Vera Bradley, Inc. (VRA) Earnings Call Transcript & Summary

Hello, and a warm welcome to each of you. We appreciate your presence on today's call. Certain remarks we make while presenting and when answering your questions might qualify as forward-looking statements, issued under and as defined by the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995, as amended. Those forward-looking statements carry both known and unknown risks along with uncertainties, any of which could lead actual results to vary materially from what we anticipate. For a review of known risks and uncertainties, please see today's press release along with the company's most recent Form 10-K filed with the SEC. Investors ought not to presume that anything stated during the call will still hold true at a future point. We assume no duty to supply any information talked about on today's call. At this point I'll hand the call over to Vera Bradley's CEO, Rob Wallstrom. Rob?

Thanks, Mark. Morning, everyone, and thanks for being with us on the call today. Our CFO, John Enwright, is here with me as well. Total company revenues in Q2 came in at $130.4 million, which was slightly under what we had expected, and we're still dealing with gross margin pressure tied to logistics costs, but we kept pushing product innovation at both Vera Bradley and Pura Vida, kicked off significant cost-cutting moves, and bought back $6 million in shares, all while keeping our balance sheet solid and free of debt. We keep observing a split in how our customer base spends. Over at Vera Bradley, comparable revenues in the direct full price channel were close to even with a year ago and rose by double digits against fiscal 2020. On top of that, our Vera Bradley indirect channel kept enjoying a strong rebound compared with last year. That said, inflation, and particularly higher prices at the pump, kept dragging down traffic and spending at our Vera Bradley factory stores. Even so, with gas prices coming down, we've recently noticed factory traffic and revenues getting better; we're acting decisively to reinforce our core brands across the whole enterprise. We've started carrying out targeted cost reductions totaling $25 million, which should be fully realized in fiscal 2024. Those cuts will help counter inflationary expense pressure as well as the recession-style spending habits of lower income households. We're finding expense savings in many parts of the company, such as retail store efficiencies, marketing expenses, information technology contracts, professional services, logistics and operational costs, and corporate payroll; beyond that, we keep assessing and rolling out strategic price increases for both brands to counter climbing raw material and freight costs. With our Vera Bradley brand, we stay confident in our core strategy, continuing to innovate and build on our lifestyle merchandising focus. We keep optimizing the travel category, which has almost returned to pre-pandemic levels, making the most of back to campus opportunities through strategic assortment enhancements, and carrying on with strong product collaborations such as Disney and Harry Potter. We're eager to broaden our home assortments this fall and to add VB Cloud slip-ons and mules to our Vera Bradley footwear franchise next month. Pura Vida's e-commerce revenues remain impacted by the change in social and digital media effectiveness along with rising digital media costs. At Pura Vida, we're shifting our business model away from one that leans heavily on e-commerce and digital marketing toward one that is a genuine omni-channel business with a broader marketing base. This won't happen overnight, but we're taking the steps needed to bring about this transformation and get the brand back to long-term growth. Our top priority is creating a more diverse, innovative, effective and performance-based marketing program to boost e-commerce sales, and we're strengthening our in-house marketing and data analytics talent. The biggest thing I want to highlight is that we're currently rolling out a full customer data platform from Pura Vida. The goal is to create one unified, comprehensive picture of every customer, which will let us do a better job targeting and personalizing our marketing and reduce how much we depend on outside marketing partners. While that's happening, we're still working with our micro-influencers, growing our presence on TikTok, rolling out high-impact connected TV advertisements, fine-tuning our SMS efforts, and actively looking at other ways to reach our customers effectively each and every day. Going forward, Pura Vida's growth will come from a mix of online expansion and expansion through physical distribution channels. As we keep diversifying our marketing platforms, stores are going to be essential for bringing in new customers. This quarter, we launched a new Pura Vida shop at the Irvine Spectrum Center in Irvine, California, and during August, we opened our third site at Broadway at the Beach in Myrtle Beach, South Carolina. Just like the first location we opened last year at Westfield UTC Mall in San Diego, both of these new spots are doing better than we anticipated. In September, we're opening a fourth store at SanTan Village in Metro Phoenix. As we continue diversifying our marketing platforms, stores can be crucial for acquiring new customers, and they show how much a retail footprint can boost digital sales, omni-channel loyalty, and spending. For instance, ever since that San Diego store opened, our e-commerce business there has consistently seen a double-digit gap compared to the rest of the country. We're eager to see what more stores will do down the road. When it comes to products, we keep generating excitement and engagement among customers through partnerships such as Disney, Harry Potter, Hello Kitty, and the World Surf League, teaming up with important influencers, rolling out themed collections tied to major moments like Shark Week, and introducing our Demi-Fine line, which features 18-karat gold plating, sterling silver, and natural stones. As we look at the rest of this year and into next year, we're anticipating the macro environment will stay tough. Even with the strength in Pura Vida's store business and the chance to open more stores, we think it will take time before Pura Vida's e-commerce business gets back to growth, since the work of rebuilding and overhauling the marketing program is still going on. We're taking essential steps that will make both core brands and our entire company even stronger, not just to get through this stretch successfully, but to set ourselves up for what's ahead. Our teams are locked in, and our cash position and balance sheet are still solid. We've navigated difficult business cycles successfully in the past, and I'm sure we'll get through this one too. We're looking forward to getting both brands back to consistent growth. Now I'll hand the call over to John so he can go over the financial results. John?

