Vera Bradley Inc (VRA) 2012 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to today's Vera Bradley fiscal 2012 third quarter results conference call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question and answer session. Instructions will be provided at that time for you to queue up for questions. As a reminder, today's conference is being recorded. And now I would like to turn the conference over to Mr. Paul Blair, Vera Bradley Investor Relations. Please go ahead, sir.

Thank you, Rica. Good afternoon and welcome. We would like to thank you for joining us this afternoon for Vera Bradley's fiscal 2012 third quarter results conference call. Some of the statements made on the conference call during our prepared remarks and 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. Those risks and uncertainties are described in today's press release and in the Company's Form 10K filed with the SEC. 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.

In addition, during this call we'll make reference to certain non-GAAP financial measures, including the adjusted net income and adjusted diluted earnings per share. A reconciliation of these non-GAAP financial measures to the net income and earnings per share is included in the press release issued this afternoon, a copy of which is available on our investor relations section of the Company's website, at www.verabradley.com. We understand that this is a very busy reporting day, and we'll do our best to keep today's call in close to an hour in length. Therefore during our question-and-answer session, we ask that participants pose one question with one follow-up to allow as many callers as possible the opportunity to take part in today's call. I will now turn the call over to the Company's CEO, Mike Ray.

Thank you, Paul, and good afternoon, everyone. I'd like to thank all of you for joining us today. With me are Jeff Blade, our Chief Financial and Administrative Officer and Roddy Mann, our Executive Vice President of Strategy and Business Development.

Today we'd like to focus on three main topics. The highlights of our fiscal 2012 third quarter performance, an update on our progress against the Company's long-term growth plans, and our outlook for the balance of fiscal 2012. During the third quarter, we continued to experience strong demand for the brand across all of our sales channels as reflected in the net revenue growth of 32%. This positive momentum is the result of a fresh product portfolio that continues to resonate with consumers, a healthy and growing base of indirect retail partners, the opening of new Vera Bradley stores, an increase in comparable store sales, and the continued growth of our e-commerce business. These strong results are on top of an increase in net revenues of 26% in the same quarter last year. One of the key drivers of growth in the third quarter was the overall strength of our product offering, led by the September release of our winter assortment and enhanced by the continued success of our fall collection, as well as a number of high-performing patterns and styles from prior releases.

In our indirect segment, net revenues grew 16% during the third quarter, incremental to growth of 10% in the same quarter of last year and following an 18% increase in the second quarter of this year. The sales increase in this quarter includes some modest sales of retired inventory. We experienced strong growth across all of our sales regions, driven by the strength of our product offering and by improved productivity through our retail partners. They continue to represent our brand well by providing our customers with excellent service and unique shopping experiences. During the quarter, we worked closely with our retail partners with an expanded array of sales tools and an emphasis on building their holiday inventory to ensure that they were in the best position possible to serve our customers during the important kick off of the holiday shopping season. In our direct segment, net revenues increased 63% during the quarter, reflecting strong growth across all of our channels, including full priced stores, outlet stores and our e-commerce business. Our direct segment accounted for 43% of revenue in the quarter, up from 35% in the third quarter of last year.

In our stores, net revenues grew 72% in the third quarter driven by the opening of 13 full price and four outlet stores during the past year, as well as an increase in comparable store sales of 7.4%. The comparable store sales growth is incremental to an increase of 32.5% in the same quarter last year. Our e-commerce net revenues grew 55% and represented 23% of total revenues during the third quarter. A source of this increase was growth in both traffic and conversion with an appropriate mix of full and reduced price sales. The channel is growing at an impressive rate, and we're constantly making improvements to content, targeting and promotional offerings. This strong growth across distribution channels and disciplined management of SG&A resulted in adjusted consolidated operating and net income increases of 39% and 45%, respectively during the third quarter.

Overall, we are pleased with our performance during the period as it reflects the continued strength of the Vera Bradley brand and significant opportunity for future growth. We believe that our iconic brand, distinctive designs and exceptional customer loyalties support our long-term growth strategies of expanding our product offerings and our presence in underpenetrated markets. As we execute these strategies, we are focused on several key initiatives during fiscal 2012. We continue our long tradition of bringing to market products that resonate with our loyal and diverse consumer following. Our merchandising, product design, marketing and sales efforts are increasingly integrated, yielding seasonal product offerings that both surprise and delight, elevating the consumer's experience with Vera Bradley. This is evident in the success of our winter product assortment which includes an expanded range of holiday gifts.

In addition to expanding our product offerings, we will continue to focus on growth in underpenetrated markets. We believe that there is a significant growth opportunity founded on the strength and portability of our brand and our significant multichannel distribution capabilities. In the department store channel, according to plan, we introduced our brand in an additional 30 Dillard's stores during the quarter. We are now in 65 locations and are encouraged by the consumer response to our presence in this channel. We are continuing to refine our product assortment and enhance the visual presentation of the Vera Bradley brand within these stores. Dillard's provides yet another way to attract new customers and gives existing Vera Bradley customers another opportunity to access our products. We appreciate the spirit of partnership from the entire Dillard's team and are enthusiastic about the future opportunities to grow the relationship.

