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Vince Holding Corp. (NYSE:VNCE)

Q2 2014 Earnings Conference Call

September 3, 2014 09:00 pm ET

Executives

Jill Granoff - Chairman and CEO

Lisa Klinger - CFO

Analysts

Robbie Ohmes - Bank of America/ Merrill Lynch

Evren Kopelman - Wells Fargo

Erinn Murphy - Piper Jaffray

Matthew Boss - JPMorgan

Mark Altschwager - Robert W Baird.

Joan Payson - Barclays

Richard Jaffe - Stifel Nicolaus

Operator

Good afternoon my name is Sally and I will be your conference operator today. At this time I would like to welcome everyone to the Vince Holding Corporation Second Quarter and First Half Fiscal 2014 Earnings Conference Call.

All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. (Operator Instructions). Thank you. I would now like to turn the meeting over to Jennifer [Poland], Vice President, Finance. Please go ahead Ms. Poland.

Unidentified Corporate Participant

Thank you Sally and good morning everyone. Welcome to our second quarter and first half fiscal 2014 earnings conference call. I am Jennifer Poland, Vice President of Finance and joining me today is Jill Granoff, our Chairman and Chief Executive Officer, and Lisa Klinger, our Chief Financial Officer, who will be your speakers for today’s call.

Before we get into the discussion of our results, I need to remind you that any forward-looking statements we make today are subject to our cautionary statements regarding forward-looking statements found in our press release and SEC filings.

Our second quarter and first half earnings release and related financial information are available on our website under the investor section. For those who cannot listen to the entire live broadcast, a replay will be available for 30 days on our website at www.vince.com.

I would also like to point out that on November 27, 2013, Vince Holding Corp. completed its initial public offering. As a result of the IPO and the related restructuring transactions, Vince became the sole operating business of Vince Holding Corp. while the non-Vince businesses were separated

Additionally, on July 1, 2014, certain stockholders of the company considered a secondary public offering of the company’s common stock, with all proceeds going to the stockholders.

In today’s discussion, we are presenting financial results in conformity with GAAP including the financial results of the non-Vince businesses for the second quarter and first half of fiscal 2013 as Discontinued Operations.

In addition we will be presenting financial results relating to the second quarter and first half of fiscal 2013 on an adjusted basis in order to exclude the impact of results of the non-Vince businesses and certain public company transition costs, as well as fiscal 2014 on an adjusted basis, in order to exclude the impact of secondary offering expenses.

These adjusted results are non-GAAP measures and include adjusted measures such as adjusted selling, general and administrative expenses, adjusted operating income, adjusted interest expense, adjusted taxes, adjusted net income and adjusted earnings per share.

Discussions of these non-GAAP measures and reconciliations of them to their most comparable GAAP measure are included in today's press release and the schedule thereto which are available in the investor section of our website.

After our prepared comments, we will be available to take your questions for as long as time permits. Now, I'll turn the call over to Jill.

Jill Granoff

Thank you Jennifer and thank you all for joining us. I would like to welcome each of you to our second quarter and first half fiscal 2014 Vince Earnings Call, we look forward to today’s discussion.

Let me begin by saying that it was another terrific quarter for the Vince brand. This quarter’s performance was due to continued brand momentum as well as better trend in the high-end and accessible luxury sectors.

We delivered strong sales growth of over 20% in Q2 as we again achieved double-digit increases across all distribution channels. In wholesale, sales grew nearly 17% driven by the strong performance in both our women’s ready-to-wear and licensed footwear businesses , both domestically and internationally.

In the direct to consumer segment, we delivered overall growth of nearly 40%, with 7.1% comparable store sales growth, marking our 19 consecutive quarter of comp store increases. We also benefited from seven new stores opened since Q2 last year and from traffic increases across the fleet.

In addition, our e-commerce business continued its momentum due in part to products category extension. We find the solid double-digit growth, particularly impressive in light of the somewhat soft and highly promotional retail environment.

Our strong sales performance reinforces the fact that our compelling product assortment and everyday luxury essentials continue to resonate with our broad customer following. Additionally, we are pleased to report that we improved our gross margin rate by 400 basis points over last year’s second quarter, despite a relatively high promotional intensity in the retail industry.

We also increased adjusted diluted earnings per share in the second quarter by nearly 22% to $0.28. We believe these results further demonstrates the strength of our brand and establishes Vince as one of the leading contemporary fashion retailers in the marketplace today.

In just a few moments I will provide you with an update on our various strategic initiatives and our updated guidance for fiscal 2014, but first I’d like to turn the call over to Lisa, who will provide additional details on our financial results for the second quarter and first half of 2014. Lisa?

Lisa Klinger

Thank you Jill as you mentioned in our introductory comments. The company has presented adjusted financial results for the second quarter and first half of both fiscal 2013 and 2014 in order to provide investors with additional information to evaluate our comparable operating performance.

As Jill highlighted and as we anticipated, the company delivered strong total sales growth of 28.2% for the second quarter with net sales of $89.3 million, versus $74.3 million achieved during the corresponding period in fiscal 2013.

