there 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 department. And so we’ve expanded on that program this year and we’ve gained some efficiencies there as an example. We’ve always looking at our advertising and making sure that we are placing our dollars in the most productive places, so you know we’ve shifted things as we always do quite frankly to be more productive on ad spend. So those were a couple of the things that we are doing to offset some of the particularly the shipping revenue pressure that we are seeing.

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

You know we – the risks that would kind of come up in opening stores close together would kind of fall along three lines, building, you know build out and is that on time we feel really good about that, and that’s actually why two 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, 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 own that product. So you’ve got the product stocked before it’s there and the team has done a really nice job in seasonal products where we’ve needed to augment to add to those stores. So overall, I feel really good, we are well on down the path of opening those stores and I feel like they are going to be a nice win for us – and it gets us ahead of 2018 with those extra stores. Thanks.

Thank you.

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

Thank you. Hi Stephanie, hi Dave

Hi, Jim.

Hello, a few questions from me. First off, I look to visiting the Thornton store later this week. We are excited to have you coming to Colorado.

Oh, good we’ll see you there.

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 improvements in doors opened more than a year, very strong growth I guess I’m just curious whether it’s the new store outperforming or are you seeing good growth across the store base.

Overall, Jim we are really pleased with both new stores and the existing store base. We have not reported comps at this point, mostly because there are seven stores of the 25ish and thing is because the 25th is Thornton that we have out there, but we are very happy with what our existing stores are doing and most importantly we are 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 are 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 are 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 number of years that continues to build brand awareness nationwide and so when we enter a market we are much more well known today than we were seven 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 opened doors in larger markets versus smaller Metropolitan areas or is there not necessarily distinct patterns?

Variance in what sense, Jim?

Just door productivity, return on the investment so forth.

No, they are actually very similar. The one – so what we are looking at when we see the first 12 months of a store – we are looking at a four wall EBITDA that’s very similar. We are 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 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, Philadelphia, like Washington DC market. And we are going to learn a lot over the next six 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 your end?

Sure, you know in operating cash flows there is 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? Line of credit…

Do you feel 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 the subsequent calls.

Fair enough. Thank you.

Thanks.

[Operator Instructions] Our next question comes from Andrew Burns from D. A. Davidson. Please go ahead with your question.

Good afternoon, and thanks for taking my question. Just to follow up on Dan’s earlier one on promotional activity. In store promotional strategies can be very different than online strategies this year, retail fleet gets built out and you have much more data and experience. How is your promotional strategy evolving online versus in-store are they feeding off each other or are you able to keep them well aligned clearly driving store traffic in this retail environment is challenging for a lot of people. Thanks.

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 two 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 alignments. 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 promotion, those what we call temporary promotions or product promotions that is very short lived, maybe one or two days, specific product mark downed $5, $10 that sort of thing. And there are two reasons why we are not fully aligned on that. First of all those are fast moving promotions and to try and 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 print out of that email, we absolutely honor that email promotion in the store. That’s kind of how we are looking at promotions across all of our channels.

Thanks and good luck.

Thank you very much.

And ladies and gentlemen, at this time we’ll conclude today’s question and answer session. I now would 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.