Vera Bradley Inc (VRA) 2017 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Vera Bradley third-quarter FY17 earnings conference call.

(Operator Instructions)

As a reminder, today's conference is being recorded. I would now like to turn the call over to Mark Dely, Chief Legal Officer. Please go ahead, sir.

Good morning and welcome, everyone. We would like to thank you for joining us for Vera Bradley's third-quarter earnings call.

Some of the statements made on today's call during our prepared remarks and in response to your questions may constitute forward-looking statements made pursuant to and within the meaning of the Safe Harbor provisions of the Private Securities and Litigation Reform Act of 1995, as amended. Such forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from those that we expect.

Please refer to today's press release and the Company's Form 10-K for the fiscal year ended January 30, 2016 filed with the SEC for a discussion of known risks and uncertainties. Investors should not assume that the statements made during the call will remain operative at a later time. The Company undertakes no obligation to update any information discussed on the call.

I will now turn it over to Vera Bradley's Chief Executive Officer, Rob Wallstrom. Rob?

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

The third fiscal quarter was an important one for our Company with the launch of Vera Bradley's new brand positioning supported by our comprehensive marketing initiatives, select store remodels, and the opening of our new SoHo flagship. We're pleased with the improved consumer engagement driven by these initiatives. We experienced improving traffic trends in our stores and online in conjunction with our brand relaunch in marketing efforts earlier in the quarter.

However the overall retail environment remains very challenging. Our third-quarter diluted EPS of $0.20, excluding a $0.04 per share positive tax adjustment, was modestly below our guidance range, largely due to continued weakness in the specialty channel and incremental promotional activity in our factory stores. In addition, verabradley.com sales were below expectations, primarily due to reduced levels of retirement product.

Recovery is a long process and it is taking time to transform and reenergize the brand so that it will become top of mind for consumers. We believe our focus on evolving our product offerings, while honoring our heritage, working to distribute our products in the most impactful channels, and enhancing consumer engagement and traffic through our market and rebranding efforts are the right ones for the future of the Company. We believed that we have a unique opportunity to expand our customer base and grow our Company over time, but know that there's still a lot of work ahead.

In the meantime, we continue to closely manage both our distribution channels and our expense structure while prioritizing customer-facing investments. Given the headwinds we're facing, particularly in the wholesale channel, our fourth-quarter revenue expectations are well below our initial thoughts, which is putting pressure on gross profit, our ability to leverage SG&A and EPS.

Let me now turn the call over to Kevin who will discuss our third-quarter financial performance and fourth-quarter outlook. Kevin?

Thanks, Rob, and good morning. Let me go over a few highlights for the quarter. Current-year third-quarter net revenues totaled $126.7 million, modestly below our guidance of $128 million to $133 million. Prior-year third-quarter revenues also totaled $126.7 million.

Prior to the previously mentioned income tax benefit, net income totaled $7.2 million or $0.20 per diluted share. Prior-year third-quarter net income was $10.3 million or $0.27 per diluted share. Direct segment revenues totaled $86.1 million or 2.3% increase over $84.1 million last year.

This revenue number reflects a comp sales decline, including e-commerce, of 5% for the quarter, which was more than offset by new store growth. Comp sales continue to be negatively impacted by year-over-year declines in traffic. Indirect segment revenues decreased 4.6% to $40.6 million from $42.5 million last year, primarily due to lower orders from our specialty retail accounts, partially offset by higher sales to certain department stores and non-department store key accounts.

At quarter end the number of specialty accounts remained essentially flat at around 2,600. Gross profit totaled $72.9 million or 57.6% of net revenues compared to $73.3 million or 57.9% of net revenues last year. The year-over-year 30 basis point gross profit percentage decline primarily related to modestly increased promotional activity at our factory stores, which also caused gross profit percentage to fall modestly below the low end of our guidance range of 58% to 58.5%.

SG&A expense totaled $61.8 million or 48.8% of net revenues in the current year third quarter compared to $57 million or 45% of net revenues in the prior year. SG&A dollars increased over the prior year primarily due to expenses related to new stores, incremental marketing, and $600,000 of store impairment charges. The SG&A expense rate was slightly higher than our guidance of 47.6% to 48.6% primarily due to lower-than-expected revenues.