Thanks, Rob, and good morning. I'd like to walk through several key points regarding Q2. All figures I'm about to mention are non-GAAP, and they leave out the charges detailed in today's release, which come to $32.2 million after taxes. Breaking down that amount, the largest pieces are a Pura Vida goodwill write-down along with intangible asset impairment charges adding up to $18.2 million, then $7 million for severance and consulting fees tied mainly to efforts aimed at saving costs, plus $5.6 million in inventory-related charges from writing down masks and other inventory, together with fees stemming from canceled orders for spring 2023 goods. For a full breakdown of what's excluded from non-GAAP figures, and a reconciliation between GAAP and non-GAAP, please see today's press release. Consolidated net revenues came to $130.4 million, versus $147 million during last year's Q2. Consolidated net income was $2.4 million, equal to $0.08 per diluted share, against $9.5 million, or $0.28 per diluted share, a year ago. Revenues for the Vera Bradley Direct segment reached $87 million, down 10.4% from $97.1 million a year earlier. Comparable sales fell 13.8% during Q2. The Vera Bradley Indirect segment brought in $17.3 million, up 2.9% from $16.8 million in last year's Q2. Pura Vida segment revenues were $26 million, a decline of 21.3% from $33.1 million the previous year. Q2 gross margin was $67.8 million, or 52%, versus $80.4 million, or 54.6%, a year ago. This year's rate took a hit from higher inbound and outbound freight costs, overhead cost deleverage, and shifts in channel mix, though price increases provided some offset. Consolidated SG&A expense for the quarter was $64 million, or 49.1%, compared with $68 million, or 46.2%, last year. As anticipated, Vera Bradley's SG&A expenses came in below the prior year, largely because of reduced variable-related costs from lower sales volume along with other cost reduction efforts. Consolidated operating income for Q2 was $3.9 million, or 3% of net revenues, versus $13.4 million, or 9.1% of net revenues, the year before. Let's now move to the balance sheet. Total inventory at quarter end stood at $179.6 million, versus $148 million at the close of last year's Q2; we're carrying $24 million more in inventory that's in transit this year as we keep dealing with supply chain delays and make sure we're adequately stocked heading into the fall and holiday selling seasons. Cash, cash equivalents, and investments at quarter end were $38.3 million, versus $76.5 million at the close of last year's Q2. One main factor behind the lower cash position is the $31.6 million inventory build compared with last year. We're still in a strong cash position with no debt on the balance sheet; we'll keep taking a cautious stance on cash, especially given this volatile and difficult environment. During the quarter, we bought back roughly $6 million of our common stock, which works out to 1 million shares at an average price of $6.11. There's $29.3 million left available to us through our $50 million buyback program; let's now turn to what we're expecting in fiscal 2023. We believe the tough macroeconomic conditions will persist through the rest of the year, and we think getting the Pura Vida e-commerce business back to growth is going to take more time. Elevated gas prices along with other inflationary forces are going to keep weighing on the Vera Bradley factory channel, and gross margin will remain under pressure as well. Because of that, we've revised our guidance for the remainder of the fiscal year. Every forward-looking figure I'm about to give is non-GAAP. Looking at fiscal 2023, our expectation is consolidated net revenues between $480 million and $490 million, versus $540.5 million in fiscal 2022; for consolidated gross margin, we're projecting a range of 53.7% to 54.1%, compared with 53.3% a year ago. The anticipated increase from one year to the next is mainly tied to added inbound and outbound freight costs plus expected deleverage on overhead, which should be more than offset by higher prices. Consolidated SG&A expense is expected to land between $246 million and $250 million, against $258.8 million in fiscal 2022. The decline in SG&A comes from cost-cutting measures as well as lower compensation, marketing, and other variable-related costs tied to the anticipated sales drop from the prior year. We're looking for consolidated diluted EPS of $0.20 to $0.28, versus $0.57 a year ago. Net capital spending is projected at roughly $8 million to $10 million, compared with $5.5 million in the previous year. Operator, at this point we'd like to take questions from the call.

