Vera Bradley Inc (VRA) 2015 Q3 法說會逐字稿

Good morning, ladies and gentlemen; thank you for standing by. Welcome to the Vera Bradley Third Quarter 2015 Earnings Conference Call. At this time all participants are in a listen-only mode.

(Operator Instructions)

As a reminder, today's conference call is being recorded. I would now like to turn the call over to Stacy Knapper, Vera Bradley's Senior Vice President and General Counsel. Please go ahead.

Good morning and welcome, everyone. We would like to thank you for joining us for today's Vera Bradley Third Quarter Earnings Conference Call.

Some of the statements made on today's call during our prepared remarks and in response to your questions may constitute forward-looking statements made pursuant to and within the meaning of the Safe Harbor provision 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 we expect. Please refer to today's press release and the Company's Form 10-K for the fiscal year ended February 1, 2014, filed with the SEC for a discussion of known risks and uncertainties.

Investors should not assume that the statements made during the call will remain operative at a later time. The Company undertakes no obligation to update any information discussed on the call. I will now turn the call over to Vera Bradley's Chief Executive Officer, Rob Wallstrom.

Thank you, Stacy. Good morning everyone, and thank you for joining us on today's call. With me today are Kevin Sierks, our Chief Financial Officer; Sue Fuller, our Chief Merchandising Officer; and Julia Bentley, our VP of IR and communications.

We posted EPS from continuing operations of $0.21, which exceeded our guidance for the quarter. Our third quarter revenues and gross margin rate were in the midrange of our guidance, but SG&A was favorable to expectations due to expense control and the timing of certain expenses that will be incurred in the fourth quarter. Importantly, we have continued to carefully manage our inventories and we ended the quarter with a very solid cash position and no debt.

During the third quarter, our VeraBradley.com performance was solid, but our store sales continue to be challenging. As you know, generating store traffic continues to be difficult for many retailers, including us.

We are in the early stages of our transformation and we have made substantial progress over the last three quarters against our strategic plan. We're continuing to modernize and elevate our product assortments, expand our reach through opening new full-line and factory outlet stores, evolve to made for factory format, enhance our online presence, and grow our department store relationships. We continue to face short-term challenges like very weak store traffic, but we believe we are headed in the right direction and these efforts will pay off in the years ahead.

The third quarter was a period of especially important activity as we introduced our new coordinating collections, further intensified our solid microfiber offerings, launched our leather and faux leather halo collections, enhanced visual presentation in our full-line stores, added a larger selection of factory exclusive products to our factory outlet stores, opened 13 new locations, and ramped up our marketing initiatives. Much of this activity happened towards the end of the third quarter.

We are seeing positive customer response to our new products, and although they are still a small portion of the overall assortment. We had hoped to attract more new customers to the brand and to gain traction in traffic and sales at this point in time; unfortunately the weak trends have extended into the fourth quarter thus far and are reflected in our guidance that Kevin will discuss.

As we move ahead we are hopeful that our initiatives will take hold, leading first to stabilization and then to growth in our business. We know this will take time. We are moving faster on pieces of our business that we know are working, like solid microfiber, leather, MFO product, and our department store relationships.

We remain confident that our five-year strategic plan and the steps we are taking to evolve our merchandising, distribution, and marketing are the right ones for the future of the business. I believe we are laying a solid foundation to achieve our five-year target of approximately $1 billion in sales and a high-teen operating margin by the FY19 timeframe. I will now ask Kevin to provide additional details regarding our results and fourth-quarter outlook.

Thanks Rob, and good morning. Before I begin, let me remind you that in June we entered into a five-year agreement with Mitsubishi and Look to import and distribute Vera Bradley products in Japan.

As a result of moving this wholesale business model, we exited our direct business in Japan during the third quarter of FY15, and our accounting for it as a discontinued operation. The income statement numbers I will reference reflect continuing operation, which is consistent with how we provided guidance.

Current year third-quarter net revenues from continuing operations of $125.2 million were in the midrange of our guidance of $123 million to $128 million. This compared to $128.9 million last year. Third-quarter direct segment revenues totaled $77.9 million, a 15.1% increase over $67.7 million in the prior-year third quarter.

In our stores, third-quarter year-over-year net revenues grew 10.4%, reflecting the opening of 11 full-line and 12 factory outlet stores during the past 12 months, which was partly offset by a comparable store sales decline. Comparable sales, including e-commerce, increased 0.9% for the quarter, which reflects a 13.5% decline in comparable store sales, and a 22.2% increase in e-commerce sales. As expected, our third-quarter comparable store sales continued to be negatively impacted by year-over-year declines in store traffic.

Indirect segment revenues decreased 22.8% to $47.3 million, from $61.2 million in the prior-year third quarter, primarily due to lower orders from our specialty retail accounts as well as a reduction in the number of specialty retail accounts. Gross profit from continuing operations for the quarter totaled $65.8 million, or 52.5% of net revenues, compared to $71.2 million or 55.2% of net revenues in the prior-year third quarter. The year-over-year decline in gross margin rate was primarily related to deleveraging overhead costs and modestly increased year-over-year online promotional activity.

The third-quarter gross margin rate was consistent with guidance of 52% to 53%. SG&A expense from continuing operations totaled $53.3 million, or 42.5% of net revenues in the current-year third quarter, compared to $47.6 million or 36.9% of net revenues in the prior-year third quarter. As expected, SG&A dollars increased over the prior year, primarily due to strategic investments including new store expenses, key management additions, marketing, and e-commerce initiatives.