Operating income totaled $11.4 million or 9% of net revenues in the current-year third quarter compared to $16.8 million or 13.3% of net revenues in the prior-year third quarter. By segment, direct operating income was $17.1 million or 19.9% of sales compared to $19.3 million or 22.9% of sales in the prior year. And indirect operating income was $16.9 million or 41.7% of sales compared to $19.1 million or 44.8% of sales last year.

Cash and cash equivalents and short-term investments as of October 29 totaled $83 million compared to $61.8 million at the end of last year's third quarter. And we had no debt outstanding at quarter end.

Quarter-end inventory was $95.7 million compared to $118.2 million at the end of last year's third quarter, and at the low end of our guidance range of $95 million to $100 million due to diligent inventory management. During the third quarter we continued to repurchase shares under a $50 million repurchase program. We've repurchased approximately $7.6 million equating to approximately 523,000 shares at an average price of $14.58.

Now let's talk about our outlook for the fourth quarter and full year. Our guidance reflects the extremely challenging retail and competitive landscape. Keep in mind that as I discuss our prior year comparisons, the current-year numbers exclude the previously mentioned tax adjustment, and prior-year numbers exclude the manufacturing facility closing and other excluded charges outlined in our release.

For the fourth quarter we expect net revenues of $135 million to $140 million compared to prior-year fourth-quarter revenues of $154.1 million. We expect direct segment net revenues to be flat to down in the low single-digit percentage range, with a comparable sales decrease, including e-commerce, in the mid single-digit percentage range.

We believe our fourth-quarter indirect net revenues will be down significantly in the 35% to 40% range, reflecting a meaningful reduction in orders from specialty retailers, as well as modestly lower than originally expected orders from the department stores and other key accounts. The gross profit percentage for the fourth quarter is expected to range from 55.9% to 56.2% compared to 58.2% in the prior-year fourth quarter. The decline reflects expected increased promotional activity in our factory stores.

SG&A as a percentage of net revenues is expected to range from 46.1% to 46.7% in the fourth quarter compared to 42.1% in the prior-year fourth quarter. The expense deleverage is primarily attributable to the expected revenue decline.

We expect fourth-quarter diluted EPS to be in the range of $0.23 to $0.25. This compares to diluted EPS of $0.41 in the prior-year third quarter.

For the full year we expect net revenues of $486 million to $491 million compared to $502.6 million last year. Our revenue guidance includes direct segment net revenue growth in the low single-digit percentage range, with a comparable sales, including e-commerce, decrease in the mid single-digit percentage range. Indirect net revenues are expected to decline in the low to mid teen percentage range for the full year.

The gross profit percentage for FY17 is expected to range from 56.8% to 56.9% compared to 56.6% last year. The planned improvement reflects sourcing and operational efficiencies and increased sales penetration of higher-margin MFO products, partially offset by increased promotional activity in our factory stores, as well as product mix changes. Gross profit margin improved in the first half of the fiscal year and is under pressure in the second half of the year.

SG&A as a percentage of net revenues is expected to range from 49.5% to 49.7% for FY17 compared to 46.6% last year. The expected increase primarily relates to the lower revenue base as well as incremental expenses associated with new stores, severance and second- and third-quarter store impairment charges. Our year-over-year marketing spend will approximately be flat with last year.

We are lowering our full-year diluted EPS guidance range to $0.62 to $0.65, which includes $0.04 of second- and third-quarter asset impairment, and excludes the previously mentioned $0.04 per share tax benefit. On a comparable basis adjusted diluted EPS totaled $0.82 last year.

We expect inventory to be $100 million to $110 million at the end of the fiscal year compared to $113.6 million at the end of last year. Net capital expenditures should total approximately $20 million for the full year, primarily related to new store openings, store renovations and continued technology investment.

Let me turn the call back over to Rob who will update us further on the business. Rob?

Thanks, Kevin. Let me make a couple of comments on product. We are continuing to build functionality and innovation into our core classifications of fashion bags and accessories, travel and campus, and continuing to add additional products to enhance her lifestyle such as in home and beauty. Creating beautiful solutions for our target customer is always top of mind.

During the third quarter we drove our back-to-campus initiative by focusing on our core business and added enhance functionality along with expanding our new collegiate initiative to representation of over 70 schools. We also drove innovation in our core business of bags and fashion accessories by adding such features as RFID and charging capabilities, and introduced our Gallatin Relaxed Leather Collection.

