Mark Dely - CLO Rob Wallstrom - President and CEO Kevin Sierks - CFO Theresa Palermo - EVP and CMO Sue Fuller - CMO.

Mark Altschwager - Robert W. Baird Oliver Chen - Cowen and Company Eric Beder - Wunderlich Securities William Dezellem - Tieton Capital Management Dana Telsey - Telsey Advisory Group Steve Marotta - CL King and Associates.

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Vera Bradley Second Quarter Fiscal 2017 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 and instructions will be provided at that time for you to queue up for questions. As a reminder, today's conference call is being recorded. I would now like to turn the call over to Mark Dely, Vera Bradley's Chief Legal Officer. Please go ahead..

Good morning and welcome everyone. We would like to thank you for joining us for Vera Bradley's second quarter earnings 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 January 30th, 2016 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.

The company undertakes no obligation to update any information discussed on the call. I will now turn it over to Vera Bradley's Chief Executive Officer, Rob Wallstrom.

Rob?.

Thank you, Mark. Good morning everyone and thank you for joining us on today's call. I am joined today by Kevin Sierks, our CFO, and Theresa Palermo, our Chief Marketing Officer. Sue Fuller, our Chief Merchant, is also here to respond to questions following our prepared remarks.

Second quarter diluted EPS of $0.14 was within our guidance range and ahead of consensus. Although the overall retail environment certainly remains challenging, we are pleased that we achieved total revenues within our guidance range. Like many others we're seeing a softening of traffic in the outlet business.

We're pleased with our second quarter 230 basis point gross profit expansion primarily related to sourcing and operational efficiencies. The third fiscal quarter will be an exciting and important one for our company and our brand. As you know one of our main objectives this year is to complete our brand transformation.

We believe this new brand positioning which we are beginning to launch in the third quarter will lay the foundation for comparable sales growth by the end of the year.

Our new SoHo flagship store, refreshes of key full-line stores, launch of our new verabradley.com digital flagship, and our comprehensive marketing initiatives will all deliver beautiful solutions to our Daymaker target customer and be catalysts for growth.

In addition, another key objective this year is to begin exploring additional licensing opportunities and we also have some news to report on that front. I will provide more detail on all of these initiatives after Kevin discusses the results for the quarter and our outlook for the balance of the year.

Kevin?.

Thanks, Rob and good morning. Let me go over a few highlights for the quarter. Current year second quarter net revenues totaled $119.2 million which was within our guidance range of $118 million to $123 million. Net income totaled $5.1 million or $0.14 per diluted share which included $1 million of store impairment charges.

Prior year second quarter net income was $5.7 million or $0.15 per diluted share. Direct segment revenues totaled $87.2 million, a 4.1% increase over $83.8 million last year. This revenue number reflects a comp sales decline including e-commerce of 5.7% for the quarter, which was more than offset by new store growth.

Comp sales continue to be negatively impacted by year-over-year declines in store and e-commerce traffic.

Indirect segment revenues decreased 13.4% to $32 million from $36.9 million in the prior year, primarily due to lower orders from the company's specialty retail accounts as well as the timing of a product launch that positively impacted the first quarter and negatively affected the second, partially offset by higher than expected sales to certain non-department store key accounts.

At quarter end, the number of specialty accounts remained essentially flat at around 2,600. Gross profit totaled $68.4 million or 57.4% of net revenues compared to $66.6 million or 55.1% in the prior year. The year-over-year 230 basis point improvement primarily related to various sourcing and operational efficiencies.

The gross profit percentage fell below our guidance range of 58% to 58.5%, primarily due to fabrication product mix and modestly increased promotional activity in our factory stores. SG&A expenses totaled $60.3 million or 50.6% of net revenues compared to $57.4 million or 47.5% last year.

As expected, SG&A dollars increased over the prior year, primarily due to new store expenses and approximately $1 million in additional severance charges. In addition, SG&A includes approximately $1.6 million of pretax store impairment charges in the quarter.

