Vera Bradley, Inc. (VRA) Q3 2016 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Welcome to the Vera Bradley Third Quarter 2016 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded. I would now like to turn the call over to Julia Bentley, Vera Bradley's Vice President of Investor Relations. Please go ahead.

Thank you. Good morning and welcome, everyone. We'd like to thank you for joining us today 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 based pursuant to and within the meaning of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995 as amended. Such forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from those that we expect. Please refer to today's press release and the Company's Form 10-K for fiscal year ended January 31, 2015, 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 today's call. I will now turn the call over to Vera Bradley's, Chief Executive Officer, Rob Wallstrom.

Thank you, Julia. Good morning, everyone, and thank you for joining us on today's call. With me today are Kevin Sierks, our Chief Financial Officer, and Sue Fuller, our Chief Merchandising Officer. We are pleased that better-than-expected revenue and gross profit percentage performance along with our disciplined expense management drove EPS of $0.27, which was well above both our guidance and the prior year. These results were achieved despite continuing headwinds in the retail environment, including increased promotional activity of certain retailers and overall weak mall traffic. We are especially pleased with our 540 basis point gross profit percentage improvement in the quarter. This increase was largely driven by various sourcing initiatives, the success of our made-for-outlet products, and reduced promotional activity. In our full-line stores and on verabradley.com, we eliminated our hyper-promotions of 60% to 70% off and pared back our total promotional days by approximately 50% during the quarter. Our better-than-expected revenues were generated despite this lower promotional activity. And for the second quarter in a row we have seen sequential improvement in our comparable sales trend which we believe is reflective of our new product offerings, improved in-store execution, and our initial marketing efforts. While our overall comparable sales fell 9.5%, our store comps declined just 2%. As expected, our e-commerce sales continued to be especially negatively impacted by our substantially reduced promotions. As I noticed, customers are responding to our new product offerings. For the second quarter in a row our direct comp sales trends were better than our traffic trends. We see indication that awareness of and affinity for our brand are increasing, and we are beginning to see new customers come into our brand and customer retention improve. We are also seeing continued enthusiasm and growth from our department store partners. We are making progress in gaining some traction, but we realize it will take more time and substantial effort to return the business to solid top-line growth. We believe we have the product, distribution, and marketing initiatives in place to achieve our fourth quarter financial plan and to continue improving our momentum into fiscal year 2017. I will now ask Kevin to give us a brief update on our third quarter results and outlook for the fourth quarter and full year. And then Sue and I will update you on the three pillars of our strategic plan, product, distribution, and marketing. 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, a 1.2% increase over $125.2 million last year and above our guidance of $120 million to $123 million. Income from continuing operations totaled $10.3 million, or $0.27 per diluted share, compared to $8.7 million or $0.21 per diluted share last year and above our $0.19 to $0.21 guidance. In our direct segment, revenues totaled $84.1 million, a 7.9% increase from $77.9 million last year. This revenue number reflects a comparable sales decline of 9.5%, more than offset by sales from new store growth. Indirect segment revenues decreased 10% to $42.5 million from $47.3 million in the prior year third quarter, primarily due to lower average order size from our specialty retail account and a modest year-over-year reduction in the total number of specialty accounts. Gross profit for the quarter totaled $73.3 million or 57.9% of net revenues compared to $65.8 million or 52.5% in the prior year. This rate improvement primarily related to sourcing efficiencies, increased sales penetration of higher margin made for outlet products, reduced promotional activity, and lower levels of liquidation sales. The gross profit percentage exceeded guidance of 56.8% to 57.2%, primarily due to reduced promotional activity relative to plan and better than planned sales of higher margin MFO product. SG&A expense totaled $57 million or 45% of net revenues in the current year third quarter compared to $53.3 million or 42.5% last year. As expected, SG&A dollars increased over the prior year primarily due to investments in new stores. SG&A as a percentage of net revenues was better than our guidance of 46.5% to 47% primarily due to better-than-expected revenues and expense management as well as a reallocation of planned marketing expenditures of approximately $1 million from the third quarter to the fourth quarter this year. Operating income totaled $16.8 million or 13.3% of net revenues in the current year third quarter compared to $13.6 million or 10.9% of net revenues in the prior year