And, as usual, we also distributed several new signature patterns and colors during the quarter. Pattern strength continues to be critical as quilted cotton and Lighten Up make up over 60% of our direct sales.

We also just announced three additional licensing deals for bedding, hosiery and swim, in addition to our previously announced stationery and publishing licenses. Our iconic and unique patterns easily lend themselves to many products in our target areas of home, fashion and beauty, and we expect to announce even more partnerships in the future in those areas.

As a reminder, the revenue and net income implications of these deals are not material this year or next year. But we are excited about the expansion of our products through licensing to increase our brand exposure, acquire new customers, provide additional distribution, drive traffic to our digital flagship, and to position us for eventual international growth.

Let me take a minute to update you on distribution. As you know, we opened our SoHo and Hawaii full-line stores in the third quarter, bringing our full-line store count to 114. The SoHo store, with its innovative design elements and array of exclusive and limited edition products, is a key part of our marketing strategy, elevating our brand and showcasing Vera Bradley to consumers all over the world.

We also completed the remodel of our Jefferson Pointe store in our hometown of Fort Wayne, and refreshed 12 of the higher-traffic, higher volume full-line stores with our new branding, including storefront facade, logo and interior changes. In addition, we rebranded the facades of our 15 newest full-line stores so that about one-third of our fleet now reflects our new logo and signage. We will continue the refresh program into next year.

We opened one additional factory store during the third quarter and our last store of the year in November, bringing our current factory outlet count to 46. We continue to focus on driving traffic, conversion and sales in both our full-line and factory stores through must-have key items, superb visual and in-store execution, strategic promotions, improved discipline and accountability, and engaging in-store events.

The relaunch of our digital flagship platform, which is a key part of our distribution and brand transformation strategy, will go live in the first quarter of next year. The new platform will allow for enhanced ease of shopping and will offer incremental functionality, including, among other things, additional navigation and search enhancements, strategic segmentation and personalization, and order online/pickup in store.

Moving on to department stores, we are in over 350 Macy's stores including nine World of Vera Bradley lifestyle shops, and we're in approximately 40 Belk and 40 Bon-Ton locations. Including Dillard's and Von Maur, our total department store count now is over 730. In the department stores, we continue to work on enhancing our brand presentation to focus on key item intensification and travel, and to expand our lifestyle brand offerings.

Now let me turn the call over to Theresa Palermo, our Chief Marketing Officer, who will give you an update on our rebranding and marketing efforts. Theresa?

Thanks, Rob. Marketing is key to our brand transformation as we improve brand perception, engage the consumer, increase desire for our brands, and ultimately grow market share. This fall we have been focused on attracting our new consumer, as well as increasing engagement within our existing span. And we clearly defined the role we play in her life, creating beautiful solutions that both solve challenges as well as ignite her senses.

Our fall marketing strategy focused on three key components -- increasing brand visibility, igniting a social movement, and building brand love. We activated our vision through our new branding and evolved visual identity; store redesigns; and an inspiring, targeted and integrated marketing campaign, with a mix of digital, social, experiential and print advertising.

This year's campaign offered a heavier emphasis on influencers, social, mobile and video content than in years past. This media mix allowed us to both reach her in a high impact format, as well as leverage micro-targeting to speak to her in a truly personalized and individualized way.

Our national advertisements have appeared in People StyleWatch, InStyle, Glamour, Cosmopolitan, Seventeen and Teen Vogue. Our online and digital investment include Hulu, Pandora, the Conde Nast Network, and many more. We are continuing to intensify our influencer marketing, partnering with names like Miss Universe Olivia Culpo; dancer, singer and actress Julianne Hough; and rising country music star Kelsea Ballerini.

We were especially excited when our Gallatin Sidesaddle Crossbody was recently chosen on the 2016 Oprah's favorite things list. Our Good to be a Girl campaign has already over-delivered on initial projections and generated over 424 million targeted consumer impressions in the third quarter alone. We're building awareness and have been very encouraged with the initial consumer engagement.

But we know that brands don't transform overnight. Vera Bradley has held a specific place in her life for over 30 years. It will take us more than a few months to expand her understanding of our brands and build passion with the new generation.

Our product has been evolving for some time. However, we only began our implementing our new brand strategy in its entirety this third quarter. We know we still have a lot of work to do but are confident we're on the right path.

