VERA BRADLEY, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

[June 12, 2014]

VERA BRADLEY, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion summarizes the significant factors affecting the consolidated operating results, financial condition, liquidity, and cash flows of our Company as of and for the thirteen weeks ended May 3, 2014 and May 4, 2013. The following discussion should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended February 1, 2014, and our unaudited consolidated financial statements and the related notes included in Item 1 of this Quarterly Report.

Executive Summary Below is a summary of our strategic progress and financial highlights: Strategic Progress • We opened four new full-line stores and one factory outlet store during the first quarter in both current and underpenetrated markets.

• We hired key executives in sales, e-commerce, merchandising, and sourcing.

• We implemented omni-customer capabilities so that we can better understand what our customer is purchasing in all channels.

• We made improvements to our website which we believe will improve customer acquisition, full-price conversion, and retention.

Quarterly Financial Summary • Net revenues decreased 7.8% to $113.5 million.

• Direct segment sales decreased 0.3% to $73.4 million. Total comparable-store net sales declined 9.4%.

• Indirect segment sales decreased 18.9% to $40.0 million.

• Gross profit was $60.5 million (53.3% of net revenue).

• Operating income was $10.8 million (9.5% of net revenue).

• Net income was $6.6 million, or $0.16 per diluted share.

• Cash and cash equivalents were $81.5 million at May 3, 2014.

• Cash generated from operations of $27.0 million was used to fund capital expenditures of $4.0 million.

How We Assess the Performance of Our Business In assessing the performance of our business, we consider a variety of performance and financial measures.

Net Revenues Net revenues reflect revenues from the sale of our merchandise and from distribution and shipping and handling fees, less returns and discounts.

Revenues for the Direct segment reflect sales through our full-line and factory outlet stores, department store locations in Japan, our websites, verabradley.com and verabradley.co.jp, and our annual outlet sale in Fort Wayne, Indiana. Revenues for the Indirect segment reflect sales to specialty retail partners, department stores, national accounts and third party e-commerce sites.

Comparable-Store Sales Comparable-store sales are calculated based upon our stores that have been open at least 12 full fiscal months. Remodeled stores are included in comparable-store sales unless the store was closed for a portion of the current or comparable prior period or the remodel resulted in a significant change in square footage. Total comparable-store sales includes net revenues from our e-commerce site verabradley.com. Some of our competitors and other retailers calculate comparable or "same store" sales differently than we do. As a result, data in this report regarding our comparable-store sales may not be comparable to similar data made available by other companies. Non-comparable store sales include sales from stores not included in comparable-store sales.

13 -------------------------------------------------------------------------------- Table of Contents Measuring the change in year-over-year comparable-store sales allows us to evaluate how our store base is performing. Various factors affect our comparable-store sales, including: • Overall economic trends; • Consumer preferences and fashion trends; • Competition; • The timing of our releases of new patterns and collections; • Changes in our product mix; • Pricing; • The level of customer service that we provide in stores; • Our ability to source and distribute products efficiently; • The number of stores we open and close in any period; and • The timing and success of promotional and advertising efforts.

Gross Profit Gross profit is equal to our net revenues less our cost of sales. Cost of sales includes the direct cost of purchased and manufactured merchandise, distribution center costs, operations overhead, duty, and all inbound freight costs incurred.

The components of our reported cost of sales may not be comparable to those of other retail and wholesale companies.

Gross profit can be impacted by changes in volume, fluctuations in sales price, operational efficiencies, such as leveraging of fixed costs, promotional activities, such as free shipping, commodity prices, such as cotton, and labor costs in Asia.

Selling, General, and Administrative Expenses (SG&A) SG&A expenses include selling; advertising, marketing, and product development; and administrative. Selling expenses include Direct business expenses, such as store expenses, employee compensation, and store occupancy and supply costs, as well as Indirect business expenses consisting primarily of employee compensation and other expenses associated with sales to Indirect retailers. Advertising, marketing, and product development expenses include employee compensation, media costs, creative production expenses, marketing agency fees, new product design costs, public relations expenses, and market research expenses. A portion of our advertising expenses may be reimbursed by Indirect retailers, and such amount is classified as other income. Administrative expenses include employee compensation for corporate functions, corporate headquarters occupancy costs, consulting and software expenses, and charitable donations.