Despite these impairment charges, the SG&A expense rate was below our guidance of 51.3% to 51.8% due to continued diligent expense management. Operating income totaled $8.3 million or 7% of net revenues compared to $9.5 million or 7.9% of net revenues in the prior year.

By segment, direct operating income, which includes the impairment charge, was $18.1 million or 20.8% of sales compared to $16.6 million or 19.8% last year and indirect operating income was $12 million or 37.5% of sales compared to $14.8 million or 40% of sales last year.

Cash and short-term investments as of July 30th totaled $85.5 million compared to $76 million at the end of last year's second quarter and we had no debt outstanding at quarter end.

Quarter end inventory was $96.5 million compared to $103.9 million at the end of last year's second quarter and below guidance of $105 million to $110 million due to receipt timing and diligent inventory management. During the second quarter, we continued to repurchase shares under our $50 million share repurchase plan.

We repurchased approximately $10 million equating to approximately 638,000 shares at an average price of $15.67. Now, let's talk about our outlook for the third quarter and the full year. Although we have a lot of initiatives beginning in third quarter, the overall retail and competitive landscape remains both challenging and unpredictable.

Keep in mind that as I discuss our prior comparison, the prior year numbers exclude the manufacturing facility closing and other excluded charges outlined in our release. For the third quarter, we expect net revenues of $128 million to $133 million compared to prior year third quarter revenues of $126.7 million.

We expect direct segment net revenues to increase in the low to mid-single-digit percentage range with a comparable sales decrease including e-commerce in the low to mid-single-digit percentage range. We believe our indirect net revenues will be flat to up in the low single-digit percentage range during the quarter.

The gross profit percentage for the third quarter is expected to range from 58% to 58.5% compared to 57.9% in the prior year third quarter. The modest planned improvement reflects sourcing and operational efficiencies.

SG&A as a percentage of net revenues is expected to range from 47.6% to 48.6% for the third quarter compared to 45% in the prior year third quarter. The current year estimate includes approximately $3 million of incremental year-over-year expenses related to marketing, store renovations, and e-commerce.

We expect third quarter diluted EPS to be in the range of $0.22 to $0.24. This compares to diluted EPS of $0.27 in the prior year third quarter. The third quarter EPS will be negatively impacted by strategic SG&A spending and the timing of certain marketing and other expenditures that I already mentioned.

We expect inventory to be $95 million to $100 million at the end of the third quarter compared to $118.2 million at the end of the third quarter last year. The planned reduction is primarily due to careful inventory management. For the full year, we expect net revenues of $510 million to $515 million compared to $502.6 million last year.

Our revenue guidance includes direct segment net revenues, growth of mid-single-digit percentage increase and a comparable sales including e-commerce decrease in the low to mid-single-digit percentage range. As Rob noted, we expect comparable sales to turn positive by the end of the fiscal year.

Indirect net revenues are expected to decline in the mid-single-digit percentage range for the full year. The gross profit percentage for fiscal 2017 is expected to range from 57.3% to 57.5% compared to 56.6% last year. The planned improvement reflects sourcing and operational efficiencies and increased sales penetration of higher margin MSO products.

The vast majority of the gross profit rate improvement occurred in the first half of the year as we have begun to anniversary certain sourcing efficiencies and the buildup of MSO product to our current penetration level in the second half of the year.

SG&A as a percentage of net revenues is expected to range from 47.3% to 47.5% for fiscal 2017 compared to 46.6% last year. The planned increase is primarily related to incremental expenses related to new stores, store renovations, e-commerce, severance and second quarter store impairment charges.

Our year-over-year marketing spend will be approximately flat with last year. We are narrowing our full year diluted EPS guidance range to $0.88 to $0.92, which includes $0.03 of asset impairments taken in the second quarter. On a comparable basis, diluted EPS totaled $0.82 last year.

