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Duluth Holdings Inc. (DLTH) Q4 2018 Earnings Conference Call Transcript

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Duluth Holdings Inc.  (NASDAQ: DLTH)
Q4 2018 Earnings Conference Call
April 04, 2019, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, and welcome to the Duluth Holdings Incorporated Fourth Quarter 2018 Earnings Conference Call. All participants will be in listen-only mode. (Operator Instructions) Please note, this event is being recorded.

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

Donni Case -- Investor Relations

Thank you, Gary, and welcome to today's call to discuss Duluth Trading fourth quarter and fiscal 2018 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'm here today with Stephanie Pugliese, Chief Executive Officer; and Dave Loretta, Chief Financial Officer. On today's call management will provide prepared remarks and then we will open the call to your questions.

Before we begin, I would like to remind you that the comments on today's call, which include forward-looking statements can be identified by the use of words such as estimate, anticipate, expect, and similar phrases. Forward-looking statements by their nature involve estimates, projections, goals, forecasts and assumptions, and are subject to risks and uncertainties that could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements.

Such risks and uncertainties include, but are not limited to, those that are described in our most recent Annual Report on Form 10-K and other SEC filings as applicable. These forward-looking statements speak only as of the date of this conference call and should not be relied upon as predictions of future events.

With that I'd like to turn the call over to Stephanie. Stephanie?

Stephanie L. Pugliese -- President and Chief Executive Officer

Thank you and welcome everyone to our fourth quarter and year-end call for fiscal 2018. This past year was one of significant growth and accomplishment for the Duluth business. Our goal this year were to achieve strong revenue growth, strengthen our omnichannel presence, implement key infrastructure improvements and reach more customers than we ever have before.

We achieved these objectives and some highlights for the year include revenue growth of almost $100 million over 2017; a 50% expansion of our store base, ending with the year with 46 stores, including three locations in Texas, one of our top three states; market share growth in both new and established store market; the power of the omnichannel model continues to prove out as evidenced by established store markets consistently achieving direct growth rates at more than doubled the non-store market rates; continued double-digit growth in our active customer base along with an improvement in key metrics such as the percent of customer shopping across categories and average annual spend per customer; implementation of a large-scale infrastructure improvements, including a new order management system, inventory planning system and e-commerce platform, and upgrade to our distribution center in Belleville, Wisconsin. And finally, the launch of customer-facing omni programs such as Buy-Online-Pickup-In-Store or BOPIS, ship-from-store and e-gift cards.

While executing all these important initiatives puts us in a stronger competitive position for the future, our fourth quarter, which is the lion's share of our revenues and profitability, fell short of our expectations. We began the holiday shopping season with a strong showing on Black Friday and Cyber Monday, and we were on track to deliver higher sales results through the first week of December.

As we got closer to Christmas and through January, we experienced a slowdown in customer response, which we attribute to some factors that were in our control and others that were not. On a macro level, we were not immune to the overall slowdown in consumer spending and we felt the impact of lower traffic across all of our channels. Internally, we encountered some challenges with systems implementation and late deliveries of product. As a result we had inventory that was misaligned to the timing of sales and not distributed optimally throughout the network. This affected store productivity and added extra cost throughout the system, and some of our high-demand product didn't hit the market in time to reach the full benefit of the holiday season.

For example, we were out of stock in some of our highest volume sizes of our women's Plus Size program during this critical time of the year. We also took more back orders than we had planned due to later deliveries of the product and incurred more labor in the distribution centers and in the stores to process the flow of goods, which added considerable expense for the quarter. It is important to note that despite these issues we delivered a 15% increase in revenues over last year.

Critical to the business, our new e-commerce platform had the stability to handle peak volumes and we saw significant improvement in site speed. Total website visits in the fourth quarter increased 11% year-over-year with continued growth in new visitors. Most importantly, we recognize that as our model successfully shifts from direct to omnichannel, retail stores continue to influence customer engagements and revenues and across the entire ecosystem.

We know that when we open a store, that store presence quickly increases market penetration and longer term it's a catalyst for higher growth rate in direct. With total market growth being key to our success, top priority efforts are under way to drive awareness of and traffic to the stores. This is especially important as we expand to more new markets. This requires even more focused on the specific drivers of retail stores.

For example, the importance of new high volume products in our assortments each season. Unlike the direct business that drives on core stable, delivering fresh assortments to our retail stores, drives overall sales, attracts new customers to the brand, and boots traffic overall. We increased our new product introduction this past year, but several of our program fell short to our sales expectations, particularly in men's accessories and outerwear.