The SG&A expense rate was below the 43% to 44.5% guidance, primarily due to cost containment efforts and the timing of about $300,000 of expenses, which were delayed to the fourth quarter. Operating income for continuing operations totaled $13.6 million or 10.9% of net revenues in the current-year third-quarter, compared to $24.7 million or 19.2% of net revenues in the prior-year third quarter. By segment, direct operating income was $13.9 million or 17.8% of sales, compared to $15.3 million or 22.6% of sales last year, and indirect operating income was $19.2 million, or 40.6% of sales, compared to $26 million or 42.4% of sales in the prior year.

Cash and cash equivalents as of quarter end totaled $90.3 million, compared to $13.7 million at the end of last year's third quarter. We had no debt outstanding at November 1, 2014.

Quarter-end inventory was $106.3 million, below guidance of $125 million to $135 million, and compared to $150.5 million last year. Inventories were below guidance, primarily due to the timing of receipt flow.

Net capital spending for the nine months totaled $22.4 million. During the quarter we repurchased approximately $3.5 million under our $40 million share repurchase plan, which equates to approximately 169,000 shares at an average price of $20.96 per share.

Now moving on to the outlook. For the fourth quarter, we expect net revenues to be in the range of $158 million to $163 million, compared to prior-year fourth quarter revenues of $156.4 million. We expect direct segment net revenues to increase in the mid- to high-single digit percentage range, with a comparable sales including e-commerce to decrease of mid- to high-single digits.

We believe our indirect net revenues will decline in the high-single digit to low-double digit percentage range during the quarter. This sales guidance effects our current fourth-quarter selling, which is so far below our expectations. The gross margin rate for the fourth quarter is expected to range from 53.5% to 54.5%, an improvement from 52.8% in the prior-year fourth quarter.

If you recall, the prior-year fourth quarter gross margin rate was negatively impacted by about 300 basis points, due to an inventory write-down primarily related to fabrics and certain retired patterns no longer considered salable, and a certain merchandise in the baby gift category which was discontinued by the Company. Excluding the prior-year write-down, the expected year-over-year rate decline is primarily due to deleveraging overhead costs and modestly increased promotional activity.

SG&A as a percentage of sales is expected to range from 35.5% to 36.5% for the fourth quarter, compared to 33.6% in the prior-year fourth quarter. The expected deleverage is primarily due to incremental investments in key areas like e-commerce, marketing, and management. We expect fourth-quarter diluted EPS from continuing operations to be in the range of $0.43 to $0.47, based on diluted, weighted average shares outstanding of $40.4 million, and an effective tax rate of 38.4%.

Diluted EPS from continuing operations totaled $0.49 in the prior-year fourth quarter. On a continuing operations basis for the full year, we expect net revenues will be in the range of $514 million to $520 million, compared to $530.9 last year. Our revenue guidance includes direct segment net revenue growth in the mid-single digit percentage range, with a decline in comparable sales, including e-commerce, in the mid-single digit range.

Indirect net revenues are expected to [climb] in the high teen percentage range. The gross margin rate for the FY15 is expected to range from 53% to 53.5%, compared to 55% last year. This decline reflects overhead costs, deleveraging, a slight shift in the channel mix with factory outlet sales being a higher percentage of the sales mix, and modestly increased online promotional activity in FY15.

SG&A as a percentage of sales is expected to range from 40.8% to 41.3% for FY15, compared to 37.9% last year. The rate increase is the result of previously discussed strategic investments in the business in FY15, such as our key management hires and incremental (inaudible) in e-commerce expense. In addition, we expect to incur incremental year-over-year incentive compensation expense.

We do have an active expense control program in place and we are focused on reducing expenses where possible. We have identified and are implementing several cost reductions beyond what we originally identified at the beginning of the year. These include reductions in supply costs and increased manufacturing and shipping productivity.

Our expectations for diluted EPS for continuing operations range from $1 to $1.05 for FY15. On a comparable basis, diluted EPS continue operations totaled $1.48 last year. We believe inventory will be $100 million to $110 million at the end of the fiscal year, compared to $136.9 million at last fiscal year end.

This projected year-end inventory level reflects a much better balance of current to retired inventory than a year ago. We still expect our total capital expenditures to be approximately $40 million for the full year, with approximately $20 million related to our corporate office campus consolidation. The balance primarily is related to new store openings and continued investment in our systems.

Let me turn the call over to Sue, who update you on the product component of our strategic plan. Sue?

Thanks, Kevin and good morning, everyone. As you know, we are working hard to more fully engage our core customers and also to acquire new customers through execution of our product strategies. We have spent a lot of time this year on elevating and modernizing our assortment, and trying to stabilize the business through better focusing our assortment and narrowing it in the short term.

We have introduced a lot of newness this year. We launched Laser-Cut in May, our Lighten Up backpack fabrication in June, faux leather in August, and leather in September. In addition, in October we expanded our solid microfiber assortment and introduced our full coordinating collections, including our smaller prints.

Our customers are responding to the newness and in the aggregate, our SKU productivity on these products is higher than on our traditional merchandise. Customers are also definitely shifting towards solids and simpler patterns. Consequently, we are continuing to lessen our dependence on our signature patterns and will continually refresh and expand the colors and styles in our Laser-Cut, faux leather, leather, and solid microfiber assortments, and we will continue our fabric and product innovation going forward.

By the fiscal year end, approximately 30% of our assortment will be these new items introduced in 2014. Of these new introductions, I believe our two biggest needle movers going forward will be solid microfiber and our new coordinating collections.

As we better focus our assortments, we have reduced the numbers of signature cotton quilted pattern launches from 18 last year to 14 this year. We are no longer thinking simply in terms of signature pattern launches, but will instead focus on our collections.