third quarter. By segment, direct operating income was $19.3 million or 22.9% of sales compared to $13.9 million or 17.8% of sales in the prior year. And indirect operating income was $19.1 million or 44.8% of sales compared to $19.2 million or 40.6% of sales in the prior year. Quarter end cash totaled $61.8 million compared to $90.3 million at the end of last year's third quarter, reflecting higher inventory levels as planned and share repurchases. Quarter end inventory was $118.2 million compared to $106.3 million at the end of last year's third quarter and at the high end of our guidance of $112 million to $118 million primarily due to timing of fourth quarter receipts. Now let's talk about our outlook for the fourth quarter and full fiscal year 2016. Guidance for the fiscal year excludes the previously disclosed first quarter charges related to closing our domestic manufacturing facility, severance, restructuring, and the income tax adjustment. We believe we are approaching the fourth quarter realistically and taking into account continued headwinds in the handbag space, challenging mall traffic, a promotional environment, and other macro factors at play. We will continue to pull back on our own promotional levels. Year-over-year fourth quarter promotional days will be roughly the same, but we will continue to reduce our level of discounting. Of course this reduced promotional activity will continue to have a negative impact on sales, but this is the right course of action for the health of the brand and for our gross profit performance. For the fourth quarter we expect net revenues of $151 million to $155 million compared to prior year fourth quarter revenues of $152.6 million. We expect direct segment net revenues to increase in the low to mid single-digit percentage range with a comparable sales, including the web, decrease in the mid to high single-digit percentage range. We believe our indirect net revenues will decline in the high single-digit percentage range during the quarter. The gross profit percentage for the fourth quarter is expected to range from 58.3% to 58.7% compared to 52.4% in the prior year fourth quarter. The plan improvement reflects sourcing efficiencies, increased sales penetration of higher margin made for outlet product, reduced promotional activity, and lower levels of liquidation sales. SG&A as a percentage of net revenues is expected to range from 42% to 42.5% for the fourth quarter, compared to 35.8% in the prior year fourth quarter. The expected de-leverage is primarily due to incremental investments in key areas like marketing, e-commerce, and incentive comp, as well as fourth quarter asset impairment charge that's expected to be approximately $3 million versus approximately $0.5 million charge taken in the prior year fourth quarter. We expect fourth quarter diluted EPS to be in the range of $0.40 to $0.43. Diluted EPS totaled $0.43 in the prior year fourth quarter. We expect inventory to be $116 million to $120 million at the end of the fiscal year compared to $98.4 million at last year's fiscal year end. The projected inventory level reflects improved balance of current to retired inventory than in prior years as well as investments in key growth classifications, including new fabrications. Keep in mind that inventory was down nearly 30% last fiscal year in which in hindsight was too low. For the full year we expect net revenues of $499 million to $503 million compared to $509 million last year. Our revenue guidance includes direct segment net revenues growth of low to mid single-digit percentage increase with decline in comparable sales, including e-commerce, in the low double-digit percentage range. Indirect net revenues are expected to climb in the low double-digit percentage range. The gross profit percentage for fiscal year 2016, excluding the charges outlined related to the first quarter, is expected to approximate 56.7% compared to 52.9% last year. The planned improvement reflects sourcing efficiencies, increased sales penetration of higher margin MFO product, reduced promotional activity, and lower levels of liquidation sales. SG&A as a percentage of net revenues, excluding the charges outlined for the first quarter, is expected to approximate 46.7% for fiscal year 2016 compared to 41% last year. The planned increase is primarily related to incremental spending and marketing, e-commerce, and incentive compensation on a slightly lower sales base as well as fourth quarter asset impairment charges. We have adjusted our full year diluted EPS expectations upwards to $0.80 to $0.83, reflecting our third quarter performance. This estimate range excludes the previously mentioned first quarter charges. On a comparable basis, diluted EPS totaled $1.00 last year. We expect our net capital expenditures will total approximately $28 million for the full year, primarily related to new store openings, continued investment in our systems, and the spring 2015 completion of our corporate campus consolidation. This is modestly lower than the $31 million originally estimated due to the timing of certain expenditures delayed until fiscal year 2017. As you know, we completed our $40 million share repurchase program in the third quarter. I wanted to make sure you're aware that yesterday our Board approved another share repurchase program authorizing up to $50 million in common stock repurchases. This program expires in 24 months. Let me turn the call over to Sue who will give us an update on product. Sue.