We know that we can do better and we are planning for more new styles, sizes and color options to create a pipeline of fresh impactful product year-around. We will double the number of SKUs in our women's plus size category and we will also continue to build out the rest of our women's business, Alaskan Hardgear and men's base layers, which are significant and proven drivers of growth.

Overall, we are planning for a 40% increase in new product that will be ready for the fall and peak season. In addition to evolving the assortment to meet the expectations of our omnichannel customers, we are focused on improving our ability to attract new and retain existing customers through targeted marketing and a more personalized web and store experience. This past season we did not yet have all of the elements of customer-facing marketing efforts in place and we were still -- are still working on these initiatives through the first quarter. For example, we know that the influence of women customers on omnichannel sales is important and growing, yet we were underpenetrated in marketing efforts that spoke specifically and directly to her. We will leverage the momentum in this part of our business by investing in additional advertising, increasing visibility within retail stores and doubling and improving our marketing mix.

Our men's business grew 19% year-over-year with Alaskan Hardgear being one of the fastest growing segments and achieving a three-year CAGR of 95%. We have a lot of opportunity to grow this popular sub-brand by expanding its retail footprint in appropriate store markets and by leveraging its brand appeal beyond outerwear with year-around apparel.

In a few minutes I will share our plans for this year. But first I'll turn the call over to Dave to discuss the details of our financial results and our guidance for 2019.

Dave Loretta -- Senior Vice President and Chief Financial Officer

Thank you, Stephanie, and good afternoon, everyone. In the fourth quarter, we reported net sales of $250.5 million, up 15% compared to $217.8 million last year. This included $7.7 million for an extra 53rd week in 2018 as compared to 2017. Net sales growth was driven by both our retail and direct segments, with retail sales increasing 39% to $86.8 million and direct sales growing 5.4% to $163.8 million. Excluding the 53rd week, direct segment growth was 2.5% to $159 million and retail segment growth was 34% to $83.8 million.

For the quarter, shipping revenues were $3.4 million, a decrease of 40% compared to the prior year. In retail, we opened a total of three new stores, adding approximately 40,000 gross square feet to our retail footprint. We ended the year with a total of 46 stores and approximately 716,000 gross square feet. As Stephanie mentioned, our holiday business was on trend heading into December, but we started to see some mixed results two weeks prior to Christmas.

Direct sales were healthy through Christmas with the first eight weeks of the quarter growing 7% over last year. This trend reversed at that point with direct sales lagging last year by close to negative 6%. Our store sales productivity was good through early December, but didn't finish the holiday selling season as strong as last year. In January, we were up against a very promotional period last year and direct sales growing over 20% in that period. The addition of clearance goods and flash events this year didn't result in enough business to see online gains in January.

Gross profit for the fourth quarter was $131.3 million or 52.4% of net sales compared to $116 million or 53.3% of net sales last year. The 90 basis point decrease in gross margin rate was primarily due to an 80 basis point decline in shipping revenues and increased freight cost of our stores. Gross margins on our product sales improved over last year by 40 basis points, but were largely offset by end of year shrink and other cost of goods adjustments, including some adjustments that related to correcting system, inventory balances which were inflated by the cut over to the new order management system earlier in the year. We discovered the inflated inventory during our year-end close, but have determined that the adjustments are immaterial to our full year results. We are completing our assessment of the effectiveness of internal controls related to this and expect that that assessment will be completed in time for our 10-K filing.

Moving on to expenses; selling, general and administrative expenses increased 16.7% to $109 million compared to $86.5 million last year. This increase included $300,000 in advertising and marketing expenses, $9.6 million in selling expenses and $4.6 million in general and administrative expenses. As a percentage of net sales, SG&A expense increased 60 basis points to 40.3% compared to 39.7% last year. As a percentage of net sales, advertising and marketing costs decreased 200 basis points to 14.4% compared to 16.4% in the fourth quarter last year. The 200 basis point decrease was largely due to cost reductions related to catalog circulation and the shift of women's and men's catalogs from late January into February 2019, as well as leverage gained in advertising from a higher mix of retail net sales.

Selling expenses as a percentage of net sales increased to 16% compared to 14.1% last year. The 190 basis point increase was primarily due to higher retail selling costs from additional stores, an increase in shipping expense and an increase in distribution and call center labor. The increase in shipping expenses were primarily due to back orders and higher shipping rates during the peak season. The increase in direct fulfillment expenses were the result of our planned increase in wage rates as well as higher shipments per order due to a greater percentage of back orders.

