Vera Bradley Inc (VRA) 2015 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Vera Bradley second-quarter 2015 earnings conference call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions. As a reminder, today's conference is being recorded.

I would now like to turn the call over to Ms. Stacy Knapper, Vera Bradley's Senior Vice President and General Counsel. Please go ahead, ma'am.

Good morning and welcome, everyone. We would like to thank you for joining us for Vera Bradley's second-quarter earnings conference call.

Some of the statements made on today's call during our prepared remarks and in response to your questions may constitute forward-looking statements made pursuant to and within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 as amended. Such forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from those that we expect. Please refer to today's press release and the Company's Form 10-K for the fiscal year ended February 1, 2014, filed with the SEC, for discussion of known risks and uncertainties.

Investors should not assume that the statements made during the call will remain operative at a later time. The Company undertakes no obligation to update any information discussed on the call.

Thanks. I will now turn the call over to Vera Bradley's Chief Executive Officer, Rob Wallstrom.

Thank you, Stacy. Good morning, everyone, and thank you for joining us on today's call. With me today are Kevin Sierks, EVP, Chief Financial Officer; Sue Fuller, EVP, Chief Merchandising Officer; and Julia Bentley, VP of IR and Communications.

We achieved our earnings-per-share guidance for the quarter and reconfirmed our EPS guidance for the full year. Second-quarter sales were at the high end of our expectations, and as a percent of sales, SG&A expenses were at the low end of our target. We carefully managed our inventories and ended the quarter with a strong cash balance and no debt.

Although we posted a negative total comparable sales number for the quarter, we began to experience some improving trends in July. E-commerce began to turn around, and although store traffic remained weak, our customers began to respond to newness in our stores. During our winter early order period for the specialty gift channel, the retailers also responded favorably to our updated assortments.

Even though the short-term continues to be somewhat challenging, I am pleased with the progress we are making against our long-term product, distribution, and marketing strategies. We are evolving and modernizing our product assortments, expanding our reach through opening new full line and factory outlet stores, transitioning to a made-for-outlet format in our factory stores, enhancing our online presence, broadening our department store relationships, and intensifying and focusing our marketing efforts. A little later on the call, Sue and I will provide more details about the progress we are making regarding the key elements of our five-year strategic plan.

The third quarter is certainly a period of important activity, as we introduce our new coordinating collections, further intensify our solid microfiber offerings, launch our leather and faux leather halo collections, enhance the visual presentation in our full-line stores, add more MFO products to our factory outlets, open 13 new locations, and ramp up our marketing efforts.

As we move into the fourth quarter, we believe these initiatives will take hold and that our customers will begin to respond, leading to more stabilization in the business. This is reflected in our guidance that Kevin will discuss.

We remain confident in our ability to achieve our five-year target of approximately $1 billion in sales and a high teen operating margin by the FY19 time frame. This is predicated upon a modest comp sales increase in our stores, e-commerce sales growth, new store growth that I will discuss shortly, stabilization of the gift channel, growth in our department store and key account revenues, and gross margin expansion through several initiatives, including made for outlet, product expansion, and sourcing efficiencies.

As a reminder, we don't foresee any significant SG&A leverage opportunity in the long term, and although we expect to reduce expenses in certain areas, we anticipate reinvesting savings in strategic growth initiatives, such as e-commerce and marketing.

Before I turn the call over to Kevin, allow me to update you on our leadership team. I believe we have assembled the right group to drive the execution of our long-term strategic plan. We are lucky to have a blend of some executives with important Vera Bradley history and others with a wide range of other industry experiences.

The last open position on the executive team was filled in July, when Angel Ilagan joined us as EVP, Chief Marketing Officer. Angel most recently served in a similar capacity with Pandora jewelry.

I will now ask Kevin to provide additional details regarding our results and forward-looking guidance.

Thanks, Rob, and good morning. Net revenues totaled $120.1 million for the current year second quarter, compared to $125.4 million in the prior year. These sales were at the top end of our guidance of $113 million to $120 million. Net income totaled $7.6 million, or $0.19 per diluted share, compared to $15 million, or $0.37 per diluted share in the prior year. For the quarter, direct segment revenues totaled $78.9 million, a 5.2% increase over $75 million in the prior year.

In our stores, second-quarter year-over-year net revenues grew 3.5%, reflecting the opening of nine full-line and six factory outlet stores during the past 12 months, which was partly offset by a comparable sales decline. Total Company comparable sales fell 5.3% for the quarter, which includes a 14.2% decline in the stores, partially offset by 9.3% increase in e-commerce sales, including e-Bay direct-to-consumer sales.

Excluding eBay sales, total Company comparable sales fell 8.8% for the quarter. Going forward, we will include eBay sales in our comparable sales calculations.

The direct segment accounted for approximately 66% of total revenues in the second quarter versus 60% last year. Indirect segment revenues decreased 18.2% to $41.2 million, from $50.4 million in the prior year, primarily due to lower orders from our specialty retail accounts, as well as a reduction in our specialty retail accounts.