Going forward, we expect to introduce in the range of 11 or 12 collections annually, as opposed to our previous 18 pattern launches. The gap left by the reduced signature patterns is being filled in with the coordinated collection pieces, as well as our new fabrications like solid microfiber, leather, and faux leather.

Part of focusing our assortment is majoring in the majors. Making a bigger impact in the big volume drivers and classification Vera Bradley is known for and what we do best, like travel, backpacks, bags, and accessories. The success of our backpack business during the back to campus period at the beginning of the quarter is a great example of this.

We intensified our inventory assortment, introduced new styles, and supported the products with a comprehensive marketing and service strategy. It worked and proved that when we put our energy and resources behind an initiative, it will be successful. We are very optimistic that these product changes will lead to better sell-throughs, increased revenues, and higher gross margin over time.

We are also taking other actions that we believe will expand our future growth margin rate. For example, we are in the process of building a more flexible, efficient, and cost-effective supply chain through vendor and country diversification.

We are broadening our base to countries outside of China to other countries with expertise in specific product classifications. For example, we recently began manufacturing certain products in Vietnam. Rob?

Thanks, Sue. Let me update you on the multichannel distribution portion of our strategic plan. As you know, we have a fairly aggressive growth plan for both our full-line and factory outlet stores over the next few years, and of course this growth is coming off of a relatively small base.

During the third quarter, we opened six full-line stores in Whitehall, Pennsylvania; Knoxville, Tennessee; Salem, New Hampshire; Grand Rapids, Michigan; Sarasota, Florida; and Cherry Hill, New Jersey. And we opened our final two stores for the year early in the fourth quarter in Lexington, Kentucky and Lawrence Township, New Jersey. We have opened 13 full-line stores this year, bringing our current total to 97.

We continue to believe that we have opportunities to add an average of 20 to 25 new full-line stores per year going forward, equating to about 300 full-line stores over time. As a side note, we recently announced we will close our unprofitable full-line store in the Hill Center Green Hills lifestyle center in Nashville, Tennessee, and we are currently looking for a more suitable, higher-traffic location in the Nashville Metro area.

Factory stores are an economic engine and allow us to better control promotional activity in our full-line stores. We opened seven new factory stores in the third quarter, in Eagen, Minnesota; Grapevine, Texas; Clinton, Connecticut; Concorde, North Carolina; Sunrise, Florida; Destin, Florida; and Niagara Falls, New York, and we opened our last two outlet stores for the year in November, in Gretna, Nebraska and West Palm Beach, Florida. This growth brings our total openings for the year to 14 and our current count to 29, leaving us with a ratio of a little over three full-line stores to every factory outlet store.

Growth opportunities in the factory outlet channel continue to be plentiful. We expect to open an average of 10 to 15 stores per year and believe the opportunity exists to have over 100 factory outlet stores in the long term.

We currently have about 20 factory exclusive styles in our factory outlet stores, and these items are generating higher sell-throughs and gross margin rates than our traditional outlet goods. These goods represent some of our most popular full-line styles that have been reengineered for the outlet stores. They are still great quality, they have the functionality that Vera Bradley is known for, and offer a tremendous value to the customer.

By the beginning of next year we expect approximately 25% of the merchandise in our factory outlet stores will be factory exclusives, and they should grow to around 70% or so over time. We are really excited about the November implementation of our Locate system in both our full-line and factory outlet stores. If an item is out of stock in a particular store, Locate will allow the sales associate to find the item in another store and ship it directly to the customer, and we believe this will drive incremental sales and we will expand Locate to e-commerce in spring.

E-commerce is an integral component of our five-year plan. We have made key enhancements to VeraBradley.com, including adding product recommendations, enhancing product descriptions, adding silhouettes for product scale, generating cart and site abandonment emails, and gathering and analyzing customer feedback. These site improvements have collectively enhanced the shopping experience, generated traffic, and increased conversion.

We will begin our two-year conversion to a new web technology platform early next year. Once fully implemented, this new platform will allow for a true omni-channel experience for our customers and will offer significantly enhanced search capabilities, personalization, and segmentation of customer experience and offers, better management of promotions, and multi-site for separate full-line and factory sites. Over time, this new platform should allow us to better focus on our brand and product story and to reduce promotional activity on our full-line site.

As we work towards improving the productivity in our indirect channel, we are placing greater focus on department stores. Department stores allow us to attract new customers to Vera Bradley and to showcase our elevated product assortments. We are taking a methodical and strategic approach to building a profitable department store business that represents our brand.

We are now in 100 Macy's stores, including a small outpost in the Herald Square flagship store. We are pleased with this relationship and expect to add additional doors and enhance both our product assortment and store presentation as we move into next year. In November, we began testing our products in three Belk stores, one of which is a prototype shop in shop in the Dallas Galleria, and over time we expect to expand that relationship as well.

Of course, Dillard's remains a very special partner for us and they were a central platform for our third-quarter leather launch. We believe that we will continue to expand the number of department store locations going forward.

One development I am very excited about that will affect the direct side of the business as well as our department store business is the addition of Harry Cunningham to our team. Just this week Harry joined us as our new Head of Store Development.

Store presentation and site selection are critical as we continue to evolve and elevate our brand. Harry will be charged with developing and implementing innovative visual in-store merchandising design for our own stores as well as our department store partners, overseeing new store construction and remodels, and working on site selection for new Vera Bradley stores. He will spearhead the design of our new prototype store.

Harry is an industry icon with nearly 25 years of experience in store design and digital merchandising who has won numerous industry awards, and he has been with Saks Fifth Avenue since 2006 and most recently held the post of Senior Vice President of Store Planning, Design, and Visual Merchandising.

