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Vera Bradley, Inc. (NASDAQ:VRA)

F3Q13 Earnings Call

December 5, 2012 4:30 p.m. ET

Executives

Paul Blair - Investor Relations

Michael Ray - Chief Executive Officer and Director

Jeffrey Blade - Executive Vice President, Chief Financial and Administrative Officer

Roddy Mann - Executive Vice President, Strategy and Business Development

Analysts

Erika Maschmeyer - Robert W. Baird

Neely Tamminga - Piper Jaffray

Jennifer Davis - Lazard Capital Markets

Edward Yruma - KeyBanc Capital Markets

Evren Kopelman - Wells Fargo

Peter Wahlstrom - Morningstar

Janet Kloppenburg - JJK Research

Operator

Good afternoon, ladies and gentlemen and thank you for standing by. Welcome to today's Vera Bradley Fiscal 2013 Third Quarter Results Conference Call. At this time all participants are in a listen-only mode. (Operator Instructions) As a reminder today's conference is being recorded. I’d now like to turn the conference over to Mr. Paul Blair of Vera Bradley’s Investor Relations department. Please go ahead.

Paul Blair

Good afternoon and welcome. We would like to thank you for joining us this afternoon for Vera Bradley's fiscal 2013 third quarter results conference call.

Some of the statements made on the conference 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 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 28, 2012 filed with the SEC for a discussion of known risks and uncertainties. Investor's 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.

We understand that this is a busy period for reporting and intend to keep today's call to an hour in length. Therefore, during our question-and-answer session we ask the participants pose one question with one follow-up to allow as many callers as possible the opportunity to take part in today's call. I will now turn the call over to the Vera Bradley's CEO, Mike Ray.

Michael Ray

Thank you, Paul. Good afternoon, everyone, and thank you for joining us today. With me are Jeff Blade, our Chief Financial and Administrative Officer; and Roddy Mann, our Executive Vice President of Strategy and Business Development. Today we will focus on two main topics, the highlights of our fiscal 2013 third quarter performance and our outlook for the holiday season and the remainder of fiscal 2013.

We are pleased with our performance during the third quarter, the result of a compelling product portfolio that drove sales gains across our operating segments. During the quarter we experienced continued selling strength in the back-to-campus collection as well as the successful launches of our fall fashion and Ribbons collection. Our results were further enhanced by the updated timing of our seasonal releases allowing for natural marketing themes more in line with how and when our customer is shopping.

As a result, consolidated net revenue increase 14% over the prior year to $138 million. Consolidated gross margin increased $380 basis points to 58%, reflecting operational efficiencies, the prior year opportunistic sales of retired inventory and lower input cost, partially offset by $1.2 million charge related to damaged written off during the quarter. The resulting net income increased 37% to $17.7 million or $0.44 per share versus $13 million or $0.32 per share in the prior year.

In our indirect segment, net revenue grew 7% reflecting strong demand in both our specially retails and department store partners. In our direct segment net revenues grew 24% driven by the opening of five new stores, solid comparable store sales, and slight gains in ecommerce. Comparable store sales grew 7.1% reflecting the strength of our product offering and the impact of incremental traffic driving events. Our ecommerce business grew 1.2% during the quarter, reflecting reduced levels of discounting as compared to the prior year that discounting growth of 55% in the third quarter of fiscal year 2012. While the reduced level of discounting this year impacted the growth rates, it also resulted in increased gross margins within the channel.

Regarding our efforts in Japan, we continue to gain valuable insight from our market entry there. We have an avid Japanese customer and our experiences to date both in our permanent shop-in shops and through a number of marketing events, have given us a foundation by which we can map a long-term vision for the market. We are actively developing that vision bearing in mind our successes and learnings to date as well as our shorter-term priorities here in the U.S.

As we look to the fourth quarter, we believe we are well position with traffic driving events to execute through the remainder of the holiday season. On November 2 we launched our winter collection featuring two new patterns, Dogwood and English Rose and signature styles as well an expanded assortment of holiday gifts. Although the quarter got off to a slow start in November as a result of slower overall traffic and the impact of hurricane sandy, demand rebounded over the post-thanksgiving holiday weekend and since then sales have been in line with our expectations.

I would like to briefly mention that we recently identified an issue related to our inventory planning process that inadvertently resulted in order quantities in excess of forecasted demand which we will receive in the fourth quarter and the first quarter of fiscal 2014. Jeff will provide additional details during his remarks, however, I want to assure you that we have addressed the underlying process issue and feel confident it will not recur in the future.

