Categories Consumer, Earnings Call Transcripts

Vera Bradley, Inc (VRA) Q2 2022 Earnings Call Transcript

VRA Earnings Call - Final Transcript

Vera Bradley, Inc (NASDAQ: VRA) Q2 2022 earnings call dated Sep. 01, 2021.

Corporate Participants:

Mark Dely — Chief Administrative Officer

Robert Wallstrom — President, Chief Executive Officer and Director

John Enwright — Executive Vice President and Chief Financial Officer

Analysts:

Mark Altschwager — Baird — Analyst

Eric Beder — SCC Research — Analyst

Oliver Chen — Cowen — Analyst

Steve Marotta — CL King & Associates — Analyst

Dana Telsey — Telsey Advisory Group — Analyst

Presentation:

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Vera Bradley’s Second Quarter Conference Call. [Operator Instructions]

I would now like to turn the call over to Mr. Mark Dely, Vera Bradley’s Chief Administrative Officer. Please go ahead.

Mark Dely — Chief Administrative Officer

Good morning and welcome, everyone. I would like to thank you for joining us for Vera Bradley’s earnings call.

Some of the statements made 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 most recent Form 10-K filed with the SEC for a discussion of known risks and uncertainties. Investors should not assume that the statements made during the call will remain operative at a later time. We undertake no obligation to update any information discussed on today’s call.

I will now turn the call over to Vera Bradley’s CEO, Rob Wallstrom. Rob?

Robert Wallstrom — President, Chief Executive Officer and Director

Thank you, Mark.

Good morning, everyone, and thank you for joining us on today’s call. John Enwright, our CFO, also joins me today.

We posted consolidated year-over-year second quarter revenue increase of nearly 12%. On a comp basis, Vera Bradley was essentially back to its pre-pandemic fiscal 2020 second quarter revenue level, and Pura Vida was up nearly 7% over the second quarter of fiscal 2020. Second quarter Vera Bradley brand revenues continued to improve as customers responded to product innovation, stores were fully operational and sales of travel related products rebounded despite anniversarying exceptionally strong mass sales from the prior year. However, we experienced two major factors that negatively impacted our results.

First, the Apple iOS 14.5 update negatively affected Pura Vida’s revenues primarily due to the impact it had on the effectiveness of Facebook and Instagram advertising. The Facebook and Instagram platforms have been our primary marketing vehicles to drive sales and Pura Vida has maintained a market leading position, consistently ranking as the number one engaged brand in the jewelry category on Instagram. Our team is working diligently to quickly diversify a portion of our marketing resources to other platforms, and consequently, we began to see Pura Vida DTC sales volume build momentum throughout the balance of the second quarter and into the beginning of the third. We expect Pura Vida revenues will return to a 15% to 20% growth rate in the second half of the year.

Second, like much of the industry, Vera Bradley continue to experience supply chain challenges and significantly increased freight and tariff expenses that put meaningful pressure on gross margin in the quarter. We expect these pressures to continue for the moderate term. We were able to continue to diligently manage our SG&A expenses, and our balance sheet and cash flow remains strong. With our strong first quarter performance, fiscal 2022 is off to a solid start with year-to-date earnings well ahead of last year and ahead of where we were in fiscal 2020 pre-pandemic. We realize we will continue to face certain headwinds and uncertainties for the balance of the year, but we also know that both our lifestyle brands have significant long-term growth opportunities well beyond their core product categories. We are on track and remain committed to our vision to be a purpose-driven, multi-lifestyle brand high-growth company.

Now let me turn the call over to John to discuss the financials.

John Enwright — Executive Vice President and Chief Financial Officer

Thanks, Rob, and good morning.

Let me go over a few highlights for the second quarter. The numbers I will discuss today are all non-GAAP. For complete detail of items excluded from the non-GAAP numbers as well as a reconciliation of GAAP to non-GAAP numbers, please reference today’s press release. Consolidated net revenues totaled $147 million for the current year second quarter, an increase of 11.6% over $131.8 million in the prior year second quarter. Prior year revenues were adversely affected by temporary store closings and reduced store hours related to COVID-19, although they were also substantially benefited by mask sales.

For the current year second quarter, Vera Bradley Incorporated’s consolidated net income totaled $9.5 million or $0.28 per diluted share compared to net income in the prior year of $10.9 million or $0.32 per diluted share.

Current year second quarter Vera Bradley Direct segment revenues totaled $97.1 million, a 19.6% increase over $81.2 million in the prior year second quarter. Since the Company’s stores were temporarily closed for a portion of the prior year second quarter, a comparable sales — comparable store sales calculation is not pertinent. On an apples-to-apples basis, comparable sales were nearly flat, down just 1.3% for [Phonetic] the second quarter of fiscal 2020. Vera Bradley Indirect segment revenues totaled $16.8 million, a 5.1% decrease from $17.7 million in the prior year second quarter, reflecting a reduction in orders primarily related to mass sales, partially offset by a rebound in specialty and key account orders in other product categories that were negatively impacted by COVID-19 in the prior year. Pura Vida segment revenues totaled $33.1 million, a 0.8% increase over $32.8 million in the prior year.