And prior to that he held various merchandising roles of increasing responsibility with Liz Claiborne, [bax] department store groups, and Dillard's. We are really pleased to have Harry on our team.

Now let me switch to the indirect specialty gift channel. We now have about 2,000 partners, comprising approximately 2,850 locations in this channel. While the specialty gift business is becoming a smaller percentage of our total revenue base, it remains an important and very profitable piece of our business.

We're focusing on our largest accounts that represent our brand the best and discontinuing unproductive accounts that do not represent the Vera Bradley brand well. We're working closely with our retail partners to stabilize the business by carefully controlling and balancing inventories, and by better tailoring and segmenting our product assortments by door, and I think we have made progress on this front. Beginning next year we will further segment our inventory by offering our specialty gift retailers some exclusive products.

In addition, we're in the process of restructuring our sales consultant team in the field that services the specialty gift channel, reducing the number of consultants by about 20%. This will better align the number of sales consultants with the current sales level.

Let me just briefly mention that Mitsubishi Look opened the first two Vera Bradley stores in Japan during the third quarter to overwhelmingly positive customer response. As a reminder, Mitsubishi Look is targeting as many as 25 Vera Bradley locations in Japan by the end of our five-year agreement.

Lastly, let me touch on the third component of our strategic plan, marketing. In addition to optimizing the web, which I have already touched on, there are three additional key elements to our marketing strategy: marketing the brand, building our customer base, and increasing our customers' wallet share. We intend to market the brands by increasing our advertising spend and being more strategic about the marketing investment we are making and reallocating our total spend to be more impactful.

We'll increase both digital and print advertising and enhance our PR and social media efforts with the intent of doubling our media impressions and exponentially increasing our customer reach. We want to modernize and strengthen how the brand is perceived.

These efforts have begun. As you know, we launched our first national ad campaign in September, focused on leather and faux leather. This campaign included a strategic combination of carefully placed national ads, special events, social media, with a focus on Twitter and Instagram, and creating buzz through bloggers and fashion influencers. And in November we also launched a digital campaign with 180 million impressions targeting 45 million customers in our Brightest Gifts Ever holiday print and digital campaign.

As we think about building our customer base, our focus will be to attract new customer segments and to ensure continuity across all life stages. Our primary focuses for new customer growth are to those unaware of our brand, career women, and male gift-givers. In order to increase our customers' share of wallet, we must engage our customers beyond single need occasions, focus on multi-product marketing, and implement a more robust CRM program using our recently implemented omni-channel database.

We are in the very early stages of these marketing efforts and will have more to share on future calls. Operator, we will now open up the call to questions.

(Operator Instructions)

Steve Marotta, CL King and Associates.

I just have a couple of quick questions. The first is that, Kevin, I believe you cited that gross margins were a little bit under pressure in the quarter due to more promotional activity than initially expected online.

That was supposed to be a little bit more about full price resource for you guys. I thought that was part of the strategy going forward; can you reconcile those, please?

Sure, over the long term that's exactly right, Steve, but it was highly competitive during Q3. We're also moving some of our liquidation inventory through the web. We've realized higher margins on the web to move it there via some outlet sales, versus trying to sell it to some liquidators.

So we're ultimately able to get more margin dollars by selling that on the web. But over the long term, that is a part of our strategic plan which is moving the website to more of a full price offering.

Okay, great. As it pertains specifically to the inventory decline, you mentioned that it's largely timing on some of the differential between guidance and actual timing of receipts. Does anything have to do with port issues?

There was a little bit related to port issues. We've seen about a 7- to 14-day delay in terms of getting our product here. We didn't have anything of significance impacting the quarter but nevertheless there was a little bit related to that.

In addition, we have one key supplier now over in China that is actually taking ownership of the fabric. They ultimately had more inventory than we expected as we exited the quarter. That was an impact of about $6 million as well.

So primarily time, but nevertheless the port. Very small issue there, but then a key supplier over there we've actually been able to move the risk of us holding us the fabric to that key supplier that helped us move our inventory number down as well.

Terrific, and lastly, as you were guiding to Q4 comps, if you gave it, I missed it, the differential between store and e-commerce?

Yes, sure. We expect from a store perspective to be -- we didn't give that number but we do expect that to be down similar to Q3, but down slightly more. So you could call that mid- to high-teens.

Okay. And e-commerce?

And e-commerce we don't typically give guidance for that in particular, but if you look at what we've given from a guidance range for the quarter, (multiple speakers) high single digits down.

Okay. Great. Thank you.

Consolidated.

Consolidated, right.

Consolidated both the web and the stores.

Right, thank you.

Thanks, Steve.

Mark Altschwagger, Robert W. Baird.

Rob, you mentioned in the prepared remarks that you would have expected maybe a bit more traction by now in some of these initiatives. What do you think is driving that divergence? And then if the store comp trends remain more challenged for a longer period than expected, would that lead you to reconsider the pace of new store expansion over the next year or two, or how are you thinking about that?

Yes, the number one thing we've been facing is this change in the customer traffic environment. It's definitely been more challenging than we had anticipated going into the end of the third quarter going into the fourth quarter. And our business, when you look at our sales performance and our traffic performance, there is a high correlation.

So on the positive side, what we're seeing is the customer is absolutely responding to the new product assortment so as we look at the selling of all the new product introductions it's outselling our core. So that part has been very encouraging but the store traffic has definitely been a large challenge. And it was definitely one that we did not anticipate as we were going forward.

So it's going to make us have to work harder; the marketing initiatives that we put in place literally have just started to hit, particularly the digit marketing which started at the very end of October, going through December and a lot of those impression campaigns take a little while to get consumers back in store, but the early reads on clickthrough and customer response with the digital advertising has been encouraging. But we need to get more customers in our store.