Net capital expenditures should total approximately $20 million for the full year, primarily related to new store openings, store renovation, and continued technology investments. Let me turn the call back over to Rob, who will update us on our third quarter initiatives.

Rob?.

Thanks Kevin. We remain focused on executing the product distribution and marketing elements of our long-term strategic plan. As I mentioned earlier, our third fiscal quarter will be an exciting and important one for our company and our brand as our brand transformation is underway which involves each of these three key elements.

Our official brand relaunch began last Thursday, August 25th. Our fall product assortment, new SoHo flagship store, refreshes of key full-line stores, launch of our new verabradley.com digital flagship, and comprehensive marketing initiatives will be the catalyst for growth. As usual, let's start with product.

Innovation and creating beautiful solutions for our Daymaker target customer are still top of mind. In early August, we launched our Gallatin Relaxed Leather Collection and expanded our Collegiate Products from 17 schools to over 70.

In conjunction with our brand relaunch date last week, we debuted two new patterns, Java Floral and Painted Feathers and launched new colors and materials in our Northbrook Faux Leather Collection. We also introduced our Feathers Jewelry Collection and a new seasonal fragrance.

This fall we are expanding our much in demand line of bags with charging capabilities and in October, we will begin testing a limited line of rain boots and slip-on shoes featuring our signature patterns.

We also just announced two licensing deals, one for stationery and organization and another one for publishing and we expect to have more to announce in the future in our key focus areas of home, fashion and beauty. Our iconic and unique patterns easily lend themselves to many products in home and other areas.

While the revenue and net income implications of these deals are not material, we're excited about the expansion of our products through licensing to increase our brand exposure, acquire new customers, provide additional distribution, drive traffic to our digital flagship, and to position us for eventual international growth.

As you can see, there is a lot happening in product and there is certainly a lot going on in distribution related to our brand relaunch. Last Thursday, we officially opened our flagship store in SoHo, which is receiving a lot of positive press and most importantly traffic. If you get a chance, we would love for you to visit and give us your feedback.

We are so pleased with how the store turned out with its innovative design elements, an array of exclusive patterns, limited edition items and unique store experiences. This store is as much a marketing strategy as it is a distribution strategy by helping elevate our brand and showcase Vera Bradley to consumers all over the world.

We are continuing the implementation of our renovation strategy with our Jefferson Pointe Store in our hometown of Fort Wayne and beginning this month, we will also refresh 16 of our higher traffic, higher volume full-line stores with our new branding including storefront, facade, logo and interior changes.

In addition, we will rebrand the facades of our 15 newest full-line stores so that a third of our fleet will reflect our new logo and signage by year end. As you know relaunching our digital flagship remains a key part of our distribution and brand transformation strategy.

As you may have noticed, the site has been rebranded to align with the new brand visual direction and to provide a more cohesive consumer experience. The conversion to the new platform is targeted to go live in October and the new site will enable consumers to shop faster and easier both online and in-store.

Our enhanced functionality will truly allow us to accommodate the mobile-first and cross channel shopping habits of our customers.

Among other things, some of the key features will be additional navigation and search enhancements, strategic segmentation and personalization, enhanced payment options and e-gift cards, order online, pick-up in store, and site capabilities for future foreign expansion.

Now as we shift to marketing, let me introduce Theresa Palermo, our Chief Marketing Officer, who for the past year has been working diligently with her team on our rebranding efforts. Marketing is key to our brand transformation as we improve brand perception, engage the consumer, increase desire for our brand, and ultimately grow market share.

Theresa?.

Thanks so much Rob. Vera Bradley has always celebrated femininity and the power that it has created by connecting women together. In fact, the connection and bond of two amazing women is how we got our start. Our new marketing campaign, It's Good to be a Girl, is a celebration of that femininity.

It’s a statement meant to demonstrate that femininity has real value and to create an optimistic voice to lift the status of women everywhere and of every age. There are numerous reasons why it's good to be a girl from sisterhood to the power of leading with empathy to having the ability to make all things beautiful.