Gross profit for the quarter totaled $64.1 million, or 53.3% of net revenue, compared to $71.8 million, or 57.2% of net revenues last year. The gross margin rate decline was primarily related to overhead cost deleveraging and modestly increased year-over-year online promotional activity. The second-quarter gross margin rate was slightly below guidance of 53.5% to 54%, primarily due to a modest increase in online promotional activity.

SG&A expense totaled $51.8 million, or 43.1% of net revenues in the current year second quarter, compared to $48.3 million, or 38.6%, of net revenues in the prior year second quarter. The SG&A expense rate was at the low end of the 43% to 44.5% guidance, primarily due to cost containment efforts and sales at the high end of guidance.

As expected, SG&A dollars increased over the prior year, primarily due to incremental investments related to achieving the five-year strategic plan, including key management additions, new store expenses, and marketing and e-commerce spending. Operating income totaled $12.8 million, or 10.6% of net revenues in the second quarter, compared to operating income of $24.1 million, or 19.2% of net revenues, in the prior year.

By segment, direct operating income was $16.8 million, or 21.3% of sales, compared to $19.1 million, or 25.5% of sales last year. And indirect operating income was $15.9 million, or 38.7% of sales, compared to $21.8 million, or 43.3% of sales in the prior year.

The effective tax rate was 40.3% for the quarter, compared to 37.7% in the prior-year second quarter. The year-over-year increase in the effective rate was due primarily to state tax matters, including an incremental reserve related to an ongoing state income tax audit.

Cash flow from operations for the six months totaled $32.8 million, compared to $27 million for the same period last year. Cash and cash equivalents as of August 2, 2014 totaled $79.1 million, compared to $9.3 million at the end of last year's second quarter. The Company had no debt outstanding at quarter end.

Inventory at the end of the period totaled $112 million, below guidance of $118 million to $128 million, and compared to $142.9 million last year. Net capital spending for the six months totaled $12.2 million.

Yesterday, the Board of Directors authorized a share repurchase plan using up to $40 million of available cash to buy back common shares through September 2016.

Before I talk about our guidance for the third quarter and full year, let me remind you about what is going on in our Japan business. We have entered into a five-year agreement with Mitsubishi and Look Inc to import and distribute Vera Bradley in Japan.

We will finishing exiting our existing 13 locations this quarter, and are working with Mitsubishi and Look to determine the right points of distribution for the future. In fact, Look will open the first locations in October.

As a result of moving to the wholesale business model and exiting our existing direct Japan business, we will account for this business as a discontinued operation beginning in the third quarter. We expect to incur a pretax charge related to Japan in the third quarter of approximately $2 million, equating to $0.03 per share, which will be reflected in discontinued operations and not in our third quarter or annual guidance.

Approximately $1 million of that amount relates to a non-cash charge for a currency translation loss that has accumulated in equity since entering the Japan market over three years ago. The remaining charge relates to the write-off of certain assets, employee severance, and other exit charges. The new wholesale business in Japan is included in the indirect segment guidance, but given the timing of opening the new locations, the impact to the current year sales and earnings guidance is minimal.

For the third quarter, on a continuing operations basis, we expect net revenues to be in the range of $123 million to $128 million compared to the prior-year third quarter revenues of $128.9 million. We expect the direct segment net revenues to increase in the mid to high teen percentage range, with comparable sales including e-commerce, which includes eBay sales, down in the low single-digit percentage range. We believe our indirect net revenues will decline in the low to mid-20% range during the quarter.

The gross margin rate for the third quarter is expected to range from 52% to 53%, compared to 55.2% in the prior-year third quarter. This expected decline is primarily due to overhead cost deleveraging and modestly increased promotional activity.

SG&A as a percentage of sales is expected to range from 43% to 44.5% for the third quarter, compared to 36.9% in the prior-year third quarter. The deleverage primarily is being caused by incremental investment in key areas like e-commerce, marketing, and management.

We expect diluted earnings per share to be in the range of $0.18 to $0.20 in the third quarter of FY15, based on diluted weighted average shares outstanding of $40.7 million, and an effective tax rate of 36.5%. Diluted earnings per share from continuing operations totaled $0.39 in the prior-year third quarter.

We believe inventory will be $125 million to $135 million at the end of the third quarter, compared to $150.5 million at the end of last year's third quarter. For FY15, on a continuing operations basis, we expect net revenues will be in the range of $520 million to $530 million, compared to $530.9 million last year. Our revenue guidance includes direct segment net revenue growth in the low teen percentage range, with a decline in comparable sales, including e-commerce which includes eBay in the low to mid single digit percentage range.

Indirect net revenues are expected to decline in the high teen to low 20 percentage range. The gross margin rate for FY15 is expected to range from 52.5% to 53.5%, compared to 55% last year. This decline reflects overhead cost deleveraging, a slight shift in the channel mix with factory outlet sales being a higher percentage of the sales mix, and modestly increased promotional activity in FY15.

SG&A as a percentage of sales is expected to range from 40.5% to 41.5% for FY15 compared to 37.9% last year. We are making certain key investments in the business in FY15, such as the previously discussed key management hires in incremental marketing and e-commerce expense that will increase SG&A, but that are intended to enable us to realize our long-term objectives. In addition, we are budgeting incremental year-over-year incentive compensation expense.