The second question you've raised is if we continue to see a challenging traffic environment and therefore a challenging comp environment, in the store is would we relook at our ability (technical difficulties) constantly looking at our real estate. We are constantly looking at how many stores we're opening. We do have our leases completed for next year so as we look at the next fiscal year those leases are basically [dolid] and moving forward.

But we are definitely watching these comps closely and will continue to evaluate our store opening based upon the comp performance. But at the same time, as we've said we do believe we still have a very small store footprint. So we have just under 100 full-line stores, and we believe that attracting new customers to our brand, exposing new customers to our brand, is critical though the store expansion is one of those areas that we're leveraging as a marketing opportunity to gain new customers.

Great, thank you, and then Sue, as the Company shifts to more of a collection strategy, what are your expectations for the indirect channel in terms of depth of buy into each of these collections? And then more broadly, what's going to be the biggest point of differentiation between what we see in the full-line stores versus the wholesale channel moving forward? Thank you.

As it relates to the collection, we actually have started selling in these collections to our independent channel, actually, starting with spring. We did actually -- we were very pleased with the results of what our initial EOP reflected and we are, in fact, seeing that the consumer is, from that channel, responding to moving towards this direction as well.

From a depth of buy perspective, again, we were pleased with the initial results. We feel that they're buying in at the appropriate amount that we had anticipated, and in terms of how will we continue to differentiate as we move forward, one of the things that we're keeping a really eye on is as we continue to expand and diversify into fabrications and also continue to diversify our print penetration, we are considering what that looks like by each channel of business moving forward.

And I think the one thing that I would add is as you look at the fabrications that we are introducing, like the leather product, we definitely see those more elevated price points being distorted within our own stores and the department store channel as opposed to the gift channel. And we do believe that the gift channel's base is on the more opening price point, so we do believe that's where we'll focus the majority of the assortment is more on the opening price within our specialty gift channel. And then the higher (technical difficulties) fabrications will be more in our own stores and in our department stores.

Randy Konik, Jefferies.

Just a couple of things. I guess, Sue, can you elaborate a little bit more on maybe some more firm data points on what you are saying, really improve response to the new product?

I guess second question, when you look at the indirect order -- the indirect sales pattern reflecting lower orders and as well as reduction on the specialty channel that you kind of mentioned, what was more impactful to that indirect number? Was it the reduction on the specialty -- number of doors versus lower orders? And then within the lower orders, is that a function of the base, kind of classic-type product being ordered less versus the newer-type looks that are maybe up in orders? Can you give us some color there?

And I guess lastly if you kind of think about Deckers UGGs brand as a somewhat similar situation here, where their classic UGGs business saw a big decline and then now has rebounded, that company transformed itself to get their classic UGGs boot as now under, about under 40% of total sales. If you look at, as a, I guess, a similarity here with your business, you're going after new product and some of the older styles or the styles, the classic styles, you could say, are going down.

Where do you envision, over a long period of time from a merchandising standpoint, that the new stuff, or the more fashion, more modern brand stuff, would be as a percent of the mix versus the core classic, I would say, that everybody knows is traditionally known or perceived Vera Bradley to be? Thanks.

What I'll do is I'll start with, first of all your question on orders and where we're seeing that balance between newer versus older as we're moving forward on EOP and what I would say it's basically been in line with where our sales have been on those diversified fabrications et cetera. So signature still makes up in that channel, still the vast majority of the overall sales volume.

As we continue to move forward, we had given a guidance that by the end of this fiscal year, we would be at 30% in terms of newness and we are, in fact, seeing that the specialty track channel is in fact tracking with us when you look at where their orders are coming in. And so I would say they are right in line with our expectation and sort of what we had projected for them.

Also, over the long term, and obviously we're going to continue to keep a very close eye on this as you can imagine, but we had given a guidance that said that we believe that 70% of our business will still remain within core, but that core of mix may change over time. So a good example of that would be as we continue to see microfiber continue to trend, that will now become a core fabrication for us, but we expect core made up of, over the next couple years, made up of signature and now microfiber, which is a brand new core business for us, along with Lighten Up fabrication, which was a brand new fabrication for us, representing about 70% of the volume. 20% will be in what we're calling our fashion core product or some of those newer introductions like faux leather that we're seeing checking representing about 20%.

And then 10% will remain halo, Randy, from that perspective. And we see that being pretty consistent over time and as things check moving into the core pocket.

From a SKU productivity perspective, what we are seeing is in the high double digits where we have seen our increases and we've been really pleased with that. It actually exceeded our initial expectations of where we thought that SKU productivity would come in on the new product specifically.

Got it, so can I just ask one more math question, then? So if the signature or the core is like the 70% number, and now this microfiber is now part of the core, how big of that 70% pie do you envision that microfiber to get towards? Because I'm just trying to get to the end-all, how low does the signature piece get in terms of this merchandise mix of company? Thanks.

So microfiber, by the end of this year, will represent about 20% of our overall volume and if you remember, that was in the single digits one year ago. This was one of the major strategies that we said that we were going after first and foremost in order to stabilize this business.

We were going to invest in solids and so where do we see that, we will continue to watch it but we do continue to see that expanding into FY16 in terms of percentage points as well. But by the end of this fiscal period, it will work present around 20% already.

Great, very helpful. Thank you. I'm sorry, go ahead, Rob.

Just to add to that a little bit, because I know part of your question, Randy, really is purely around what I'll call the signature cotton quilted printed business. And interestingly enough that we believe that business probably is going to end up representing somewhere, give or take, 50% of the business as we go forward. It might get down to the 40%s, but hopefully we'll call it around the 50%.