We want to celebrate all of those reasons. To that end, our marketing plan is comprised of two key components; one, increasing brand visibility; and two, igniting a true social movement. First, to drive visibility and relevancy, we have launched a comprehensive multifaceted media plan with a mix of digital, social, experiential, and print.

Versus years past, our plan this year offers a stronger emphasis on social, mobile video, and includes an experiential partnership with Madison Square Garden. We're partnering with MSG to sponsor female artists that are coming to the stage this fall and throughout next year.

It is an effort to not only engage the New York City community in support of our SoHo store, but also to reach a broader national audience with women who truly exemplify the power of femininity and are at the top of their craft.

If you haven't already seen, you will soon see our spread national advertisements in People StyleWatch, InStyle, Glamour, Cosmopolitan, 17 and Teen Vogue as well as a broad online and digital -- online media and digital investment including Hulu, Pandora, Spotify, and the Condé Nast Network.

This campaign in total will deliver over 225 million targeted consumer impressions. We also just launched an exciting sweepstakes for where one lucky woman and her squad of four girls will travel to New York City for a sightseeing, VIP shopping, a Broadway show, and a concert with a Grammy Award-winning female artist at the Garden.

To enter all she has to do is tell us why she loves being a girl. Our stores and store windows will be transformed to invite our guests to experience the brand, take pictures, text to win their sweepstakes, and share their reasons right inside the store.

Our SoHo and presence in New York City give us all kinds of opportunities for fun and memorable marketing. Coming later this month, look for our colorful double-decker bus wraps and subway train wraps throughout the city.

Second, we have embarked on an ambitious project to start a movement and engage women by gathering millions of reasons why it's good to be a girl.

We're inviting women from across the country to tell us in their own words why they love being a girl and we've created a digital gallery for women to share and connect with one another through their unique and varied reasons.

To get the conversation going, we have created a video content series starring Noël Wells, former cast member of Saturday Night Live and star of Master of None. Noël is interviewing fascinating women from around the country revealing hilarious, touching and shockingly shareable reasons that women love being women.

To get involved, you simply need to #ItsGoodToBeaGirl. To ensure our campaign has that contagious energy we must have, we'll be staggering the release of our content and celebrating key milestones along the way. Via social and paid media, the campaign will culminate into a one-day media blitz in October.

I won't spoil the surprise of that excitement just yet. These are the exciting days for our brand filled with passion and energy. I'm thrilled with our initial launch and I'm looking forward to the amazing days ahead.

Rob?.

Thanks Theresa for updating us on all of these great marketing initiatives. Operator, we will now open up the call to questions..

Thank you. [Operator Instructions] We'll take our first question from Mark Altschwager with Robert W. Baird..

Good morning. Thanks for taking the question and congrats on the continued progress. Rob, I wanted to ask about the competitive positioning as you embark on the bigger brand repositioning.

A couple of years ago I think you talked about the sweet spot for Vera Bradley that was above traditional Vera price points but perhaps below some of the accessible luxury brands.

And just given how the pricing and promotion has evolved over the last 12 to 18 months for the broader environment, any updated views on how you see Vera fitting into that landscape?.

Thanks for the question, Mark. Yes, currently, we still have the same positioning in mind as we're going out into the market. We still believe that that there's this great space below some of the aspirational luxury players.

And we've been very happy to see how we've been able to fill in that space kind of at the top end with our leather business, which still offers incredible value and in sliding in all of our nylon and other fabrication businesses just below that. But our positioning at this point would still be the same as we started a couple of years ago..

That's great. Thank you. And then following up on the comp guidance turning positive in Q4, do you think that will be a story of better conversion of some of your core customers or is it really about getting that new buyer to try the brand? Clearly a ton going on in the marketing side, so clearly that's going to be key.

But I guess what are you seeing that gives you the confidence that the new brand positioning in marketing will have such an immediate impact on comparable store sales in the back versus being more of in early 2017 story?.