We do have an active expense control program in place and we are focused on reducing expenses where possible. We have identified and are implementing several cost reductions beyond what we originally identified at the beginning of the year. These include reductions in supply costs and increased manufacturing and shipping productivity.

Our expectations for diluted earnings per share from continuing operations remain unchanged and range from $1 to $1.10 for FY15. On a comparable basis, diluted earnings per share from continuing operations totaled $1.48 last year.

We still expect our total capital expenditures to be approximately $40 million for the full year, with approximately $20 million related to our corporate office campus consolidation. The balance primarily is related to planned new store openings and continued investment in our systems, including our e-commerce platform.

Let me turn the call over to Sue who will update you on the product component of our strategic plan. Sue?

Thanks, Kevin and good morning, everyone. As you know, we are working hard to more fully engage our core customers and also to acquire new customers through execution of our product strategy, which includes elevating and modernizing our assortment, better focusing our assortment, and pursuing brand extensions over the long term. I am really pleased with the progress we are making, and the good news is that the customers are beginning to respond to our strategies and to the newness in our assortment.

We are elevating and modernizing our assortment through the introduction of our halo collections of faux leather and leather, intensifying our solid microfiber offerings, and launching our coordinating collections.

On August 28th we launched our faux leather collection on VeraBradley.com, and all our own full-line stores, and about 75 of our top independent gift retailers. This launch built on the earlier success of our faux leather laser-cut tote and wallet launch in May. There are eight styles in the faux leather collection in a variety of colors, and the price points range from $24 to $138.

Although it has been less than two weeks, and faux leather is a relatively small piece of our assortment, we are happy to report that we are seeing very good early sell-throughs on this product. Next week, we will roll out signature quilted and non-quilted leather collections online, in all Vera Bradley stores, and to about half of Dillard's stores. This collection will feature six styles in several colors and color combinations; leather prices range from $98 to $298, certainly elevated from our typical price points but still very competitively priced.

The faux leather and leather products feature our trademark, distinctive, and fun prints on the inside. We will continually refresh and expand the colors and styles of our laser-cut, faux leather, and leather products, but as a reminder, these halo products will represent no more than about 10% of our assortment going forward.

I believe our two biggest needle movers will be solid microfiber and our new cohesive collections. Solid microfiber continues to be a big win for us, with black continually one of our top sellers. In addition to black, we consistently include several other seasonally appropriate solid colors in our mix.

In October, we will introduce our first comprehensive collections, including stripes and small geographic inside-out prints that coordinate back to our signature patterns and solids. This year, we have already introduced cotton-quilted and faux leather totes and other products in some of these smaller coordinating geometric prints, and they have been among our best sellers. In fact, several of the small prints have had better sell-through rates than the larger signature patterns.

While our traditional cotton-quilted products will continue to be an important piece of our assortment, we are substantially lessening our dependence on them and diversifying our offering. By the end of fourth quarter, we expect one-third of our assortment will be new products, including leather, faux leather, and our collection pieces.

As we better focus our assortment, we are reducing the number of signature cotton-quilted pattern launches from 18 last year to 14 this year to 11 the following year. The gap left by the reduced signature patterns is being filled in with these halo products, solid microfiber and collection pieces I just discussed. Our SKU reduction has resulted in a substantial increase in our SKU productivity.

Part of focusing our assortment is majoring in the majors, making a bigger impact in the big volume drivers and classifications Vera Bradley is known for and what we do best like travel, backpacks, bags, and accessories. A good example of majoring in the majors is our increased backpack assortment this back-to-campus season, adding new styles and a new water-resistant, lighten-up fabrication. Sell-throughs have exceeded our expectations.

Another example is our planned travel collection expansion, adding new travel totes, hard-sided luggage, rolling luggage, and our new lighten-up fabrication and accessories updated with more solids. This will launch next year.

Over the long term, we will pursue brand extensions that will enhance our position as a lifestyle brand. We will either do this in house or look for the right strategic partners or licensees that can augment the brand and provide established distribution networks for certain categories of business.

For example, we have entered into arrangements with two strategic jewelry partners to relaunch and expand our jewelry offering, elevating the aesthetic and increasing our customer reach. This will launch early next year in our stores, online, and in our specialty retailers. We are very optimistic that these product changes will lead to better sell-throughs, increased revenues, and higher gross margins over time.

We are also taking other actions that we believe will expand our future gross margin rate. For example, we are in the process of building a more nimble, efficient, and lower cost supply chain through vendor and country diversification. We are broadening our base to countries outside of China, where the majority of our goods are manufactured to other countries with expertise in specific product classifications.

We're also improving efficiencies and processes in our domestic facility. We believe we can further reduce our manufacturing cycle and sourcing costs as we move into next year.

Rob?

Thanks, Sue. Let me give you an update on the multi-channel distribution component of our strategic plan. We plan on growing our relatively small store base over the next few years.

