Duluth Holdings (NASDAQ:DLTH) continued to buck the "death of retail" trend in its second-quarter earnings report, with impressive sales growth from its rapidly expanding store base leading the way. By all visible measures, the company's strategy of building physical stores to attract new customers and expand awareness of its brand is working well, helping the company overcome the industry headwinds that have crushed other apparel retailers.

Sizzling sales growth fueled an excellent quarter

For the quarter, net sales were up 31% to $86.2 million. Breaking down the sales mix, we see that the company's retail segment is growing much more quickly than its direct (e-commerce and catalog) business.

  Q2 2017 Year-over-year growth % of total sales
Direct sales $57.7 million 7% 67%
Retail sales $28.6 million 138% 33%

CEO Stephanie Pugliese noted that while Duluth isn't reporting comparable-store sales numbers yet, its retail locations continue to meet or exceed expectations for sales per square foot and store-level EBITDA.

A Duluth Trading store

Image source: Duluth Holdings. 

Gross margin decreased 240 basis points to 56.7%, with around half of the decline caused by the higher number of free shipping days compared to last year. However, the company noted that product gross margin actually increased slightly, indicating that the company's core products are maintaining their pricing power. Shipping revenue is expected to continue to decline throughout 2017 as a percentage of net sales, but as retail becomes a larger part of the overall business, this should have a less meaningful impact over time. Despite the lower gross margin, adjusted EBITDA increased 26.7% to $9.5 million.

The company also reaffirmed its full-year net sales guidance of $455 million to $465 million, reflecting 22% growth at the midpoint, along with adjusted EBITDA guidance of $47 million to $49.5 million, which would be a 18% increase at the midpoint.

An omni-channel strategy that's paying off

The interior of a Duluth Trading store

Image source: Duluth Holdings

For years, Duluth relied primarily on catalog and website sales, only opening its first physical store in 2010. But it now believes that these retail stores are a crucial channel that helps attract first-time shoppers -- company data shows that 25% of new customers year-to-date made their first purchase in a retail store. The stores also help grow brand awareness, according to Pugliese:

In men's, the aided brand awareness in markets with a retail presence was 11 points higher than in markets without a store. The findings in women's are even more dramatic. In women's, there was a 26 point increase in aided awareness in store markets versus those without stores. This, as we know, is the first step in consideration of brand and eventual purchase. And these survey findings support our internal data that in the first year of a store being opened, as many as 50% of the people purchasing in that store are new to the Duluth brand.

Pugliese offered additional evidence that retail isn't cannibalizing its direct sales:

While we do see a deceleration in direct sales into the low single digits in the first year that a store is open, after approximately one year in a market, the reacceleration of the direct business surrounding a store is over twice the growth rate of the national average for direct in markets without stores.

The strongest proof that Duluth's retail sales are incremental to online sales? The company said that its four markets with retail stores that have been open at least 24 months show a three-fold increase in sales volumes compared to what those markets would have achieved with direct sales alone. That's extremely encouraging as the company continues to expand its footprint.

Accelerating toward 100 stores

While Duluth does expect its direct sales to continue to grow by around 6% in 2017, it's obvious that the company's future growth will be driven more by opening new retail locations. Encouraged by its early retail results, Duluth now plans on opening a total of 15 new stores in 2017, up from its previous guidance of 13 stores. With only 16 locations at the end of 2016, the company's new guidance represents nearly 100% year-over-year growth.

And if Duluth makes good on its initial outlook of another 15 new stores in 2018, the company would essentially be tripling its store base in just two years. The next 18 months mark an important period in Duluth's expansion as it begins to enter the western portion of the U.S. The company just opened its first store in Colorado in early September, with locations in Alaska, North Dakota, Oregon, and Texas to come next year. Ultimately, Duluth is targeting 100 total stores, and based on current projections, it should be nearly halfway there by the end of 2018.

With these encouraging retail segment tailwinds, it's curious that the market hasn't been more enthusiastic about the company's recent earnings reports. Perhaps it will take another quarter or two for investors to believe that the brand can truly withstand the brick-and-mortar retail malaise. But if the company keeps putting up sales numbers like this, it'll only be a matter of time before investors want a piece of Duluth's growth prospects again.

Andy Gould owns shares of Duluth Holdings. Andy Gould has the following options: Short Nov. 2017 $25 puts and short Nov. 2017 $30 puts. The Motley Fool recommends Duluth Holdings. The Motley Fool has a disclosure policy.