Hello there, Rob and John. Morning to you both. Regarding inventory, could you describe where things stand — you've got coverage, but you're also absorbing write-downs — and explain why now was the correct moment to take those write-downs, plus what that implies for future periods? There are also some cancellations in the mix, so I'd appreciate getting a picture of what makes up the inventory, since it seems certain items are performing while others plainly are not. Thanks.

Sure, Oliver — I get why you're asking that. As far as the write-downs go, they were mostly concentrated in a few specific areas. When we went through our mask stock, we had accumulated that inventory with COVID-19 in mind, and we figured we'd continue selling it down. But with some of the changes coming from the CDC, along with the way customers are acting, that sell-through just isn't materializing. Across both brands, mask inventory made up the big majority of the write-down. Turning to what remained, it was largely related to tech accessories — things like older iPhone accessories — and those, once again, aren't moving the way we thought they would, because buyers have gravitated toward newer models. That's basically what caused the write-down, and the reason we took it in this period. On the inventory side, there are really two things behind the year-over-year gain. First, in-transit inventories — that number is up about 100% versus the same point in Q2 a year ago, and that's so we have the right product available for the holidays. In fact, $13.8 million of that increase stems from this. Second, there are the extra freight costs that have added to inventory. Compared with a year earlier, we've seen that go up relative to where it was in the first half. Naturally, in the back half, freight expense worsened a year ago, and we're getting some benefit — or we should get a modest benefit — from that, because freight is less of an issue now than it was 12 months ago.

Alright. With comps falling 13.8%, what drove the swings? Is traffic the largest drag, and what does your outlook assume about what you're observing? Did you shut more locations than anticipated, or was that already part of what you'd intended?

When it comes to this year, in the end, the count of locations we shut will land roughly where we had planned. As for the coming year, we're still figuring out exactly what that picture looks like. On the comps side, what's really fueling them is the off-price side of things along with the outlet side. At the same time, our full price operations are putting up stronger results, and that covers both the full line locations and verabradley.com. What we're doing is taking the pattern we witnessed across the first half in those channels and projecting something comparable for the year's back half.

All right, when it comes to Pura Vida, the problems with digital marketing have been clear across the broader industry for some time now. What's taking place at present regarding where digital marketing stands, and what lies ahead for that business? What are the main obstacles, and what do you need to accomplish to fix it in a more structural way and get it growing more sustainably as time goes on?