Looking ahead to January, we will launch our spring collection on 9th, with four new patterns, Jazzy Blooms, Plum Crazy, Midnight Blues and Go Wild. The collection also features several new cross-body, tote and backpack styles, as well as many of our signature silhouettes solid black microfiber. In addition we are finalizing plans for our new baby gift assortment that we will launch as part of the summer product offering in March.

In conclusion, we are pleased with our accomplished throughout the third quarter. We believe the progress we made to enhance our teams and processes that support how we go to market was evidenced in our performance. The desire to continually improve that permeates our culture coupled with our ongoing commitment to executing our growth strategies, makes us optimistic about our future prospects. I will now turn the call over to Jeff Blade, our Chief Financial and Administrative Office, who will provide additional details regarding our third quarter financial results as well as guidance for our fiscal 2013 fourth quarter and full year.

Jeffrey Blade

Thanks, Mike, and good afternoon. I will begin my remarks with a review of our fiscal 2013 third quarter and then provide you with our outlook for the fourth quarter and full year. As Mike mentioned, we are pleased with our performance during the third quarter. We delivered financial results that met our top line expectations while delivering strong earnings per share results.

Net revenues for the third quarter increased by 14% to $138.3 million from $121.1 million in the prior year, with growth across our operating segments. The performance was on top of revenue growth of 32% in the third quarter of last year. Indirect net revenues increased 7% to $74 million, above our expectations for the quarter. This includes $3 million of sales that we are expected to ship in the fourth quarter. However, better inventory and stock levels allowed us to meet our specialty retailer partners requested delivery dates.

The overall increase was due primarily to the strength of the product portfolio, resulting in consistent reorders from our specialty retailers as well as the continuing success of our partnerships with Dillard’s and Von Maur. In the department store channel we continue to build on a positive momentum at Dillard’s, opening in an additional 54 locations during the quarter. We are now represented in 230 Dillard’s locations, expect to open the final 54 stores in conjunction with our spring launch in January.

In the direct segment, net revenues increased 24% to $64 million, primarily driven by growth across our full price and outlet stores as well slight gains in ecommerce. The direct segment accounted for 46% of total revenues in the third quarter versus 43% in the prior year. In our stores net revenues grew 44% during the quarter, driven by the opening of 17 full priced and three outlet stores during the past year as well as in increase in comparable store sales of 7.1%.

Our performance is attributable to our compelling product assortment and the expansion of traffic driving events related to our new product launch cadence. In the third quarter we opened four full price stores and one outlet store in both current and new markets, ending the quarter with 64 full price and 11 outlet stores. In November we opened our final store for the year bringing our total new store openings for fiscal 2013 to 20. Our ecommerce business grew 1.2% on top of 55% in last year’s third quarter and delivered higher gross margin due to reduced levels of discounting. Ecommerce accounted for 20% of total net revenues during the third quarter.

Profit for the third quarter increased 22% to $80.2 million, resulting in a gross margin of 58% compared to 54.2% in the prior year. The third quarter increase in gross margin was due primarily to operational efficiencies, the prior year opportunistic sale of retired inventory and lower input cost, partially offset by $1.2 million charge related to damaged inventory written off during the quarter.

Total SG&A expense was $53.6 million for the third quarter compared to $45.4 in the prior year. SG&A as a percent of net revenues was unfavorable by 130 basis points versus the prior year due primarily to annualizing fiscal 2012 infrastructure investments made in the second half of last year and increased marketing expenses, some of which are related to development of the marketing strategy for the launch of our baby gift assortment.

Operating income for the third quarter increased 28.1% to $27.6 million or 19.9% of net revenues, compared to $21.5 million or 17.8% of net revenues in the prior year. Operating income in our direct segment increased by 32% to $17.7 million, with operating margin of 27.6% in the third quarter of this year compared to 25.9% in last year’s third quarter. Operating income in our indirect segment increased by 13.5% to $13.3 million compared to $26.7 million in the same period last year with operating margin of 40.9% compared to 38.6% in the third quarter of last year.

The effective tax rate for the quarter was 35.2% compared to 38.9% in the prior year. The effective tax rate was positively impacted by nearly 4% due to three tax projects that were finalized during the quarter, including a state tax incentive we received based on the completion of our distribution center expansion. These tax projects are expected to favorably impact the effective tax rate by 1% in the fourth quarter driven by the distribution center expansion which only benefits fiscal 2013.

The resulting net income for the third quarter increased 37% to $17.7 million or $0.44 per diluted share compared to net income of $13 million or $0.32 per diluted share in the prior year. The third quarter results include $0.03 per share related to indirect sales we expected to occur in the fourth quarter and $0.03 per share due to the tax projects previously mentioned, partially offset by $0.02 per share due the damaged inventory.