Leather and solid cotton styles are helping attract our target consumer to the brand and are creating more wearing occasions for her. Consumers and influencers alike our loving mixing and matching cotton and leather together. Stories of female empowerment through our It's Good to be a Girl campaign are helping generate brand awareness and positive consumer sentiment.

New store environments are helping consumers understand the role of our brand and how our products can play in a more modern and fresh context. As we now pivot to focus on holiday gifting, we will continue to be targeted and strategic in our marketing efforts, celebrating the amazing power of women and the power of the Vera Bradley brand to bring her new and innovative beautiful solutions.

Rob?

Thanks, Theresa, for the marketing update. And, operator, we will now open up the call to questions.

(Operator Instructions)

Randy Konik, Jefferies.

Great, thanks a lot. A quick question to start. Can we get some more perspective on the independent specialty channel? When you look at that business, can you just remind us of the size of the business, the number of the accounts, what's going on there? Are you seeing any type of impact potentially from geographic overlap of more distribution in the bigger department store accounts or anything like that? Just trying to get a sense of what you think is impacting that channel, how long-lasting is that impact, et cetera. Thanks.

Thanks, Randy. This is Kevin. I will start out and then I can turn it over to Rob. We have about 2,600 accounts. A lot of the reduction continues to be from a comp perspective, so it continues to be retailers continuing to reduce their stock in their stores and order less from us. That's the biggest impact.

And we have had trouble trying to stabilize that. We feel like we are seeing some good things with some big accounts, though. We've seen some stabilization and even some comp growth from some of our big accounts, which has been encouraging but nevertheless it's not throughout the chain yet.

I think what I would add is a couple things. In the specialty channel, part of what we're seeing is the destocking that we've seen also begin to happen in the department store world. So, we've had an overall wholesale softness out there.

As we look at what's going on in the specialty channel, they also are really reacting to what's happening in the overall retail environment in terms of what's happening with multiple brands in their store and the pressure that puts on independent retailers. What we know from our own business is that our focus to bring new customers in and reestablish the full-price positioning of our brand is what's critical.

We have seen, as we've opened up new distribution end markets, some impact in terms of to our specialty store, but the impact is also being felt in areas where we don't have that additional distribution. We believe a lot more of it has to do with the macro environment, what's happening overall in retail right now. The level of promotional activity that's in the market is very hard for the specialty store operator to operate within.

Got it. And my last follow-up, if possible, just holistically how do you think about the most efficient or optimal channel distribution from your perspective if we look across e-com, the department store channel, the specialty channel, and then your own retail channel? How do I think about what you want the optimal distribution pattern to be? Thanks.

Yes. As we look at the long-term distribution we believe that getting our digital flagship launched and really letting e-commerce lead the way as we go forward is by far our most important channel because we believe that's where the consumer is experiencing brands and bringing brands to life. So, we are very excited about the digital flagship launch in first quarter of next year, and we believe that will be critical.

But in terms of the rest of the distribution channels, we believe that there really is an advantage in having a balanced approach between having distribution in specialty stores, which are really focused on this main street concept that we talk about in how our brand started and localized that allows us to get into smaller markets particularly. And, at the same time, having a presence in department stores where we know from our consumer research 50% of all of her purchases are happening in department stores. So, we think that's an important place to have a presence.

But at the end of the day we believe that a balance between our own direct-to-consumer network, running at about 70% of our business through our wholesale business and about 30% of our business is close to where we feel the optimal level would be.

Thanks so much.

Oliver Chen, Cowen and Company.

Hi. Thank you. On the specialty accounts channel, the road ahead here, should we expect it to be relatively cautious for the next 12 months just given what you are seeing there? And were you happy with how specialty accounts felt about the new brand positioning? Should we understand that may have had impact in terms of cautious spending there, or not read into that too much?

And then, also, I think as we try to understand, one point might be dissecting how you feel about the retail environment versus where your product assortment is in helping us disaggregate those. Are there areas in your product assortment that you still feel have lower hanging fruit from which you can improve? Thank you.

Great. Thank you, Oliver. Let me answer, first of all, on specialty. As we go forward on specialty, I think your words in terms of taking a more cautious approach going forward is true. I think they are rebalancing the business there is pressure.

I think what is encouraging for us to see, though, is in our top accounts, the ones that have really taken a very aggressive approach to driving the Vera Bradley brand in their store repositioning with the new branding, new shop layout, marketing it, keeping a very clean merchandise assortment focusing on the new product, they are having success. I think that part of it is as we work with all the independent retailers to get everybody up to that kind of aggressive forward look to build the brand back up is really where our opportunity is. So, we're trying to work with them account by account to get each of their businesses back into the healthy column. But I think caution is a good word.