Yes. Regarding Pura Vida's marketing, Oliver, a handful of points come to mind. First, you're correct that they're certainly operating in that direct-to-consumer space, and everyone there is experiencing the pressure; as for us at Pura Vida, we've been adding outside agencies along with extra personnel to reduce how much we depend on what I'd describe as the Meta platform — no better phrase comes to mind — meaning Instagram, Facebook, and similar channels, while beginning to lean harder into first-party marketing, developing our CDP platform, and exploring additional options too. Put differently, a connected TV initiative is being rolled out by them during the upcoming quarter, so we're examining fresh approaches for that. Over the longer horizon, we believe that a portion of the answer to this marketing difficulty will likewise be that diversification into omni-channel, something you've observed among other direct-to-consumer businesses, and what we've witnessed in San Diego has been heartening — seeing that kind of notable relative gain in the San Diego market. Should that keep showing up — and the initial indicators suggest it, though it's, well, only been weeks and months at the other stores — we're noticing comparable patterns at the remaining locations, so in our view the stores themselves are going to be extremely significant in steadying the Pura Vida business as we move ahead.

All right. Regarding the margins on merchandise and the higher prices, could you bring us up to date on what you're thinking? The climate seems to have deteriorated, but you've still managed to push through certain price hikes. What's your view on what's assumed for merchandise margins, as well as COGS inflation versus those price increases down the road?

When you look at it through the lens of merchandise margin, what we're really observing is that customers are accepting the higher prices, and that's translating into an improvement compared with a year ago. The real difficulty we're running into relates to what we're paying for logistics. In fact, on the logistics cost side, there may be some upside coming in the back half of the year, and we believe that upside will carry into next year simply because of the inflationary pressure sitting in the broader economy. We'd anticipate gaining something from those inflationary costs — freight, that is — during the back half and going into next year. As far as product cost goes, we're still navigating certain difficulties tied to it, yet we don't expect any meaningful rise in certain raw material costs going into next year, in light of some of the macro events taking place, or inflation, and the way the economy worldwide, broadly speaking, isn't as robust as it was at this point a year ago. We're still evaluating whether continuing to raise prices is sensible, and we'll keep doing that for the rest of this year while we look ahead to next year.

Regarding pricing actions, Oliver, my view is that we implemented fairly extensive increases for both brands early in the year, and we've been managing our way through those during the first half. Looking ahead, I'd expect far more granular tweaks to those higher prices rather than sweeping moves. In many instances, shoppers have gone along with them, in our estimation, yet resistance is already emerging on a handful of products; over the coming 12 months, our approach to pricing will need to be considerably more item-by-item.

Alright, that's quite useful. Regarding the balance sheet and cash position, what details should we have about working capital and where cash flow came from or went in terms of Q4 to 4Q? Your cash balance declined by $38.3 million compared with a year earlier. Is that something we ought to be concerned about?

Sure, so of course, it all comes down to how we perform in the latter half of the year, right? When we think about cash and how we're using it during the first half, we put some funds toward building up inventory, and we also used cash for share repurchases. On the back half of the year, we'd prefer to take a more conservative approach with both of those cash outflows. Based on what we're forecasting right now, we anticipate our cash balance will increase by year-end, but again, that depends entirely on how we do.

All right. Rob Wallstrom, regarding the consumer, that split pattern has kept going, and you flagged it before most people did, and since then a lot of retailers have even pulled their guidance. What's your read on the consumer at this point? Does the choppiness worry you? There are definitely plenty of pluses and minuses out there, but spending power remains with the consumer.