Thanks, Kevin. In the product area we continue to make substantial progress in our three main goals of, one, delivering innovation, newness, and diversification. Two, segmenting our offerings by channel and, three, enhancing our gross profit percentage which Rob and Kevin have just discussed in detail. Innovation, newness, and diversification are critical in order to stay relevant. Our efforts are paying off as existing customers are responding to the newness, and we are beginning to attract new customers to the brand. As you might remember, we now offer seven fabrications. Quilted cotton, solid micro fiber, leather, faux leather, Lighten Up, Preppy Poly, and Streeterville. At the end of the third quarter, approximately 50% of the SKUs in our full line business were cotton, and approximately 50% were in these new fabrications in other categories compared to less than 20% at the beginning of the year. Having said that, we are not walking away from signature cotton. Cotton remains the largest and most important piece of our business, and our design team is working hard to reinvigorate and modernize our cotton assortment with new patterns and styles. Customers are responding to solids, particularly our high-end Sycamore leather collection and micro fiber as well as to our pattern, particularly our Lighten Up and new Streeterville offerings. We will continue to test and learn and then edit or add to our assortment as appropriate. Our collegiate program, which we began testing in August has been a success. We launched a focused collection of 16 universities with just five SKUs with distribution on verabradley.com and limited Vera Bradley in specialty stores. While collegiate is very small at this point, we believe there is certainly a growth opportunity. We will add several more universities in mid 2016 in time for back to campus. These products target both students and alumni, and they are attracting new customers to our brand. We continue to be excited about our line extension opportunities as well. We have partnered with industry experts and in January we are introducing our fragrance collection and expanding our jewelry collection. Both will be sold in all of our own stores, on verabradley.com, and in several hundred specialty stores. We believe there are other licensing and extension opportunities for us going forward. Rob.