The balance sheet highlights as of the end of the third quarter include cash and cash equivalents of $4.5 million, accounts receivable of $46.9 million compared to $38.6 million in the prior year and related days sales outstanding of 64 compared to 55 in the prior year and 74 days in the second quarter of this year. The higher days sales outstanding compared to the prior year reflected timing of the winter release at the end of the third quarter versus mid-September in the prior year.

Inventory at the end of the third quarter was $135.3 million compared to $111.1 million in the prior year increase of 21.8% compared to revenue growth of 14.2%. The increase in inventory growth compared to revenue growth which was anticipated due primarily to earlier release dates for the spring and summer product offerings compared to the prior year.

Before I review our outlook I would like to further expand on Mike’s comments regarding our inventory. During the third quarter we identified in issue related our inventory planning process that inadvertently resulted in increased order quantities. The result was the ordering of approximately $15 million of inventory which would have been ordered in the first half of fiscal 2014. As a result we expect inventory growth to outpace revenue in a range of 10% to 20%, primarily in the fourth quarter and the first quarter of fiscal 2014.

The inventory while in excess of current demand, is in popular patterns and styles and we expect to sell the majority of this product through our normal sales channels throughout next year. We have since revised our inventory planning process to include additional oversight and controls to insure this won't reoccur.

I would now like to review our outlook for fiscal 2013 fourth quarter as well as full year. In the fourth quarter of fiscal 2013 we expect net revenues to be in a range of $147 million to $152 million compared to $135 million in the prior year. This includes comparable store sales growth of low single-digits and indirect net revenue growth of low single-digits which includes the shift of indirect sales into the third quarter as previously mentioned.

A lower consolidated net revenue guidance reflects the weakness in sales we experienced in early November, including the impact of hurricane sandy that will be difficult to make up during the balance of the quarter, as well as our expectations for the remainder of the holiday season. Gross margin for the fourth quarter is expected to expand over the prior year by approximately 130 basis points. It will leverage our supply chain overhead cost, driven by the increased inventory in it, previously discussed.

Diluted earnings per share are expected to be in a range of $0.55 to $0.57. This includes $0.03 per share related to indirect sales we expected to occur in the fourth quarter, $0.01 per share impact from hurricane sandy, plus an additional $0.01 to 1.5 cent per share to support this year’s investment in Japan, partially offset by the previously mentioned tax benefit of $0.02 per share. Our earnings per share estimate assumes an effective tax rate of 38% and fully diluted weighted average shares outstanding of $40.6 million.

For full year fiscal 2013 we expect net revenues to be in the range of $526 million to $531 million, compared to our previous guidance of $531 million to $536 million, driven by the third quarter ecommerce performance, the early November sales softness and the impact of hurricane sandy in the fourth quarter. This includes indirect net revenue growth of low single digits and comparable store sales of mid-single digits for the full year. We expect gross margins to improve by approximately 100 basis points for the full year.

We expect diluted earnings per share from the full year to be in the range of $1.63 to $1.65. This assumes an effective tax rate of 37.5% and fully diluted weighted average shares outstanding of $40.6 million. Going forward we expect our normalized tax rate to be approximately 38.5%. With regards to capital spending, I would like to mention that during the quarter we completed the expansion of our distribution center in Fort Wayne, which doubled the capacity to 400,000 square feet. The project was successfully completed on time and is now fully operational. We expect the expanded distribution center to support our growth for the next several years.

Overall, capital spending for the fiscal year remains on track as previously guided, at approximately $36 million. With that I will turn the call back over to Mike for some closing remarks.

Michael Ray

Thank you, Jeff. In closing, we are very pleased with our performance in the third quarter and are optimistic about our prospects for the remainder of the holiday season. I would like to thank all of our team members and our retail partners for their hard work and dedication. Our team, our unique culture, the strength of our brand and the ongoing commitment to serving our customers, gives us confidence that we will achieve our long-term objectives.

Operator, we are now ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And we will take our first question from Erika Maschmeyer with Robert W. Baird.

Erika Maschmeyer - Robert W. Baird

Could you talk a little bit about the compings that you saw in throughout end of August (inaudible). What did you see after that? And then I know Sandy would have early November a while, could you talk a little bit about your results for Black Friday and early December. Thanks.

Michael Ray

This is Mike. I had a hard time hearing the very first part of your question. You said something about Q4...

Erika Maschmeyer - Robert W. Baird

I apologize. Your comp in Q3?