And what we've seen as we've gone through the third quarter is that we are getting growth out of all of the other fabrications. But the core place we were losing the most is in kind of that core cotton signature business. And that's really where were dropping so customers definitely responding to newness, definitely responding to the movements we are making in product innovation, but there is a little bit of fatigue in the core.

Very helpful. Thank you.

Jennifer Davis, Buckingham Research Group.

A couple, and I'm sorry if I missed this, but did you guys say -- give any more detail on kind of what the difference will be in the specialty channel -- the specialty gift channel versus your own stores? I think you said you were going to have some exclusive product in there; I was wondering if it was SKUs or different kinds of patterns? And then also just wondering anecdotally what you're seeing with the new product, the leather and the faux leather, in terms of new customers or existing customers, any anecdotal takeaways from that? Thanks.

Jennifer, it's Sue, thanks for the question. If you talk specifically about the specialty gift channel, so one of the areas that we started with was the diversification between the two channel segments, starting with leather, and we, again, we will continue with that strategy, where in our own stores as well as in select department stores and very limited specialty stores, we will continue with the diversification of our leather products. We also had also product segmented the faux leather this year as well, where we actually had it in our full-line stores, obviously, our online follows our full-line concept.

We also segmented that into select department stores and only very select specialty stores. So our strategy as we move forward and introduce new fabrications is we will take the same approach. We will take a channel segmentation approach determining which fabrications, based upon consumer type, are right for the new -- to drive that new innovation and to make sure we are appropriate in that channel of business.

As we start to see those different fabrications checking and once we're getting the customer data back, we may continue to then expand that fabrication into other channels, or deeper into channels as we see fit, and then constantly introduce new newness and innovation in our own stores and in our online business. So that is sort of the methodology that we're following from a merchandising perspective.

From a pattern perspective, right now we are diversifying our print -- obviously our print portfolio. That has been our first avenue that we have gone after; we have not really segmented specifically by channel there.

We believe that's an opportunity over time. And then from leather and faux leather I'll actually -- Rob is going to be answering that question and then new customers but at a high level, what we are seeing is that the new customers, in fact, we did see these fabrications and we did see a response from the new customers.

I think what's been exciting as we look at the new customer performance and the new fabrications is that we're overindexing in the very customer that we wanted to attract to the brand, so really getting in that 25- to 35-year old, career-focused customer, we are definitely seeing an overindex there which is very encouraging. It's also been very encouraging to see how well newness is performance across all channels. So whether it's been the faux leather in our select specialty stores, whether it's been our leather product, been very encouraging in our stores to watch how well the consumer has responded to leather because it was such a significant jump in price point for us.

Again, very encouraging signs in terms of the performance of these fabrications throughout. And we talked a little bit earlier in the script in terms of how, as we're going through this time, we've made the decision even as we go into next year to move faster and move heavier and continue to push these new fabrications through our supply chain and become less dependent upon the core signature pattern business.

We believe that's still a great foundation for us and what people know Vera Bradley for. I think the analogy to UGGs is a good one. It always will be the core of our business but we do believe the consumer's responding very, very well to the newness and we need to continue to drive the newness.

Edward Yruma, KeyBanc Capital Markets.

First, on the e-commerce number I know you mentioned it will be a little bit more promotional. I know you haven't explicitly broke out eBay as part of it, but just kind of any rough color as to what contribution, and then maybe an update on the percent of sales overdone at kind of full price versus that were done, either closeout or this kind of e-outlet that you mentioned.

First I'll start with eBay. eBay is relatively small to the total. It's very small, and we're annualizing that number as well.

So we started selling to eBay, really, in Q3 last year. So if you think about Q3 and Q4 this year it's not impacting that comp rate much at all in Q3 or Q4. So there's not a lot there.

As far as the mix, with regards to what's sold online, it's been relatively consistent year-over-year, so not a lot of changes there. We have moved more liquidation product than we originally expected, so I think on the last call I said $5 million to $10 million, but we're leaning towards the high end of that range and potentially more than $10 million.

We now expect to sell, from a liquidation perspective, somewhere in the range of $15 million to $20 million, and a lot of that has been moved to our web channel, as well as through some liquidators. Good news is we've been able to sell at a little better margin than we originally predicted, and it will help us exit the year with a much better inventory position.

(Multiple speakers) encouraging is even as we've been getting through some of our liquidation on the web, we've actually seen it lifting to full price business too because of traffic that it generated through the web. So with time we still want to remove the high liquidation from our website; it's definitely one of our core initiatives as we go into next year. But this year, it did help drive more new customers into the brand in third quarter, which was encouraging.

Great, and a follow-up: I think last call you mentioned that the -- you were starting to see some really nice results in the preorder period, I think it was the first kind of positive commentary that you had on that order period in some time, and I guess I'm assuming maybe that didn't manifest itself in the quarter. So just trying to understand kind of the performance of some of the new patterns that you've launched, not necessarily the new new product but the new classic patterns, and kind of what's working and what's not, and how we should think about the aging of some of the older patterns and the performance of those that are older in the portfolio. Thank you.

So, a couple of things. One, in terms of what's been going on in our indirect channel, the early order periods have been flat, basically, with last year, which has been encouraging. Where we still continue to see weakness is in reorders, and part of that is due to our independents are much cleaner, I think they are very focused on what's new, they know that the customer is responding to new, so they're not taking as long of a view in terms of reordering and staying in stock, they're moving forward into the new assortments.

So I think what we're seeing is a recovery in EOP first, but we're not seeing the recovery in the reorder. I believe that channel has just really changed in terms of the way we're looking at it. And that's part of what's driving the weakness in the indirect channel that you're referring to.