During the quarter, we opened four full price and two outlet stores, including stores at the Mall of America in Minneapolis, King of Prussia in Pennsylvania, Smith Haven on Long Island and Miramar outlets in Florida. Our final new store for the year opened in new early November in 12 Oaks Mall in suburban Detroit, bringing the total for the year to 17. Going forward, we expect to open 14 to 20 new stores each year. We're in the process of finalizing the new store pipeline for fiscal 2013 and are enthusiastic about the lineup of great locations in both current and new markets.

Finally, our efforts to enter the Japanese market continued to gain momentum. We're just concluding our six pop-up shops, and we'll open our seventh later this month. Each of these temporary shops has had a unique target audience and all have performed very well, providing further confirmation that the brand resonates with a wide variety of Japanese consumers. As previously discussed, our focus for fiscal 2012 has been to build brand awareness with the Japanese consumer and demonstrate our sales potential to major department store operators. The insight gained from our initial introduction will shape the development of our long-term strategy in Japan.

In closing, we recently completed the selling of our spring 2012 assortment and the response from our indirect retail partners has been very positive. And while the holiday season is just getting underway, we've been very pleased thus far with consumer response to our winter collection, including our lineup of holiday gifts. Overall, we are pleased with our performance so far in fiscal 2012, given our strong operating results through the first three quarters of the year and the progress we've made in executing our long-term growth strategies. I will now turn the call over to Jeff Blade, our chief financial and administrative officer, who will provide additional details regarding our third-quarter financial results and updated guidance for the fourth quarter and full year 2012.

Great. Thanks, Mike, and good afternoon, everyone. I will begin my remarks with a review of our fiscal 2012 third quarter results and then provide you with an update on our outlook for the fourth quarter and full year. As Mike mentioned, we are pleased with our financial performance and operational progress during the third quarter in which we delivered strong top and bottom line financial results while continuing to make progress against our long-term growth initiatives. Net revenues for the third quarter increased 32% to $121 million from $92 million in the prior year. This performance was on top of sales growth of 26% in the third quarter of last year. Indirect net revenues increased 16% to $69 million compared to revenue growth of 10% in the prior year. We experienced strong growth across all of our sales regions, driven by the strength of our product offerings and by improved productivity across our 3,400 retail partners. As Mike shared, this sales increase in the quarter included modest sales of retired inventory.

In the direct segment, net revenues increased 63% to $52 million, driven by sales increases across our full price and outlet stores as well as continued growth in e-commerce. The sales increase in our stores was driven by the opening of 17 new stores since the third quarter of last year and a comparable store sales increase of 7.4% during the quarter. As previously mentioned, the comparable store sales growth is on top of an increase of 33% in the same quarter last year. This growth rate reflects the maturing of some of our earliest store openings, which began in 2007, as well as the high productivity of our fiscal year 2010 and fiscal 2011 store openings, which benefited from increased consumer awareness for our brand, group site selection capability and enhanced marketing in conjunction with new store launches. We ended the third quarter with a 47 full price and eight outlet stores.

In e-commerce, net revenues increased $10 million, or 55% and represented 23% of total revenues during the third quarter. The increase was due primarily to a strong product assortment, continued growth in website traffic, coupled with strong conversion rates that reflects the continued evolution of site content, customer targeting and promotional offerings. Gross profit for the third quarter increased 27% to $66 million, resulting in a gross profit margin of 54.2% versus 56.4% in the prior year. The decline in gross margin of 220 basis points during the quarter was due primarily to lower supply chain absorption costs and the opportunistic sale of retired inventory. As we have mentioned in prior quarters, efforts have been underway to bring the growth of inventory in line with the growth in net revenues by the end of this fiscal year. We were able to accomplish this by the end of the third quarter, ahead of schedule, through continued improvement of key inventory and supply-chain processes. Because the inventory reduction was ahead of schedule, driven by lower inventory receipts during the quarter, supply chain cost absorption was not fully in alignment with lower inventory levels, resulting in an impact to margins. In addition to the process improvements, we took the opportunity to sell more retired inventory during the third quarter than was in our original plan. While this impacted gross margin for the quarter, it was slightly accretive to earnings, and we believe it is consistent with ensuring that inventory levels are appropriate to support the revenue growth and profitability of the business.

Total SG&A expense was $45 million for the third quarter compared to $38 million in the prior year adjusted for a one time stock compensation expense of $15.7 million. As a percent of sales, the 350 basis point decline in SG&A expense reflects disciplined expense management and leverage as we grow the business. Our SG&A expenses are grouped into three categories including selling expenses, advertising marketing and product development expenses and administrative expenses. I'd like to take you through each of these categories. Selling expenses for the third quarter increased to $26.1 million versus $20.2 million in the prior year. As a percentage of net revenues, selling expenses were 21.6% compared to 22% in the prior year. The decrease as a percentage of net revenues and selling expense was due primarily to leverage a fixed costs, partially offset by costs associated with our market entry into Japan.