Michael Ray

Okay. If you recall, coming out of Q2 we felt some nice momentum from the back to campus collection. And really Q3 was the first full quarter where we implemented that new cadence. And so on the heels of back to campus collection, we had the launch of fall fashion, we had the launch of ribbons, and we had a number of traffic driving events. So really what we experienced was strong demand across the quarter and carried into early Q4. And then Q4 -- yeah, it was early November we felt some softness in the business. Just traffic overall and then the impact of hurricane sandy certainly in some of our markets.

The business rebounded very nicely over the post-thanksgiving holiday weekend. We had record sales that weekend in line with what we expected and our demand since then has been in line with our expectations.

Erika Maschmeyer - Robert W. Baird

And then just a follow up, the $0.01 from sandy, does that include a weaker comping of your own stores as well as expected lower orders on the part of your indirect partners?

Jeffrey Blade

The $0.01 would be primarily in our own stores, so that’s where we felt the majority of the impact. Certainly some of our indirect retailers have been impacted as well but that’s a lesser amount of the overall impact.

Erika Maschmeyer - Robert W. Baird

And then are you able to reduce the quantity of your future orders to offset some of the higher inventory that you have coming in due to the issue?

Michael Ray

So as I mentioned in our prepared remarks, the inventory issue that we identified affected approximately $15 million of inventory, and that is inventory that we would have brought in largely in the future anyways. And so it becomes largely a timing issue. So to the extent that we would have brought it in the future both for full price sales as well as continuing to round of the assortments when those patterns retire. We will adjust future purchases next year accordingly.

Erika Maschmeyer - Robert W. Baird

That’s makes a lot of sense. So it’s essentially instead of you reordering that product later in the year, it’s just coming in slightly earlier but given the long life of your product, it’s not going to cause a dramatic pressure.

Michael Ray

That’s what we believe.

Operator

And we will now go to Neely Tamminga with Piper Jaffray.

Neely Tamminga - Piper Jaffray

I want to talk a little bit more about the composition of the $15 million of the inventory, Jeff. Is this product been printed on particular seam patterns and does it fit on any particular sort of style or category of styles? Just trying to get a sense -- was that kind of affecting your trade off of a very strong best sellers sort of trends that you are seeing. Just trying to really get a sense of what's the potential risk is here on the inventory. And then I have a follow up.

Jeffrey Blade

Sure. So as I mentioned again the prepared remarks that this was essentially all patterns and styles that are top sellers. So the process here that occurred was really a higher level of reorder cadence than it should have been. But the good thing is that it’s all in current strong selling patterns and styles. So that’s the reason that we made the comment that we believe that this will sell through our normal channels throughout next year.

Neely Tamminga - Piper Jaffray

All right. So a little bit more to in terms of the -- it seems to be overall you guys are pleased with the cadence here of kind of fewer patterns, falling more frequently with more traffic related events in the store. As you look into next year, is that part of the strategy that you hope to implement? It seems like things have been kind of walked down already for the first half but would you anticipate repeating somewhat sort of cadence in the number patterns in the flow of patterns throughout the back half of your next year?

Roddy Mann

This is Roddy. Yeah, you can think of next year pretty much mirroring this year. Particularly in the cadence side as it relates to traffic driving events, we are constantly tweaking that but we are very pleased with how the year has laid out so far.

Neely Tamminga - Piper Jaffray

And can I just sneak in one housekeeping to Roddy, for you. The 30th anniversary, obviously you only have one 30th anniversary kicking off right now in the stores. Is that incremental to events that occurred last year?

Roddy Mann

It is, yes.

Neely Tamminga - Piper Jaffray

Okay.

Roddy Mann

In many ways it was. We put a lot of time and effort in planning out the holiday season assuming that Black Friday was going to be big and traffic won't might go away until the weekend or two before Christmas. And so a lot of the events and naturally having a 30th anniversary plays well at having a common theme for the current event.

Operator

And we will go next to Jennifer Davis with Lazard Capital Markets.

Jennifer Davis - Lazard Capital Markets

First congratulations on very good third quarter. Gross margins looked really good and I was glad to see less discounting online. Should we expect that going forward kind of in the fourth quarter next year? Are you going to continue to pullback on that promotional activity potentially at the expense of sales but at much better margins?

Michael Ray

Yes. Jen, this is Mike. You know our intent long term is to continue to migrate away from the level of discounting we have seen historically. We had a little taste of that in Q3. Certainly, we have to be mindful of the current environment, and Q4 we need to be mindful of what's going on the marketplace. But over the long haul, the intent is to continue to migrate away from the amount of discounting we have done historically. And it’s really a balancing act between revenue growth, gross margin and really doing what's right for the brand long-term. And so that’s how we think about it.