For the quarter, our wholesale segment sales increased 16.9% driven by strong domestic and international demand as well as our growing licensing business. Our direct to consumer segment sales increased 39.8% as we added seven net new stores versus the second quarter of last fiscal year, and we grew comparable store sales during the quarter by 7.1% over the comparable period last year.

This comparable store sales performance was on top of a 28.8% increase last year for a two-year stack over 35% and was driven by fairly balanced increase in both transactions and transaction size.

Gross profit in the second quarter of fiscal 2014 increased 30.8% to $44 million from $33.6 million in the second quarter of fiscal 2013 as a result of both an increase in net sales as well as an increase in the gross profit rates.

Gross profit as a percentage of net sales increased 400 basis points to 49.3% from 45.3% in fiscal 2013. The gross profit rate increase was driven primarily by supply chain efficiencies, strong penetration in higher margin products, and increased sales penetration of a direct to consumer, our international, and our licensing businesses.

Selling, general and administrative expenses in the second quarter of fiscal 2014 were $24.1 million or 27% of sales compared to $18.7 million or 25.1% of sales in the second quarter of fiscal 2013. Excluding the secondary offering cost and public company transition cost from the respected period, adjusted selling, general and administrative expenses as a percent of sales were 26.3% during this quarter and 21.4% in the second quarter of last year.

As we continued to invest in our growth, our SG&A rate deleveraged primarily due to increase labor and occupancy costs related to our retail growth strategy, strategic investments in our marketing program to build awareness and guide traffic to all of a distribution channels, investments in new talents to support our faded initiative, and incremental costs related to our public company status.

We also incurred higher deposition expenses as we strategically invested in new retail stores and wholesale shop in shops. Operating income for the second quarter of fiscal 2014 increased 33.1% to $19.9 million, compared to $15 million for the second quarter of last year.

Excluding the secondary offering cost and pubic company transition cost, operating income for the second quarter of this year increased 15.8% and as a percent of sales was 23% compared to 23.9% for the same period in fiscal 2013. This slight deleverage was again driven by investments to support our various growth initiatives and costs necessary for Vince to operate as a stand-alone public company.

GAAP reported net income for the second quarter of this year increased to $10.5 million compared to a net loss of $10.5 million for the second quarter of fiscal 2013. Reported diluted earnings per share for the second quarter of this year was $0.27 compared to a diluted loss per share for the second quarter of fiscal 2013 of $0.40.

Again in the fiscal 2014 result included a secondary offering cost and fiscal 2013 results includes impact of public company transition cost and result of the non-Vince events businesses that were separated on November 27, 2013.

On an adjusted basis net income for the second quarter of fiscal 2014 increased to $10.8 million from $8.7 million in fiscal 2013, an increase of 25.2%. Adjusted diluted earnings per share increased to $0.28 in fiscal 2014 from $0.23 on an adjusted basis in fiscal 2013.

Now moving on to the fiscal 2014 first half results. Net sales for the 26 week period were $142.8 million, an increase of 24.5% over the same period last year. This increase was driven by 20.7% increase in wholesale segment sales and 40.7% increase in our direct to consumer segment sales.

Our comparable store sales for the first half of fiscal 2014 increase 9.2% over the comparable 26 week period for fiscal 2013. This comparable store sales performance was on top of a 31.7% increase last year for a two-year stack of over 40% and was driven by nearly balanced increase in both transaction and transaction size.

Gross profit for the first of a fiscal 2014 increased 37.7% to $70.4 million from $51.2 million in the first of fiscal 2013. The increase in gross profit was driven primarily by the nearly 25% increase in net sales and an increase in the gross profit rate.

Gross profit is a percentage of net sales for the first of fiscal 2014 increased by 470 basis points to 49.3% from 44.6% in the first of last year. The increase in gross profit rate was primarily driven by overall supply chain efficiencies, increased penetration in higher margin products and increased penetration of sales, direct to consumer, our international’s, and I licensing businesses.

Selling, general and administrative expenses for the first half of fiscal 2014 increased 32.1% to $45.3 million or 31.7% of sales versus $34.3 million or 29.9% of sales in the corresponding period of last year. Excluding the secondary offering cost and the public company transition cost, adjusted selling, general and administrative expenses as a percentage of sales increased to 31.3% this year from 26.4% last year.

Consistent with the second quarter, the deleverage in our SG&A rate for the first half was driven primarily by increased investments support our growth initiatives and for Vince to operate as a stand-alone public company.

Operating income for the first half increased $8.3 million or 49% to $25.2 million, up from 16.9 million in the first of last year. Excluding the secondary offering cost and public company transition cost, adjusted operating income increased 21% compared to the same period in fiscal 2013.

As a percentage of sales, adjusted operating margin for the rest of this year was 18% compared to 18.2% in the first of fiscal 2013. On a GAAP basis, the company reported net income for the first half of fiscal 2014 of $11.9 million, which includes the impact of the secondary offering cost, compared to a net loss of $25.6 million for the first of fiscal 2013, which includes the impact of public a transition cost and the results of the non-Vince businesses that were separated on November 27, 2013.