Second quarter consolidated gross profit totaled $80.4 million or 54.6% of net revenues compared to $79.6 million or 60.4% of net revenues in the prior year. Keep in mind that in the prior year, we expanded our year-over-year gross margin by approximately 300 basis points through the sales of cotton masks which was not replicated this year. The current year rate was negatively impacted by higher costs for inbound and outbound freight expense. In addition, the lower margin rate reflects higher tariffs from previously duty-free countries where we source products whose GSP duty status — duty-free status expired at the beginning of the year. As has happened numerous times in the past, we believe Congress will retroactively reinstate the duty status of the tariffs — have been assessed so far this year. On average, this is — this is negatively impacting us approximately $1 million per quarter.

Consolidated SG&A expense totaled $68 million or 46.2% of net revenues for the current year second quarter compared to $58.6 million or 44.5% of net revenues in the prior year. As expected, our current year SG&A expenses were higher than the prior year, primarily due to expense reductions related to COVID-19 last year.

Our second quarter consolidated operating income totaled $13.4 million or 9.1% of net revenues compared to $21.1 million or 16% of net revenues in the prior year.

Let me talk about our forward outlook. The retail environment continues to be uncertain and future financial performance is difficult to predict. We are updating our estimates for fiscal 2022 based on our second quarter performance, current business trends and consideration of certain macro industry and economic conditions that could impact the Company’s sales and gross margin performance for the balance of the year. We are continuing to see volume and traffic increases over prior year levels and expect to control our operating expenses. However, like many retailers, we are facing supply chain headwinds, including manufacturing delays, extended transit times and substantial projected inbound and outbound freight expense increases. Keep in mind that all forward-looking guidance numbers are non-GAAP. While we are not providing quarterly guidance, let me give some directional commentary on the third quarter. We expect year-over-year revenues to increase by high-single digits for the Vera Bradley brand and by over 20% for Pura Vida. We also expect continued gross margin pressure related to ongoing supply chain challenges and incremental freight expense as well as the GSP issue. We are forecasting the GSP savings to flow through to P&L in the fourth quarter, but the third quarter margin will continue to be under pressure until GSP is renewed by Congress.

For fiscal 2022, we have updated our annual expectation as follows. Consolidated net revenues of $550 million to $565 million. Net revenues totaled $468.3 million in fiscal 2021. Free cash flow between $50 million to $55 million compared to $15 million last year. A consolidated gross profit percentage of 54.6% to 55.3% compared to 57% in fiscal 2021. The expected rate decline relates to an abatement in mass penetration this year, coupled with ongoing supply chain challenges and a substantial increase in freight costs. The retroactive reinstatement of GSP is included in the current year gross margin estimate. Consolidated SG&A expense of $260 million to $266 million compared to $233 million in fiscal 2021. The expected SG&A increase is primarily related to Vera Bradley’s stores being open for the full year, non-comparable compensation and CARES Act savings in fiscal 2021 and general variable increases associated with higher sales expectations. Consolidated operating income of $40 million to $46 million compared to $34 million in fiscal 2021. Consolidated diluted EPS of $0.80 to $0.95 based on diluted weighted average shares outstanding of 34.6 million and an effective tax rate of approximately 21%. Diluted EPS totaled $0.63 last year. Net capital spending of approximately $8 million to $10 million compared to $5.7 million in the prior year, reflecting investments associated with new factory locations and technology and logistic enhancements.

Now let me turn to the balance sheet. Cash, cash equivalents and investments at quarter-end totaled $76.5 million compared to $77.1 million at the end of last year’s second quarter and $65.5 million at last fiscal year-end. We had no borrowings on our $75 million ABL credit facility at quarter-end. Total quarter-end inventory was $148 million compared to $136.2 million at the end of the second quarter last year. Quarter-end inventory was higher than prior year primarily due to incremental Pura Vida inventory. We expect year-over-year inventory should be down by approximately 5% by the end of fiscal 2022.

Rob?

Robert Wallstrom — President, Chief Executive Officer and Director

Thanks, John.

As a reminder, for fiscal 2022, the four key growth drivers for our Company are: one, driving our digital first strategy by evolving the digital distribution of our products and further refining and utilizing digital experiences to serve our customers; two, enhancing our product innovation pipeline, collaborations and category extensions to attract new customers and increase share of wallet with existing customers; three, building our community through marketing and by creating an impactful positive brand movement that not only enhances lives but deepens our customers’ brand loyalty; and fourth, evolving our distribution channels by focusing on future growth opportunities and addressing the change in retail environment and the consumer marketplace.

Let’s begin with Vera Bradley. As I mentioned at the end of last quarter, we were looking forward to continuing recovery of our travel and campus segments of the business in the second quarter. Research indicated that nearly three quarters of Americans plan to travel this summer alone and sales of our travel products have indeed been robust, exceeding our 2019 levels. On the other hand, although overall back to school market has been strong, sales for non-tech and accessory elements did not return to pre-pandemic levels. Similarly, at Vera Bradley, we saw growth in our back-to-campus business over 2020, but sales did not exceed the 2019 levels. Like many in the industry, we faced supply chain disruptions that caused delivery delays throughout the quarter. We have experienced on average delays of 30 days or so before a full assortment of goods was available for each of our product launches. Unfortunately, we do not expect this situation to improve in the fall season. We are working diligently to mitigate the situation as best we can, but expect shipping delays and freight expense increases to continue for the near future.