In terms of did the new branding impact them, actually not at all from I think what you are suggesting was potentially a pullback. Actually what we heard from them was a lot of positive reaction to the new branding. What they continue to tell us is they are looking to bring a new customer in to the Vera Bradley brand.

The journey that we are on in terms of bringing new customers into the brand, the change in the perception of customers that Vera Bradley had something to offer a wider customer range, is really the same path that they want us to be on, and they are very supportive of that. So, I would not read anything into it in terms of the new branding position. They are actually excited about that.

In terms of our assortment in terms of how much is macro and how much of it is our own merchandising, I'd answer it a couple ways. One, we definitely know that the macro environment is very challenging. We watch all the data, we look at what's going on in the handbag category overall. We look at what's going on in the handbag category in the department stores and the destocking that's happening in the department stores. We know that there's a lot of macro pressure.

For us, as we look about micro, a couple things that we are very focused on. One is really getting the optimal balance between our channels, particularly from our full-price channels and our factory channels. That's an area that we're focusing on and really looking at inventory levels in detail, and some opportunity there.

The second area that we're really focusing on is we spent the last couple of years really bringing new innovative fabrications into market. And we did that to really begin to get a new customer to look at our brand. And all of our research said that part of it is causing her to rethink Vera Bradley and be more encouraged to come in and begin to take a look.

But now where the team's focus has been, and we will start bringing to market really going into next year, is a lot of innovation around cotton and making cotton very fresh and very new, and that it's not just about a new pattern but it's going to be about how we really design and drive our cotton business, because that is still the majority of our business and will continue to be in the future. And getting that refreshed and re-excited, we think, is really the key as we go into next year.

Okay. And, Rob, on the full-price department store, your own stores, can you highlight what's the main SUR opportunity there? Is it a traffic consideration in terms of a little softer than you would have liked on the full-price owned store channel?

Actually when we look at our full-price stores, our full-price stores quarter after quarter have been improving in their comps. So, they are marching in the right directions, which is one of the things that gives us confidence in the long-term strategy. So, our full price stores are getting stronger.

What's happened is the factory channel has been getting softer relative to where it's been. So, the pressure that we're seeing in the macro environment in the outlet channels is part of where that pressure is. It's not been in the full line. The full line is getting a sequential improvement in their comp performance.

Okay. And, lastly, the specialty account channel, it's just very difficult for you to forecast historically, but was there a way you could have seen this coming? Or it just happens because it's hard to tell how your relationships around the country in these specialty accounts may practice ordering techniques. I'm just curious, as you diagnose what happened if there was a methodology or an ability for you to glimpse into how those trends were formulating.

Yes, I think that's one thing we definitely continue to look at from our side. But you are right that it's not easy because you were dealing with 2,600 accounts as opposed to your major key account relationships, which you can obviously, they have a lot more insight in terms of how each buyer is thinking. Trying to do that with 2,600 accounts is a little bit more challenging.

And part of what impacts them is not only what's happening with Vera Bradley but what's happening with their businesses overall. Because, as we even look at accounts that close, more often than not over half the time it's usually due to their own performance for their entire store. So, it is a harder place for us to look at. I think we're always challenging ourselves to get smarter and more insightful, and we definitely are working hard on that.

Okay. Good job on the inventory management and the new brand. And best regards for the holiday.

Eric Beder, Wunderlich Securities.

Hi, good morning. Could you talk a little bit about -- you mentioned it in the last comment but I'd like to go a little bit deeper in terms of the outlet channel. It's been weak. We've heard this from other people. How do you fix the outlet channel to make it a better value proposition for you and to make a value proposition for the customer?

Eric, thank you for the question. I think there are a few different answers to that. First of all, what we're seeing in the outlet channels two things.

First of all, we are seeing a weakening of traffic overall, which is one of the drivers in the weaker performance. And the second thing we're seeing is a level of promotional activity, particularly within the handbag sector, that is very aggressive. Up until recently we have been able to compete in that, but what we felt is a lot of pressure on the pricing side.

One area that we're trying to address is how to sharpen the price point offering for the consumer. The expectation level in terms of discount level is getting higher and we're trying to react to that. So, we've got a lot of work going on internally in how to do that and react to the changing market dynamics.