Other Income We support many of our Indirect retailers' marketing efforts by distributing certain catalogs and promotional mailers to current and prospective customers.

Our Indirect retailers reimburse us for a portion of the cost to produce these materials. Reimbursement received is recorded as other income. The related cost to design, produce, and distribute the catalogs and mailers is recorded as SG&A expense. Other income also includes proceeds from the sales of tickets to our annual outlet sale.

Operating Income Operating income equals gross profit less SG&A expenses plus other income.

Operating income excludes interest income, interest expense, and income taxes.

14 -------------------------------------------------------------------------------- Table of Contents Results of Operations The following tables summarize key components of our consolidated results of operations for the periods indicated, both in dollars and as a percentage of our net revenues ($ in thousands): Thirteen Weeks Ended May 3, May 4, 2014 2013 (unaudited) (unaudited) Statement of Income Data: Net revenues $ 113,461 $ 123,033 Cost of sales 52,936 54,567 Gross profit 60,525 68,466 Selling, general, and administrative expenses 51,312 55,227 Other income 1,577 1,951 Operating income 10,790 15,190 Interest expense, net 80 141 Income before income taxes 10,710 15,049 Income tax expense 4,143 5,860 Net income $ 6,567 $ 9,189 Percentage of Net Revenues: Net revenues 100.0 % 100.0 % Cost of sales 46.7 % 44.4 % Gross profit 53.3 % 55.6 % Selling, general, and administrative expenses 45.2 % 44.9 % Other income 1.4 % 1.6 % Operating income 9.5 % 12.3 % Interest expense, net 0.1 % 0.1 % Income before income taxes 9.4 % 12.2 % Income tax expense 3.7 % 4.8 % Net income 5.8 % 7.5 % The following tables present net revenues and operating income by operating segment, both in dollars and as a percentage of our net revenues, and store data for the periods indicated ($ in thousands, except as otherwise indicated): Thirteen Weeks Ended May 3, May 4, 2014 2013 (unaudited) (unaudited) Net Revenues by Segment: Direct $ 73,448 $ 73,687 Indirect 40,013 49,346 Total $ 113,461 $ 123,033 Percentage of Net Revenues by Segment: Direct 64.7 % 59.9 % Indirect 35.3 % 40.1 % Total 100.0 % 100.0 % 15-------------------------------------------------------------------------------- Table of Contents Thirteen Weeks Ended May 3, May 4, 2014 2013 (unaudited) (unaudited) Operating Income by Segment: Direct $ 13,449 $ 16,965 Indirect 15,439 17,739 Less: Corporate unallocated (18,098 ) (19,514 ) Total $ 10,790 $ 15,190Operating Income as a Percentage of Net Revenues by Segment: Direct 18.3 % 23.0 % Indirect 38.6 % 35.9 % Store Data (1): Total stores open at end of period 104 85 Total comparable-store sales (decrease) increase (2) (9.4 )% 10.9 % Total gross square footage at end of period (all stores) 219,212 176,437 Average net revenues per gross square foot (3) $ 162 $ 226 (1) Includes our full-line and factory outlet stores.

(2) Comparable-store sales are the net revenues of our stores that have been open at least 12 full fiscal months. Increase or decrease is reported as a percentage of the comparable-store sales for the same period in the prior fiscal year. Remodeled stores are included in comparable-store sales unless the store was closed for a portion of the current or comparable prior period or the remodel resulted in a significant change in square footage.

Total comparable-store sales includes net revenues from our e-commerce site verabradley.com.

(3) Dollars not in thousands. Average net revenues per gross square foot are calculated by dividing total net revenues for our stores that have been open at least 12 full fiscal months as of the end of the period by total gross square footage for those stores. Remodeled stores are included in average net revenues per gross square foot unless the store was closed for a portion of the period.

Thirteen Weeks Ended May 3, 2014, Compared to Thirteen Weeks Ended May 4, 2013 Net Revenues For the thirteen weeks ended May 3, 2014, net revenues decreased $9.6 million, or 7.8%, to $113.5 million, from $123.0 million in the comparable prior-year period.