On the product front, we continue to be excited about our innovation pipeline and the development of new fabric offerings, which are important to not only increase the share of wallet with our existing customers, but to attract new customers to Vera Bradley. We remain very optimistic about our new recycled cotton collection and look forward to offering new solid colors seasonally. Solid Galaxy gray, purple and red will launch this fall. We will offer Navy in the spring, and we will expand our Blacks aisles next summer. Our partnership with Lana Condor during the launch of the Cotton Reimagined collection helped bring a younger and more diverse customers to the brand. We continue to build on the momentum in our other alternate fabrications like Performance 12 and our factory exclusive UltraLight collection. We’re constantly researching and innovating to bring our customers more eco-friendly options, and we are committed to updating 100% of our fabrics to more sustainable alternatives by 2025.

We had another exciting quarter for product collaborations. Our classic accessories outdoor collection of furniture covers, seat and lounge covers, accent pillows, umbrellas and rugs launched in June. In addition to being available on verabradley.com, classicaccessories.com and in select Vera Bradley stores, this collection can also be purchased online through leading retailers such as Wayfair, Amazon, Lowe’s and Home Depot. And we launched the always popular Disney and Harry Potter mini collections during the quarter.

In the marketing area, the substantial investments we have made in data science, business analytics and customer data capture in the past continue to pay off and are reflected in our marketing efforts and results. As expected, our customer count continue to grow. Our customer journey centered activations and customer level personalized messaging are meaningfully engaging new customers and aiding in the reactivation of lapsed customers across our full line and factory stores. We are driving more engagement on social media. Specifically, we are employing more user-generated content, have grown our influencer and investor programs, continued to enhance our social storytelling and have expanded social selling. We are expanding our TikTok engagement, continuing to grow this platform to strengthen our Gen Z customer acquisition. These tactics, along with our quality media placements, continue to drive brand awareness with year-over-year media impressions up over 200%, fueled by our Cotton Reimagined campaign with Lana Condor, summer travel collections, back to school essentials and collaborations. We are proud that our marketing efforts are increasingly reflective of our commitment to a more diverse and inclusive audience.

We are honored to continually amplify our VB Cares mission. In August, we entered the third consecutive year of partnership with Blessings in a Backpack to support the nonprofit’s mission of providing food to millions of elementary school children across America who might otherwise go hungry. To date, with the help of our customers, we have donated over $750,000 to the organization. And this month, the Vera Bradley Foundation for Breast Cancer begins its series of annual fundraising events to support the groundbreaking research being conducted at the Vera Bradley Foundation Center for Breast Cancer Research at Indiana University School of Medicine in Indianapolis. To date, the Foundation has contributed over $36 million to the Foundation’s Center for Breast Cancer Research.

Our digital business has become a larger portion of our revenue over time, and stores continue to support this omnichannel strategy. We want our customer to have a seamless shopping experience. Digital sales are typically higher in the markets where we have a retail presence, and the average omnichannel customer spends over 3 times more than the single-channel customer. Many customers have missed in-person interactions and many are seeking shared experiences.

We continue to focus on enhancing and reinventing the customer experience in our full-line stores, and certain digital shopping perks that gained popularity during the pandemic have remained popular like appointment selling, buy online pickup in store and curbside pickup. We are continuing to improve the profitability of our full line fleet by focusing on our highest potential stores, optimizing and localizing our assortments and rationalizing our existing portfolio through select closures. We have closed three full-line stores so far this year and expect to close up to two more this fiscal year, which will bring our total full line closings to 44 since the beginning of fiscal 2018. We have opened four new factory stores so far this year and expect to open two more by the end of October. During the quarter, we fully implemented Afterpay across all Vera Bradley channels, allowing customers to pay for their purchases in instalments, gaining higher units per transaction and increased sales. We are also now excited to have distribution of Vera Bradley on Target Plus marketplace, which is a great exposure for our brand. And, as sustainability and resale continue to gain traction, so does our partnership with thredUP, which launched earlier this year.

Now let’s switch to Pura Vida. Even though Pura Vida’s business temporarily slowed in the second quarter due to the iOS update, we believe we are positioned to generate a 15% to 20% revenue growth for the second half of the year, driven by our new product launches, wholesale growth, the marketing initiatives and adjustments we have put into place and our new store openings. One of the critical initiatives we completed during the quarter was our Project Novus ERP integration at Pura Vida which unified our technology platform companywide, allowing for enhanced capabilities in sourcing, customer service, CRM, data analytics and accounting, among other areas. This critical infrastructure enhancement has strategically positioned Pura Vida for future growth. Innovation Pura Vida continues to be key to our growth. In addition to continually adding new designs and elements to our jewelry collections, we also have diversified well beyond jewelry. We are truly building a lifestyle brand.