In terms of the traffic overall, we're monitoring that and really trying to find out where that stabilization level is in the outlet channel.

Okay. And could you give us, when you look at the higher-end product that you're selling at the full-price stores, the leather goods and other pieces, how have they done versus the rest of the store? And are you going to expand their percentage or are you happy with where you are with them right now?

Right now we actually have been pleased with where our leather business has been trending. Just as a reminder, it is and will continue to remain a small percentage of our business. But we are encouraged that our consumer does continue to react to it.

We believe that the best course of action is continue to focus on reinvigoration of our signature cotton. And that's really where we are putting our focus for the remainder of this year and next year.

I think just to give you a little bit more color on that, our leather business in our full-line stores, we always said we were targeting it at about 10% of our business, and that's basically where we're ending up. So, it's doing exactly what we thought.

As we do our customer focus groups, we continue to here from consumers that it's definitely something that's bringing her in. It's getting both our lapsed customer and a new customer to reconsider Vera because we are addressing her needs for the work environment. So, we are very encouraged by those reactions.

And then we are also learning. As the team has been designing and launching leather connections, I think we get more and more on target for what our customer wants. We launched our Gallatin collection this fall, which was reacting to her desire for a more casual leather line that could do a good crossover between casual into work. And that reaction has been strong. And we're beginning to take those lessons are really work that through the entire leather collection.

So, I think that we are excited about the future. We think it is an important part of the business but we do believe it's only a small part of the business.

The great success and what our consumers continue to come to us as a first choice are things around our heritage -- so, our cotton fabrication, our Vera Vera, our solid microfiber collection, as well as our Lighten Up collection. Those are really the big drivers and the big volume drivers for us. So, that's where our focus is in terms of returning those to a growth trajectory.

And one more -- the cotton, for instance, when should we expect to see at the store these innovation in trends and get a feel for how this new cotton line focus is going to be?

We have been testing some of it in our stores during Q4. And you will start to see in the first half of the year our new Hadley collection that will be debuting.

Okay. Thank you. Good luck in the holiday season.

Mark Altschwager, Robert W. Baird.

Good morning. Thanks for taking the question.

I wanted to follow up real quick on specialty. I think 2,600 doors is the number that you mentioned, Kevin. I think that door count is it down about 25% from a few years ago. Rough numbers, sales within specialty are down by well over half.

So, the question is, does there need to be a more proactive reduction in the door count in order to ensure that Vera Bradley remains a profitable product line or a significant enough product line such that the accounts are investing in the marketing of the brand? That's the first part.

And then, separately, how much does that reduction have to do with the strategy to grow distribution through Amazon? Just wondering if the Amazon sales are maybe displacing sales that may have been happening through the specialty channel.

Mark, thank you for the question. First of all, in terms of focusing on specialty channel, we're definitely very focused on our top accounts, and how we really grow the top accounts and making them more meaningful, and really improving the brand presence. And we do agree that we're spending a lot more energy really building out our top account relationships and our presentation. So, that's really important.

In terms of the Amazon relationship, the Amazon relationship for us is still relatively small compared to our total brand. It's something that we are working on and we're working on that relationship and that assortment. They've been a great partner in us in terms of really taking control of our brand, to really clean up unauthorized distribution out there.

We still believe that Amazon, as we all know, being the number one search engine, we think it's important that we control our brand in the Amazon space. But we're not seeing it from a revenue standpoint, that being significant enough to really be displacing our specialty store channel. So, we don't believe that's a primary driver.

Thank you. And if I could also ask on inventory, it looks to be in very good shape today. But maybe just reconcile the expectation for some inventory build into Q4 with the guidance for some sales deceleration. I think inventory typically comes down sequentially in Q4. So, was hoping for some more color there and how should we think about the implications of gross margin the first half of FY18.

Sure, Mark. Really, the reason we're going to build inventory a little bit in Q4 is really to prepare for Q1 of next year. In hindsight, looking at our inventory levels for the end of Q3 and even going into Q4, we were a little short on our retirement inventory as it relates to the web specifically. So, we have that inventory starting to come in at the end up this quarter and then into Q1, so that by the time we get through Q1 we'll feel pretty good about our inventory balance.