During the second quarter, we opened one full-line store in the Houston Galleria. We will add eight additional stores in the third quarter and early in the fourth quarter, bringing our total for the year to 13. As we have previously discussed, we believe we will add an average of 20 to 25 new stores per year going forward, equating to about 300 full-line stores over time.

While we are still working on creating our new prototype full-line store that should launch next year, we are making in-store presentation changes soon. We have developed a new visual merchandising approach that will not only showcase and highlight our collections, but also improve our SKU count on the floor. These store visual changes will be implemented in late October.

We opened four new factory outlet stores in the second quarter in Las Vegas, Denver, Knoxville, and Louisville. Nine new factory outlet stores are slated for the third and fourth quarters, bringing the openings for the year to 14. We continue to believe we can open an average of 10 to 15 stores per year, with an opportunity to have over 100 factory outlet stores in the long term.

Our new factory outlet store growth is permitting us to liquidate existing inventory and to move up our MFO introduction a bit earlier. We were able to introduce a few key made-for-factory items into our assortment in the second quarter, and collectively, they were a big success, with meaningfully higher sell-throughs and gross margins than our traditional outlet merchandise. While these six MFO styles did not represent a significant portion of total inventory, their performance gives us confidence that we are proceeding in the right direction as we more fully transition into an MFO model.

We will flow more factory-exclusive product in the fall season and expect that our mix of MFO product will be around 25% in the early part of next year. Within five years, we expect that factory exclusives will compromise approximately 70% of the product in this channel.

We will focus our inventory investment on key MFO items in our assortment so that our customers should always be able to find the items they want. This MFO strategy is a profitable financial model that should drive sales and gross margins over time.

E-commerce is an integral component of our five-year plan. We have made the decision to transition to a new web-technology platform over the next couple of years, which will allow us to offer an omni-channel experience for our customers and will offer significantly enhanced search capabilities, management of promotions, personalization, and segmented customer experiences and multi-site support for the separate full-line and factory sites.

While we don't expect this transition to be fully complete until 2016, certain facets will be implemented in 2015, and in fact, we have already been able to make some enhancements to the site to drive customer acquisition, full-price conversion, and retention. Specifically, we enhanced the navigation, improved the browsing and sorting capabilities, added customer survey and cart-side abandonment e-mails, and most recently added product recommendations.

In addition, we survey our customers about their web experiences and are taking the feedback and making changes to our site. For example, based on customer feedback, our product content and scale of the product displays has been improved. We will be able to pull these high ROI enhancements forward to the new platform: year-over-year conversion, number of transaction, UPT, and most importantly, sales all increased during the quarter.

As we work towards improving the productivity in our indirect segment, we are placing greater focus on department stores. Importantly, we have hired a VP of Wholesale, Debbie Kozlowski, to oversee the department store relationships as well as our key accounts, such as QVC and Disney, and to help cultivate new department store and key account relationships.

Debbie comes to us with a wealth of experience from Marc Jacobs, Coach, and, Cole Haan, and has established great connections with the department store industry. With Debbie's leadership, we will build a long-range department store growth plan.

Department stores are the number-one destination for handbag purchasing, and they will be a great place to showcase our modernized and elevated assortments. Our presence in department stores will allow us to acquire new handbag customers and will offer great venues as we expand into more lifestyle categories.

Dillard's remains an important relationship for us, and they are the central platform for our upcoming leather launch. We also introduced a limited selection of our products primarily focused on back-to-campus in 70 Macy's stores across the country in July. Initial results have been encouraging. We are pleased with the Macy's relationship and expect to further enhance our distribution, product assortment, and store presentation with them later this year.

We remain focused on improving the productivity of the indirect specialty gift channel. Even though the specialty gift business will become a smaller percentage of our total revenue base over time, due to the growth in other channels, we are working closely with our retail partners to stabilize this part of our business by carefully controlling and balancing inventories, and by better tailoring and segmenting our product assortments by door.

Beginning next year, we will be offering our specialty gift retailers some exclusive products. We are particularly focusing on growing the sales of our largest accounts, which represent the Vera Bradley brand best.

Let me add a little more color on Japan. As Kevin mentioned, we are working closely with Mitsubishi and Look to determine the right points of distribution for our brand. They have an unparalleled retail network of department stores, boutiques, and free-standing stores throughout Japan, as well as distribution and retail partnerships with several internationally renowned brands.

Look expects to open a shop on October 4th in the high-end Takashimaya Tamagawa, and a flagship store in the trendy Daikanyama district of Tokyo on October 25th. They are targeting as many as 25 Vera Bradley locations in Japan by the end of our five-year agreement.

Lastly, let me touch on the third strategic component of our strategic plan, marketing. Our marketing goal will be to generate excitement and desire for the aspirational Vera Bradley brand, attracting new customers, while continuing to foster strong connections with our loyal fan base. We want to modernize and strengthen how the brand is perceived.

More of our spend will be allocated toward our halo, brand-enhancing assortments. For example, our comprehensive creative campaign for our leather and faux leather launches is underway, which includes the strategic combination of carefully placed national ads, special events, social media with a focus on Twitter and Instagram, and creating buzz through bloggers and fashion influencers.