Diluted earnings per share for the first up was $0.31 compared to a net loss per share for the first half of last year of $0.98. On an adjusted basis, net income for the first of fiscal 2014 increased 39.7% to $12.2 million, compared to $8.8 million for the first half of fiscal 2013, and adjusted diluted earnings per share increased 39.1% to $0.32 compared to $0.23, earned in the first half of last year.

Now moving on to the balance sheet, the company’s cash balance at the end of the second quarter were approximately $0.1 million as we more aggressively managed our debt levels and interest expense. During the second quarter, the company voluntarily reduced its debt by $10.4 million, resulting total debt outstanding of $139.6 million as of August 2, 2014, comprised of $117 million of term loan debt and $22.6 million of revolver debt.

Since the IPO in November 2013, we had voluntarily paid down $35.4 million of the initial $170 million debt outstanding, while investing behind our various growth initiatives.

Inventory at the end of the second quarter of fiscal 2014 was $58.6 million versus $34 million as at February 1, 2014 and $28 million at the end of the second quarter of fiscal 2013. This planned year over year increase was primarily driven by the addition of seven net new retail stores since second quarter of last year, a projection of 5 to 6 additional fiscal 2014 store openings and 15 to 20 new shops in shops anticipate to open in the back half of fiscal 2014.

Our inventory balances are also impacted by the rollout of our omni-channel replenishment program and received increases required to support our overall sales growth and category expansion initiatives.

Capital expenditures for the second quarter totaled $6 million of which 2.2 million was attributable to the real estate activity such as new and remodeled stores and shop in shop build-out. Additionally, $3.5 million of the capital spend during the quarter was attributable to our new headquarter and showroom space in New York.

As of the end of the second quarter of fiscal 2014, the company has signed eight leases for stores that are expected to open in fiscal 2014 or beyond. Two of these stores opened in the past few weeks in Boston and Pasadena, and as of today, September 3, the company has 33 stores in the US, including 27 full price stores and six outlet stores.

That concludes my comments regarding our second quarter and first half fiscal 2014 finance performance. I will now turn the call back over to Jill, so she can provide you with an update on our key strategic initiatives and our updated outlook for the year. Jill?

Jill Granoff

Thank you Lisa. We’re proud of our strong second quarter 2014 financial performance and the continued progress we are making in our evolution to becoming a global, dual gender lifestyle brand. I would now like to update you on that evolution and share with you our increased financial outlook for the year.

First and foremost, it is a goal to win with product. Vince’s strong second quarter and first half performance points to the power of our brand and product offering. During the second quarter, we maintained our leading position in women’s contemporary apparel sweaters, knit tops and blouses remained our largest categories. At the same time we also saw double-digit increases in dresses, outerwear and leather jackets.

We’re focused on addressing a broader variety of wear occasions and our customers are very receptive to this expanded product assortment. Our newly elevated men’s collection is also resonating with our retail partners and customers alike, and we expect double-digit growth in menswear in the back half of the year.

From a licensing standpoint, we continue to see strong demand for Vince women’s footwear, which is now sold in over 350 points of distribution world wide and is one of the bestselling contemporary footwear brand at many of our wholesale partners.

Building upon our success in woman’s footwear we launched men’s footwear in August in 50 top department and specialty doors, select Vince retail stores and on Vince.com. Additionally, the new Vince kids apparel line launched in store in June at our premier department store partners and at select Vince retail locations and on Vince.com.

Although it is very early, we are very pleased with the customer’s response to this new product extension. Next, in addition to the strong results of existing apparel and licensed categories, we’re very happy to share the details of our new handbag collection, which we developed in-house.

We held a press day in late July where we premiered our spring 2015 capsule collection and we are delighted that the initial market reaction was very favorable and the product created immediate excitement across Instagram and other social media channels.

Our new handbag collection will officially launch in the fourth quarter ahead of our first-quarter 2015 expectation that our own retail stores and website as well as exclusively at several key Saks domestic location and at Saks.com.

This new product launch will mark a major milestone in our evolution to becoming a global lifestyle brand, and we are very proud of the team and all they have accomplished to get us in to the market prior to the important holiday season.

Our second major growth opportunity is to expand our distribution. We remain focused on maximizing productivity in our existing wholesale doors selectively adding new doors and expanding our international presence.

Domestically, we continue to pursue shop in shop investments, with plans to open 4 to 6 additional domestic women shops during the second half of fiscal 2014, as well as 10 to 14 additional domestic men shops, given the strength of our new men’s assortment and strong interest by several retail partners in accelerating our men’s shop in shop penetration.

Based on this projected activity, we plan to end the year with approximately 26 to 32 total domestic shop in shops. From an international perspective, we are seeing strong growths driven by both new product introductions and new partner relationships.

During the second-quarter we saw nice growth in the UK, Canada and the Middle East, and we show traction in newer territories such as Germany, Turkey, Scandinavia and Benelux. Additionally, similar to our domestic wholesale strategy, we plan to leverage the success of previous shop in shop expansion strategy and open 1 to 2 new shop in shop in Korea in the second half of fiscal 2014.

We will also opportunistically pursue locations in Japan and the UK, bringing our total international shop in shop count at the end of this year to a range of 12 to 14 shops. Now moving on to our direct to consumer segment, we continue to grow our highly successful retail store footprint and we believe we are on track to open 8 to 9 new stores in fiscal 2014.