Yes, Mark, a couple of things. One, we believe the key to turning comps positive by fourth quarter is the combination of all the activities. So, first of all, having a third of our full-line store fleet in the new branding, launching the new verabradley.com digital flagship.

We're expecting those two initiatives to start driving comps quicker and then, obviously, supporting that with these great marketing initiatives and really driving traffic back. For us we do believe that the biggest catalyst to getting comps positive is going to be the traffic inflection caused by those three activities.

And so that traffic inflection is a combination of getting more of our customers back more often as well as bringing new customers into the brand..

Thank you. And best of luck in the back half..

Thanks Mark..

We will now hear from Oliver Chen with Cowen and Company..

Hi, good morning. We had a more general question about managing risk in a time of change. Sometimes in retail certain positive disruptions or positive changes to brands and products can just result in consumers not being quite clear in terms of what you're trying to do.

I'm just curious about your thoughts on managing risk since there are so many changes happening which do seem very encouraging. And also regarding the comps and thinking about third quarter, it sounds like you're fine-tuning the back half outlook in terms of thinking low to mid and then turning positive in fourth quarter.

I'm just curious about the tweak in that viewpoint versus a more general view previously that comps would turn positive in the back half? Thanks..

Thanks Oliver. A couple of things. First of all, I think in terms of risk, I think there's two ways to answer the question. One, we are trying to make sure that even as we're introducing all of this new marketing that we're still celebrating our heritage, our core cotton product still is an important part of what we'll be showing the consumer.

So, we're making sure that everything that we're doing in the new repositioning is a modernization of our brand as opposed to a major shift. So, we're trying to approach that in -- I would say a fairly cautious manner.

I think the second piece in terms of managing risk is we've tried to be very prudent as you've seen with our sourcing, our expense controls to make sure that we don't go too far out. We feel really good that we're doing a good job of managing the downside risk as we go through this process.

I think your other one related to comps in terms of getting a little bit more specific, we had -- as we talked about comps being positive in the back half, we had always leaned toward the end of the year. So, now I think it's just giving a little bit more clarity to that as we're getting closer, so how I would explain that.

Anything want to add on that, Kevin?.

Yes, I mean I think the other thing, Oliver, is we've got a lot of the marketing hitting throughout the Q3. So, I think as we laid out that calendar from a marketing perspective, I think it made more and more sense that Q4 was definitely where we thought comps would turn positive versus Q3.

We want to leave ourselves the ability to possibly turn positive in Q3 just because we're really happy with the offering as it relates to back-to-school, et cetera, but we always thought Q4 was probably the higher probability..

I think just to add to what Kevin is saying too, it's also by the time the stores get fully renovated, it's really the end of October, the digital flagships the end of October. So, two of those primary catalysts don't really affect third quarter, they really affect fourth quarter.

And then the other thing that we did see in the second quarter that we called out was the softening in the factory channel that we've been seeing everywhere which was obviously something we did not anticipate necessarily six months ago. So, that has been the other factor..

And Kevin, on fabrication mix, can you brief us on what happened there with respect to the gross margin? Is that a trend that we should continue in terms of what happened? And on that topic of outlets in general, will this abate over time? I'm just curious about what was happening there and the duration of it.

It's happening to a lot of people, but there seems to be maybe slight relief.

I'm curious if it should continue for several quarters?.

Yes, I think the way we're looking at factory; we have built in more promotions in the back half of the year just because we're seeing it be very competitive out there. And really your first question with regards to product mix, that actually has to do with the factory stores as well.

What we have seen is the customer gravitate more toward some of these new fabrications and many of these new fabrications have a lower margin for us in the factory stores. So, that's what we saw happen and we have planned for that in the back half of the year, so we expect that to continue..

Okay.