General and administrative expenses as a percentage of net sales increased 70 basis points to 9.9% compared to 9.2% last year, primarily due to higher depreciation from the investments we made in new stores, technology and infrastructure. As we continue to fine-tune the new order management platform, we did experience additional cost to stabilize and maintain high customer service levels, that added an estimated $1.1 million in expenses in the quarter.

For the quarter, we reported net income of $20.8 million -- of net income or $0.64 per diluted share compared to net income of $19.5 million or $0.60 per diluted share last year. This includes an update to our effective tax rate from 26% to 26.7% as a result of the greater state tax apportionment. Adjusted for the change in tax rates due to the US tax reform in 2018, our prior year fourth quarter net income was $21.2 million or $0.66 per diluted share.

Our adjusted EBITDA increased 9% to $35.3 million compared to $32.4 million in the fourth quarter last year. We closed fiscal 2018 with a healthy balance sheet that positions us well for making strategic product, inventory and marketing adjustments to capitalize on our customers' preference for newness. At the end of the year, net working capital was $65 million with $16.5 million outstanding on our $130 million line of credit. Inventories increased 8.5% to $97.2 million compared to $89.5 million at the end of the fourth quarter last year -- $9.5 million of total inventory related to the additional 15 stores opened during 2018 and partially offset by improvement in turns.

Our outlet in clearance inventory showed a minimal increase at the end of 2018. As we progress into the first quarter of 2019, the response so far has been favorable to clearing that inventory and we expect to end the first quarter in a lower clearance position, allowing us to focus more on new products and full price selling.

Total capital expenditures were $50.8 million in 2018 compared to $42.8 million last year. As we discussed a year-ago, our 2018 capital expenditure plan reflected a peak investment year that was focused on supporting our growth strategy with new store openings, foundational investments and automation in our distribution center, implementing a new order management and inventory planning system, and replacing our outdated website.

Now moving on to the 2019 financial guidance, which is based on 52-weeks. We expect 2019 net sales to be between $645 million and $655 million with the retail channel accounting for up to 45% of total 2019 net sales, and mid single-digit growth in direct. We plan to open 15 new stores in 2019.

We expect full year gross profit rate to be flat compared to 2018 with slight improvement in product margins, offset by continued decline in shipping revenues of roughly 30 basis points. The exception to this will be in our first quarter where the sluggish trend in sales, both online and in stores, and heavier clearance activity is expected to negatively impact gross profit rate by 200 basis points to 250 basis points.

We expect selling, general and administrative expenses as a percentage of net sales to be 70 basis points to 120 basis points over last year, half of which is due to a shift of lease expenses from the interest line item to SG&A, plus an incremental $1 million in lease expenses as a result of the adoption of the new accounting lease standard. Excluding these impacts, the growth in the stores channel will continue to drive SG&A increases, along with higher depreciation expenses related to technology, infrastructure projects placed into service during 2018.

As a result, the annualization of higher depreciation related technology support costs and higher fulfillment labor rates will impact the first half of 2019 much more so than the back half. We anticipate these additional expenses will be partially offset by leverage gain in advertising, primarily due to higher retail sales in 2019. The one exception will be in the first quarter where we expect advertising to deleverage up to 20 basis points based on the shift in catalog drop dates into the quarter, as well as investing deeper in women's TV advertising for the spring and summer assortments.

We expect 2018 earnings per diluted share to be between $0.74 and $0.80. This assumes a full year weighted average diluted share count of 32.5 million shares and a tax rate of 27%. We expect adjusted EBITDA to be between $60 million and $64 million or a 15% to 23% increase. We expect capital expenditures to be in the range of $40 million to $45 million with the majority of spend on new stores and omnichannel growth initiatives.

We expect our free cash flow to turn positive in 2019 as we enter the period of steady state capital investments and begin to leverage fixed costs in the business model.

In closing, we ended the year with softness in sales trends on top of the heavy investment in foundational systems that impacted profitability growth. However, we have a solid plan for 2019 and are already executing on that plan.

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

Stephanie L. Pugliese -- President and Chief Executive Officer

Thank you, Dave. Our culture of innovation is not limited to the products that we offer our customers. We did a lot of heavy lifting in 2018 to enhance our omnichannel model and to build a strong platform capable of creating deeper engagement with rapidly evolving customer expectations and technology that is moving faster than ever. While these initiatives created some near-term pressures in our business, we generated strong top line growth and maintained profitability in 2018. Looking forward, our focus will be on optimizing our investments and maximizing the opportunities we see to enrich brand awareness and engagement across all contact points with the customer. We are intensely focused on the parts of the business with greatest momentum and the greatest opportunity for increased market penetration.