A great example of the extension of the Pura Vida lifestyle was the April launch of our April — of our apparel collection of tees and hoodies. So far, the top styles have been Pura Vida logos, tie dyes and surf graphic. Now we are broadening our size ranges, styles and logos. We believe this is a significant revenue opportunity going forward. We launched backpacks in May, and last month, we introduced our fun affordable hat collection. Items like apparel backpacks and hats not only appeal to our existing customers, but are driving new customers to the Pura Vida brand. In July, we collaborated with Disney on an exciting launch of Disney themed jewelry and hair accessories which Pura Vida and Disney enthusiasts equally love. This fun collection brought new fans to our brand and we have been very pleased with the response to date. We have a few other high-profile product collaborations and licensing partnerships that will launch this fall. Stay tuned.

We worked with a popular lifestyle influencer, Sivan Ayla, during the quarter to launch a style pack that generated strong volume and appeal to a broader age demographic. Just last month, we introduced our jewelry collection with Outer Banks star and influencer, Madison Bailey, which is appealing to a more diverse customer.

As mentioned earlier, the recent Apple update impacted Pura Vida e-commerce revenues since we have historically relied on various platforms like Facebook and Instagram to reach our potential customers to drive sales. Our team has worked diligently to dive deeper into customer analytics and diversify a portion of our marketing resources to other platforms like TikTok, podcasts and YouTube. As a result, we began to see Pura Vida DTC sales volume build throughout the balance of the second quarter and into the beginning of the third quarter. Since its inception, Pura Vida has demonstrated expertise in engaging customers, building loyalty and introducing new devotees into the Pura Vida lifestyle. We’re continually focused and looking for new ways to creatively engage our customers, drive new customers to our brand, design more inclusive marketing and generate more efficiency in paid advertising.

On the distribution front, our first Pura Vida store opened in San Diego’s Westfield UTC Mall in mid-August and is off to a great start, surpassing our initial plans. The store is allowing us to showcase the Pura Vida lifestyle with a full array of existing products and new product innovations, receiving valuable customer feedback and host influencer events. From the brand’s social media follower count alone, we know how loved Pura Vida is. However, we saw another level of the brand’s power by the overwhelming response from Pura Vida’s community of enthusiasts as they experienced the Pura Vida lifestyle in-person at the store. We saw lines up to three hours for most of the opening day. The feedback and sales have been beyond our expectations. We certainly believe there are opportunities to expand the Pura Vida store concept to other locations. We are also thrilled that we have rolled out Pura Vida shop-in-shops in 23 Vera Bradley full-line locations featuring a full assortment of jewelry items, and the Pura Vida Charity Bracelet program has been rolled out in all Vera Bradley full line and factory locations. We’ve been very pleased with the results thus far.

Our wholesale growth remains strong as we continue to add new wholesale partners. We’ve added over 250 new accounts so far this year, which has exceeded our expectations. And now Dillard’s will be joining Nordstrom’s as a Pura Vida department store distributor. We continue to significantly expand our presence in existing retailers with larger in-store presentations and we are experiencing solid growth in core product categories with our wholesalers. Our current wholesale accounts on average have placed larger and more frequent orders than in fiscal 2020, as many have experienced a strong resurgence in traffic.

In summary, we continue to drive our digital-first strategy. We have made strategic shift in investments to pivot us to a digital-first company, evolving into a customer-centric, data driven, technology enabled and digitally focused enterprise, which allows us to effectively engage with our customers and offer a seamless shopping experience. Second quarter e-commerce sales grew over 20% over fiscal 2020. Over one-third of our consolidated revenues are now generated from e-commerce sales. And excluding our factory stores, over half of our total sales are driven by e-commerce. We are continuing to enhance our product innovation pipeline, collaborations and category extensions, as evidenced, at Vera Bradley, by the launch of our Cotton Reimagined collection, the introduction of other alternative fabrics, our commitment to sustainability and countless product collaborations and the continual newness and excitement in Pura Vida’s jewelry collections as well as expanding into the new Pura Vida lifestyle categories such as apparel, backpacks and accessories.

We are building on our community through marketing. Vera Bradley continues to engage and grow its customer base through analytics, social media and VB Cares efforts, and Pura Vida has demonstrated expertise in engaging customers, building loyalty and introducing new devotees into the Pura Vida lifestyle via Instagram, TikTok and broadcasts and evolving our distribution channels. We are continually looking for new ways to reach our customers and to reinvent the shopping experience, from our verabradley.com website redesign to partnering with thredUP to the opening of our first-ever Pura Vida store.

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

Questions and Answers:

 

Operator

[Operator Instructions] And we’ll go first to Mark Altschwager with Baird.

Mark Altschwager — Baird — Analyst

Great. Thank you. Good morning and thanks for taking my question. Just to start out, John, I apologize if I missed it, but could you give us some color on the Vera Bradley e-commerce sales in Q2, the growth rates versus 2019?

John Enwright — Executive Vice President and Chief Financial Officer

Just a second, because I don’t remember off the top of my head. So, if you want to go to next question, I’ll get that information for you.

Mark Altschwager — Baird — Analyst

Okay. Sounds great. With respect to back to school, is there any more detail on how the season progressed through August. We’ve heard other brands talk about potential for an elongated season this year. Just wondering if you’re seeing any indications of that. And then separately, any indications that Delta variant is affecting the trajectory of the recovery in your travel categories?