We opened three stores during the second-quarter; to dual gender stores in Boston, one on Newbury Street, and another is Chestnut Hill, and our first men’s only store in the meatpacking district of New York. These stores are currently performing at or better than we projected and we view the men’s only store as a great learning lab that will enable us to further optimize men’s business.

Also, earlier in August, we opened two additional stores. Our first store in the Philadelphia market on Walnut Street Downtown, as well as a new store in Pasadena, California. Both of these stores are dual gender stores and will increase our brand penetration in this important consumer markets.

Given that we have now opened five stores year-to-date, we will open 3 to 4 additional stores in the balance of the year, and we also have a solid real estate pipeline into 2015 and beyond with numerous projects in various stages of negotiation.

From an e-commerce prospective, we continue to focus on accelerating our digital growth supported by recently relaunching the website. Since the relaunch, our traffic is up and we have seen positive customary action to our shop-the-look section, which has resulted in successful wardrobing transactions.

Our next key initiative is to optimize our mobile and tablet customer experience and showcase the new handbag launch in the upcoming fourth quarter. Third, we are focused on increasing brand awareness to drive additional traffic and build our loyal customer following.

We recently conducted two research studies among both existing and qualified customers. The study show that from our last study in 2012, brand awareness among qualified customers has increased significantly from 20% to 33%. In addition, Vince continues to have high brand affinity and purchase intent, and there are strong perceptions of quality and value for the brand.

We recognize that we still have significant opportunity to build awareness program, and will utilize these consumer research findings to help us refine assortment strategies, strengthen marketing and branding initiatives, and identify additional product opportunities.

In addition, we believe these findings will validate our efforts to increase marketing investments and strategically expand our product offerings into related categories such as handbag.

Lastly, as evidenced by our strange gross margin rate expansion, we continue to leverage our scale in overall growth to gain operational efficiencies. As a result of a better product-to-market planning, we continue to lower our air shipment ratio from last year during the second-quarter, and we believe there is still improvement available in this area.

Additionally, we have lowered our freight costs through various supply chain initiatives, streamlined our supply base, and recently signed an agreement with a preferred sourcing partner in Asia. This partner is in the process of staffing and opening a Vince office in Hong Kong that will exclusively assist us with product development, quality assurance and vendor evaluation, as you grow our business in the region.

We are very excited about this revolution and how we operate and interact with our vendors and believe this will be a key driver of our long-term growth and profit improvement strategy. Given these very exciting activities, along with our strong second-quarter performance, we have increased our guidance for fiscal 2014 as follows.

One, the company now expects to achieve total net sales of 335 million to 345 million, including revenues from 8 to 9 new retail stores and comparable store sales growth in the high single to low double-digit range. Two, the company now expects gross margin expansion of 200 to 275 basis points driven primarily by margin rate increases due to operational improvements and the higher penetration of direct to consumer sales.

Three, we now expect to increase adjusted selling, general and administrative expenses as a percent of sales by 200 to 275 basis points over the adjusted fiscal 2013 rate of 25.6%, as we expand our reach of operation, invest strategically in marketing programs, and incur incremental public company cost for a full 12 month period.

Taking into account our current net sales, gross profit and SG&A forecast, we now anticipate generating adjusted diluted earnings per share of $0.90 to $0.94 for fiscal 2014 versus prior guidance of $0.88 to $0.92 per share.

Finally, we expect our capital expenditures to be in the $18 million to $22 million range in fiscal 2014, as we open new stores, add shop in shop locations, relocate and combine our New York corporate offices and relocate and expand our LA offices.

In summary, we remain optimistic about the balance of 2014, and the company’s long-term prospect as a high-quality, rapidly growing luxury lifestyle brand. While we recognize that we cannot control the macroeconomic environment, we are confident in our sales plan and the great work being done by design and merchandising teams to deliver compelling new product to the marketplace.

We believe we have a long growth runway, and a team is working aggressively to build the business with new product introduction, compelling shopping experiences, as well as demand creation initiatives.

We continue to exploit new sales opportunities in each of our destination channels in key markets and we remain focused on achieving gross margin rate expansion through our various operational improvement initiatives, our significant growth opportunities from a product, channel and geographic perspective, combined with our loyal and passionate customers who love us and spend have us very excited about our future.

Before done in the call over to questions, I would like to thank our amazing Vince team in New York, LA and the field for their tireless efforts in building the brand and driving these impressive results, as well as our wholesale, licensing and international distribution partners to continue to showcase and support the brand. Thank you. Operator, we will now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Robby Ohmes with Bank of America/ Merrill Lynch. Your line is open.

Robbie Ohmes - Bank of America/ Merrill Lynch

Just a couple of quick questions, first, could you give is a sense of how the outlet comps are performing versus full line. Are they similar or different and then I think in your guidance you are sort of implying that comps could reaccelerate in the back half from the 7.1 that you just put up. Is it just the easier comparisons or are there other drivers for the fall season that give you confidence that the comps could potentially move back into double-digit and then I have a quick follow-up thanks.

