Vera Bradley: Powerful Potential but Pain Ahead for Investors

Wes Aull

Thesis Vera Bradleys earnings will slow and potentially shrink in FY 2014 due to: i.) ii.) gross margin deterioration from significant excess of inventory. indirect retailers walking away from Vera Bradley b/c of channel saturation and managements open intent to right-size its indirect segment.

After two years of pain for shareholders per VRAs market price, there is still more to come. Vera looks to break into new all-time lows as patient investors throw in the towel after i.) ii.) iii.) earnings disappoint in Q2 despite management lowering guidance at Q1 14. management could again lower guidance at Q2/Q3. potentially, CEO/CFO roles are not filled easily during a period when VRAs performance is deteriorating.

Q1 and Scuttlebutt Revealing Negative Trends 1.) YOY growth rate of inventory at Q1 2014 was 41% with sales growing 5%. (central to gross margin deterioration thesis) 2.) Indirect sales growth has been slowing and is set to shrink by management. Indirect retailer feedback through scuttlebutt indicates that many are ready to leave. a. The departure of many vendors has been masked by the addition of Dillards as an indirect retailer in FY 2013. b. Moris Luggage, one of Veras largest retail partners, recently (in the past two months) pulled Vera from some of its stores. c. Indirect retailer inquiries have shown a segment, located near direct retail stores and/or outlets, that are angry with Vera and look to leave the product line soon. 3.) Scuttlebutt at outlet stores with associates showed that Vera is offering a higher level of discounts and for longer than normal at their Nashville and New York outlets. This would fit with the thesis that gross margins will decline while mark-downs are taken during the FY 2014 on substantial excess inventory. Financial Model The central factors to my thesis are indirect sales growth (shrinkage) and gross margin deterioration. My model below offers a realistic sense of potential for deterioration. Analyzing Veras past historical data on inventory/sales trends rates versus gross margin, 55-56% has been the lower range of their inventory cycles. Inventory growth (as compared to sales) has never differed this starkly. With gross margin highs at 57%, I found 55.5% realistic for my model.

Vera Bradley: Powerful Potential but Pain Ahead for Investors

Wes Aull

In addition to my project, I ran an upside scenario where same-store sales accelerate during the remainder of the year. Vera barely meets its earnings target. At year-end when Vera issues FY 2015 guidance, this will likely include managements plans to accelerate right-sizing of its indirect segment, which will leave FY 2015 guidance saddled despite the same store sales re-acceleration.

Risks to Analysis New stores opening in FY 2014 accelerate to a normal sales level more quickly than anticipated. New management is quickly hired and offers projections for international growth that the market quickly embraces.