We will broaden our customer reach by reallocating a portion of spend away from direct mail and increasing spend in digital and print ads, as well as leveraging and expanding our database to conduct more segmented, targeted e-mails. We will focus less on promotions and more on new products in our collections. Through marketing initiatives, we want to increase the quantity purchased, the number of categories purchased, and the timing and frequency of purchases.

Before we take your questions, I want to remind you that we will host an Investor and Analyst Day on Tuesday, October 7th in our New York City design center. If you are interested in attending, please RSVP to Julia Bentley by September 19th at Jbentley@veraBradley.com.

Operator, we will now open up the call to questions.

Thank you so much, sir.

(Operator Instructions)

Our first question comes from Randy Konik with Jefferies.

Thanks, guys. First, Rob, your tone sounds better than the last call. You mentioned the word encouraging with Macy's. Can you expand upon that tone and the encouragement you're talking around Macy's? Are you feeling better about the reception to the new products? You've obviously said that, but what are you -- expand upon some of the improvements you're seeing a little bit more.

And then I saw that you guys announced, it looks like your first-ever share repurchase program. Is there any color on how aggressive you may be with that? Is that a signal that you feel like you're starting to get a stabilization or some visibility back into the business?

And lastly, as it relates to your comments around -- the comments that are around editing down the assortment or the new pattern introductions, if I look on the website under the colors or patterns, there's still 30 patterns that a person can choose from. Is there some strategy going forward that you'll become -- there will be more of a statement made on a few trends rather than 30 different things to choose from, from the consumer standpoint? Because it seems a little overwhelming to look at. Just want to get some perspective there on editing the assortment both online and in stores. Thanks.

Thank you, Randy. A few things. We are beginning to see some green chutes in the business. A lot of the initiatives that we put in place we're starting to get some early reads. It's important to keep in mind that, again, they are green chutes. They are relatively small to the total performance.

But some of those things that we are seeing, we did see a nice turnaround in our e-commerce business, as a lot of these new enhancements we put in place started to take effect. We were getting a good return on those investments, so that was encouraging. We spoke to, as we started to put small prints out into the marketplace, the customer responded very well. The customers responded well to faux. The customer has been responding to new silhouettes, kind of like the Vera Trend product line that we put out there. We're beginning to see some of those encouragements out there in terms of strategy that's we've been betting on. That's been encouraging to see.

On the flip side, the one thing that we are still seeing is customer traffic still is one of our challenges. The one area in our strategic plan that we're still working through right now is all of the marketing initiatives and the marketing plan. And with Angel just coming on-board, that's a little bit further behind in the implementation than the product and distribution initiative.

That's the next one that we really need to see come online and start hitting and get customer traffic back into our store. That would be the next tipping point that we're looking at.

In terms of the 30 patterns that you see online, there's a few things to talk about that. First of all, we are absolutely editing patterns down. We've already committed to go from a height of 18 down to 11 as we go into next year. I think part of what you're seeing too is e-commerce and how is that getting reflected on e-commerce? One of our tricks, short-term is that our e-commerce site is not only showing what is current and fresh in our stores, but is also showing our outlet product, and that's where we still would end up having an over-assortment.

We talked about that we've been going through this web platform evaluation that we do see change in our platform. We are working to split apart our factory and full-price presentation, which will really clean up that by moving all of that auxiliary patterns and inventory over to a factory site. But at this point, that's still far off and probably looking at the beginning of 2016 in order to get that done in terms of calendar 2016.

I think your other question was regarding the repurchase program. Kevin, you want to jump in?

Sure. Hey, Randy, how are you?

Good, you?

Good. As you know, we have a strong balance sheet. We're very liquid, and even during tough times, we've experienced very strong cash flow. So we're very comfortable we can invest in the business to support our long-term strategy. And then we're also obviously confident in that long-term strategy, given the green chutes that Rob just talked about.

We believe it's the right time to bring some value to the shareholders. As far as how aggressively we're going to buy, it's going to most likely be an open market type of purchase, so we've only got a few weeks each quarter we can buy back. I don't expect this to be an aggressive buyback, and we're not contemplating, right now anyway, an accelerated repurchase program.

Great. Thanks a lot, guys.

Thank, Randy.

And our next question comes from Dana Telsey with Telsey Advisory Group.

Good morning, everyone and nice to see here the improvement and especially the product enhancements that are being made. It certainly sounds like on some of the new product with the halo product, how does the margins on that -- is it in all stores? How much of it is in the department stores? How much differentiation in the product between channels will there be? And are you beginning to attract a different customer or is it too early?

Great questions.

Thank you.

I think a few things. One, in terms of our faux leather product right now, it is in all of our direct stores. It's online and it's at 75 of our independent partners or about 300 stores. We definitely kept the launch tight in the indirect channel, just because it was a new launch and we wanted to make sure that we did not put too much inventory into that channel as we might have historically in the past.

But we've been very, very encouraged by the performance so far, and there definitely is a lot of demand in our indirect channel for expansion of the product line going forward. That's been very encouraging.