Advertising, marketing and product development expenses increased to $7.6 million from $6.9 million in the prior year. As a percentage of revenues, advertising, marketing and product development expenses were 6.3%, compared to 7.6% in the prior year. The decrease as a percentage of net revenues was due primarily to a decrease in the number of direct mailers distributed on behalf of our independent retailers, partially offset by an increase in marketing promotional costs.

Administrative expenses for the third quarter were $11.6 million versus $10.4 million in the prior-year adjusted for a one time stock compensation expense in the prior quarter of $15.7 million associated with vesting of restricted stock awards that occurred at the time of our initial public offering. As a percentage of net revenues, administrative expenses decreased to 9.6% compared to 11.3% in the prior year, due primarily to the decline in professional fees related to our initial public offering in the prior year. Other income, which includes advertising, expense reimbursement from indirect retailers, was $1.2 million for the third quarter compared to $1.4 million for the same period last year. The resulting operating income for the third quarter increased 38.7% to $21.5 million, or 17.8% of net revenues compared to $15.5 million on an adjusted basis or 16.9% of net revenues in the prior year.

By segment, operating income in our indirect segment increased by 13%, $26.7 million, with operating margin of 38.6% in the third quarter of this year compared to 39.5% in last year's third quarter. Operating income in our direct segment, which includes our Japan retail business, rose by 50.4% to $13.5 million compared to $9 million in the same period last year, with operating margins of 25.9% compared to 28.2% in the third quarter of last year. Excluding Japan, operating margin in the direct segment decreased by 70 basis points, 27.4%. On a GAAP basis, net income for the third quarter was $13 million, or $0.32 per diluted share compared to the net income of $6 million, or $0.17 per diluted share in the prior year. Our third-quarter results included an earnings per share investment of $0.01 for our Japanese market entry, in line with expectations. On an adjusted basis, assuming a normalized effective tax rate of 40% for the third quarter of last year and excluding $15.7 million of stock-based compensation expense related to the restricted stock awards, net income for the third quarter increased 45% to $13 million, or $0.32 per diluted share compared to $9 million, or $0.22 per diluted share in the prior year. Details of these adjustments are included in the reconciliation attached to our press release.

Key balance sheet highlights as of October 29, 2011 include cash and cash equivalents of $8.3 million and accounts receivable of $38.6 million. The accounts receivable balance at the end of the third quarter compared to the end of the same quarter in fiscal 2011 was in line with sales growth and reflects extended payment terms for a select number of our independent retailer partners to encourage them to have adequate inventory on hand as the holiday season began. Since the balance sheet date, we have collected significant receivables resulting in a current outstanding balance of approximately $23 million and a current cash balance of approximately $20 million. At the end of the third quarter, outstanding debt was $65.6 million. Since the end of the third quarter, we have paid down $20.6 million with a current debt balance of $45 million. Inventory at the end of the third quarter was $111 million compared to $84 million in the prior year, in line with our net revenue increase on a percentage basis. Turning to outlook for the fourth quarter of fiscal 2012, we expect net revenues to be in a range of $125 million to $130 million, driven by growth across all of our distribution channels. Gross margin for the fourth quarter is expected to be approximately 56.6%, and diluted earnings per share is expected to be approximately $0.44 to $0.47. Our earnings per share estimate assumes an effective tax rate of 40% and fully diluted weighted average shares outstanding of 40.5 million.

For our full year fiscal 2012, we now expect net revenues to be in the range of $451 million to $456 million from our previous guidance of $438 million to $443 million, reflecting our better than expected performance in the third quarter. In addition, we are reaffirming our full-year earnings per share net investment in Japan to be approximately $0.08. Diluted earnings per share for fiscal 2012 is expected to be approximately $1.37 to $1.40 compared to our previous guidance of $1.32 to $1.35 due to the better than expected performance in the third quarter and our outlook for the fourth quarter.

Capital expenditures for fiscal 2012 are expected to be approximately $18.5 million, which includes the buildout of the 17 new stores in fiscal '12 and approximately $4.5 million of spending related to the distribution center expansion that we announced in September. Overall, we've remained optimistic about the fourth quarter of the fiscal year despite the ongoing economic challenges. We are focused on delivering a strong fourth quarter and carrying momentum into the new year. With that, I will turn the call back over to Mike for some closing remarks.

Thank you, Jeff. We're very pleased with the progress we've made during the year, including our performance thus far in the holiday season. We remain optimistic about the balance of this year and look forward to our long-term prospects for continued growth and success. In closing, I'd like to thank all of our team members and our indirect retail partners for their hard work and dedication to Vera Bradley and their commitment to serving our loyal customers. I believe that our current momentum and long-term prospects are the result of our unique culture that attracts passionate and motivated people and provides an environment that fosters creativity. Operator, we're now ready for questions.