Robert Wallstrom — President, Chief Executive Officer and Director

Yeah, Mark, I can take that. I think first of all, from back-to-school, we also expect that there’ll be a more elongated back-to-school season. And again, we’ve seen growth over last year for sure in the back to school categories, but we just haven’t got back up to the 2019 levels which seems to be what we’re seeing in the rest of the market in terms of kind of these accessories and non-tech categories

Regarding the Delta variant, what has been interesting is we saw traffic continuing to improve quarter — I mean, month after month throughout the quarter. When we got to mid-July, you saw that improvement slow, and it’s kind of stabilized as we’ve moved through August. So there has been a softening of the upward trajectory. But still, overall, we still think the consumer is strong. In terms of the travel category, we’re still seeing a lot of travel happening out there, so we haven’t seen a major suppression in the travel category yet. And so, we’re watching it closely. But at this point, we’re still hopeful that the travel category will continue to be solid as we move through the year.

John Enwright — Executive Vice President and Chief Financial Officer

And Mark, in regards to your question regarding e-commerce, compared to 2020, results in the second quarter is up about approximately about 40% and when you compare it to last year, it’s down about 30%. But don’t forget, last year there was a significant mass volume that went through that channel.

Mark Altschwager — Baird — Analyst

Great. Okay. Thank you. Then, any detail you can share on AUR trends that you’re seeing? And then I think the Company effectively took some price increases a couple of years ago to offset impacts of tariffs. I’m wondering if you see opportunities to raise price today to offset some of these — the freight pressures and general inflation in AUC.

John Enwright — Executive Vice President and Chief Financial Officer

Yeah. In regards to AUR trends, we are seeing year-over-year AUR go up, so we are definitely seeing some benefit associated with that. In regards to kind of price increase, we are having conversations internally to talk about kind of what and if we can take some price increases and what product categories we should take those price increases internally to pass through some of the challenges we’re seeing in the supply chain.

Robert Wallstrom — President, Chief Executive Officer and Director

Yeah. So we anticipate doing price increases. We just want to make sure that we’re surgical in how we approach it. So, more information will come on that in the following quarters.

Mark Altschwager — Baird — Analyst

Okay. Makes sense. Thanks for all the detail. I’ll hop back in the queue.

Robert Wallstrom — President, Chief Executive Officer and Director

Thanks, Mark.

John Enwright — Executive Vice President and Chief Financial Officer

Thanks, Mark.

Operator

We’ll go next to Eric Beder with SCC Research.

Eric Beder — SCC Research — Analyst

Sure. Good morning, guys.

Robert Wallstrom — President, Chief Executive Officer and Director

Good morning.

John Enwright — Executive Vice President and Chief Financial Officer

Good morning.

Eric Beder — SCC Research — Analyst

Could you talk about longer-term, what we should be thinking about in terms of the Vera Bradley store base? And — let’s start with that first.

John Enwright — Executive Vice President and Chief Financial Officer

Yeah. So from a store base perspective, we continue to see opportunity to reduce some of the full line doors that are underperforming, and we think — still believe we still have growth opportunity in the factory channel. Now while we think we’re going to reduce the full line doors, we’re definitely looking at opportunities to look at — while resizing it, looking to open up new opportunities for Vera Bradley. So we will be shedding some kind of current full line doors, but ultimately looking for opportunities to open up some doors in discrete locations.

Eric Beder — SCC Research — Analyst

And I know that you have a lot of cash right now. What are your thoughts in terms of acquisitions, buybacks, utilization of the capital?

John Enwright — Executive Vice President and Chief Financial Officer

Yeah. As we’ve commented to, right now, we’re focused on having conversations in regard to M&A activity, and Rob and I are certainly taking some meetings and certainly having conversations around that. So that’s our primary focus in regards to kind of where we think we would utilize capital. But there is certainly an opportunity as we talk with the Board to use our cash in the best way possible. And we do have an open program from a share repurchase perspective. So if we think that’s the right thing to do, we still have the opportunity to spend about $30 million in remainder of this year in cash — in share repurchases, if we determine that’s the right way to use our cash.

Eric Beder — SCC Research — Analyst

Great, guys. Good luck with the back half.

Robert Wallstrom — President, Chief Executive Officer and Director

Thank you, Eric.

John Enwright — Executive Vice President and Chief Financial Officer

Thank you, Eric.

Operator

We’ll go next to Oliver Chen with Cowen.

Oliver Chen — Cowen — Analyst

Hi. Thank you. Hi, Rob. Hi, John. Regarding [Multiple Speakers]

Robert Wallstrom — President, Chief Executive Officer and Director

Hi, Oliver.

Oliver Chen — Cowen — Analyst

[Multiple Speakers] changes in the iOS, what are your thoughts on what will happen next in terms of pursuit of other platforms and how there may or may not be risk in terms of facing that industry-wide challenge? Also, second on freight and tariffs, why were they worse than you expected and what do you think the risk factors are going forward, and this definitely been industry tissue, I’m a little — I’m surprised that it was worse than you expected, but also not surprised and some reasons too. Thank you.