You also see by that what we really have been doing is focusing a little bit of product segmentation to use faux in our indirect channel as a point of differentiation, and on the flip side, with our leather launch of really focusing that not only in all of our direct stores and online, but in Dillard's. And we decided to launch in half of the Dillard's stores for the same reason, in terms of we wanted to make sure with the new launch we did not oversaturate the market initially. But we're very excited about that upcoming launch and can't wait to see the results.

And then when you talked about a lower cost supply chain, how does that develop and how does that impact the margins go forward? Is there a time frame for that?

Yes, actually. So this is Sue. We believe that by end of next year is when we will start to see some improvements from the supply chain initiatives that we are moving forward with. Country of origin diversification certainly will help with that, in addition to the product mix that we will be layering in. MFO is an example of that.

Thank you.

Thank you.

We'll take our next question from Jennifer Davis with Buckingham Research Group.

Good morning. A couple quick ones, if you don't mind. I don't know if you can answer this, but I'm going to ask anyway. Are you planning on entering any additional Macy's stores before holiday?

And then I was wondering, I think, Sue and Rob, you said that leather would be in half of the Dillard's stores. Will it be in any of the Macy's stores?

And then finally, made for products -- or the made-for-outlet product, just wondering if you could expand on that a little bit. Is it excess material you have, so old patterns that you're making into outlet product and it's different styles? Or are you -- will it be different styles or different patterns or what? If you could elaborate on that a little bit. Thanks a lot.

First, I'll talk a little about what's going on with Macy's, and then I'll turn it over to Sue to talk a little about MFO and how we're building that product. In terms of Macy's, we've been very happy with that relationship. Macy's has been encouraged by the initial sell-through, so we are working through with them.

Expansion, both in terms of the amount of square footage that we have in their existing stores, as well as potentially other stores. We want to continue to move forward in a nice, prudent manner, and make sure that we really enhance the presentation as we work through this together.

But the relationship is off to a very nice start. The customer is responding very well. We think that there's a great future in the department store channel.

From an MFO perspective, your first question as it related to the fabric, in the early stages, we have been utilizing excess fabric. We do see that evolving over time as we continue to test into this segment of business into potentially just having fabrics and prints that are exclusive to that channel of business.

From a styling perspective, we were fortunate enough to be able to test 20 top-selling styles and silhouettes that we knew the consumer was responding to early on. We have another 23 that are going into test mode in the next couple of months, and we will continue to flow those in as we see the consumer respond.

Jennifer, the margins on those have been higher than the signature quilted patterns as well, which has been nice to see.

The other thing that we've seen is the productivity on those new MFO styles. It's not only from a margin standpoint, but from a rate of sell-through standpoint. We've been getting significantly higher SKU productivity than the core factory assortment. So it's really encouraging that customer's responding extremely well, and at the same time extremely profitably for us.

Great. Kevin, can I squeeze one more in quickly? Did you guys clear through that $5 million to $7 million of liquidation inventory that you had, did you clear through that in the second quarter? Thanks.

We plan to sell $5 million to $10 million this year, and we have sold north of $5 million already in the first half of the year, so we expect to probably be on the top end of that range as we exit the year.

Thank you and best of luck.

Feeling good about inventory, Jennifer, overall.

All right. Great. Thanks.

Thank you so much. Our next question comes from Steve Marotta with CL King and Associates.

Good morning, everybody. Thank you for taking my question. SG&A costs in the third quarter are implied to be in the $55 million to $56 million range, which is an uptick from the second quarter of roughly $52 million. You mentioned investments in management and marketing, and I believe you said retail stores as well.

Can you possibly disaggregate what's fixed and variable within that, and maybe what the marketing budget is expected to be in the third quarter of this year versus the third quarter of last year?

There will be a slight uptick in marketing spend in the back half of this year, call it $1 million, maybe a little more than $1 million from a marketing perspective. A lot of what's going on, though in Q3 and Q4 is we have 17 stores opening in Q3 and Q4. So if you just think about the start-up cost as it relates to the stores, it's a lot higher than the prior year. In prior years, we opened the majority of our stores in Q1, Q2, and very early Q3.

The other thing that's happening is the annualization of a lot of our key management hires. We've got most people on-board now. So a lot of that's annualizing into Q3. Keep in mind, our revenue number is still pretty soft, in our opinion anyway, in Q3, and that's why that percentage is high as well.

The only other thing we're doing is we're investing a little bit more in the web as well in the back half of the year, so there's some web initiatives that we're investing in, and that's playing into that percentage as well.

Okay. The second question is, is it accurate to say that the expected and implied increase in the fourth-quarter EPS growth on a year-over-year basis is predicated upon accelerating sell-through of new product between now and year-end?

It plays into it obviously, but if you look at the numbers for Q4, a lot of it is just all these stores we're opening and the benefit we're getting from them. If you think about the factory stores, for example, we've typically opened four or five a year. This year, we'll be opening 14, and all of those will be opened before the holiday.

So a lot of that, being able to meet, if you will, the EPS for Q4 this year versus last year has a lot to do with all the stores opening. As well as getting the web back on track and getting that growing again.