Thank you, sir. The question and answer session will be conducted electronically. (Operator Instructions). And at this time, we'll take our first question from Erika Maschmeyer with Robert Baird.

Hi, good afternoon.

Hi, Erika.

Could you talk a little bit more about the cadence that you saw for your comp, the increases from traffic, and ticket and conversion, and what you have built into your Q4 revenue guidance for comp?

Sure. Let me start -- this is Jeff, let me start, and then Mike and Roddy can join in. Cadence during the quarter, I think relatively even cadence over the quarter. The beginning of October, in the first couple of weeks of October were a little soft, but exited October very strong. So, overall, felt good about the comp, especially when you look at the fact that we were lapping a 33% comp from the prior year. I think overall for the quarter, felt good about the cadence. In terms of guidance for Q4, consistent with what we said in Q3 is that you should expect our comp for Q4 to be in line with our long-term comp guidance, which is mid to high single digits.

Okay, great. And then I wanted to just follow up on gross margin. Could you give a little bit more detail about the supply chain process improvements, and the impact from the opportunistic sales of inventory? If you could maybe parse out the impact there a little bit more and quantify it, that would be very helpful.

Sure. So, there are -- as we've talked in the past, we have significant supply chain infrastructure, and capability and process in place, but we're continuing over time to build all of that as we grow as an organization. There's a number of initiatives that we've had underway on an ongoing basis, one of which is unifying our forecasting process so that we are forecasting across all of the segments of our business, continuing to make improvements in our ability to accurately forecast inventory demand by SKU, and then continuing to refine our supply chain capability. We've talked in the past about our sourcing office in China, and our ability to work more directly with our sourcing partners there. So, a combination of all those things contributed to helping us bring sales inventory growth in line with sales growth. As we've talked about in previous calls, our intent was to be able to bring that in line by the end of the fiscal year. And with a number of those initiatives that we've had underway, we were able to achieve that sooner, so we're feeling very good about that.

In terms of parsing out the contribution from each of those two things, so obviously the second thing was the additional sale of retired inventory that we had an opportunity to do. The two of those, the additional sales of inventory was approximately 60% of the 220 basis point impact, and the supply chain improvement impact was approximately 40%.

And then could you just elaborate a little bit on what you said about the supply chain cost absorption not being in line?

Yes. So, basically, the net result of all of the improvement efforts was that we were able to bring in fewer units without impacting any of the supply for our future releases, or replenishment of our current business. Because of the improvements, we brought in fewer units. But because it was a bit sooner than we thought, we had a bit of a Q3-only mismatch of supply chain costs relative to the number of units that we brought in.

That's helpful. Thanks so much; good luck.

Thank you, ma'am. And next we will hear from Neely Tamminga with Piper Jaffray.

Great. Thanks, you guys.

Hi, Neely.

I want to talk a little bit ahead, looking ahead to Q4. In terms of, the revenue outlook feels actually really solid, and I think you're definitely expressing some of the momentum that you're seeing here in holiday, and the spring order writing. But Mike, if you could frame it for us, given your long tenure at the Company, kind of how the order writing is framing up for spring relative to maybe last year's spring order writing, or just qualitatively, relative to maybe fall or winter? It just seems like, from my perspective, you guys keep having kind of more productive patterns being continually added to the mix, and I'm just trying to get a sense as to how that frames up for your business relative to maybe just two, three years ago? Then I have some follow-ups.

Yes. Certainly, the cadence and the introduction of product has changed significantly over the last two or three years. So, it is a little difficult to compare year on year. But just looking at spring 2012, we had a very strong response to the patterns and the styles at the premiere. And then post premiere, while the sales consultants were on the road. And I would characterize the order volume associated with the season as pretty much in line with our expectations, which were pretty solid expectations for that collection.

Okay. And then in terms of looking early into next year, Texas has been a huge win for you guys this year, and there's obviously a lot of opportunity for Texas again next year. But is there a targeted region or market that's going to be a new market that could kind of be the next Texas for you guys?

There is still plenty of fertile ground in that emerging market. Really, if you consider kind of the central part of the country between the Mississippi and the Rockies, that's the fastest growing portion of the country, that's the emerging section of the country. And so we'll be focused both on the direct and indirect side, building the business there. And really, as we've said before, there's no market that is fully penetrated. We'll continue to grow the business, for instance, in the Boston metro area.

Okay, that's really helpful. And then just one last product related question for me. Last year we saw the launch of canvas in spring, and I think that that was quite successful. Just wondering how you're thinking about spring in terms of the launches of some of the non-pattern products? Will it be similar? Will there be some sort of excitement comparable to what we had with canvas, or do you lap that? We're just trying to get a sense of the calendar for spring.

Yes, I'll let Roddy respond to that.