In terms of the cleanliness of the inventory, overall, throughout all the channels we feel that the inventory is much cleaner than it's been in a long time. We're getting that feedback from our indirect specialty stores, we're seeing that in our own stores in our inventory levels, so we feel very good about the cleanliness and the quality of the inventory. Overall, pattern selling, it's not so much about one pattern's performance versus the others right now, it's just an overall softness in the pattern part of our business and a movement to our customer to new fabrications and new solid patterns.

And then Ed, with regards to Q4 guidance on the indirect side, so we said down high single digits to low double digits, that looks like an improvement compared to the first three quarters but a lot of that is timing. So our large for winter that hit towards the end of October, some of that flowed into Q4, which was as expected, and then the same thing with our spring launch which is towards the end of January; more of that's hitting Q4 than Q1 and that's just timing with the prior year. So as Rob mentioned, EOPs, which is our early order period relatively flat to the prior year, but our reorders still are down significantly.

Great. Thanks so much.

Evren Kopelman, Wells Fargo.

I have a question on the department stores. What percent of sales do you expect the department store channel to be next year? And maybe thoughts on if it's a focus for you to accelerate that and maybe what kind of pace we can expect, and if you would consider kind of moving more broadly, which hasn't been done at the Company before, but into channels like a Kohl's, JCPenney?

Sure, with regards to the numbers, Evren, we don't give that breakdown in terms of department stores versus specialty versus key accounts just because we manage that segment as one segment within the business, and there's bound to be some ups and downs and we use to our advantage to be honest with you, Evren. As far as acceleration and then maybe Kohl's and Penneys, I'll let Rob speak to that.

We definitely believe that there's an opportunity to continue to accelerate the department store openings. We've been very happy with the initial results at Macy's and the partnership there. We believe there's a real opportunity to expand our department store reach in the North and the West Coast.

And so we continue to look for that, but we just want to make sure that we are prudent in how we built up the department store sector. Part of what really becomes important is that our in-store presentation becomes critical to the department store expansion and getting Harry Cunningham on team was really a key piece of that. Because what we don't want to do is expand too quickly into the department store world without the right presentation, we want the department store expansion to enhance the brand and attract new customers to the brand, and so we need to make sure that we have the right in-store presentation, but we definitely will continue to expand aggressively in the department stores.

But right now we think there's so much opportunity and what I'll call kind of that core department store sector, the Macy's, Dillard's types of department stores, that we believe that's our primary focus. We want to be careful about getting too spread out in terms of going into a Kohl's or Penneys at this time.

Okay. And then the second question is, as you do more, you said 11 to 12 collections per year instead of the old, I guess, launch way, is there going to be a big change in how the quarterly revenue flow that we should think about as we model out 2015 quarters? Thanks.

We're not obviously giving guidance for next year, currently we don't expect big changes. But obviously on our call related to Q4 we'll lay that out for you and if there's changes from a launch sequence we'll definitely go through that with you at that point. But we don't expect significant changes at this point.

Oliver Chen, Cowen and Company.

Regarding the journey to transition the product differently, what's happening to the overall AUR on an overall basis, as you look to elevate some elements of that? And also just regarding the big spread between bricks and mortar versus online, so was that due to the assortment being more promotional this quarter? Or where -- how is the assortment differentiated in-store versus online, maybe now and I understand that you want to transition to more full price over a longer-term basis?

And then just a housekeeping question. Is networking capital going to be neutral for the full year, or how should we model free cash flow? And if there's anything we should know about special needs for CapEx next year that it be helpful, thank you.

With regards to networking capital, we obviously don't provide guidance for that for the full year. But nevertheless we gave you -- the inventory number continues to come down and that really is what drives our net working capital as you know, Oliver. So that coming down, that's going to significantly add to our operating cash flow for the year.

So as you compare it to prior years, where we were at maybe $50 million in operating cash flow, just because of that inventory number coming down by $30 million or so, you can expect operating cash flow to be closer to an $80 million number or something like that. And then you look at CapEx being around the $40 million number.

And then obviously we're repurchasing a small amount of shares for the year as well. That's 3.5 million and then we still have kind of a quarter to go on that. And then next year as it relates to CapEx, we're not giving guidance there, but keep in mind, given our store numbers going up, you would expect the amount we're going to spend on our stores to go up from a CapEx perspective, and then we also expect to invest more heavily in the web and some of that will be CapEx as well.

So I don't expect us to go back to kind of our norm of $20 million or $25 million, from a CapEx number. We're not giving guidance right now. But I expect it to be something north of that.

And in terms of the AUR, a couple of different things. One, we definitely have seen no resistance from the customers we've introduced the leather product and again that's been very encouraging. But keep in mind that the whole leather part of the assortment is still a very small piece and not large enough to make any significant changes in AUR.

What we are seeing across our retail metrics, though, in terms of ADS, AUR, conversion, all of those numbers, is basically similar performance to last year. The big metric that's driving the negative comp is store traffic.

Store traffic is responsible for the down comparable sales. So our number one focus is getting consumers back in the store and we believe that the innovation and the marketing initiatives that we are working on are really key, as well as expanding our reach through our new stores and our department store relationships.

Thank you, and Rob, as the product does evolve, does your competitive peer group change as well? From a bigger picture perspective, where do you see it going versus where it is now?

I think one, we definitely -- Vera Bradley, I think, has been in a unique white space, which has, I think, always been part of the success of the Company, and we believe that we still will continue to be in a white space. We believe that introducing leather product will bring a new customer in.

But we're not trying to transform into the next Michael Kors. We're trying to really be true to what the heritage of the brand is.