So those are probably the two biggest things from a top-line perspective that are going to help us. Obviously, what's playing against that some is the indirect segment, as well as the opening all the stores from a start-up cost perspective.

Okay. And actually that leads right into my --

And then the one other thing I'd mention is keep in mind, we did take that inventory reserve last year of about $5.5 million, so that's a really big number that we don't expect to annualize this year.

Okay. That's very helpful. And it also leads into my final question. Robert, you mentioned stabilization in the indirect channel as being a key goal in the near term. When do you see that happening on a rough basis, where that channel is either flat or slightly positive?

In terms of the channels that we talked about, when we did our early order period for our winter delivery, we definitely were very encouraged by how our partners were responding to that offering. So we've begun to see a slight turnaround there. We have not seen that yet in the reorder line, so we need to begin to see that in the reorder line.

But we're hoping as we get towards the end of this year that that channel is beginning to stabilize and really move away from these significant double-digit drops to something that's much more manageable. Because that definitely has been very challenging to overcome on the earnings line. But we do expect that to start to move the other direction as we get through this year.

Very helpful. Thank you.

(Operator Instructions)

We'll take our next question from Mark Altschwager with Robert W Baird.

Good morning, and thanks for taking the question. On the sales side, could you break down in a bit more detail the performance of the new go-forward product versus the performance of some of this clearance and retired product? Just trying to get a better sense of the underlying run rate of the business once that liquidation is complete.

And then separately on the indirect side, I'm not sure if you touched on what are the sell-through rates that your partners are seeing in the indirect channel, and if you could let us know the indirect door count today and your target for year end.

On the indirect, maybe taking your last question, we do survey about 300 of our retailers and just talk about inventory levels, and I can tell you the inventory levels from a retired perspective continue to come down. We don't get a significant amount of sell-through data to be able to report that externally. But the good news there is we think their inventory position continues to improve.

As far as productivity of maybe the new SKUs, maybe Sue can talk a little about the productivity of the new SKUs, like the small prints and things like that.

Mark, good morning. We're very pleased actually with the results, especially on some of the new smaller patterns, as we described. We've seen, in some cases, double-digit SKU productivity increases on that product.

With regards to liquidation, we do feel like as we exit this year we'll be in a better place from a liquidation perspective. Obviously, we're accepting a lower margin on that liquidation product. So to the extent we exit the year in a better position from an inventory perspective, that will help us long term.

Part of what's been really encouraging as we look at the performance in the new product, as Sue was mentioning, that the SKU productivity is significantly up on the new product versus the old product. And as we move into fourth quarter, about 30% of our product offering will be in what we call new. So we're very excited to see that impact on the business as we move into fourth quarter.

That's helpful. Thanks. Rob, you did touch on this, but could you just talk a bit more about the new customer acquisition efforts? Recently you hired the EVP of Marketing, and I'm sure we'll hear more in October. Just curious in what's going to change in the back half of the year and what's going to be done specifically to target that 20- to 40-something customer where you're under-indexed today.

Great question. We're taking what I'll call a few foundation or small steps immediately. First of all, what you see is with the leather and faux leather launch that's out there, we put marketing behind it and really targeted that customer. The spend is definitely moving towards both the fashion magazines and the digital arena. Again, specifically to attract that new customer that we're trying to get. That's the first step that we took, even before Angel joined the team, and I think we're going to refine that strategy as we go forward.

And the second thing that we're doing is really working on our database and really making sure that we can expand our database capture in terms of how many customers we know and how we can contact them. Those are some of the early steps that Angel's already started on. And then obviously, he's working through a full strategic plan on marketing, and we'll be able to share more of that as we get to October.

Great. Thanks and best of luck.

Thanks, Mark.

And next we'll move on to Oliver Chen with Citi.

Hi. Thanks for all the details. Exciting plans ahead. Regarding your comp store sales guidance, how do we interpret how traffic and AURs may trend, and what's incorporated in your guidance level?

Also, on a longer-term basis, what should the relationship be with your own website versus eBay? And also as you engage in the indirect strategies, how should that mix of revenue change over time?

And our last question was on the outlet side of the business and what you're seeing with the promotional environment and couponing, and if you're seeing some abatement there, given the progress you're speaking to. Thanks.

Oliver, with regard to traffic and AUR, we expect mild improvements in the back half of the year. We did see that in Q2. If you think about how we started the quarter in May, traffic was dismal at best, and as we exited July, July traffic was, I'll call it okay, even though it was still obviously down in our stores, anyway. But it definitely improved throughout the quarter. We expect some modest improvements in traffic in the back half of the year.

From an AUR perspective, some of this new product may move up the AUR a little bit. It's not big enough to make big movements in the AUR, but our plan is for AUR to slightly go up in the back half of the year.

Go ahead.

On traffic, are you communicating that it will just be less negative or are you hoping for positive?

That's correct. In our stores we expect it -- bricks and mortar stores, we still expect it to be negative.

Thank you.

Regarding the e-commerce and eBay, it's a great question, because here's what we're finding on eBay. We feel that there's an opportunity to move some of our liquidation activity off of our core site and move it on the eBay site.