Hi, Neely. We're constantly looking at the cadence and the calendar, and how we can improve it. One of the ways -- I think there's a lot of excitement around, say, the canvas release or one of these special collections releases. But one of the things we've found as the merchandising function evolves is that tying the particular colors, whether it's a solid color in a particular, say, canvas bag, back to the patterns themselves, the patterns are truly what resonate with the consumer. So, we're actually going to tie those. So, what you'll probably see over the course of the year is opportunities to really focus on a particular color and that particular pattern, and then the different fabrications or takes on that pattern, building out from that.

Okay. That's awesome. All right, thanks, you guys. Good luck.

Thanks, Neely.

Thank you, ma'am. And next we'll hear from Jennifer Davis with Lazard Capital Markets.

Hi, guys. Congratulations on another great quarter. Jeff, a clarification. I'm sorry, I'm still a little bit confused on the supply chain absorption cost. You had less inventory receipts, so less units coming through, and is it less -- I mean, more fixed cost spread over that? Or what is that exactly?

Yes. So, as I just mentioned before, it basically -- so, the reason that we had the impact was, because of all the successful efforts behind supply chain, and the fact that we were able to bring the growth of inventory in line with the growth of net revenues at least a quarter sooner than we had anticipated. And as you bring those two into align, you also align the cost structure with it. And so, as a result of getting there earlier, we had some supply chain costs that were not fully absorbed by units that you're bringing in because we were able to successfully bring in fewer units, but still adequately service the business. So, that's really the driver.

All right. Great, thanks. And then I was wondering if you could talk a little bit about the status of some of your brand extensions, like jewelry or anything else you might be going into in the near future?

Yes. We have several things in the process of being developed, nothing that we are in a position to share today. And as I've discussed on several of the road show sessions that we've had, there is still a ton of fertile opportunity within the current range that we have. There are gaps in the line that we continue to focus on and fill. And so, we'll be working on those things kind of in concert with looking at future categories. We're not in a position yet today to say -- we're launching category X at this point.

All right, fair enough. And then any comments on Japan for next year? Do you think you'll open up some permanent shop-in-shops in the near future?

Japan has been outstanding. Each of the pop-up shops that we opened this year, the temporary pop-up shops has performed extremely well. And as we said earlier on the call, we are resonating with a wide, wide variety of consumers in Japan, so it gives us a great deal of confidence that we can be successful there. We've also demonstrated to the department store operators that we are a viable brand, and right now we are in discussions with a number of them on permanent -- a permanent presence in department stores there.

All right. Great, thanks. One last one, quickly, if I might. Your online sales up 55%, that's a really impressive number. Are you seeing more sales of some of the higher price-point items like the rolling luggage, or is it really more just more traffic, more conversion?

Primarily traffic and conversion -- we're seeing a lift across the entire line.

All right, great. Thanks, and best of luck for holiday.

Thank you.

Thank you, ma'am. Next we'll hear from Oliver Chen with Citigroup.

Hi, guys, thanks for your time. We had a question related to that opportunistic sale of retired assets. Could you speak a little bit about your strategy in undertaking that? And if there's any kind of dynamics within how you executed that by channel? Was it something that we could have observed by doing channel checks?

Sure. So, let me start first by just reiterating, given our business model, in which we are introducing three or four patterns per quarter during the year, we are also by definition retiring inventory as we go throughout the year. So, retiring inventory is a normal part of our business, and we're still in the early stages of building out the business model component of our own liquidation channel. So, obviously, a decent sized web business today, of which a decent percentage carries some level of discount, and then continuing to build out our own outlet stores and our annual sale in Fort Wayne. That's the traditional way that we outlet retired inventory.

On some very limited occasions over time, if we have inventory either that are in quantities that are more difficult to move through our own limited outlet channel, or don't lend themselves to outletting as well, we have in the past, and will continue to selectively use some other liquidation partners. So, in this instance, some of the opportunistic inventory that we referred to in the conference call script was an opportunity to sell more quickly some retired inventory that we would have sold over the balance of this year and next year. And given the complexion of it, we thought it made a lot of sense to liquidate it. And so, there is a limited amount of it that is currently at TJ Maxx and in HomeGoods, and we've also done some limited sales of sunglasses at Costco. And I think Costco also has a limited amount of signature product. They have, I think, two SKUs of cosmetic bag that actually got diverted by someone that told us they were going to resell them for corporate gifts. But we have used that channel in the past on a very limited basis; in the future, we'll likely use it on a very limited basis. But as we continue to build out our own outlet channel, that will lessen.

And in terms of seeing it via channel checks, given the size and footprint of those retailers that we occasionally sell through, it gets peanut buttered pretty thinly across their distribution points, and it's kind of in and out of there.

Thank you very much. And one follow up, in relation to kind of thinking about the indirect channel at large, is there a characterization or a sense you could give us of the magnitude of the mix between your historic mom-and-pop independent channel, 3,300 retailers, versus the other channels that hit that line such as the higher growth electronic commerce wholesale partners?