John Enwright — Executive Vice President and Chief Financial Officer

Yes. I’ll handle the second part of the question, and I think Rob will update the first part of the question. In regards to why the freight and tariffs were worse than we had initially anticipated, at the beginning of the year, we had — in regards to GSP, we had expected it to happen in the first half of the year, that — and renewal, we expected to happen in the first half year. With ultimately everything that’s going on within kind of Washington, DC, there’s not been much movement. There is a couple of bills that the House has as well as the Senate have and there just hasn’t been agreement. So we believe that ultimately we will see GSP get passed and it will be retroactive, but we thought it would have happened by now. So we’re just assuming it will happen by the end of the fourth quarter.

In regards to freight expense, everything we were hearing at the beginning of the year, we thought the issue was going to kind of — the challenge was going to be kind of through the summer months and ultimately we’re going to get some relief here in the summer going into peak. We just haven’t seen it, and I think a lot — there’s a lot of different challenges there. So we’ve seen COVID spikes in some of our factories which have closed down some of our factories which makes just delivery channels getting deliveries on time challenging. We’ve seen some foreclosures in Asia, which just means we have ultimately longer lead times getting here to the US. And then the dwell time in kind of LA, Long Beach Port is back up to where it was in February. And then outside of that, there is other challenges and warehouses and actually moving product through rail. So I think all the challenges have compounded, and our expectation at the beginning of the year and even at the beginning of the second quarter was some of that was going to abate, and now we don’t see that abating at all this year and we think it’s going to be some of the challenge into some part of next year and it could be the full year next year or so.

Robert Wallstrom — President, Chief Executive Officer and Director

And I think from an expense standpoint, one of the challenges we have, Oliver, is, it’s been — it’s been difficult. So we’ve moved some of our product to air, and our product with the lower AUR and higher volume size and moving it via air is a very expensive alternative. So we’re trying to really work through the complexity of what do we move to air, what do we leave on both, how do we manage through that process. But that’s why I think there has been a higher flow-through of that expense that we anticipated — we did not anticipate using air as predominantly as we have at this point.

On the Apple piece, in terms of what’s going on there, I think one thing that we’re seeing with Pura Vida is, first, they have always been good at migrating their marketing platforms. They were strong on Facebook; they became the dominant force on Instagram; they’re moving now into TikTok, so do a nice job of migrating, continuing to evolve, they’re starting to lean into podcasts and other areas, YouTube, to continue to diversify. The second thing though that we want to do is help them get even stronger data analytics, leverage some of the learnings that we’ve been able to have over at Vera Bradley to look at some traditional marketing channels in addition to kind of the forward digital channels and have a broader base. And as we begin to do that and start leveraging their SMS, email, some of the just digital advertising, Google search, SEO maximization, we think there are some opportunities for them to have a broader marketing platform and we’re seeing those early steps begin to pay off as the business momentum is recovering as it moved through second quarter and into third quarter.

John Enwright — Executive Vice President and Chief Financial Officer

And the only thing I would add to that, as we continue to open stores, we only have one store open for Pura Vida, but as we continue to open stores, we’ll have more opportunity for some first-party marketing because we’ll have more information about the customer.

Oliver Chen — Cowen — Analyst

Okay. That’s really helpful. So related to the trends you’re seeing in the inventory positions, if you could brief us on those at both brands, Vera Bradley and Pura Vida, and how are you feeling with that inventory and back-to-school period versus holiday. Thank you.

John Enwright — Executive Vice President and Chief Financial Officer

Yeah. So, from a Pura Vida perspective, inventory is probably on the high end, is higher than we probably would like it to be. If you remember, last year we had some challenges actually getting production in and we overindex for that, and ultimately, we’re working through some of that inventory. So I’d say Pura Vida is well set up for holiday. They have enough inventory for holiday and I don’t have any concerns their not being able to suffice kind of any sales growth there. In regards to Vera Bradley, Vera Bradley’s inventory is actually a little bit flattish to down from where it was last year. We have broken in a few different places. So as we continue to work through getting product here for holiday. As Rob indicated, we’re looking at air freight and airfreight associated with launches that need to be here on time, so think about that as holiday launches. They have a defined amount of time to be here. So we’re trying to ensure that we have the right product here on time. But overall, inventory from — the overall inventory from a Vera Bradley perspective is probably okay. There’re just certain categories that we have to kind of ensure that we get here on time in order to hit the holiday sales.

Oliver Chen — Cowen — Analyst

Okay. And what about store traffic more generally? Does it continue to be volatile? And how are you thinking about it longer-term versus the traffic and/or sales per square foot productivity levels versus 2019?

John Enwright — Executive Vice President and Chief Financial Officer

Yeah. So, from a traffic perspective, it’s been fairly consistent over time if you think about the first two quarters in aggregate, but we saw a slowing down near the end of July in both the factory and full line business. They both slowed down as the Delta variant became a little bit more rampant. In August, we’ve seen kind of it go back to kind of where it was prior to that. So, I think generally speaking, I think we would see kind of traffic be at the same levels as it’s been for the — hopefully for the full part of this year, be fairly consistent, down from where it was kind of call it Q2 and Q1 for many a year.

If you think about kind of a sales per square foot, the hope would be kind of as we move into next year, as the vaccination rate continues to get up, as people continue to feel more comfortable, we would hope from a factory perspective that we get back to kind of a more normalized sales per square foot and that kind of, we’ll be able to generate kind of the same level of sales that we were back in 2019. And as we evolve kind of the product lines and as we evolve from a full line perspective, what we’re selling and the productivity — at the start, we would hope we can get back to that level as well.