Yes. I think there are a few things. First, when it comes to spending behavior, the most significant issue we're facing is how gas prices are affecting the factory channel. To be completely candid, it's not so much about overall discretionary spending, but rather the capacity for people to visit factory stores and drive foot traffic there—that's where we're feeling the impact. That's what worries us most. The price of gas itself is the primary factor we're noticing; it's been positive. Once gas prices began to ease somewhat, we observed traffic starting to recover in factory stores compared to the prior trend, and we started to see that reflected in revenue. We're hopeful that the gas price trend keeps easing, which could be beneficial. On the whole, it's been fascinating to observe the consumer. I realize everyone is contemplating the back half and what will unfold with the consumer. When we consider what's occurred in July and August, we haven't observed any additional overall decline, and I believe much of that relates to the gas price element that's been recovering and easing. We're optimistic that the consumer as we see them now, as the year progresses, will resemble what we encounter in the back half; it's certainly not strong, but we aren't seeing more deterioration, which is encouraging.

All right. I'd appreciate it if you could take a moment to walk us through the main product efforts — for both Vera and Pura Vida — that ought to be our focus, just a handful of top priorities. As you know, you've put together quite a few creative collaborations, and the Pura Vida brand is clearly centered on its mission.

Okay, so a few thoughts come to mind. First off, when you look at how we think about product innovation, there are several angles we consider. On the licensing side, it's worked really well for both of our brands. It's had a big impact—not just by bringing in revenue and generating buzz, but especially when it comes to acquiring customers; those initiatives play a key role in attracting new buyers. It also boosts our marketing effectiveness. We expect to keep pursuing those kinds of partnerships and making sure they stay fresh going forward, so stay tuned—we've got more exciting things to share soon. Now, if we drill down into specific product categories for each of the two brands: over at Vera Bradley, they're constantly innovating. We've got our ongoing core developments, plus new entries too. For instance, the Vera Bradley footwear line launching in fall is going to be a big deal for us. We'll be keeping a close eye on it. With Pura Vida, there are two areas we're focused on. First, the consumer remains deeply engaged with the core bracelet offering, especially now that travel has picked back up—we're noticing that side of the business bouncing back, which is great to see. Meanwhile, they've rolled out the Demi-Fine collection, which comes with a higher price tag and better quality, and early feedback has been quite favorable. It's really allowed us to connect more deeply with that 25 to 35-year-old demographic, which has always been a key part of what makes Pura Vida special—appealing to both the younger teenage crowd and this 25 to 35-year-old group. Those are the spots I'd highlight as the ones to keep an eye on.

Right. The one point I'd tack onto what you said, Rob, is this: with Pura Vida on shelves and the apparel line, once a shopper actually has a chance to handle the merchandise and feel how good it is, what we observe is that they get involved with those items across a far wider range than happens over the internet. With additional locations coming, that segment should get its own opening.

Yes.

Right, regarding those charges — the largest item was the $18.2 million impairment on the Pura Vida assets. What drove that valuation, whether you look at it from an accounting standpoint or a market one? And then on the $0.8 million of store impairment, could you give us a bit more color on what that was tied to, along with the $0.6 million of store impairment? Thanks.

Okay. When you look at what happened with the Pura Vida write-down, most of it relates to either goodwill or the trade name. Each year, following that acquisition, we run a test and examine projected cash flows. Because of how the brand is performing right now and what we anticipate for it in the near term, the expected cash flows meant we had to reduce the value of both that goodwill and the trade name. As for the store-level write-downs, the approach was essentially identical. We compared projected cash flows from each individual location against the value of its current assets. Those expected cash flows led us to write off a portion of those assets.

Is there any reason for us to worry about additional write-offs? I understand this is a review that must be performed on a recurring basis under accounting rules. Would you agree with that? Rob, looking at the bigger picture, what would you say are the main risk factors that you're keeping an eye on?