Direct. For the thirteen weeks ended May 3, 2014, net revenues in the Direct segment decreased $0.2 million, or 0.3%, to $73.4 million, from $73.7 million in the comparable prior-year period. This change resulted primarily from a $6.7 million increase in revenues at our stores due to 19 additional full-line and factory outlet stores which was partially offset by a total comparable-store sales decrease of $5.7 million, or 9.4%, and a decrease in total sales at our annual outlet sale compared to the prior year. The total comparable-store sales decrease was primarily due to declines in traffic, underperformance of the product offering, and severe weather in the first two months of the quarter.

Comparable-store sales related to our e-commerce operations decreased by approximately 3.2% compared to the same period in the prior year, but favorably impacted our total comparable-store sales by 5.0% due to a smaller percentage decline in sales from our e-commerce channel, which accounts for approximately half of total comparable-store sales. Our comparable-store sales excluding e-commerce decreased 14.4%. The aggregate number of full-line and factory outlet stores grew from 85 at May 4, 2013, to 104 at May 3, 2014.

Indirect. For the thirteen weeks ended May 3, 2014, net revenues in the Indirect segment decreased $9.3 million, or 18.9%, to $40.0 million, from $49.3 million in the comparable prior-year period, primarily due to an increase in key account orders offset by a decrease in the specialty gift channel.

Gross Profit For the thirteen weeks ended May 3, 2014, gross profit decreased $7.9 million, or 11.6%, to $60.5 million, from $68.5 million in the comparable prior-year period. As a percentage of net revenues, gross profit decreased to 53.3% for the thirteen weeks ended May 3, 2014, from 55.6% in the comparable prior-year period. The decrease as a percentage of net revenues was primarily due to overhead costs deleveraging and increased year-over-year promotional activity.

16 -------------------------------------------------------------------------------- Table of Contents Selling, General, and Administrative Expenses For the thirteen weeks ended May 3, 2014, SG&A expenses decreased $3.9 million, or 7.1%, to $51.3 million, from $55.2 million in the comparable prior-year period. As a percentage of net revenues, SG&A expenses increased to 45.2% for the thirteen weeks ended May 3, 2014, from 44.9% in the comparable prior-year period. The increase in SG&A expenses as a percent of net revenues was primarily due to fixed expenses being spread over lower revenues in the Indirect segment and the deleveraging of store operating expenses, which were partially offset by expense management measures.

Other Income For the thirteen weeks ended May 3, 2014, other income decreased $0.4 million, or 19.2%, to $1.6 million, from $2.0 million in the comparable prior-year period. The decrease in other income was in line with a decrease in associated advertising costs related to mailers for our specialty retailers.

Operating Income For the thirteen weeks ended May 3, 2014, operating income decreased $4.4 million, or 29.0%, to $10.8 million, from $15.2 million in the comparable prior-year period. As a percentage of net revenues, operating income was 9.5% and 12.3% for the thirteen weeks ended May 3, 2014 and May 4, 2013, respectively.

Direct. For the thirteen weeks ended May 3, 2014, operating income in the Direct segment decreased $3.5 million, or 20.7%. As a percentage of Direct segment net revenues, operating income in the Direct segment was 18.3% and 23.0% for the thirteen weeks ended May 3, 2014 and May 4, 2013, respectively.

Indirect. For the thirteen weeks ended May 3, 2014, operating income in the Indirect segment decreased $2.3 million, or 13.0%. As a percentage of Indirect segment net revenues, operating income in the Indirect segment was 38.6% and 35.9% for the thirteen weeks ended May 3, 2014 and May 4, 2013, respectively.

Corporate Unallocated. For the thirteen weeks ended May 3, 2014, unallocated expenses decreased $1.4 million, or 7.3%, primarily due to expense management measures.

Income Tax Expense The effective tax rate for the thirteen weeks ended May 3, 2014, was 38.7%, compared to 38.9% for the thirteen weeks ended May 4, 2013.