And lastly, Rob, as we do look at this transformation of the Daymaker in September, which parts of this do you see as most challenging when you have been executing on this plan? I'm just curious about your strategic view of how you think about which parts are the toughest in terms of execution or strategy or consumer acceptance?.

So, let me take a shot and see if I answer it for you, Oliver.

But I think as we do this whenever you put a new marketing campaign out and you're starting a social movement, you're starting a lot of conversation, you're allowing the consumer to be a big part of that conversation as opposed to maybe a more traditional marketing campaign where you're controlling the message.

So, I would say that that's the piece of it that's probably a little bit harder to control. But at the same time, we're incredibly excited about it because we think that's what's really critical to moving up to a more modern relevant brand.

We have to let the consumer be part of our marketing as opposed to being kind of stuck in more of a print mentality. We're really moving to a digital mentality and an interactive marketing mentality. So, that's probably the area I would focus on..

Thanks a lot. Really encouraging and love the new SoHo store as well. Best regards..

Great. Thanks Oliver..

Our next participant is Eric Beder with Wunderlich Securities..

Good morning. Let me add my congratulations..

Thanks Eric..

Thanks Eric..

When you look -- so let's have a look at the department store channel. So, your competitors, many of them have started to pull out a little bit from the department store channel, you guys are much newer into that channel.

How do you view that channel opportunity in positives and negatives going forward there in terms of maybe gaining some more market share?.

Yes, thanks for the question, Eric. I think a couple of things. One, we do -- we're still fairly underpenetrated in the department store relative to our competitive set.

So, we do believe that as the department store sector goes through their changes and we see things like the closures that Macy's announced that we think in the long-term, it will allow the department store sector to have better stores left in their fleet and shed themselves to some of their smaller stores which we think in the long-term will hopefully just make them stronger.

So, for us we see it as a real opportunity and as other people are pulling out, they are looking for differentiation, they are looking for freshness.

And we believe that we really have a very unique brand for that space that we can capture share and most importantly capture new customers and get an opportunity to get our product in front of a new customer set and bring them into the Vera Bradley family. So, we're excited about the future growth opportunities in the department store sector.

But, obviously, we're still taking a fairly conservative approach. We don't see ourselves fully penetrating in their stores. We see ourselves really penetrating in their top stores. So, we still have the opportunity to probably target a store count similar to what our competitors are.

It's just for us to get there, it's about growth and for them to get there, it's about shutting some stores..

Thank you.

And for the licensing categories, are those going to be just in your own stores and your current specialty store group or do they offer you down the road the opportunity to expand kind of where you sell your product or where you sell in other places, departments?.

Hi, Eric, this is Sue. We do foresee that it will allow us to expand our distribution footprint and you should look for that as we continue to take on license partners over time..

It's actually been one of the key drivers to our licensing strategy is really getting the brand in front of new customers and new places and looking for whatever called best-of-class distribution in these new categories. But the distribution expansion is the primary driver, not driving volume through our own stores..

Okay.

And finally could you give us an update on the split between cotton and non-cotton and where do -- are you pleased with what's going on there and what changes should we see going forward?.

Yes, we are seeing similar to what we reported last quarter, so -- we -- it's really remained unchanged. Cotton represents a little over 50%, non-cotton fabrications around that 30% and then other fabrications at around 20%. And we'll continue to evaluate as we move forward and make sure that we're reacting to the consumers' demands.

For the rest of the year, we believe that we'll end around those same percentages..

Great. Thank you. And good luck for the holidays..

Thank you..

Thanks Eric..

Thank you, Eric..

We will now hear from Bill Dezellem with Tieton Capital Management..

Thank you. A couple of questions.

First of all, Sue, how is the merchandise changing or being adjusted for the new marketing campaign?.

Bill, so one of the things that we did was we start always with consumer insights and we made sure that we were really researching our existing database with -- and making sure that we were running our product through our current filter with our consumer insights of our database that profile to the Daymaker.