Jill Granoff

Sure. Well, in terms of full price and outlet, both stores continue to show positive comps, they are improving in both sales, productivity, as well as overall profitability and generally all of our new stores are performing at or above our internal expectations be that outlet or our full price stores. So we’re not seeing a huge difference across full price and outlet performance.

In terms of the 7.1% comps, we knew that would be a question that everyone was going to ask, and we did project that a sequential comparable store sales would slow within the second-quarter, because clearly, we cycled on strong prior com performance.

I think as you know, we had a 36%, nearly 36% two years [Sak], which we are pretty proud of in this relatively soft and highly promotional retail environment. Also, we had increases in traffic, which I think is really good, as well as average unit retail. So we had a pretty balanced contribution of comp growth from both an increasing transactions, as well as transaction side.

So there were a lot of [consumer] challenges at most retailers based in Q2, and anything this was good overall. I think the other thing that should be pointed out is that our comp store sales growth rate was slightly impacted by some new stores that we opened in key markets, as well as the fact that we remodeled Washington Street, and so basically, we saw slight negative impact to comps in the near-term, but certainly benefited greatly from increased brand awareness and market share as total sales grew overall in these markets, which we think is really important.

And in addition we’ve seen broad-based improvement in our e-commerce business. So I think when you sort of pull it altogether, if you look at comp store performance, non-comp performance, and e-commerce performance, we delivered 40% growth in direct to consumer overall, which I think demonstrates that our strategies are working.

In terms of the back half of the year, we want easier comparisons and in addition to that, we are going to have some new categories, so that will certainly help in the retail arena, especially with handbags, which is totally new and then we do have kids and men’s in some stores. So we think that this will drive some incrementality. So that’s why we have reaffirmed our comp guidance for the year of high single to low double-digit growth.

Robbie Ohmes - Bank of America/ Merrill Lynch

And I know its early Jill but how does the overall environment feel early fall versus eke out a little promotion there in spring, any thoughts for us?

Jill Granoff

It’s still feeling pretty promotional, so we think we have a really powerful fall collection, so we feel very very confident in a product offering, which is at the end of the day is what we believe differentiates us, but I would be remiss if I didn’t reiterate that the environment is still challenging and promotional.

Operator

Your first question comes from the line of Evren Kopelman with Wells Fargo. Your line is open.

Evren Kopelman - Wells Fargo

I think I heard you say when you were talking about the comp in the quarter, that the average unit retail improved. What was the driver of that, was it just the product mix shift or did you also feel the markdown year-over-year, as well as promotion?

Lisa Klinger

That was really shift in mix.

Evren Kopelman - Wells Fargo

Okay, and also the topic of comp, can you talk about I think you opened your Soho flagship last year around this time, and then you have the Upper Westside store I think which is larger than your average store. As those store answer the comp based, how should we expect that to impact, I didn’t to know if t, if you should tell me what should we watch out for in our models as we think of the quarterly impact.

Lisa Klinger

Yes. I mean, obviously, both of those stores are being flagship stores in New York City, operate higher than the comp average. So when they do join the base, it will be additive much like when we added our Madison store last year.

Evren Kopelman - Wells Fargo

Okay, and then lastly on the gross margin could you quantify some of the buckets, you mention in terms of the impact of the supply chain versus some of the product channel mix contribution. Thank you.

Lisa Klinger

Sure, if you want to sort of go top to bottom, really, we highlighted the fact that we had an improved mix across some higher margin product assortment and some of the mix that we have across the store, and that was roughly 145 basis points of the improvement, sort just nice product contribution.

The fact that we had a strong sales performance in international and licensing, and again from licensing perspective, it doesn’t drive a lot of the top line but it is relatively high contributor to profit being a 100% gross margin business. So the increase in the international licensing drove about a 115 basis points.

The operational improvements and all the initiatives that we’ve highlighted in the past that Jill reiterated in her comments contributed about 85 basis points, and then the overall direct to consumer increased penetration was about 55. So those for major pieces really total up to the 400 basis point improvement that we saw in the quarter.

Operator

Your next question comes from the line of Erinn Murphy with Piper Jaffray. Your line is open.

Erinn Murphy - Piper Jaffray

Good morning and congratulations on a great second-quarter. Lisa you talked a little bit high level on just the inventory balance at the end of the quarter, but I was hoping if you could walk through may be, in a little bit more detail, may be bucket out some of those components of the inventory increase, just so we can kind of appreciate where the major dollar increases were on a year-on-year basis.

Lisa Klinger

Sure. I think I want to make sure that everybody on the call understands their inventory management is clearly a top priority for this management team. It is monitored in detail on a very regular basis, and that overall we are comfortable with where we are positioned, as really our inventory is all relatively current, and is really in a great position to help us achieve a growth goal for the year.

Again, when I say that the inventories are primarily current, what I mean there is that more than 75% of our inventory is currently selling at full price. If you include the most recent season that we actually go slightly above 90%, so that includes what’s currently on sale in our stores. So 90% of that inventory totals in stores are either selling at full price or at a promotional rate right now. So these levels are relatively in line with last year.

Now if you want take a look at the various buckets, we highlighted a few areas; so new stores, our replenishment program, and the anticipated new shop in shops, those three pieces contributed about 25% of the year-over-year increase. We do have some timing shift, as many of you are aware of fall is our largest selling season.