And I think we're a brand that really focuses on women, solves women's needs, meets women's needs, and what we've been trying to do to the leather and faux leather assortment is address the one hole we thought we really had in our assortment, that our customer told us that she needs bags that she can take to the office and she can take in more formal situations and we wanted to listen to her and respond and I think that's why we've had such an encouraging response to it. But we're not necessarily moving into a completely new competitive set.

We really do believe that we provide, in the department store environment, a great bridge between what I'll call the brand's life [ramens] in different parts of the world and then the Michael Kors case bay that we kind of fit in this nice bridge between, and where we have this great brand, and at the same time we offer a very affordable product that's very focused on functionality and what women really need, not just fashion.

Okay, and if you could just, on the e-com channel question, so what was the reality of this quarter in terms of the assortment and was it a nonrecurring kind of event given the differential in the assortment online versus in-store?

The biggest difference that you would see between the two is that our web, during third quarter, definitely had a significant portion of liquidation going through it. So that was definitely a difference in the assortment so the deeper discounts that you saw going through our web was a differential. It wasn't necessarily what I'll call kind of core assortment issues, it was really the liquidation issue and some of the retirement issue.

So that was really the difference in why you saw it. At the same time as we've been doing a lot of our marketing, a lot of our digital marketing, the first response we've seen is customers visiting our website, and so it's been driving traffic quickly to the website.

It's obviously much easier to convert from a digital ad to a website visit than from a digital ad into a store visit. The store visit takes a little bit longer to get to. But we're seeing it quicker in our e-commerce side of the business.

Ike Boruchow, Sterne Agee.

I think Kevin, the first question for you, when we think about inventory and how you're planning your inventory needs for next year, I think there's a lot of SKU rationalization this year, do you think that the inventory growth should go back in line with sales as we get back into 2015 as everything's kind of normalized from a SKU perspective?

Yes, I think that's a safe assumption at this point. We expect inventory to start growing with sales as we exit this year and get into next year. From a SKU rationalization perspective, and Sue can add to this, but I think we don't expect SKUs to change significantly at this point next year compared to this year.

So relatively flat year-over-year, so we're going to be down 30% or 35% this year. We see that as being flat to slightly growing as we get into next year, and definitely see inventory growing at least with sales next year, especially as we look at other opportunities for distribution.

Got it.

As we continue to add innovation, and one of the things we knew we had the opportunity to do was make sure we right-sized our business in terms of the SKUs that were out there. But as Kevin said, we believe that we've gone through that process now, we feel really good about the SKUs where we're at, in the level that were at, and then it does allow us to introduce that new innovation to the consumer.

Got it. And then I think, Rob, you talked about the web conversion and the costs that will be associated with that, and then Kevin had mentioned that part of that might flow through CapEx. Just, can you help us understand the next two years, you're trying to do a lot on the web.

What are the costs associated with that, what would flow through CapEx? What would flow through your SG&A and just to help us understand that a little better?

It's a good question, Ike, but we're going to save that for our Q4 release because then we'll have our operating plan finalized and we'll know exactly those numbers. But we do expect a pretty significant investment in the web platform in the coming year. We announced that at our investor day in New York. We're excited about it.

We think it's a way that we'll be able to drive more traffic, a little more predictability to the web and make it a better customer experience. But at this point, we're not giving out those numbers between CapEx and SG&A as of yet.

Got it.

We definitely believe that the website kind of repositioned and it really focused in on the full price brand experience and the website still an absolute critical initiative for us. We've been taking the steps this year to set us up for it, and then this migration that we're going to begin to work on next year is going to be the next step. Because we believe that's the front door to our brand, and it's critical that we get that branded.

Janet Kloppenburg, JJK Research.

Sorry I got on a little bit late. I just had a couple of questions.

Rob, I heard you talk a lot about traffic being tough to the stores. Just wondering what your analysis is of your initial marketing campaigns? They've been terrific, but is there anything you can do there to try and tweak them, perhaps, to access a wider customer base or to motivate greater traffic from the existing customer base?

And also I think you said you have about 2,000 gift accounts and I'm wondering, should we be modeling a stable level going forward or do you look for modification in the gift account basis going forward? Thank you.

Thanks, Janet. First of all, let me answer your second question. In terms of the account base for the indirect channel, we think that it's going to be fairly stable, maybe slight reduction.

But if we are reducing it's going to be more on the marginal accounts. So we're not looking for significant changes in the accounts in our indirect channels at this point.

Great. Thanks.

Go ahead.

No, I just said great, thanks.

The second question was around store traffic and the marketing campaign. And we are definitely testing a lot of different marketing initiatives. We definitely believe getting customer to reengage with the brand any of this new customer engaged with the brand is a primary focus.

As I said, we're still early in that process. We saw significant engagement coming to the website from our leather campaign. A lot of people trying to understand what we were doing and getting excited about the new leather launch.

As we've done the digital campaign, again it is so new and so fresh that part of that's about building impressions, but what's been encouraging is to see the clickthrough rates and the engagement with the digital ads, which has been encouraging. Now we just have to build up the impressions with time to get the consumer in the stores. So we're going to continue to test innovative marketing initiatives to the consumer and the store so stay tuned.

And at this time I would like to turn the conference back over to our speakers for any additional or closing remarks.

As I look back over the prior three quarters, I am proud of how much the team has accomplished in such a short amount of time. While the current environment is difficult and we continue to face challenges in the business, I believe we are taking the right steps to position Vera Bradley for the future.

As we evolve our products, our distribution, and our marketing, there will undoubtedly be some bumps in the road, but I am very optimistic about the future of our business and our brand. And I think you for your interest and time.

Thank you. That will conclude today's conference. We thank everyone for their participation.