Thanks, Sue. Let me take a minute to update you on distribution. We opened our final four full-line stores during the third quarter, which brings our total full-line openings this year to 15. And we opened three factory stores in the quarter, bringing the year-to-date total to 11. At the end of the third quarter we had 110 full-line stores and 40 factory outlet stores. Customers continue to offer positive feedback about our new full-line store design. Traffic continues to be challenging, however, particularly in the centers that house our full-line stores. We are certainly not alone in this dilemma. Our factory stores continue to perform well. Our MFO product transition is well ahead of plan, and customers are really responding to our narrowed and deeper SKU counts and channel-exclusive patterns. Currently, nearly 70% of our product in the factory stores is MFO. E-commerce remains a key part of our distribution strategy as we establish our digital flagship. Our long-term goal is that verabradley.com will convey our brand and product story and ultimately generate more full-priced selling. In order to do that, we have three main focus areas. Strategically paring back our hyper-promotional activity which began in January 2015, improving our website engagement features such as dramatically enhancing our search capabilities, which we completed in the second quarter of this year, and redesigning and converting our website to a new platform which will be complete in the fall of next year. As I previously mentioned, our reduced promotional activity is negatively affecting overall site traffic and sales but generating substantially improved gross profit percentage performance. Department stores are another key part of our distribution strategy, allowing to us introduce our brand to new customers and showcase our new product assortments. Our department store partners remain very supportive of our product and brand direction. In the past 18 months we have doubled our department store footprint to about 620 locations, which includes 250 Macy's stores. In late October we celebrated the official grand opening of our 400-square-foot shop on the new Millennial Floor at Macy's Herald Square; 100,000 people visit this location during the holiday season, so this is a terrific opportunity to get our products in front of thousands of new customers. In addition, just in time for the holidays LordandTaylor.com is now selling a limited selection of Vera Bradley products. We have also continued to expand our relationships with key accounts, such as QVC and Amazon, with a greater focus on our full-price business. Our door count in the indirect specialty gift channel is still about 2700. While the overall business continues to run behind last year we are seeing more stores return to positive sales performance, particularly at some of our larger multi-store accounts that have embraced our new product offerings and have improved their visual presentations. We are continuing to look for other appropriate specialty store relationships outside of the gift channel, such as local high-end apparel and accessory stores, and have added several of the doors to our distribution this year. Now let me shift to marketing. Marketing and brand building are critical investments as we engage new customers and strengthen our bond with our existing customers. Our primary marketing objectives are to generate brand awareness, evolve our brand perception, drive store and site visits, and inspire brand engagement. And as you know, we are investing substantially more in marketing this year than last year, and these efforts have just begun but have started to pay off. The IM campaign continued into the third quarter and our paid media delivered over 250 million impressions in the third quarter through a combination of print and digital media. In the IM ad, the product is the hero, which has resonated with customers. Our comprehensive and cohesive marketing plan consists of national print combined with richer content on social media, and an increased emphasis on public relations and more targeted digital media spend. We believe this combination will ensure we have both a broad yet targeted reach. Our key focus areas in the third quarter were back to school, fall fashion, and campus engagement. We continue to be encouraged by improvements in our social media metrics from the first quarter this year to the third. Total on-line media impressions continue to grow due to increased media spend as well as much higher Facebook, Instagram, and blogger engagement. In fact, both social media impressions and new followers substantially increase over this time frame. New products such as leather and Streeterville have gained editorial and media attention and have been featured in such publications as Elle, Teen Vogue, and O magazine. During the quarter we also introduced our campus ambassador program on five campuses, University of Georgia, Indiana University, University of Kansas, SMU, and USC. At each school, Vera Bradley is working with college ambassadors what are a personality fit for our brand and peer influencers who can increase our brand awareness and purchasing intent. The campus ambassador program goes hand in hand with the launch of our collegiate product. Our marketing efforts are not slowing down in the fourth quarter. We are continuing to build on our IM campaign and are excited about launching an updated campaign in the spring. We know it will take time but we are excited about our momentum in this important area. Operator, we will now open the call to questions.

Thank you. [Operator Instructions] We'll go first to Oliver Chen with Cowen and Company.

Hi, this is [indiscernible] for Oliver Chen. Thank you for taking my question and congratulations on the nice improvement in the quarter. I just wanted to ask if you could just start off by sharing your thoughts on the overall handbag and luggage sector and share what you are thinking about what's driving the customer to buy?

Absolutely. I think in the overall handbag market we are definitely seeing the consumer move towards smaller bags, as we've seen, in cross bodies and a lot of the smaller shapes. We definitely have seen that. We definitely have seen that the customer is looking for innovation. It is really an innovation game. So, innovation in fabrics, innovation in shapes is really what we see the customer responding to, but it is definitely competitive out there right now and the customer is definitely seeking newness.

Thank you. And also could I ask just one more question just on the comp? Again, it was nice to see the store comp improve, though it looked like the eCom [ph] was weighing on the overall comp, I think down 19%. Could you maybe give some color on how we should think about that eCom pressure going forward over the next few quarters? Thank you.