We make those deliveries 830, 930, 1030, and so we did have some timing with receipt of our fall goods that are planned for shipment and sale in the third quarter. So timing of receipts versus timings of sales and shipments was a big contributor in that year-over-year increase, but again it’s all current and nearly all of that has order apply to it. And then we just have baseline growth in the business.

So we feel very good about where we are situated today from a quality perspective from inventory, while the quantity might be higher looking at it on paper we think that it positions us very well for where we need to be for the back half of this year from a sales support perspective.

So we would look for our year-over-year inventory increases to start to slow, it’s going to be at lower rate for the rest of the year, and I think as we’ve mentioned before, around year-end we would be looking for a year-over-year inventory increase in the range of kind of 25% to 35% year-over-year.

Erinn Murphy - Piper Jaffray

Got it, that it is super helpful. Thank you. Lisa, and then maybe just on the cost of good environment, from an AUC perspective, could you just may be speak to what you are seeing from a cotton perspective as you look out or currently now you need to look out over kind of the next couple of seasons, and then also how that compares and contrasts with other costs right now.

Lisa Klinger

I think we all know that cotton prices are down, you know they are the lowest levels they have been in quite some time and we are certainly using that as an opportunity to discuss better AUCs with the key vendor partners. I wish I could say the same for leather, but that’s not the case, but luckily we do a lot more in cotton than we do in leather.

But overall I would say that, we feel very good about our average unit cost, if anything, we do believe that we’ll be able to see improvement in that area, which is helping to drive our gross margin expansion, because we have done things by consolidating our supplier base, we also have a new partner in Hong Kong as you mentioned.

So we are able to reduce our agencies. And also when you look at a fully loaded cost, that includes logistics that switched from land to duly paid to FOB to give us greater visibility across the supply chain.

So we are really looking at all facets of cost not just the raw material costs, but overall labor giving greater concentration to a select vendors and really just improving our supply chain end to end. So as a result, we do not feel pressure in our average unit cost overall.

Erinn Murphy - Piper Jaffray

Okay, that’s good to year and then Jill just last for you. On the handbag launch, it sounds like you’ve got some great responses so far from the press, can you speak a little bit more in detail about the assortment what you most excited about, and then how should we think about some of the product that flows into your own retail stores in time for holiday before the big launch next spring.

Jill Granoff

We’re so excited about the handbag launch, we did have a press preview and this whole social media thing is crazy. But the next thing you know, it was all over Instagram and then people were asking where they can buy the bags and we were seeing it as one of the frequently asked items on our website. So the initial reaction certainly from the press that came in, the bloggers and the influencers was quite strong.

We’re delighted that were able to get a capsule collection out for holiday. So the spring launch overall will have three collections in total. We will get one of those collections out in time for holiday. It’s great opportunity for us to test and learn. We will be in our own stores, as well as on Vince.com, and then we do have an exclusive partnership with Saks Fifth Avenue in roughly 26 stores plus Saks.com and we’re working on a lot of different initiatives.

So I think the exciting thing that the handbags really are true to our core brand DNA, and they are modern and they are clean, great quality, high value. You know even if you think of rare occasions you are going to see toads, cross bodies, some clutches, but its really, really beautiful products, it’s been developed in Italy, it has really nice hard work details, and you will also see subtle branding, obviously in Vince you don’t see branding, the labels are on the inside.

But you will see some subtle branding details on outside, because we know that that is important for women when they make their handbag purchasing decision.

So Saks has been very, very excited, we think we are priced in a sweet spot in the market as we’ve talked about previously in that white space of $500 to a $1000 a square foot and we will have very nice presentation on the floor based on what space permits either in designer or contemporary area. So far we are very, very excited and more to come.

Operator

Your next question comes from the line of Matthew Boss with JPMorgan. Your line is open.

Matthew Boss - JPMorgan

Your gross margin performance clearly remains impressive, but higher SG&A is the offset. So as you think about margins going forward though, number one, do you see any structural impediments on the gross margins that we can get 50 or above. And then number two, is it fair to think about an accelerating pace of EBIT margin expansion next year or are there any constraints to be aware of that would hold the EBIT margin gains back next year and beyond.

Lisa Klinger

So there is nothing structural that want us to go back to the 50% [gross] margin rate that we were at few years ago. Again structurally we’ll see how we perform through that shift. From an EBIT perspective, again, we don’t necessarily provide guidance on 2015 just yet.

But I think when we have spoken about the future, we have said that we will need a couple of years of investment from an SG&A perspective, and wouldn’t really see any sort of meaningful operating or EBIT margin expansion for 2 to 3 years was the IPOs.

So again, we don’t see anything structural that would prevent us from achieving EBIT margin expansion in the future either.

Matthew Boss - JPMorgan

Can you speak to some of the changes on the marketing front, what to expect going forward, and then with that where do you see brand awareness today and what do you think the opportunity is going forward?

Lisa Klinger

Certainly we think that we have an opportunity to increase our marketing investment in our to build a brand awareness and our loyal customer following. When we first did our research back in 2012, our awareness was a 20%. Initially we were surprised by that, but then when we reflected upon it wasn’t that surprising, because we hardly spend any money on marketing.