Oliver Chen — Cowen — Analyst

Thank you. And lastly, on the merchandise margins and promotional environment. What are you seeing now in terms of average unit retail trends, full priced selling and also what and how might you expect holiday to proceed as it can be a little different in that environment? Thank you.

John Enwright — Executive Vice President and Chief Financial Officer

So, from a promotional perspective, we are fairly consistent from where we were last year. Our intention is to stay fairly consistent in both brands. So we would expect kind of maintain margin if you think about it to be fairly consistent with where we were last year. From an — I don’t remember the second part of your question, Oliver.

Oliver Chen — Cowen — Analyst

The promotional environment and how it might — how you might plan for the holiday period as well.

John Enwright — Executive Vice President and Chief Financial Officer

Yeah. So, I don’t see any significant adjustment from our current plans from a holiday perspective in either brand. I think we’re well positioned from an inventory — as I said, and from a Pura Vida perspective. As we look at Vera Bradley, how to think about kind of, as we bring in new launches, as we bring in new category of products, if we need to be less promotional depending on kind of where inventory sits.

Oliver Chen — Cowen — Analyst

Okay. Okay. Thank you very much. Best regards.

Robert Wallstrom — President, Chief Executive Officer and Director

Thanks, Oliver.

John Enwright — Executive Vice President and Chief Financial Officer

Thanks, Oliver.

Operator

[Operator Instructions] We’ll go next to Steve Marotta with CL King and Associates.

Steve Marotta — CL King & Associates — Analyst

Good morning, Rob and John. Rob, is it possible for Pura Vida to effectively get back on to Facebook and Instagram with workarounds and if so, how long would that take?

Robert Wallstrom — President, Chief Executive Officer and Director

Well, just for clarity, Steve, they’re both — they’re continuing to advertise on both platforms; they continue to be very important. It’s just that the targeting of individual customers with all of the changes is not as effective as it once was. So you’re not getting the same type of return on the advertising dollars, so the overall kind of conversion reach. So the teams continue to work on that, continuing to refine the models. It’s getting stronger, and I think with time we’ll get better and better at it. But it just — we do believe that it’s critically important to be able to supplement the strong Instagram and Facebook marketing with other advertising form so that we have more diversification in the marketing portfolio.

Steve Marotta — CL King & Associates — Analyst

I see. And, John, can you quantify air freight in the first half and the second half?

John Enwright — Executive Vice President and Chief Financial Officer

Yeah, from a dollar perspective, I won’t give that. But ultimately, we’re going to see more significant dollars work through the P&L in the second half of the year versus the first half of the year.

Steve Marotta — CL King & Associates — Analyst

Okay. Fair enough. Thank you. I’ll take everything else offline. Thank you.

Robert Wallstrom — President, Chief Executive Officer and Director

Thanks, Steve.

John Enwright — Executive Vice President and Chief Financial Officer

Thanks, Steve.

Operator

And we’ll go next to Dana Telsey with Telsey Group.

Dana Telsey — Telsey Advisory Group — Analyst

Hi. Good morning, everyone. As you think about the change with the Apple iOS platform — platform shift, what are the — what are the markers that you’re looking for to show that it’s improving or do you just have to transition to something else and just never expect it to get back to the levels that it had been?

Robert Wallstrom — President, Chief Executive Officer and Director

I think a couple of things, Dana. First of all, what are we watching. I mean, what we’re really watching is kind of a combination of, on those two platforms, what is the conversion from the advertising, what is the reach, what is the customer acquisition cost and the return on ad spend, kind of key metrics that we’re watching. And we’re seeing some improvement in those. We do not anticipate getting back to the heights of that and we do believe that it becomes more important that we diversify our marketing spend. So it will continue to be the dominant source of marketing for Pura Vida. But we expect to have more diversification as we move forward.

Dana Telsey — Telsey Advisory Group — Analyst

Got it. And do you see — and with the optimal diversification that you’re looking for, what do you want it to be as a percentage and when do you expect to achieve that?

Robert Wallstrom — President, Chief Executive Officer and Director

Right now, I think we’re still working on what would be the optimal number, but what we expect — we’ve already seen a reduction in our amount of advertising spend on Facebook and Instagram by over — a 10% reduction in total spend so far in the quarter. We expect that that probably will continue as we move into fourth quarter. And then we’re just going to have to watch in terms of how effective we’ve become with the new algorithms on Facebook and Instagram and how effective the other platforms are. So we don’t have an exact target yet, but we would probably expect with time as we get into next year, under 75% of our spend would be, I mean, with Instagram and Facebook.

Dana Telsey — Telsey Advisory Group — Analyst

Got it. And then lastly, just on — you mentioned that you’re testing the Shopandshops for Pura Vida and the Vera Bradley test. What are you learning from that? Would you go forward — is it bringing in a different customer than Vera?