These areas include the women's business, Alaskan Hardgear and men's base players. We are introducing proportionately more new product innovations in these areas and we have outsized our marketing efforts to drive growth and awareness. We will continue to expand and refine our omnichannel model with the goal of an additional 15 new stores and holistic effort to engage customers across channels, including the roll out of BOPIS. Regarding BOPIS, I can report to you that our trial in seven stores during 2018 exceeded our expectations. 91% of the customers polled indicated that they're likely or very likely to use BOPIS again. We expect to have this slide in all existing stores by the end of this month and we will make it available in all of our new stores as well.

As we see it, BOPIS creates multiple opportunities. It gets product to the customer faster than shipping, it encourages purchases in the store at the time of pickup and it ensures that we will have the product on hand when customers make the trip to the store. We will refine the investments that we implemented this past year, including improving the speed of our order management systems and continuing to build on the assortment and inventory planning tool, which will more accurately predict inventory needs by location and ultimately allow us to localize assortments by store and respond to customers' different needs by climate and geography.

Hand-in-hand, we will focus on productivity improvements to leverage the variable costs associated with our investments. This includes, increasing our use of pop up distribution centers for peak selling season, increasing the amount of product that is retail ready from our vendors and more accurately projecting on-hand inventory needs throughout the network.

And finally, we will begin to utilize insights from our marketing mix study to more fully engage customers across all of our marketing efforts. As our model has become more complex, our ability to understand and act on what is truly driving customer behavior is increasingly important. Through test and learn, we expect to more fully leverage the spend in the future.

We have an ambitious yet achievable agenda for 2019. The investments made to date have not been just in brick and mortar and IT systems, but also in talent and training. (Technical Difficulty) stronger and deeper than it's ever been. We remain fully committed to our long-term strategy of building the Duluth Trading brand through an omnichannel experience that we entirely control. We are well positioned to move our business forward and thereby create long-term value for our shareholders.

With that, we welcome your questions.

Questions and Answers:

Operator

We will not begin the question-and-answer session. (Operator Instructions) The first question comes from John Morris with D.A. Davidson. Please go ahead.

John Morris -- D.A. Davidson -- Analyst

Hi, thanks. Hi, Stephani, hi, Dave. Hi, couple of questions on the product category performance. Stephanie, I know you did mention it, you mentioned it very quickly, so I'm wondering if you give us a little bit more color on what you saw in terms of the product category performance, for example, I think I heard you say that outerwear didn't perform as well as you wanted it to. And so maybe that also kind of begs the question, if that's the case and/or volunteer your feeling on how whether or not weather impacted you on the quarter. And just generally on the product category performance, both men and women.

Stephanie L. Pugliese -- President and Chief Executive Officer

Sure. So first, let me start at a slightly higher level on the men's versus women's. Our women's business continues to outpace the overall business in growth and -- the men's business. We picked up another couple of points of penetration in the women's business overall. And we are definitely seeing an increasing momentum in women's even as we go into the first quarter, particularly around some of our newest product launches and our plus-size business, for example, continues to be a very strong part of our business overall. So on the women's side of things, we certainly had a few products that exceeded expectations, a few that were -- fell a little bit shy, but overall in women's, I'd say we had some pretty decent momentum throughout the quarter.

The struggles that we had specifically on product really were twofold. There were a couple of large-scale programs that we had that were more weighted toward our men's business in outerwear. They were new launches of products that just didn't meet our expectations overall. We had certain pockets of outerwear that were good, but by and large, our outerwear business fell short. We also saw that the accessories hard goods part of the business didn't meet our expectations, again geared more toward the men's side of things.

That said, there was also an exacerbation of product performance, in that I mentioned in my prepared remarks that we had some later deliveries, some inventory that was misaligned. Specific to that we had some deliveries that were later than we expected due to some port congestion, a little bit later on into the quarter. And that was -- they added to our problems there in that. We had tight deliveries to begin with and then trying to get some of those goods out to the full network, including all of the stores in time for certain peak selling -- peak parts of the selling season was difficult. So we found -- we also found that we had some of our inventory that we didn't get out to our DC network fully and completely in time, again for some of those peak weeks.

So we were taking on more burden in our Belleville, Wisconsin distribution center than we had anticipated, which added to cost and slowed down the inventory replenishment to our retail stores. As you may remember Belleville is the one DC that replenishes our retail stores. So when we get clogged up there on the direct side, it tends to impact the whole system. So those were the big things around the product side of things. And what I'd say, John, in terms of the impact of both of those, they are probably both -- both equally weighted in terms of the sales volume impact, but the second thing that I talked about with the inventory misalignment also had expense ramifications as well.