We didn’t have shops, we didn’t have stores, our website wasn’t there to be. So clearly over the last two years, we have made a lot of windows and we just completed an update to our market research study and we have been able to increase awareness among qualified customers from 20% to 33%.

So we think that’s a nice improvement over this period of time. Clearly, there is still significant opportunity to increase awareness further, we’d like to get it up to 50% the next few years, and that’s why we’re looking to increase the investment overall.

But we have stated previously that the last year we spent about 2.6% of sales, and a goal this year is to spend 3% of sales rationing that up to 4% of sales, obviously on a significantly higher sales base. So that means a lot more dollars for marketing investments.

In terms of where we’ll spend a marketing dollars, we will continue to invest behind co-op advertising, which is obviously very important given our strong wholesale business. But in addition to that, we will be doing more year round print advertising. In the past, we focused on the fall, we are now doing spring and fall, we are doing dual gender advertising, which we haven’t done in the past.

The thing look books have a great ROI, we send them to homes, we have a call to action to drive to stores. So we are investing there, we are investing in search engine optimization and search engine marketing to support a digital growth projections, and then also we’re doing a lot more in the PR arena, which we think is great. We are seeing a great increase in the editorial credits that we’re getting, also we’re doing a lot more celebrity dressing, and we know this is important to build a buzz.

Again, we are pleased with the progress that we’ve made. We will continue to invest and increase our investment in this area as we then look to drive greater awareness and also continue to build traffic increases.

Operator

Your next question comes from the line of Mark Altschwager with Robert W. Baird. Your line is open.

Mark Altschwager - Robert W. Baird

Congratulations on an excellent quarter. I just wanted to talk a bit about the pace of new product introduction, you know we’ve seen a lot recently with footwear, kids and the broader assortment overall. So where is the assortment today versus where you want it to get in terms of breadth and depth, and then more broadly, how should we think about the revenue growth from greater productivity of core skews and bringing new customers to the brand versus these new offerings and greater share of wallet from existing customers.

Lisa Klinger

I just want to be sure that we reiterate that many of the new product categories are licensed. So that means we’re not going to see a big impact on sales line for things like women’s footwear, men’s footwear, and the kids apparel lines. Obviously we think those are very, very important from a brand building initiative, and we love the royalty income, which flows through to the bottom line almost dollar-to-dollar.

So that’s important. So in terms of the pace of the new product introductions, we internally are very focused obviously on our women’s ready-to-wear business. We want to maintain dominance in tops, while radio broadening the assortment to encompass both head to toe look, so bigger emphasis on bottoms and pants, as well as addressing a broader variety of wear occasions, including dresses and also outerwear, which currently includes jackets, and the good news is, when we look at our bestselling categories, we saw tremendous amount of traction in dresses and outer wears.

So we will see growth in our core skews, we never want to walk away from our core, we want to build upon our core with some new product categories like dresses and like outerwear, and obviously we see an opportunity in the pants business as well, which by the way, did have high single-digit growth this past quarter. So that’s also an area of growth

From a men’s perspective, there we are looking to elevate the assortment, we are very excited about the fall collection, which is really the first collection developed by a new menswear designer [Nicky Wiseman], and the reaction has been tremendous.

We are seeing great growth in our own stores and also traction in the department store doors. That’s really an elevated assortment with great branding details, interesting materials, and also we are looking to address our wider wear occasions, and we’ve introduced things like suit separates et cetera.

So I think the key drivers of growth in the near-term will continue to be women’s ready-to-wear and our men’s sportswear business. Obviously, we have high hopes for handbags as well, but you know, obviously for this year its capital collection in Q4, so that’s not going to be that material, and then based on our key learnings, we think that can begin to ramp up over time.

The other categories as I said are licensed categories so that won’t be a material top line mover, but we’ll contribute to both margin and bottom-line profit expansion.

Mark Altschwager - Robert W. Baird

This very helpful. Thank you. Just a quick clarification on the handbags, is any impact from the handbag launch incorporated in the revised revenue guidance, if so can you quantify it. And then secondly, how big of a business do you think handbags can be for you over the next couple of years?

Lisa Klinger

Mark we certainly have incorporated the early launch. We have to understand it’s a small capital collection that’s going to primarily be in a handful of Saks stores as well as a handful of our stores and our online business. So is going to be $1 million to $2 million quite truthfully in the fourth quarter.

So not substantial, again given the limited distribution and the short amount of time, but we do think that it is a clear milestone for us as we evolve into the lifestyle brand that we communicate, and so from that perspective, we are very excited that we were able to get into the market prior to the holiday season, and I guess I’ll refer to Jill on her long-term thoughts for handbags.

Jill Granoff

I mean, look, we have seen what competitors have been able to do with a successful handbag business. We love the fact that it is more seasonless, that you don’t have sizes, and it’s easier to sell online, that’s a higher ticket, and we’ll have good margins once it reaches scale. So we think that there can be great potential, at this point we are reticent to talk about a number until we have really seen what the initial results and consumer reaction are, so let’s talk about that are given a subsequent call.

Operator

Your next question comes from the line of Joan Payson with Barclays. Your line is open.