And in addition, we also did -- we made sure that we were understanding the functionality that she viewed along with the fabrications and also making sure that our concept of beauty was aligning with her concept of beauty.

And so that's how we're making sure that we're fully aligned from the beginning of concepting all the way through to be messaging that Theresa's team has been conveying to the market..

I think the thing I would add, Bill, is that Sue and the team have been working hard on the product, innovation, and modernization now for the last year and a half and so part of this marketing campaign is now getting that message out to the consumer, so they really begin to understand all the changes.

So, what you've seen in terms of the new fabrications, the leather, the Preppy Poly have all been introduced to really fill in this hole that we talked about in this 25 to 35 year old target that we're going after.

So, we felt that a lot of the merchandise has been moving in that direction and there's a continual movement to bring more refinement and more target as we go forward..

That's helpful. Thank you.

And then would you please discuss how you're entering the footwear market?.

Yes. So, we will be performing a test in the second half of this year. We're focused initially on key items, making sure that we're building our key items such as we see an opportunity in the market as it relates to wellies and rain boots as well as the canvas slip on.

And again, this starts with research within our own consumer database around what the Daymaker values as well.

You will see that testing primarily taking place within select Vera Bradley stores along with verabradley.com and select specialty partners that we believe can give us a great read on the consumer reaction and making sure that we're reacting to that accordingly..

And so really Q4 we should be viewing this as a test rather than a full rollout?.

That is correct..

Great. Thank you.

And then lastly would you discuss further the fabrication and mix issues that negatively impacted gross margin?.

Yes. It was really just product within our factory stores so we retired a fair amount of product this year that was in other fabrications other than cotton and microfiber.

And a lot of those, Bill, have lower gross margins and so that's why we saw a reduction in our gross margin as it specifically relates to our factory doors just because the consumer gravitated to these new fabrications..

We have not taken those new fabrics and put them kind of through what I will call the MFO filter yet. They were really the full-line retirement which if you remember we talked that the margin started out narrower because of the smaller selection and that we would gain margin over time.

So, we're seeing that flow through and have penetrated higher in the factory business than we had anticipated..

That's right..

Great. Thank you all for the insights..

Thanks Bill..

[Operator Instructions] And we will take our next question from Dana Telsey with Telsey Advisory Group..

Good morning everyone.

Just one moment back on the wholesale channel for a second, what are you seeing with orders from the wholesale channel and how do you think about the difference in product versus stores versus the wholesale channel? And then on the gross margin, any more color on the factory store cadence with the level of promotions and how you see that and how you are planning for it go forward? And just one more thing on operating margin by direct and indirect, levers to improvement particularly obviously on the direct side of the operating margin business and then the indirect? Thank you..

Yes, let me start with the wholesale channel. We still saw softness in the specialty channel, so their orders are still below what our expectations are. So, I wouldn't say we have stabilized that channel as of yet. You'll see in Q3, the indirect segment we are expecting to be around flat.

Now, we'll expect that to come down in Q4, so that really relates to timing of our release for winter. So, there will be a little more sales in October than there will be in November. So, really if you think about the indirect channel, I'd look at it Q1 and Q2 combined and then you'll have to look at it Q3 and Q4 combined as well.

So, we haven't stabilized that. Though we're seeing some good progress with some of our big accounts on the wholesale side. So we're very happy with that.

As it relates to factory, what we've seen out there with the competitive set is there's a lot of competition and the discounts have gotten really high in the factory channel and we expect that to continue over the course of the year.

So, we've baked that into our gross margin guidance as it relates to factory being a little less than what we would have anticipated from a margin perspective.

As it relates to operating margin, Dana, on the direct side of the business, we need to get the web growing again, obviously, and we're going to be able to leverage SG&A expenses when we get the web growing again in Q4. As it relates to stores, really the same thing. As we see positive comps in the stores, we'll be able to leverage SG&A.

That's really where we can improve our operating margin. On the indirect side, you'll see that it came down a little bit in the quarter, but that was really because of the shipments in Q1 having about $2.5 million more sales in Q1 due to timing than Q2 on the specialty side.