John Morris -- D.A. Davidson -- Analyst

That's a lot of helpful color. I'm wondering, I mean, given that the pace of the slowdown coming so late in the quarter, whether or not you all want to comment on what you're seeing so far top line wise here at the beginning of the first quarter since we're you know pretty well through it, whether or not you're seeing and to what degree you can comment qualitatively on recovery. Dave, I know you gave a fair amount of color on some other below the top line item things, but I'm wondering if you can comment any kind of a recovery that you've seen so far, top line wise.

Stephanie L. Pugliese -- President and Chief Executive Officer

On the top line side, John, I'll take that one and then pass it off to Dave for any additional comments. Q1 has been slow for us. We haven't come out of the sluggishness that we saw in Q4. We're not really seeing a trend reversal at this time, particularly on the men's side of the business. That said, our women's customer, particularly with the new product has been responding more quickly and stronger.

So our women's trend is actually still quite good, but we did come out of fourth quarter with, you know, because of those issues that I described just a moment ago, with additional end of season clearance inventory, which we took some additional markdowns on in late February and early March to move those goods, we feel good about where we are today on that inventory position and we feel good about, as we keep going deeper into the year, the plans and the new products that we have in place to introduce to the customer, but we really see first quarter sluggish, second quarter perhaps a little bit of recovery, but really it's going to be -- and the inflection point is the latter half of the year for some of the product turnaround as well as some of the marketing efforts that we have in place.

The last thing that I would mention to you is, we haven't yet seen an all-out kind of spring whether reversal, if you will, with a lack of rain and obviously not such hot temperatures. So in terms of really gauging some of our warmer weather product, it's still a little too early to tell and call that.

John Morris -- D.A. Davidson -- Analyst

Yeah, OK. All the best for spring there. Thank you.

Stephanie L. Pugliese -- President and Chief Executive Officer

Thanks, John.

Operator

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

Jonathan Komp -- Robert W. Baird -- Analyst

Yeah, hi. Thank you. I wanted to just first follow-up about the inventory-related comments and you already characterized more of the operations, factors that you called out. Just curious, Stephanie, kind of when do you think you'll have a good handle on all those factors and (Technical Difficulty) any more color as diagnosed some the operating factors (Technical Difficulty).

Stephanie L. Pugliese -- President and Chief Executive Officer

Jon, you broke up a little bit for me. So I'll start with what I did hear about commentary on some of the inventory comments that I made, as well as where we are today and how we see that evolving and improving. Is that a fair -- is that your question?

Jonathan Komp -- Robert W. Baird -- Analyst

(Technical Difficulty)

Stephanie L. Pugliese -- President and Chief Executive Officer

Okay. So we really saw some pretty significant impact on inventory misalignment over -- in fourth quarter, obviously because fourth quarter is such an important part of our year and every day is a significant amount of volume. So one or two days of misalignment or missed delivery of an order is very impactful in the fourth quarter, more so of course than any other quarter. That said, the things that we can control, we have found that our deliveries are back to the standard, if you will, in terms of being on-time delivery. We haven't of late experience those same types of inventory delays or delivery delays, I should say, that we experienced in the fourth quarter.

In addition, in fourth quarter we were just coming off of the transition to our new expansion of our Belleville distribution center, which primarily affects retail replenishment, that was a slow kind of restart at the end of the third quarter. It stayed impacting us in fourth quarter. So we're past some of those things. The piece that we are still working on from an inventory perspective is we're still fine-tuning the new assortment and inventory planning tool that we put in place in late third quarter and that is the tool that anticipates sales curves and demand needs in stores ahead of the curve.

And while we think that is working well, we definitely think there's opportunities to improve that and to optimize that system, looking at things like opportunities for highest volumes SKUs to be in a never out situation and what type of inventory levels would it take to do that and we're working with our vendors to be able to fast track some inventory on some of these higher volume items so that we are in better stock position across the entire system.

The other thing that we're looking at is, as we have -- as I mentioned in the remarks, we are finding more and more that our retail business and our retail customer is responding more disproportionately to new and the new seasons good. And so we are looking -- we're going back into our placement of orders on those types of goods and ensuring we have the depth of inventory levels to be able to stay in stock, in that product across, you know, now the 50 stores with our with our Spokane store coming online that we have and making sure that we've got enough inventory to go across the entire system.