What we found by doing that is one, we are reaching out to a different customer on eBay. It also allows us to focus our site on more full-priced product and less on the liquidation market. So over time, we believe there's a real opportunity to migrate a little bit in terms of where the liquidation product is sitting.

Part of the reason we wanted to combine those results is not only is it a direct-to-consumer situation for us with eBay where they pass the orders through and we fill it, but even more importantly, we've seen that there is an ability to move this clearance onto eBay, and we did not want to overstate what was happening in the e-commerce space overall. So we do think it will be brand enhancing for us over the long term.

What about your indirect channel overall? Is the mix going to decrease, or will an offset be as you engage in more department store relationships over time? (inaudible)

Sorry, Oliver. For the current year, you can tell by our guidance, obviously, we're still expecting the indirect channel to be down low 20s for the full year. So not a big mix change as you think about how we exit this year. As we continue to build the department store base and to build the key accounts, that will help increase the indirect segment of the business, but the direct side will still grow quicker than the indirect side, just because a big part of our LRP and our long-term strategy is to grow the store base and to get e-commerce growing on a consistent basis.

Thank you. And the outlet side, what are your thoughts on how the promotional environment looks and has there been some relief there?

Yes, from a promotional standpoint, particularly as we came through the end of July, we saw some improvement in terms of performance in the outlet world. But obviously, we're continuing to watch it very closely. Traffic in the outlet side of the business is also down. So we still are seeing a weakness in traffic, but overall in the channel, some stabilization in the promotional activity.

Thanks. And Robert, just a final question. Within the context of the department store channel, what are the adjacencies? Are you comfortable with where Vera Bradley's getting placed and what are you typically next to in the store? And do you feel like there's more opportunity for developing the aspirational shop-in-shop over time, and what should we notice when we check that out? Thank you.

Yes, a couple things. In terms of where we see adjacencies, as we've spoken with our department store partners, we really see Vera Bradley as kind of this, what I'll call perfect bridge. The bridge would be between on one side, you'd have Coach, Michael Kors and Kate Spade. On the other side you have brands like Dooney & Burke. We feel that we really are the brand that can bridge that well to play both in the aspirational designer market, at the same time more in this core, functional handbag business that some of the other players play in.

We definitely are looking to enhance our presentation in the department store world, moving to more hard-shop presentations, stronger brand presentations. As we talked about in Macy's, we ran very quickly in both Macy's and [us]. Got product in their stores in a hyper time frame. Now we're really going back with them and working on improving adjacency, improving presentation. They've been good partners with that, and we continue to look at how we upgrade our presentation throughout our department store channel.

Great. Thank you. Best regards. Looking forward to the Investor Day.

Thank you.

Thanks, Oliver.

Thank you so much.

(Operator Instructions)

We'll take our next question from Ike Boruchow with Sterne Agee.

Hi. It's actually Tom Nikic on for Ike. Thanks for taking my question. I was wondering about the sales in Q2, and thus far in Q3, have you seen any change in the cadence, like are things getting sequentially better? Did things change as the quarter progressed or anything like that?

Also, just a housekeeping question. The sales via eBay, were those previously in the indirect channel and are now being counted as e-commerce? Or is there any change in the treatment of those sales? Thanks.

No problem, Tom. With regards to the sales of eBay, they used to be -- still in the direct segment of our business, but think about them in the non-comp part of our direct segment. So they've always been there.

With regards to Q2 sales, I think you mentioned Q2 sales, how they progressed. It basically did sequentially get better for us during the quarter. So and then as you think about as you get into August, obviously August is baked into our guidance, and we used that to come up with our guidance.

We did see a little bit of an improvement in our winter EOP selling into our indirect side of the business. That gave us a little confidence that at least the indirect side of the business likes what they're seeing. We still have to wait and see if it results in increased reorders, because that will give us a little more confidence. Nevertheless, they like what they're seeing from a product perspective, which gives us a little more confidence that we're going the right direction.

Thanks. I was also wondering about the full-year sales guide. It looks like you just raised the low end by $10 million. It seems like there weren't really any changes to the indirect guide or the comp guide. So I was just wondering how it is that the low end moved up by $10 million.

Very slight, slight improvements, maybe across the board, but also the over-achievement of Q2 plays into that as well. So, because we are at the very top end of our range from a revenue perspective, that helped us. We've also seen some good traction from selling our liquidation product as well. So we moved over $5 million in the first half of the year, and we actually estimate we can at least move that in the back half of the year.

Okay. Great. Thanks very much.

Thank you so much. That is all the time we have for our question-and-answer session today. At this time, I would like to turn the conference back over to our presenters for any additional or closing remarks.

Thank you. Our team members throughout Vera Bradley have made great strides, and they inspire me daily. I am very pleased with the progress we are making against our five-year strategic plan.

We carefully laid out our plan six months ago and are executing to it. We are evolving our products, distribution channels, and marketing to drive sales, profitability, and shareholder value. We obviously have a lot to do, but I hope that you share my optimism and excitement about the future of the Vera Bradley brand. Thank you for your interest and time.

This will conclude today's conference. We thank you for your participation.