So, that impacted that operating margin on the indirect side for Q2, so a little lower than what we would expect on a yearly basis. But on the indirect side, we don't expect huge gains from an operating margin percentage.

I think what we'll be doing is trying to keep that relatively flat, especially as we move into department stores where you have a little more challenges as it relates to chargebacks and returns and things like that. So, expect flat from the indirect side generally speaking and improvement on the direct side as we get sales going again..

Thank you very much..

Thanks Dana..

Thanks Dana..

And once again we will hear from Mark Altschwager with Robert W. Baird. Mr. Altschwager your line is open, please go ahead..

I'm sorry about that. I was on mute. I just wanted to ask a follow-up product question on backpacks and the campus business.

What percent of your business does that represent in the second and third quarter? It seems like there has been a lot of excitement and emphasis there in the store, so just curious how that's performing relative to your expectations? Thanks..

In terms of our total campus business overall, generally, about 30% of our business is in campus. We were encouraged with the back-to-school performance. We had a lot of new product innovation that was brought in backpacks this year.

So, as we added a lot more solutions into our backpacks, brought the laptop functionality, and other functionality into the backpacks, we saw nice improvements. So, it's encouraging to see that category for us continue to be strong..

Thank you..

And our next participant is Steve Marotta with CLK Associates..

Good morning everybody. I had to join late, so please forgive me if you have gone over this. Kevin I believe that you mentioned that year-over-year marketing spend will be roughly flat for 2016.

Can you delineate that specifically for the third quarter and the fourth quarter growth please?.

Sure. So, we do expect that number to be relatively flat this year, but what we did do is we took some marketing dollars from Q1, Q2, and Q4 and we really put that into Q3 really to center around all the great marketing that's occurring in Q3 as it relates to the new marketing campaign et cetera.

So, there's about almost $2 million of additional spend as it relates to marketing going into Q3 versus last year. And then you see a reduction really across the board in Q1, Q2, and Q4 related to that $2 million. Also what you have in Q3 is the renovations, so there is a lot of stores that we're redoing.

As Rob mentioned, about 16 of them in Q3, so a lot of -- there's about a little over $1 million going into those renovations that will be expensed as well in Q3. So, that's really the $3 million of additional spend in Q3 versus Q3 last year..

Okay. A couple of other quick questions then.

As it relates to the percentage gain in Q3, what would that be in marketing spend on a year-over-year basis?.

I'll have to look at that and get that to you, Steve. But we spend about $38 million in total in marketing, so -- but I'll have to get that to you if you want that. But it's about $1.9 million of additional spend in Q3, but I'm not sure as a percentage what that represents off-hand..

That's okay; we can go over that later.

And the other question I had as it pertains to the renovations, how long do they have to be closed for or is this done while the store remains open?.

It varies across the store base. I think there will be some stores that don't need as much work and we may not have to close much and then there will be some stores that will have to be closed a few weeks to get the work done. But part of the reason we're doing it in September, October, Steve, is October is the smallest month of the year for us.

So, that's a lot of the reason for the timing is just so we don't impact sales too dramatically. That's why we have timed that to redo the stores in September and October versus doing them earlier during back to school period..

That's terrific. Thank you very much for the help..

Thanks Steve..

That concludes today's question-and-answer session. At this time, I will turn the conference back over to your host for any additional or closing remarks..

As you can tell, we're really excited about all of our rebranding initiatives that touch product, distribution, and especially marketing. Our team has been diligently and collaboratively working on these efforts for many months and we are all focused on superb execution as we finish out this year.

In the nearly three years since I've been at Vera Bradley, I believe we have never been better positioned to generate long-term growth. Thank you for joining us today and for your interest, time, and questions and we look forward to speaking to you on our third quarter call in December..

That concludes today's conference. Thank you for your participation. You may now disconnect..