Yes. The vast majority is with the 3,400 independent retailers that we sell through. Dillard's is part of the indirect segment. It's certainly a growing piece of the business, but those 3,400 indirect retail partners still represent the vast majority of the volume in that segment.

Yes, and just to reiterate, too, because I think there's been some confusion. In terms of e-commerce partners, we really only have any significant presence at all with Zappos and with eBags, and those retailers are almost exclusively full priced retailers. And occasionally, if they have markdowns, it's because they follow our markdown cadence.

And Zappos and eBags are in the indirect revenue line as well?

They are.

Okay, and finally, if I could ask you guys -- what are you generally seeing with real estate availability in terms of looking at opportunities for your store strategy going forward?

Oliver, this is Roddy. We feel very comfortable with the pipeline for fiscal '13, didn't really -- we continue to have good opportunities brought to us with good economics, and more importantly, good locations in the centers that are desirable. So, as we were looking out at fiscal '13, and targeted locations, we were able to fill those in pretty quickly. We were in the, really in the stage of negotiation, varied negotiation stages with all those different targets for fiscal '13.

Thanks very much for your time.

Thanks, Oliver.

Thank you, sir. And next we'll hear from Edward Yruma with KeyBanc Capital Markets.

Hi, this is actually [Jade] in for Ed. Congratulations on a good quarter. I just had a quick question on the department store opportunity. Could you elaborate a little bit more about what your opportunities are that you're seeing currently, beyond Dillard's?

Yes. We're not pursuing another department store partner at this point. We are focused on continuing to grow that relationship. We're in 65 doors now, they have close to 300 doors in their system, so we'll continue to grow by adding additional doors. When you think about brand extension opportunities, part of the challenge that we have relative to that is the channel -- the indirect segment at times isn't necessarily the appropriate segment, at least those independent retailers for brand extensions. So, Dillard's will be a great opportunity for us, as that footprint grows. To have a channel that's viable for extensions that we have on the priority list, as well as our own stores, as we continue to build out that distribution.

Okay. That's great. And I just had one quick follow up. Does your guidance, which implies flat year-over-year operating margin, reflect heavier year-over-year promotions, cost of goods or just another effect?

Can you repeat the question? I'm not sure we fully understood -- I want to make sure we are answering what you're asking.

The guidance, which, by my calculations, would imply a flat year-over-year operating margin, does that reflect heavier year-over-year promotions through your end?

So the only --.

Or would it reflect faster inventory turns due to better supply management?

So, I think if you're -- let me try to answer what I think you're asking, which is the full year operating margin guidance. So, the full year operating margin guidance should reflect the fact that we had higher input costs during this year. And so we were able to recover some of that by taking pricing, but it wasn't until July, so there was a full-year impact to gross margins because of that. And we had guided for the year to down 50 basis points, and the only difference from that is the impact in Q3, because our Q4 margin guidance is in line with where I believe all of you are.

Right. Okay. All right, great. Thanks for the clarification.

Thank you, ma'am. And next we'll hear from Evren Kopelman with Wells Fargo.

Thanks, good afternoon, guys. I wanted to ask first about comps. You mentioned maturing of some of your early 2007 store openings. What sales per foot level are they maturing at, and are comps at younger stores still double digits?

Yes. Let me give you a little more color, and it's probably easiest if we illustrate it by class. So, our first year of opening stores was 2007, and so our 2007 and 2008 stores are beginning to mature. We are still seeing year-over-year growth in comps, but the growth rate of the comps is coming down in line -- more in line with our long-term guidance. And as you can imagine, in our 2008 class, we had a number of West Coast stores that opened weak because we weren't that well known, and it was during the economic downturn. So, those stores, in a few years after that, had very large comps, which are now coming more in line.

Our 2009 stores, we opened five full-priced stores, and that year represented our first two full-price stores in Texas, our store in San Antonio and our Southlake store in suburban Dallas. And because we were not that well known in Texas, and we've been extremely well received, the first year of comp for that class driven by those two stores was nearly 80%. So, just a really outsized comp that you would not expect to see continuing. And then the 2010 class, last year's class actually had the highest average sales per square foot class opening of any of the classes so far. So, that class just opened as a more mature class.

Okay. Very helpful. Then the other question I had, I just wanted a clarification, you talked about 60% and 40% when you were talking about, I think, the 220 basis points of gross margin decline. Are you saying -- so, 60%, so 130 basis points is driven by your efforts to retire or manage inventory? And the 90% -- 90 basis points of the decline is supply chain?

Yes. I think it's -- I think the math is probably closer to 140 and 80 basis points. So, about 180 of the 220 was related to the opportunity to sell retired inventory a little bit sooner, and the 80 was related to the cost absorption.

Okay. So, then I had a broader question on the retiring of inventory. First, why maybe did you decide to accelerate -- why did you think it was a good opportunity to accelerate that in the quarter? And the second question is, I guess, maybe why did inventory growth get ahead of sales growth in the first place? Does that have to do with supply chain efforts or certain categories were bought too much, or is it a result of your increasing number of pattern introductions? If you could give a color on those, that would be great.