Jennifer Davis - Lazard Capital Markets

Okay. And then can you go through, Jeff, I guess the $5 million decline in revenue guidance. How much of that is from online -- I am sorry, I think you mentioned it but I missed it. How much of it is from the lower online and how much it is from hurricane sandy and how much is it for a lower start to November?

Jeffrey Blade

So we didn’t breakout the specific dollars but it’s a combination of those items. So we did get off to a slower start at the beginning of November. We had the impact of hurricane sandy and then -- yeah, so those were the primary drivers.

Operator

And we will now go to Edward Yruma with KeyBanc Capital Markets.

Edward Yruma - KeyBanc Capital Markets

Not to beat a dead horse, but on this $15 million of incremental inventory, have you put into your plan any incremental promotions that you may or may not need to help move some of that inventory, or is it because it’s best selling or inventory you would have already placed, it’s items you don’t believe you will need to markdown?

Jeffrey Blade

So we have not guided for next year yet, so it’s too early to do that. We will do that on our fourth quarter call in March. But going back to our prepared remarks what we did talk about was the fact this is inventory that largely would have been ordered anyways next year to support the continued selling in those current patterns and styles. They are all or a majority in best sellers. So we do feel comfortable that this inventory will sell in our normal channels throughout next year. So that’s the reason at this point we didn’t indicate anything incremental.

Edward Yruma - KeyBanc Capital Markets

Got you. Is there more specificity you could provide on the actually cause of the inventory increase? I mean was it a systems issue, a personal issue? And I guess what have you done to remediate the problem?

Jeffrey Blade

It was not -- it was absolutely not a systems issue. So I think as we have talked quite a bit over the last year to 18 months, we have continued to make considerable evolution in our overall supply chain and inventory management both from a people, process and systems standpoint. So it was not systems related. It was really a process issue and we have -- as we have continued to evolve and get more sophisticated on our inventory management, this specific issues had to do with the level of safety stock that we were ordering for our best selling patterns and styles. And we had some process errors that enabled us to order at higher quantities than we intended to.

So what we have done as a result of that from a process standpoint was obviously revisit the process to understand where the breakdown was. Secondly, to address that with better level of process rigor including another level of management oversight as well as some additional exception reporting and process reporting that will help us going forward.

Edward Yruma - KeyBanc Capital Markets

Got you. And my final question, you guys obviously had some nice indirect growth. What specifically around -- or how do you feel about your indirect inventory levels today and your ability to manage that going forward, I think given your increased scrutiny of that channel.

Michael Ray

We feel very good about the channel overall. The response to the change in the cadence that was always a question and I think the retailers by and large have embraced that. I think it’s benefitted from the changes that we have made. I think they have managed through that fairly well. And what we have seen is just nice consistent reorder activity that tells us -- when you see that it’s a decent proxy for sell-through and so we feel very good about the channel. We are not hearing anything from the field or from the independence that there is an inventory challenge in the channel.

Operator

And we will now go to Evren Kopelman with Wells Fargo.

Evren Kopelman - Wells Fargo

I wanted to ask about the gross margin in the third quarter. It was significant ahead of your guidance. Was that just driven by the outside sales or is there something else despite the charge it was a lot better?

Jeffrey Blade

It was driven certainly the upside to sales. The fact that we had lower level of discounting in ecommerce. And then we also had some very nice operational efficiencies as well. So we because of the overall flow of inventory we ended up airfreighting less during the quarter and we have also been testing the full operational use of smart post on our outbound shipping both for our ecommerce business and delivery to our indirect retailers which continues to generate nice savings for us. So it was a combination of all those things.

Evren Kopelman - Wells Fargo

Okay. And then on the ecommerce, was the level of discounting even lower than you planned? And also was the sales impact maybe greater than you expected? Could you give a little bit more color around that?

Roddy Mann

I would say the level was lower than we had planned. Certainly lower than last year but we didn’t plan it to be as good as it was and I think we saw a nice pick up in margins as a result. And with regards to sales being essentially lower than we thought, you know you are always trying to find that balance and I think we were -- again, we were trying to, to Mike’s comment earlier, you are always trying to find that balance of being competitive in the marketplace, trying to continue to migrate to lower levels of discounting on the web and more full price over time. So in any given quarter it’s a function of trying to make all those things balanced.

Evren Kopelman - Wells Fargo

Okay. And then lower level of discounting, did it had to do with maybe you are feeling much better about the inventory levels on the ecommerce or maybe -- what were the reasons why you ended up, I guess, discounting lower than you even planned at the end of August when we last spoke.