So, I think that number between $100 million and $110 million looking forward is the right number to be at. I think the team has done a good job managing that inventory down. But we were surprised a little bit in the back half of this year as it relates to web sales for the retirement.

On the other hand, our full-price selling on the web was a surprise the other way. It actually performed relatively well in Q3. But our retirement sales on the web were a little short so we're going to firm up the inventory as we exit the year.

Just to add a little bit to what Kevin was saying, I think the other one, the fact that we're looking at the long-term performance of the brand, is that we are seeing full price growing on the web. We're seeing the full price get better relative to retirement even in our full-price channel.

So, our full-price performance is leading the way. The trick has been the retirement levels that we have at our cotton inventory have been lower than they needed to be. And part of it was because we were planning on the web repositioning with the digital flagship in fourth quarter to be driven strongly through full price. And when we had that shift moving from the third-quarter launch into first quarter of next year, it definitely caused more pressure on us in terms of managing some of that retirement volume.

And then I think you mentioned margins in the first half of next year. Obviously we're not giving guidance yet for next year, and more to discuss in March. But we feel good about being able to manage the cost part when it comes to margins in terms of efficiencies in our supply chain, in terms of negotiating with our suppliers, better costing. We feel really good about that.

Obviously the promotional environment is pretty intense right now, so that's a little bit more outside of our control. But, overall, over the long term we feel good about margins.

Thank you for all the detail and best of luck over the holiday.

(Operator Instructions)

Steve Marotta, CL King & Associates.

Good morning, everybody. Thank you for taking my question. As it pertains to the number of accounts -- just a little housekeeping here -- there were 26 accounts currently. What was the number last year, please?

Let me find that real quick. I think last year we were right around 2,600. It didn't change very much, so very small changes compared to the prior year.

Okay, that's helpful. And I know that you're not giving guidance into next year, but with such steep drop off in the indirect channel, and I understand the conservatism looking forward, is it possible that's a number that could stretch into the first half of next year or at least a similar magnitude?

In terms of the indirect business being down?

Correct.

We're not giving guidance on that until March because there's still a lot of work to be done between now and then, and there's a lot of holiday selling to focus on, as well. So, will definitely update you in March.

In terms of the number of the accounts, the 2,600, though, we wouldn't be surprised if that came down 100 or 200 accounts over time. Typically you see a fall out in January as some of these small accounts get through holiday, try to make the business work, and then have to close the doors. So, it wouldn't surprise us to go down maybe 100 accounts or 200 accounts over the long term. But definitely not giving any guidance as of yet for next year.

Okay. One more question on next year that you probably will not answer, but that is okay. As it pertains to unit openings next year, what are your thoughts on both full-price and factory stores given the backdrop of the current environment?

We opened 10 stores this year. And as we look to next year we probably see a number between 5 and 10. So, we don't expect to open a lot of stores next year until we see comps start to turn around positive, and then obviously we'd reconsider. But for now we're going to keep those openings on the low end.

And that would be inclusive of both factory and full price?

That's correct.

That's helpful. Thank you very much.

Bill Dezellem, Tieton Capital.

Thank you. I have a group of questions. First of all, would you please talk a little bit more about how your new fall product resonated with customers?

And then, secondarily, you mentioned the importance of cotton and the emphasis you're going to be putting on reinvigorating that over the course of the next year. Would you dive further into your strategy to reinvigorate that cotton line, please?

Yes, I can start. First, BIll, speaking a little bit about the new fall product, we were happy with our back-to-campus business, which is obviously an important portion of our business. And in addition with the launch of our Collegiate line.

We also saw strength in our crossbodies and some of our smaller fashion accessories. And in terms of pattern strength and collection we also were encouraged for fall.

In terms of our cotton strategy overall, cotton remains the most important portion of our business. We hired a new designer that started with us about six months ago, and that has been the sole focus of the team. We're looking at new ways of stitching, we're looking at new proportions of silhouettes. So, you will see several new collections coming out over the course of the next several years. We are very excited.

The only thing I would add to what Sue is saying is that when we brought in our new VP of Design, Beatrice, that we really had her focus on reinvigorating cotton. She's brought a really fresh perspective working with the team of how do we really work on modernizing the silhouettes, modernizing all the detailing.

She has a real fine eye to the iconic details, the zippers, the pulls, to all of that, to develop a real consistent and more modern take on it, in addition to continuing to look at not only the patterns, the quilting patterns that we use, but also looking at the actual color patterns themselves and how do we get this great blend between our heritage but at the same time with a really modern hand to it.