Sure. Remember, last year the Q3 was our best quarter from a web perspective. It was up 22%. So really as we've pulled down these promotional days in the third quarter pretty significantly, about 50%, we did see a pretty big impact on the web. Obviously it impacted the traffic which impacted the sales. As we look forward we continue to an impact in Q4 because we do plan on taking down the depth of the discount in Q4 more so than the number of days. We plan to be obviously competitive in Q4 with of some of our peers in competition out there, but nevertheless we're going to take down the depth of the promotions, so I still see some softness in the web in Q4. And then next year that should ease a little bit just because we've taken out call it 80% of the promotions this year and we'll take out another 20% next year, but we should see that ease next year.

Okay, thank you again.

We'll go to Eric Beder with Wunderlich Securities.

Congratulations on some solid progress.

Thanks, Eric.

Your made-for-outlet is now at about 70%. What should it be? We're getting close I think to the numbers that you have talked about. How does that going forward, will that impact the margins for the outlet business?

Eric, this is Sue. We feel that around 70% is what we're comfortable with in terms of the MFO product that we have in stores.

I think 70% is definitely our target for the penetration and it will obviously go up and down depending upon various factors, but 70% is the target. And we do see that that obviously is a big impact into our margin in our factory stores and has been a great driver not only in margin but even from a sales standpoint. So it is definitely been a major factor in our turnaround of our factory business.

And then, Eric, specific to margin, it helped our margin this year for the full year. It will help it by over 100 bays points, so definitely on a consolidated level, so definitely a huge help this year. And then as you project out to next year because we started the year around 25%, we'll end the year around 70%, we'll still get a little bit of a pickup next year in margin as it relates specifically to MFO as well. So it has been a huge success. The team has done a wonderful job.

Great. Let me just ask one more. In terms of store expansion, are the long-term goals still the same and what should we think about in terms of 2016 in terms of potential store expansion?

As we look at the long term we do believe that there's still an opportunity for the 300 full-line stores and about 100 of our factory stores. So, I think the long-term plan is still in place but we are definitely taking a slower approach next year. We've discussed opening up to 10 total stores between our factory and full-line business which obviously is a significant slowdown from where we were this year. And we're doing that and working on our full-line store performance and improving the comps and working through ways of dealing with the declining mall traffic. But we feel that that really is a slowdown for the next year or so, but we do believe in the long-term target still.

Great. And good luck for the holiday season.

Thank you, Eric.

[Operator Instructions] We'll go next to Mark Altschwager with Robert W. Baird.

Good morning. This is Drew North on for Mark Altschwager. Thanks for taking my question. I just wanted to ask one question on the marketing initiatives. Now that the campaign has had several months to ramp, do you feel it's having the desired effects of bringing new customers to the brand like you kind of mentioned earlier, or how has the customer acquisition and retention to date been versus management's original expectations? Thanks.

Thank you for the question. No, we feel good that the marketing campaign is definitely starting to move us in the right direction. We're seeing more new customers come into the brand. We're seeing retention improve. We're seeing our social metrics go up. So we feel that we're off to a very good start. We do believe as Theresa has come in she has continued to look at the plan, and we're looking forward in terms of how the campaign continues to evolve and become even more impactful as we go into next year, but we do feel very good about how it started so far.

Okay, thank you.

Thanks, Drew.

We have no further questions at this time. I will turn it back over to Management for any additional remarks.

Operator, thank you. As I reflect back on the last three quarters, I am really pleased with all of the progress our talented team has made on our key initiatives. Innovating and adding newness to our product assortment, substantially enhancing our gross profit percentage, growing our store base, rolling out MFO to our factory stores, expanding our department store relationships, and ramping up our marketing efforts just to name a few. Although it will take time for all of these efforts to fully pay off, I am confident that we are taking the right steps for the future of the business. Thank you for joining us today and for your interest, time, and questions. We look forward to speaking to you on our year-end call on March 9.

This does conclude today's conference. Thank you for your participation.