Yes. Let me actually start with the last question -- why was it not in line? The answer is that this is a business that's been growing very rapidly. We're in relatively new segments over the last several years that we traditionally weren't in. We've also made major transitions in the supply chain over the last five years that saw us go from being everything produced in the US to 90% outsourced, and a new distribution center and a number of things. So, as you might imagine, over time, as you try to bring everything in line, as you try to refine it, as you try to continue to get better, one of the things that we have focused on is the importance of also ensuring that we're growing net revenues in line with inventory. So, it's more of an ongoing effort to make all of the different parts come together, and work in unison and synergistically. And it's part of the Company's heritage of continuing to refine and improve the way we manage supply chain, which the Company has done an outstanding job of, over time. So, it's really related to that.

The first part of your question regarding, why did we choose to outlet this inventory? Why now, et cetera? So, as I mentioned in the previous answer, by definition, given the way our business works, we always have retired inventory because we're keeping the product assortment fresh, and we're constantly introducing new patterns and styles. And by definition, we're retiring styles, and that works well in terms of the business model because we also have a growing outlet channel in which we're able to sell product at strong margins.

In some instances, there is some retired inventory that does not lend itself as well to our own outlet channels, or there are opportunities that come along from time to time, which gives us the opportunity to sell some of that retired inventory at a more rapid pace. And in this instance, the trade-off was selling off some of that inventory, but doing so at lower margin. And we thought that given everything we have going on, and given the nature and stratification of that inventory, that this was a good opportunity for us to sell it.

Great. Thank you.

You bet.

Thank you, ma'am. And next we'll hear from Ike Boruchow with JPMorgan.

Hi, thanks for taking my call, guys. Just real quick, can you talk about the price increases that you guys, I believe, put in place this quarter -- the magnitude of them? Do you believe that they had any negative impact on demand? And then specifically, can you give us maybe what AURs were for the quarter, and what they had been in Q1 and Q2?

Yes. So, the second part of your question, average unit retail continues to be a little over $30, and that's been relatively consistent, so we're not seeing that dramatically change. In terms of price increases, we took a price increase this summer, which corresponded with our fall launch. So, in July we took price increase, and we really saw no response or reaction from the customer whatsoever. And that was consistent with what we thought we would see because we did seek a relatively modest price increase. And given the relatively low AUR, and the Company's consistent process of not trying to drive too much price or do anything to hurt the consumer perception of the brand stayed intact.

Okay. And then, I know you've talked about it a lot on this call, but the gross margin this quarter coming down 220, and then next quarter it sounds like you're keeping your outlook the same. Was the entire 220 essentially one-time? I'm trying to parse out how to think about the Q3 versus Q4 sequentially. Is there anything else that we should be thinking about?

No, I think you're thinking about it in the right way, and that's the reason we guided where we did for Q4.

Okay. All right. Thanks, guys.

Yes.

Moving forward, next we'll hear from Randy Konik with Jefferies.

Hi, this is Amanda Sigouin on for Randy. Not sure if I missed it, but did you quantify the size of the opportunistic sale of retired inventory?

I did not. I indicated that it was essentially 60% of the 220 basis point impact. And in dollar terms, relatively small, in the $3 million to $4 million range.

Okay. And just, do you mind expanding a little bit on the instances where you said some inventory doesn't make sense for your outlet channels? Just what sort of items are you referring to?

Yes. So, for instance, we have some sunglasses that Costco helped sell last year. And it's the kind of item that doesn't necessarily merchandise well in our outlet stores. It's difficult to move at our annual outlet sale in Fort Wayne, because it's an item that's frequently stolen, or just difficult to have folks trying them on and sell them, et cetera. So, there are just instances where there is either some items or the quantities of the items where it makes sense to do that. Again, I want to re-emphasize, because there's been a lot of confusion on this -- the Company, over time, has used outlet channels other than our own on a very limited basis.

Got it. And then just to make sure I understand, so it does sound like in the third quarter, aside from these -- the 220, which you've been very clear on breaking that out in gross margin, you had successfully offset the rising sourcing costs with your price hikes. So, I guess as we think about kind of next year, now that cotton has come down for the last five months or so, around $1, when should we start to think about that benefit flowing through your P&L?

We haven't guided yet for next year, so we'll do that on our Q4 call. And given our sourcing cycle, obviously we're already into sourcing next year. So, we'll update that on the Q4 call. If you recall, the reason for our input cost rise was not only cotton, but was also labor costs in China. So, that piece of it will not [receive] the cotton we're optimistic on.

Great. Thank you.

Thank you, ma'am. And moving forward, we will hear from Sam Panella with Raymond James and Associates.