Michael Ray

You know the promotional cadence online was essentially kind of inline with what we did a year ago Q3. What we were able to do was reduce the level of discounting relative to those promotions. So that was primarily the driver of the improved margins and also had the impact on the topline.

Evren Kopelman - Wells Fargo

And then lastly on the new patterns in fall one and two. Maybe sitting here now looking at your reorders, how do you feel about this tail of sales from those patterns versus last year’s patterns where the tail was a little bit disappointing?

Michael Ray

I think we have seen over the last several launches of patterns, the portfolio gets incrementally stronger. It’s hard to say sitting where we are today what the tail of those recently launched patterns is going to be. But I think just if you broaden the view, you know we feel better about the portfolio than we did say a year ago.

Operator

And we will now go to Oliver Chen with Citi Investment Research.

Unidentified Analyst

This is [Nancy Holicer] filing in for Oliver Chen at Citi. Wondering if you could give us a little bit more color about the outlet strategy currently and going forward. And how is it going versus your expectation and maybe how do you see AUR trending going forward?

Michael Ray

The focus for us has really been to outlet merchandising in brand rate way. Prior to having our own outlet channel, you know we had the outlet sale here in [Four Plains] and when we launched the web in 2006 unfortunately it was one of the few where we had the outlet inventory when the economy slowed in like 2007 and 2008. Since we started opening our own stores the desire is to, to the extent that we can, move all of the outlet merchandise through that channel and I think that we are dialing that in better. We have more capacity obviously as a result of opening more doors. We are also doing a better job assorting those outlet stores. We have the ability to round out the assortment with top selling styles as patterns retire. So we are seeing improvement in the metrics within that outlet channel.

Unidentified Analyst

Also just a little bit color on the accounts receivable increase versus last year. Is that just because the sales were moved into third quarter?

Jeffrey Blade

Yeah, it’s just really the timing. It’s just really timing related to the release given the cadence change that we had this year. We had the release at the end of the quarter versus mid-quarter last year. So it’s just a matter of timing.

Operator

And we will now go to Amanda Seguin with Jefferies.

Unidentified Analyst

It’s actually [Randy Cornik] A quick question here. (inaudible) the last several quarters on the gross margin line, essentially you have had about five quarter of down gross margins. You have gross margin in the current third quarter, you are guiding up gross margin for the fourth quarter. Are we at the inflexion point in the gross margin cycle? Can you give us a yes or no on that? And then with regards to normalized gross margin as we think about next two years, is there some sort of -- is it going to be in the high-50s, is it going to have (inaudible), just a little color there, and how you are kind of getting or not getting there?

And then lastly, just on the $15 million of inventory, this has basically in core type replenishment patterns or is it new patterns, just give a little bit more color where that inventory is residing would be very helpful.

Jeffrey Blade

Let me take your first part of the question regarding gross margin. So from a gross margin perspective, we did have a strong third quarter gross margin for the items that I just mentioned before. So it was a combination of the strong sales, the lower discounting in ecommerce as well as operational efficiency saving. So that was the primary driver of Q3. We have also guided up Q4. Q4 you get some benefit because of the inventory issue we mentioned. You are essentially bringing in more units so you get some gross margin left. We are also getting benefit in the back half if you recall, from lower unit costs. So the back half of this year was the first time in the last year plus that we have seen the benefit of what were cotton costs.

We haven’t guided for next year so I am reluctant to sort of give you any gross margin guidance at this point. But I had referred to our long term guidance around margins which essentially says that from an operating margin standpoint we think that we should be able to achieve at least 30 basis points a year of improvement. And that would be a combination of ongoing evolution of supply chain as well as the fact that you will continue to get nice evolution as we continue to migrate to being more of a full fledged retailer. And overtime -- and it will take us a while, but overtime and as you do migrate the web to a more full priced channel you also get some gross margin benefit from there. So those would be some of the primary ways that we believe that margin will continue to evolve over time.

And then secondly, with regard to the $15 million of inventory characterizing the profile of that. As I mentioned in the prepared remarks, it is all in current patterns and styles and it’s all in best selling current patterns and styles. So that’s the reason that we indicated we believe we will be able to sell it through our channels during the next year.

Unidentified Speaker

I guess last question, if I may, Mike, just how do you feel about the consumer right now? How do you feel about the environment?