John Enwright — Executive Vice President and Chief Financial Officer

Right now, what we’re finding is that our customer is engaging with that — with what we did. Let me just back up, what we did in most of our stores is, did the Charity bracelet program, and what that’s just doing is engaging our customer — our current Vera Bradley customers coming in. They’re not necessarily coming in for the bracelet but when they’re in our stores, they’re seeing it, picking up an incremental sale. In our factory stores, we’re doing a combination of the full priced charity bracelet program, which has been very successful even in our factory stores, as well as adding in some liquidation product which has also worked. So I wouldn’t say that it’s as much a new customer acquisition opportunity as a wallet builder in our current Vera Bradley stores, which we think is just, again, a good — a good sign.

Dana Telsey — Telsey Advisory Group — Analyst

Got it. Thank you.

Robert Wallstrom — President, Chief Executive Officer and Director

Thanks, Dana.

John Enwright — Executive Vice President and Chief Financial Officer

Thanks, Dana.

Operator

And we’ll go next to Oliver Chen with Cowen.

Oliver Chen — Cowen — Analyst

Hi, again. I had another question about supply chain. So, as you think longer-term, do the factors that you’re seeing now give you — give you an impression that you should change your supply chain or not in terms of what you look to do? And on your details on factory closures, which regions is that affecting most and what percentage of your supply is from those regions? Thanks.

John Enwright — Executive Vice President and Chief Financial Officer

So, in regards to the factories and what we are thinking of, right, so what we are looking at is there opportunity for other country of origin opportunities to think about versus Southeast Asia. So we’re definitely looking into that. Some of the challenges — but still the vast majority of product likely will still come from Southeast Asia, and if we were to move it — so some of the challenges associated with the freight and just the delivery and what’s happening kind of here in the ports as well as — as well as kind of in the rail yards and in the warehouses, I think it will just take some time to clean up. I don’t see a significant change around that. We’ve looked at opportunities to move from different ports and to see if that would speed up our ability to get the product here. And it really wouldn’t — all ports are challenged right now.

So, we are assessing opportunities for changes in countries of origin to see if we can speed up kind of some of the factories. So that’s really a long lead. That’s not going to be a fix from a material perspective next year. It’s something we’ll have to look at from a more strategic perspective. Some of the countries that were closed were Vietnam, Indonesia. So Vietnam is a fairly significant portion of — you can call it kind of mid-teens from a factory perspective, kind of where we get our product. So that being closed for up to two to five weeks has kind of made it more challenging just to hit our delivery dates. And then Indonesia was closed for a couple of weeks, and that’s becoming a bigger part of our — our production facilities as we’ve moved our production out of Vietnam, a lot of that is moving into Indonesia, and over time, it will be probably one of the larger countries for us. But again, that was only closed for a few weeks. So the more critical one was kind of Vietnam.

Robert Wallstrom — President, Chief Executive Officer and Director

And I think one thing that we’ve been able to do across Vera Bradley for a while and beginning to do at Pura Vida is just have a flexible supply chain. So when we have shocks that hit — for example, we had significant production in Myanmar which we moved out into other countries that we continue to just be flexible. That’s part of the reason why we’re moving more into Indonesia. And as John says, over the years ahead we think there’ll still be adjustments in the supply chain as we continue to work [Multiple Speakers].

Oliver Chen — Cowen — Analyst

Thanks for those details. Very helpful. And Rob, as you think about air freight, what is your general framework for which products would be more suitable for that expensive mode and why?

Robert Wallstrom — President, Chief Executive Officer and Director

Yeah. First of all, the number one factor is, those products that are super time-sensitive. So, give you an example of that could be something like a holiday pattern, right. We would hate for a holiday pattern to be four, six weeks late and really condense the holiday selling season. The good news is that most of our products has a more season-less point of view. And so those are the things that were not accelerating. But if there is a really important marketing initiative, if there is something that’s hyper-seasonal, those are the areas that we’re looking at. We obviously look more towards things that take up a little less cubic space, but even in some of those cases, we might have to bring some of those larger products in via air if it’s time sensitive from a fabrication or a launch standpoint.

Oliver Chen — Cowen — Analyst

Okay. Great. Thank you very much.

Robert Wallstrom — President, Chief Executive Officer and Director

Thanks, Oliver.

Operator

And there are no further questions in the queue at this time. I’d like to turn the conference back over to Mr. Rob Wallstrom for any closing remarks.

Robert Wallstrom — President, Chief Executive Officer and Director

Thank you. We have an extraordinary culture and outstanding team, loyal customers and a clear vision to be a purpose-driven, multi-lifestyle brand, high-growth company. Our strong cash position, debt-free balance sheet and capacity to generate free cash flow will allow us to continue to invest in our two powerful brands and seek out prudent acquisitions of other comfortable, affordable purpose-driven brands over time. This year, we expect to deliver double-digit revenue growth over both fiscal 2021 and 2020, post healthy operating income growth over the prior two years and generate free cash flow of over $50 million. We have an exciting future ahead and we believe we have the opportunity to create value for all of our stakeholders. I would like to thank the Vera Bradley, Pura Vida and corporate teams for their resourcefulness, tenacity and extraordinary work as we accomplish so much while continuing to navigate through this challenging environment.

Thank you for your time and interest in Vera Bradley Inc. We hope you can join us for our third quarter call on December 8.

Operator

[Operator Closing Remarks]

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