Okay. Thanks, and good afternoon. I just want to make sure I'm clear on this. So, with the indirect sales up 16%, so about $3 million to $4 million would be that -- the opportunistic sale of the retired inventory. So, that would suggest that you're running maybe at the higher end of your expectation to be up high single digits in that channel? Is that the correct way to think about that?

Yes. Still very -- if you back that out, still very solid double-digit growth in the indirect channel.

Okay, thanks. And then, obviously your e-commerce business is very strong. A couple of things here, just wondering -- it looks like you're up against a tough comparison in the fourth quarter as that channel benefited from the retirement of the Java Blue product. Anything we should think about this quarter? And then also, what type of progress are you seeing in that channel in terms of driving more full-price sales?

We are -- just to answer the latter part of the question first, the progress on the full price is similar to what we've been seeing since really the Q4 of last year. And that's really the proportion of discounted merchandise to -- retired merchandise to full price merchandise is about the same roughly, but the level of discount is less. A good example is promotions we ran in September, where a year ago we were 25% off, we were only 20% off in September. So, it is providing a benefit to margins in that way.

As far as trying to grow e-commerce, it is a -- it's pretty big in itself. I think it is just a matter of -- and we're being very diligent and focused on everything we can do to grow the business. I know there was a little bit of chatter about Friends and Family, another opportunity for us to focus on growing the business outside of just tying it to, say, a Java Blue retirement. Friends and Family makes a lot of sense for our brand because our brand is very much about friends and family.

Great, thanks. And then just lastly, I think you said earlier in your prepared commentary about talking about your holiday gift items. Can you give us any sense as to what percentage of the mix that comprises this year versus last year? Do you have a stronger penetration year over year?

The assortment is broader, and the proportion of sales is -- the percentage of sales is greater as well. So, we're pleased with the way holiday gift has performed this year.

Okay. Thanks, and best of luck.

Thanks, Sam.

Thank you. And next we'll hear from Dana Telsey with the Telsey Advisory Group.

Good afternoon, everyone. Hi. Could you give us any updates on new store productivity? What you're seeing from stores that opened earlier in the year, how you're thinking about real estate for next year, and what's happening with the cost of real estate? Thank you.

Let me just take the first part, and then I'll turn it over to Roddy. In terms of productivity side, I just, in one of the previous answers, stratified the openings by class of what we were seeing. So, this year's class, while it's still very early, we feel very good that it looks like another year of having high productivity openings in terms of sales per square foot.

Just as far as the pipeline and the economics, we continue to look at both lesser penetrated markets and more highly penetrated markets, and we think we have a good mix. So, you'll see some in new markets, as well as some more mature markets. And when I say new markets, those include markets that are new to the direct segment of the business.

As far as economics go, I think generally, as I mentioned earlier, we're getting good locations. At the same time, I think the rents have been pretty much in line. We didn't really see a decrease in rents during the downturn. And that's primarily because we're looking at stronger centers. The construction allowances and tenant allowances, we continue to see good, strong ones.

Thank you.

You bet.

And we'll take our final question from Peter Wahlstrom with Morningstar.

Good afternoon, thanks for taking my question.

Sure.

Quickly circling back on the real estate topic, I know we're kind of getting close to fiscal 2013, and if you provided the range of 14 to 20 stores, and a lot of the work has already been done, what could push the openings to either the lower or higher end of the range? Is that something more a function of timing, or is there macro or something else that we're not considering here?

Yes, I think -- so, we haven't guided for next year yet, so we will on our Q4 call. We will tighten the range, but our long-term guidance does stay the same, as you mentioned, 14 to 20 stores. I think we're very focused as a Company on opening the number of stores that we think we can do successfully. And you're only as good as the last store you opened, so I think it would be less about factors other than we want to open great stores. So, the organization has been very patient over time of waiting for the right sites. And if you can't find the right sites, being willing to wait, even if that means lower openings.

And that's really it, it's the availability of great space. Because we have the capacity to be at the higher end of that range. We've got a great team, site selection team, store opening team, operating team. It's really about availability of great locations.

Very good. And then quickly on the online, you've obviously seen tremendous growth there, you've talked a little bit about the traffic and ticket and conversion. Could you talk maybe a little bit about how the demographic is skewing in the online component versus the indirect and direct channel, whether you're seeing a difference there?

Not really. Not really a difference at all. The online, the shoppers, it is pretty much the same as in our other channels. What we tend to see is it's actually a multichannel shopper. As we say, she may be shopping online at 12 midnight or 1AM in the morning. When she's driving home from work, she may stop at an independent retailer, and on the weekend she may go to the mall and go to a Vera Bradley store.

Very good. Thank you.

Thank you.

That is all the questions we have at this time. I'd like to turn the conference back over to management for any additional or closing remarks.

All we wanted to say is thanks for joining us today, and for your continued interest in Vera Bradley. We look forward to speaking with you on our fourth-quarter conference call, which will be held on March 14, 2012, at 4.30 PM. And we wish you all the best during the holiday season. Thank you.

And that does conclude today's conference. We thank you for your participation. You may now disconnect.