Michael Ray

You know what, we feel excited about the holiday season. Now certainly lot of things weighing on the consumer’s mind but I think just given the strength of our brand, our accessible price points, the cadence of new merchandise that’s flowing, the excitement that’s being generated within our doors through the marketing events that we mentioned, I feel very optimistic about our ability to manage through what is a bit of a challenging time right now.

Operator

(Operator Instructions) And we will now go to Peter Wahlstrom with Morningstar Investment Research.

Peter Wahlstrom - Morningstar

Maybe just as a quick follow up to Randy’s, have you seen the customer coming into the stores, your sales growth is largely traffic driven or is the customer more willing to put more items in the basket at this point?

Michael Ray

It’s primarily traffic driven, Pete.

Peter Wahlstrom - Morningstar

Okay. And then thinking about some of the new category launches that you had over the last few quarters, whether it’s new bedding or dorm category or even into the baby bags. Is it a little bit too early to think about distribution beyond the traditional indirect stores and maybe into more specialty like a Buy Buy Baby or Babies"R"Us or Pottery Barn, something like that. And as an add on that, have you been able to attract a new customer to the brand and more beyond the core?

Michael Ray

With regards to distribution beyond what we have today, I think as we extend the brand in new categories it is going to open up opportunities for us to partner with other retail partners. Certainly we want to be mindful of what's right for the brand and mindful of the existing distribution that we have, but we believe overtime there will be incremental opportunities for distribution points as a result of extending the brand into new categories. And then, can you remind what the second part of your question was?

Peter Wahlstrom - Morningstar

Have you been with those new categories? Have you been able to attract a new customer to the brand beyond the core Vera Bradley customer that’s quite familiar with the brand?

Roddy Mann

I think we have definitely expanded our customer base as it relates to whether something for more on the younger side, for back to campus or bringing in more moms. The way we think about our core is probably more on a attitudinal basis and her thoughts about fashion, about color, fun as well as the brand. And we think we are just sort of expanding further into that sweet spot within customers?

Peter Wahlstrom - Morningstar

Okay. And perhaps a follow-up -- sorry, a housekeeping question. Is there a little bit of background that you can provide on the damaged inventory. This is obviously perhaps the first time we have seen, just wondering if it’s fairly unique, happens from time to time and if it’s also covered by insurance.

Jeffrey Blade

So the write-off that we took during the quarter is $1.2 million. It was the inventory that arrived and has been damaged by water which we think happened in transit. So it’s not something -- you know from time to time you have seen some instance of where inventory gets damaged for various reasons but it tends to fairly infrequent. And we are working with our insurance carrier right now to determine if some portion of it is recoverable but given the uncertainty surrounding that we wanted to be conservative and record the write-off.

Peter Wahlstrom - Morningstar

Okay. And the last item. If I may, as you cycle through some of the infrastructure investments and the finishing of the DC build out, can you help us think about a normalized CapEx level?

Jeffrey Blade

Yeah. So this year’s CapEx was $36 million and that included finishing the distribution center. What we have talked about in the past is a normalized level of CapEx assuming that you are opening 14 to 20 new stores a year which is our long term guidance. That CapEx annually would be in the approximately $15 million range. With that said, there are a number of things that we continue to think about, so the good thing is that given the strength of our balance sheet, relatively low debt levels, a barge revolver in place at attractive rates, we are very interested in high return on invested capital projects. So we will continue to look at a number of things. But a normalized rate would be -- CapEx would be around $15 million if you are not doing any other major products with good returns.

Operator

And we will now go to Janet Kloppenburg with JJK Research.

Janet Kloppenburg - JJK Research

I am sorry I got on a little bit. I think someone had asked the question about, and I am sorry I didn’t hear the answer, about the inventory levels in the indirect segment and what orders trends look like they are going forward. I am sorry if I am asking a question you have already been asked, please accept my apologies.

Michael Ray

It’s okay, Janet. What we are seeing right now is just good consistent reorder activity from that channel. What we hear from our retail partners and from the field, it works directly with the independent retailers is that the channel is pretty right in terms of inventory levels. So we don’t have concerns at this point that there so much inventory in that channel.

Janet Kloppenburg - JJK Research

All right. No, no. It sounds like it is clean. So the question is, are you optimistic about the spring orders Mike or have you already taken a look at those. I think the orders trends were light across (inaudible) or so, perhaps there is an opportunity there?

Michael Ray

We had to start selling in spring to the channel. And it’s always a trick, kind of balancing between the sell-in and what will come in the way of reorders. Certainly our service levels have improved and our ability to respond quickly has worked in our favor. So we feel between the sell-in and reorders that the season will be in line with our expectations.

Janet Kloppenburg - JJK Research

But are you feeling better about that channel on a go forward basis?