Jonathan Komp -- Robert W. Baird -- Analyst

Okay. That's helpful. Maybe a question just some of the (Technical Difficulty) drivers (Technical Difficulty) marketing initiatives later in the year, can you talk about your degree of confidence that those are the business forward and any -- any results that kind of tests related to some of that or any more color that you could share.

Stephanie L. Pugliese -- President and Chief Executive Officer

Sure. So one of the -- one of the kind of confidence proof points that we have today, I've mentioned it a couple of times in terms of the juxtaposition of women's results versus our men's results right now. Women's, we have doubled the amount of newness and the floor right now that we have in men and that business is trending better. The product that we have -- that we have introduced, that is transitional product as well as some of the early reads that we've gotten in women's, and remember that our women's customer will shop a little bit more ahead of the season than our men's buy now, wear now guy is, we've seen some very positive indication on some of the early reads even there in summer goods, if you will.

The other piece that we have seen is that in our men's business where we've had small collections of new product, we've gotten actually an early good response but we haven't been in the inventory position to be able to sustain some of these new kind of trending products. The last piece that you asked about confidence as we go forward, I would say that the depth of newness and some of the large-scale programs that we have or introducing a full new category in women's. I'll keep you guys in suspense on that until we get a little bit closer on exactly what that looks like, but that's a, that's an important driver of what we've got go forward. We've doubled the SKUs available in our plus size business which is proving itself out.

So I feel really good about where we're going go forward. It's going to take a little bit of time for us to get there because we're not there yet. The other thing that I would just mention is marketing efforts. We have already started some of the test and learn efforts coming off of our first marketing mix indicators that we got in late fourth quarter and we're starting to see indicators of results there. We expect that we'll have the results shortly coming off of fourth quarter and we'll be utilizing that to adjust our marketing investments for third and fourth quarter for the year as well.

Jonathan Komp -- Robert W. Baird -- Analyst

Okay, great. And just last one from me, a bit of a follow-up. But when you look at the margin performance of the business, given the marketing model, mix changes maybe leveraging some of the systems that are now in place, like how far out do you think you are from stabilizing and maybe starting to improve operating margin again?

Dave Loretta -- Senior Vice President and Chief Financial Officer

Jon, we have talked about the second half of 2019 as a point where we expect some operating margins to start to expand and that is what we are expecting to see. So I'd kind of characterize this as, third quarter, we expect that trend to begin and that's what's reflected in our guidance.

Jonathan Komp -- Robert W. Baird -- Analyst

Okay, great, thanks for all that color.

Stephanie L. Pugliese -- President and Chief Executive Officer

Thanks, Jon.

Operator

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

Jim Duffy -- Stifel Nicolaus -- Analyst

Thank you. Good afternoon. Couple of questions from me. First, just on trends during December, the check showed a more promotional stance on a year-to-year basis, that's consistent with your comments on trends across the quarter. Did you find that consumers just weren't responding to promotions like they have in the past?

Stephanie L. Pugliese -- President and Chief Executive Officer

Yes, I think it was part was partially that, Jim. It was also that we were up against some pretty deep flash sales. And while we stayed very promotional and increased some of our global, you know, take X percent of your orders promotions in the month of January, we still just didn't see quite the response that we expected. We are attributing some of that -- quite frankly, to some of the things that I've already talked about with having impactful new large-scale programs that some of them that we had and the customer just didn't react to them at full price or at markdown, as well as just some overall slowdown because we did see that it was enterprisewide, if you will, that sluggishness.

Jim Duffy -- Stifel Nicolaus -- Analyst

Okay. And Stephanie, maybe you just answered my next question. But I'm curious trends across the quarter, the linearity of the quarter was fairly consistent between the direct and the retail business.

Stephanie L. Pugliese -- President and Chief Executive Officer

Yes. And I would say that they've also been fairly consistent in terms of what we've seen in prior quarters. And what I mean specifically, Jim, about that is that we do consistently see, for example, that we sell more of a proportion of our sales at full price in retail stores then in direct. Direct is a more promotional segment or channel for us, primarily driven with emails, as you would imagine, and we saw that consistently, but it was all kind of -- there was an umbrella of sluggishness across all aspects.

Jim Duffy -- Stifel Nicolaus -- Analyst

Okay, helpful. Thanks. And then you have referenced a couple of times the need for more newness in the stores. What are you seeing with respect to store traffic trends. Is that something you can comment on, any help that would be...

Stephanie L. Pugliese -- President and Chief Executive Officer

Yeah, sure. I would say -- there are two things I can say about that. Number one is, when we talk about the quarter that we just came off of and even the continuation into first quarter, we have seen traffic sluggishness across the board. So that's web traffic sluggishness as well as store traffic. In regard to the newness and what we see with that, there are two things.