I'll just take the first question, okay. Yes, the goodwill balance has to be looked at on a regular basis. Every quarter we review it; the full test happens once a year, and that takes place in Q2; we'll keep reviewing it. Based on what we've laid out in our expectations for the business, if we hit those expectations, then another write-down shouldn't occur. On the second part of your question, Oliver, let me cover the risks and the opportunities, since I believe both matter a great deal. Looking at risk by brand, at Vera Bradley the top risk factor right now, I'd say, is gas. If gas rebounds and suddenly we're back at $5, $6, $7, $8 a gallon in the back half of the year, the factory channel gets suppressed. Gas, I'd say, is far and away the biggest risk. At Pura Vida, it's really about the recovery, the digital marketing, and how something that was a major asset for the business — its ability to manage digital marketing — isn't having the same impact; the marketing platform has to be reset. That reset is the biggest risk in the Pura Vida business. It's also important to discuss opportunity, because if you step back and consider what's happening with the company, three big macro impacts have hit us. First is logistics cost. The logistics costs hitting our P&L today are probably what we'd call peak based on what we're seeing. We're starting to see logistics costs, especially international inbound shipping, begin to moderate, so hopefully that becomes a tailwind going forward and helps us. That's encouraging. I really think that's a positive on the logistics side as we move through the end of the year, especially since next year we can redo contracts, and as capitalized costs work through the balance sheet, that will improve profit, and you'll definitely see that as we move into next year, which is encouraging. One of the macros is logistics and duty getting better. That's good news. The second big one has been the gas price impact in factory. As gas prices moderate, which we think — we're hoping to see — that will be a lift. The third has really been the performance marketing with Pura Vida. More stores will help us there. As all the work we're investing now in the data platform and in rebuilding the performance marketing organization gets done, I think that's another big lift. So, regarding gas, logistics, and that shift toward digital media — those three items have hit our operations, and honestly they're major macro forces where our exposure ended up bigger than the industry's overall. We're grinding our way past these challenges, though I do believe we're making progress on them, and conditions should improve once we get into the following year.

All right, that's the final one. First, about digital marketing and performance — was that a problem for the Vera Bradley brands, or were there some positives there? Then on the inventory cancellations, that seems proactive. In terms of composition, which portions of the inventory did you do that with? Thanks very much.

John, how about you handle a portion of the inventory topics, and I'll simply cover digital?

Right, could you go over that inventory question again? I honestly didn't catch what you asked, Oliver.

John, when it comes to those cancellations, specifically the ones tied to inventory, which portions of that inventory had to be canceled?

Honestly, we examined upcoming orders we'd placed across every category. We considered where we thought sales would land going forward into roughly the following year, and where we thought our inventory would stand. We considered chances where we believed we could counterbalance part of that liability through fresh sales projections, and clearly with inventory rising from one year to the next. This wasn't tied to any one category; it came down to, you know, the chance to cancel certain orders opportunistically, truly.

Yes. The one point I’d tack on there, Oliver, is if you consider what’s been going on with our factory channel, correct? Business has decelerated as the gas price has risen. Probably one of the main reasons behind that cancellation is getting that inventory back where it should be. Don’t view it as, “Oh, well, a category isn’t working or an item isn’t working.” That isn’t truly the case; it’s simply overall demand, and it gave us a chance to sort of temper that inventory risk as we headed into the next year, so.

Yeah, I think it's more channel specific versus category specific.

Yeah.

That's a good way to think about it.

Right. Regarding your second question, Oliver, I believe it concerned Vera Bradley and digital marketing. There are, I'd say, a couple of distinct dimensions to this. To start with, a significant strength we possess at Vera Bradley is an exceptionally robust first-party marketing operation. As you know, we have direct ownership of our customer relationships and engage with them straightaway. For our established customer base, our reliance on third-party marketing is comparatively lower; that channel is utilized primarily to bring in new customers. Over the past 2 years or so, the team has developed an extremely granular, analytics-driven performance marketing foundation, and through that they've managed to offset a portion of the costs by reallocating and sharpening their focus. You could say they now have additional instruments available to them. Our approach involves taking many of those insights already put into practice at Vera Bradley and starting to apply them in support of Pura Vida, so that we can gain knowledge from it. The most notable distinction at Vera Bradley isn't that they've avoided encountering certain of those same difficulties. They've actually been somewhat more successful at discovering ways around them, but secondly, the effect on the overall business isn't as significant as what happens at Pura Vida.

Okay. Thanks for answering all my questions. Best regards.