Michael Ray

Yeah, we always feel good about the channel. It’s just very very difficult to predict.

Janet Kloppenburg - JJK Research

Okay. And then just I had a follow on to that. All the new categories that you have added to your own source, have you decided to sell those in direct channel as well? The baby, the kitchen, etcetera.

Michael Ray

The kitchen accessories are available for that channel. There are certain independent retailers that are right for the baby collection. But we need to make sure we are placing that merchandize in the right points of distribution. So we are being selective there. And going forward, we want to make sure that we are sorting right by each channel and so that will be kind of a category by category decision as we build our plan for merchandizing for the future.

Janet Kloppenburg - JJK Research

And just looking back to the ecommerce channel, well I think you had a loss less discounts in the third quarter. Should we expect that strategy to continue on a go-forward basis?

Michael Ray

Over the long-term, yes. We may need to react from time to time to what's going on in the marketplace. Our intent over the long-term is to continue to migrate towards a more full price channel through ecommerce.

Operator

And we will now go to Evren Kopelman with Wells Fargo.

Evren Kopelman - Wells Fargo

Back on the ecommerce, do you have off hand the increase on the gross profit dollars in ecommerce in the quarter?

Jeffrey Blade

No. We typically don’t disclose that.

Evren Kopelman - Wells Fargo

Okay. And then, I promise the last one, for the fourth quarter you guidance, it seems like embedding about a low single-digit growth for the ecommerce channel. But the compare doesn’t look as difficult at this third quarter. Can you talk about may be the trends you have seen in November and over the Black Friday, Cyber Monday periods on ecom?

Michael Ray

Evren, as we said in the prepared remarks in the script, we felt both good about the post-thanksgiving holiday sales overall. And that included both Black Friday and Cyber Monday. So overall I think we feel good about it.

Operator

And we have time for one more question. We will now take our last question from Jennifer Davis with Lazard Capital Markets.

Jennifer Davis - Lazard Capital Markets

I am going to try to squeeze a couple and so one last one on the inventory and two quick bigger picture ones. So on the inventory, the $15 million in say last year, how much inventory did you end up reordering later in this season? Is it comparable to that amount?

Jeffrey Blade

Jennifer, this is Jeff. I am not sure I fully understand the question.

Jennifer Davis - Lazard Capital Markets

So last year in the first quarter or when you would normally have reordered this inventory in the current patterns, current styles last year, can you tell us kind of the amount that you ended you reordering? Is it a comparable amount or more last year, less last year?

Jeffrey Blade

You know it’s hard to give you an exact amount just because every season is different and the flow of patterns and styles is different year-over-year. But other than this happening sooner because of the process issue we had identified, our normal cadence of placing inventory orders to start a selling season for the ELP selling and then placing orders for a reorder cycle are essentially consistent.

Jennifer Davis - Lazard Capital Markets

Okay. And the looking at Japan, how many locations are you in now and is there any update on your thoughts there? Are you going to continue to open shop-in shops on your own or have you thought about maybe partnering up with anyone?

Roddy Mann

I think we are in six locations, that’s just the shop-in shop. There is a total of 15 [stores] from a consumer perspective the number of department stores we are in. Some of them are more highly branded shop-in shops that we are calling in six, and the remainder are inline merchandize. As Mike mentioned, we are in that process of figuring out how to growth the brand in Japan. And I should say not figuring out, mapping out that plan and whether that plan includes some sort of partnership, to what degree it includes working further with department stores, or working through ultimately our own stores. We will map that out and we will share that in the near future.

Jennifer Davis - Lazard Capital Markets

And then lastly, on brand awareness, I believe last year on the East Coast there was -- or unaided brand awareness was 70% to 80% and it was around 20% to 40% I believe in the west. Is there any more recent numbers or any updated numbers for that?

Michael Ray

Our most recent study was back in January and it basically had -- generally speaking those numbers, I think it was actually more than 60s on the East Coast. But it had us roughly in the low to mid-50s and that was roughly -- it was a slight increase over the prior year. So we have consistent growth in brand awareness but it’s not the significant change that we saw a few years ago. We are pleased with that.

Operator

And that concludes today's question-and-answer session. Mr. Ray, at this time I would like to turn the conference to you for any additional or closing remarks.

Michael Ray

Okay. We just want to say thank you for joining us today and for your continued interest in Vera Bradley. And we look forward to speaking with you during our fourth quarter conference call to be held on March 13 at 4:30 pm. Thank you.

Operator

Ladies and gentlemen that does conclude today's conference call. Thank you for your participation.

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