So, that is definitely a primary focus of the team. And we're excited about some of the product that's coming out as we go into next year.

And are you feeling as though you really have an opportunity to make a noticeable difference to your customer? And I ask that question from a male perspective where maybe I might not see the difference or find it meaningful enough.

Yes, actually. We feel very good about the fact that we will be making a meaningful difference to our consumer when she not only walks into Vera Bradley but also into our wholesale channel, as well. We're very excited about what Beatrice and the team are focused on in terms of reinvigorating the core.

That's helpful. And then, lastly, the retirement product revs being below plan on the web, does that imply that some of your past patterns were less desirable? Or is that something completely unrelated?

No, I think as we look at the retirement on the web the primary thing is that our retired cotton product continues to sell very well. So, we continue to move through the retired cotton product very quickly, and move through it, in some cases, a little bit faster than we had anticipated.

I think that where there is a difference in rate of sale is, as some of our newer fabrications go through the clearance channels, it doesn't move quite as quickly. So, keeping the right balance between the new fabrications and the core fabrications is the journey that we're learning right now and what impacted us a little bit as we got into third quarter of this year.

Great. Thank you both.

Dana Telsey, Telsey Advisory Group.

Hi, everyone. Can you please tell a little bit about SKU count, the changes that are being made, how do you think about the SKU count by category and also by fabrication, and what could that mean to gross margin over time? Thank you.

Hi Dana, it's Sue. Our SKU count remains relatively flat by classification of business and by overall fabrication this past season. And as we look forward I would say we are continuing to monitor how the consumer is reacting to our mix of product and mix of fabrications, and we will continue to adjust accordingly.

And, Dana, maybe to add to that, as we come out with some of these new product categories, at times they are below the average margin that we would like them to be. Jewelry is a good example. But then the lack launch of jewelry is actually going to get up to about our average. A lot of times we don't have the scale when we launch the product initially, but over time the goal is to continue to reengineer the product or to get scale, and we've been able to get the margins up over time.

Thank you.

Brian Gustavson, 1060 Capital.

Hi, guys. I was wondering if you talked about spring orders for 2017. I just got on the call recently.

You were just wondering about spring orders?

Yes, because I heard you talking about new products so I'm just curious if that's something you might see in spring orders. Or have you talked about spring orders? And do you expect wholesale orders to be positive with some of these new products?

Good question, Brian. If you really look at our spring orders, it really relates to our January launch. So, that is baked into our guidance for Q4. And we did see softness across the specialty sector and that's why it's down pretty considerably in Q4.

We heard a lot of anecdotal good information that they do love the product, but I think they are all a little nervous about holiday and their orders came up soft. But we still feel really good about the product offering for spring. But, nevertheless, hopefully the specialty will have to see the better sell throughs before they start to reorder it.

I think what I would add, just to give you a little bit more color on that, is we brought the new lines out in front of our retailers in terms of editors, in terms of market influencers. We continued to get very positive feedback in terms of direction of the product, how it's looking going forward, a lot of excitement around the brand.

The journey that we are really on is to get that same level of excitement and awareness in the consumer mind. And getting the consumer to see it obviously takes a little more effort. We can't get all of them into our showroom in New York to get the full immersive experience. We wish we could. So, through marketing it just takes a little bit more time to begin to change perception. I think that's really the journey we are on and that's the journey that we hear from our retailers, is we like the direction, we just need to get the consumer caught up to the new direction of the product.

Got you. And the store openings, you talked about 5 to 10. How many closings are you planning or are there no closings?

We'll always assess the stores from a productivity perspective, profitability perspective, and then the marketing that it brings. Nothing to announce right now but we're always looking at the stores and what they bring and whether or not we need to close some. But the 5 to 10 is both full price and factory. It'll probably be a little more skewed towards factory than full price for next year.

Got you. Thank you, guys.

At this time I'll turn the call back over to our speakers for any additional or closing remarks.

We continue to make progress in evolving and strengthening our product, distribution and marketing. And although it is taking longer than we would like to turn the business around, I am appreciative of our entire team and their diligent and collaborative efforts to transform Vera Bradley into an even stronger company.

And thank you for joining us today. We will continue to work to improve performance and enhance shareholder value. And we look forward to speaking to you on our year-end earnings call in early March.

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