Number one is, as I mentioned just a few minutes ago, we know when we look at the proportion of sales that are driven by core basics versus brand new product versus seasonal new product, and when I mentioned, seasonal new that something like a flannel shirt that might be a repeat of prior year, but it goes away in the spring and summer then comes back again in the fall, that seasonal new and the brand new product is the higher driver of our retail revenues than it is in direct.

And we see that when we deliver a new store set, when we deliver a new catalog, for example, or a new television ad that is featuring either that seasonal product or brand new product, we see store traffic increase more quickly and staff and -- at a faster stronger or pace, if you will, than even the web traffic.

Jim Duffy -- Stifel Nicolaus -- Analyst

Okay. So it seems like the retail stores are showing some different characteristics than the online, which is to be expected, I suppose. Merchandise assortments, you're still getting figured out. I'm curious, you're adding retail stores, putting new systems in place. Does it make sense to take some time to get your feet underneath you before and tap the brakes on opening stores. Is that something that's been discussed?

Stephanie L. Pugliese -- President and Chief Executive Officer

As we're looking at the opening of the stores and the 15 store plan that we have again this year, the primary filters, if you will, that we're using are, you know, the stores that we are opening, even though we're coming off of a sluggish quarter, the stores that we're opening are still achieving or exceeding our model goals. All of the things that we've talked about a number of times with sales per square foot goals as well as four-wall EBITDA projections, projection of payback on the initial investment and we are seeing continued strength in the omni model, the direct side of the business in our more established longer store market. So there is all the really positive indications around the omnichannel model and the growth there.

That said, the other filters, if you will, that we use and we want to make sure that we always have in place, are obviously the capital in place. The second thing would be the available real estate that is right for us, not just they are because it's available and the ability to manage staff and create a customer experience that we expect from our stores.

So if those things are all in place, we expect to keep moving forward with our store expansion. And as far as the systems piece of things, we are obviously still dealing with the refinement of the system and what we sometimes call the tail that flows and after the implementation and we're working on those things, but the very large scale implementations are behind us at this point and we're really focusing on refining the use of those systems this year as opposed to kind of turning over again.

Jim Duffy -- Stifel Nicolaus -- Analyst

Very good, thank you for that.

Stephanie L. Pugliese -- President and Chief Executive Officer

Thank you.

Operator

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

Dylan Carden -- William Blair -- Analyst

Yeah, hi. Thank you very much. Curious to trying to understand the wider spread between store productivity and direct business and how direct was able to kind of pull out of this quarter with some positive momentum which you expect to continue this year. I guess how much of the implementation of new order management systems do you attribute to the decline in the retail channel from a productivity standpoint. And then go forward, any update you can give vis-a-vis kind of the interaction of the two channels, one year, two years in, you know, customer retention of the 50% new customers, how many you're seeing in that second year that come back to the store, any sort of second-year trend in these newer stores you've now had opened from 2017, any kind of data points in and around sort of the aging of the fleet, so to speak, would be helpful.

Stephanie L. Pugliese -- President and Chief Executive Officer

Dylan, that with a lot of questions. So I'm going to try to them off one at a time and please let me know if I forget about one, OK? So just starting with sales productivity and the retail versus direct and the results that we saw and how OMS and systems might have impacted that, I would say that the impact of the systems implementation overall was threefold.

Specific to your question about was there an impact to the trend line, if you will, of retail, we definitely had some impact. It's hard to quantify on the lack of inventory or lack of timely inventory in the stores in the peak season I've mentioned before with the changeover of both of our DC as well as the new assortment and inventory planning system that we implemented at the end of third quarter. That definitely had an impact on our stores where people were coming in during the peak season and we didn't have full inventory position, particularly in some of our higher volume items.

One of the benefits that we have go forward for that will be the BOPIS roll-out to all of our stores. But remember in the fourth quarter that was only in seven stores, so it was really not impactful at all in terms of the grand scheme of things. The second impact that the systems implementations had were obviously with expenses and that's not necessarily a retail trend line issue, but it was certainly very real impact to our bottom line for fourth quarter and for the year. And we've talked I know about some of that in our prepared remarks.

The third piece that systems implementation had in terms of an impact was quite frankly there were a lot of our team members that were working through the implementation of those systems as well as the refinement and making sure that we were fixing the bugs as we came through third and fourth quarter this year. And there were some energy spent on those systems implementations and refinement that we have back now to be able to be focused on retail replenishment and inventory levels and making sure we have newness and assortment and all that sort of thing. So I do think that we lost some kind of mindshare time, if you will, on some of the retail specific business drivers.