Joan Payson - Barclays

Could you please speak a little bit too international growth and the opportunities, maybe which regions of the best performers right now, whether awareness is highest and which areas you are investing the most in.

Jill Granoff

Certainly, we definitely had nice international growth this quarter, and what we’re seeing is that the best market for us are really the UK, Canada, Japan, and we are also seeing nice traction in the Middle East. We are currently number one with Harvey Nichols Dubai and Bloomingdale Dubai and we see that as a source of opportunity going forward.

If you look across the board, we are showing nice year-over-year growth with our key international department stores, good sell-through, and we are in the top five in most terms.

In addition, some of our international partners are also buying our women’s footwear in their very excited about the new elevated men’s assortment that’s beginning to hit stores right now. So we feel very good about that, and going forward, we are going to continue to take a concentrated approach. So while we are in 47 countries today, we will concentrate in our four largest markets those being Canada, UK, Japan and Korea.

As a matter of fact, I’ll be going to Asia in October to meet with the Korean partners, Japanese partners. You really look at the business in China, Hong Kong, because we do see Asia as a key growth opportunity, in addition to that, we are investing in Western Europe.

We have just hired someone to be a director of Western Europe, recently joined us, so we are very excited about that. We’re also seeing growth from some of the new deals we signed in Western Europe, whether that’s Benelux or Scandinavia. We’re doing great in Germany, Turkey. So we are seeing nice growth there.

So I would say the areas of concentration just to summarize would be our key markets today plus, as I said newer markets, which would be Western Europe, China, Hong Kong and the Middle East.

Joan Payson - Barclays

And then just in terms of the retail comps, you provide some helpful color on the back half earlier. But could you also talk a little bit about, what drove the deceleration between 1Q, up 11% and 7% in the second quarter, or maybe were the biggest differences were?

Lisa Klinger

Again, it was a very balanced or similar trends in the first quarter versus the second quarter, again from contribution of both tickets and transaction size. So again, it was a good healthy mix of both. What we’re really pleased with the second quarter was increased traffic. Again in a relatively tough retail environment that was out there, seeing the nice increase in traffic that we saw was very good.

I think that we did see consumers focus a little more on buying our wear now, and so we’re thinking about that as we move forward with our 2015 collection where we’re already working on. But I would say that there wasn’t any sort of significant shift in traffic, in ticket, in AUR.

It was a pretty similar trend to what we saw in the first quarter again from cycling perspective, we were cycling on a very strong second quarter last year as well.

Operator

Your next question comes from the line of Richard Jaffe of Stifel. Your line is open.

Richard Jaffe - Stifel Nicolaus

I guess a follow-on to the inventory question wondering how that, I know it’s balanced because its essentially a new product, so I was wondering how its meant for each of the different channel, whether it’s men’s or women’s the major retail partners, your own stores or what will be held for on if that’s going direct to consumer.

Jill Granoff

It’s all of the above. Again, the inventory reflects where we get our sales. So the vast majority of it is in women’s ready-to-wear. Certainly a large portion of that has already been spoken for from our wholesale partners from their initial full price orders.

We also certainly have some of that product set aside for fourth quarter off price shipments to our wholesales partners, and then obviously we plan each store and allocate each store in our fleet as well as e-commerce business appropriately as well.

So again, we are very methodical and how we think out our inventory plans and our buying decisions and so it’s all channels, it’s both genders, and it’s clearly ratable across our sales plan.

Richard Jaffe - Stifel Nicolaus

And how much of this increase is related to this increase in customer choices that you brought in the offerings for both men’s and women’s [progressive investment].

Jill Granoff

I didn’t hear, you broke up a little bit in there Richard. How much was what?

Richard Jaffe - Stifel Nicolaus

I am sorry, the customer choices, how much has customer choices increased and how of that would be explainable would help explain the inventory buildup, that’s just more SKUs, more style.

Jill Granoff

So, again we believe (inaudible) but that’s just part of the underlying growth strategy. So when we are putting together our merchandising plans, we put together our lion plans to reflect that, and we buy accordingly.

From a true new category perspective, again most of those new categories are licensed businesses, so we do not have or carry the inventory for women’s footwear, men’s footwear or children’s wear.

Richard Jaffe - Stifel Nicolaus

I get those signs of look at department store assortment broadening and wondering what the change would be year-over-year.

Jill Granoff

Again that’s part of our merchandize lion plan of how we buy it. So again --.

Richard Jaffe - Stifel Nicolaus

Jill I am just trying to understand the change, you got [25] in maintenance last year, this year you got [50] a huge increase and try to quantify that.

Jill Granoff

You are breaking up really poorly, I caught about half of you question.

Richard Jaffe - Stifel Nicolaus

Okay, I will take it offline.

Operator

There are no further questions at this time. Ms. Granoff, I will turn the call back over to you.

Jill Granoff

Thank you all for listening and participating in our call today. We look forward to speaking with you again in early December for our third quarter earnings call. Have a great day.

Operator

This concludes today’s conference call. You may now disconnect.

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Source: Vince Holding Corp. (VNCE) CEO Lisa Klinger on Q2 2014 Results - Earnings Call Transcript
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