The last thing that I would mention is, one of the things that I tried to communicate and I think with some of the other questions is, becoming a little bit clear is, we are now at the point where almost 40% of our business last year was done in the retail channel and we know that retail customers go back and they shop across channels. So they may come into retail stores for the new seasonal product or the brand new product, but oftentimes they will often go back and order online for their core basics or a new color or something that they just bought.

So while 40% or so the transactions are done at retail, a far greater amount of the overall sales are being influenced and impacted by our presence in retail. And we have an opportunity to get a little bit sharper, a little bit smarter about the specific demands of the retail channel that drive customer decisions like this newness we've been talking about a lot and how we go forward and strengthen that.

The other part of your question I believe was how -- what are like kind of the customer metrics around retail stores.

Dylan Carden -- William Blair -- Analyst

Yes, you've provided before some handy metrics around sort of in the second year you see direct sales in these new markets to X growth relative to the plea, that's kind of where I was going within?

Stephanie L. Pugliese -- President and Chief Executive Officer

Yes. So let me talk first about just some quick kind of view of the customer. Our retail customers are, they shop more often with us, there's a higher retention rate of retail customers. They spend more on an annualized basis, particularly driven by the visits that occur more often. They also are more likely to buy across categories, across genders and to go back and forth between the channels, kind of what I just explained a couple of minutes ago with back to quarter in basics online.

In terms of the overall business and what happens in the market, we are still seeing that, that same dynamics that we've talked about for a little while now which is, we enter a store -- a market with a store, we instantly see that market penetration grow substantially with the store volume that we've just added to the market. In the first year, we do see direct growth rates contract to a little bit lower than what the non-store or average market direct growth rates are. As we enter into the second year of that store being in the market, we are still seeing, and even in the slower fourth quarter, we are still seeing direct growth rates in established store markets being double or more so than growth rates in non-store markets. So we're absolutely still seeing that retail has a positive impact on direct growth ultimately.

We do see that in the second year of a store being in a market, we do see some contraction in four wall store sales, but that's happening, you know, we've got a few months where the direct sales are not reignited to a really fast pace and the store sales are kind of hitting up again the grand opening in their 14th, 15th month before the direct starts refiring to the level where the market is growing again. And so, there is that period of a lull, if you will, in that second year of a retail store, but we've consistently seen between direct growth and the retail store being present significant market penetration increase and absolutely an improvement in direct growth rate.

Dylan Carden -- William Blair -- Analyst

Great. Thank you very much. Can I sneak one last one to hear about on profitability? I'm just curious, on the gross margin guidance you know I think it was kind of similar last year and ultimately (Technical Difficulty) I guess sort of confidence level that you're going to go to offset or is it that shipping level -- shipping threshold should stay more consistent this year given kind of where they are trended? And then also on marketing whether or not kind of your plans for the year and what you saw in the fourth quarter gives you some hesitation on leveraging that line item longer term more aggressively? Thanks.

Dave Loretta -- Senior Vice President and Chief Financial Officer

Yes, Dylan, on the gross margin expectation, we do expect that the shipping revenue decline will continue and that was call out in the comments around 30 basis points of impact to gross margin as a result of that. We do expect that product margin will largely offset that and that will play out through the course of the year, similar to last year with the first quarter being a bigger decline in the gross margin rate and then the other periods of the quarter of the year being positive. But in terms of advertising, we also see that the new element that we've got going into 2019 is some learnings from our marketing mix modeling study that we'll apply to our spend already this first part of the year and probably more so in the back part of the year because we'll have the learnings after this past back half of the year analysis available to us.

So we're confident that the advertising leverage will be there, but it'll be more targeted and more focused on the elements that drive the activities that we're looking for. So that's in what's available to us going forward.

Dylan Carden -- William Blair -- Analyst

Great, thank you very much.

Stephanie L. Pugliese -- President and Chief Executive Officer

Thanks, Dylan.

Operator

This concludes our question-and-answer session. And the conference is also now concluded. Thank you for attending today's presentation. You may now disconnect.

Duration: 55 minutes

Call participants:

Donni Case -- Investor Relations

Stephanie L. Pugliese -- President and Chief Executive Officer

Dave Loretta -- Senior Vice President and Chief Financial Officer

John Morris -- D.A. Davidson -- Analyst

Jonathan Komp -- Robert W. Baird -- Analyst

Jim Duffy -- Stifel Nicolaus -- Analyst

Dylan Carden -- William Blair -- Analyst

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