Liquidity and Capital Resources General Our primary source of liquidity is cash flow from operations. We also have access to additional liquidity, if needed, through borrowings under our $125.0 million amended and restated credit agreement. Historically, our primary cash needs have been for merchandise inventories, payroll, store rent, capital expenditures associated with operational equipment, buildings, information technology, opening new stores, and debt repayments. The most significant components of our working capital are cash and cash equivalents, merchandise inventories, accounts receivable, accounts payable, and other current liabilities. We do not believe that the expansion of our Direct business or campus consolidation will materially increase borrowings under our amended and restated credit agreement in the near term.

We believe that cash flows from operating activities and the availability of borrowings under our amended and restated credit agreement or other financing arrangements will be sufficient to meet working capital requirements, anticipated capital expenditures, and debt payments for the foreseeable future.

17 -------------------------------------------------------------------------------- Table of Contents Cash Flow Analysis A summary of operating, investing, and financing activities is shown in the following table (in thousands): Thirteen Weeks Ended May 3, May 4, 2014 2013 (unaudited) (unaudited) Net cash provided by operating activities $ 26,957 $ 14,879 Net cash used in investing activities (4,040 ) (5,811 ) Net cash used in financing activities (606 ) (10,412 ) Net Cash Provided by Operating Activities Net cash provided by operating activities consists primarily of net income adjusted for non-cash items, including depreciation, amortization, deferred taxes, and stock-based compensation, the effect of changes in assets and liabilities, and tenant-improvement allowances received from landlords under our store leases.

Net cash provided by operating activities for the thirteen weeks ended May 3, 2014, was $27.0 million, compared to $14.9 million for the thirteen weeks ended May 4, 2013, an increase primarily due to less growth in inventory.

Net Cash Used in Investing Activities Investing activities consist primarily of capital expenditures for growth related to new store openings, buildings, operational equipment, and information technology investments.

Net cash used in investing activities was $4.0 million and $5.8 million for the thirteen weeks ended May 3, 2014 and May 4, 2013, respectively; capital expenditures of $3.0 million were incurred but not paid at May 3, 2014. The $1.2 million increase in capital expenditures was due primarily to the campus consolidation project, which was not in the prior year, partially offset by the opening of five stores during the thirteen weeks ended May 3, 2014, compared to nine stores during the thirteen weeks ended May 4, 2013.

Capital expenditures for fiscal year 2015 are expected to be approximately $40.0 million, which includes approximately $20.0 million related to the campus consolidation.

Net Cash Used in Financing Activities Net cash used in financing activities was $0.6 million for the thirteen weeks ended May 3, 2014. This compares to net cash used in financing activities of $10.4 million for the thirteen weeks ended May 4, 2013, resulting primarily from $10.0 million net payments under our amended and restated credit agreement.

Amended and Restated Credit Agreement On October 4, 2010, Vera Bradley Designs, Inc. entered into an agreement to amend and restate our credit agreement with JPMorgan Chase Bank, as administrative agent, and certain other lenders. The amended and restated credit agreement provides for a revolving credit commitment of $125.0 million and matures on October 3, 2015. On June 1, 2012, Vera Bradley Designs Inc., entered into an amendment to the credit agreement. The amendment extends the maturity date from October 3, 2015, to June 1, 2017. Certain permitted indebtedness covenants were also amended. All borrowings under the amended and restated credit agreement are collateralized by substantially all of our assets. The credit agreement is also guaranteed by the Company. The credit agreement requires us to comply with various financial covenants, including a fixed charge coverage ratio of not less than 1.20 to 1.00 and a leverage ratio of not more than 3.50 to 1.00. The agreement also contains various other covenants, including restrictions on the incurrence of certain indebtedness, liens, investments, acquisitions, and asset sales. We were in compliance with these covenants as of May 3, 2014.

Borrowings under the amended and restated credit agreement bear interest at either LIBOR plus the applicable margin (ranging from 1.05% to 2.05%) or the alternate base rate (as defined in the agreement) plus the applicable margin (ranging from 0.05% to 1.05%). The applicable margin is tied to our leverage ratio. In addition, we are required to pay a quarterly facility fee (as defined in the agreement) ranging from 0.20% to 0.45% of the revolving credit commitment. As of May 3, 2014, the Company had borrowing availability of $125.0 million under the agreement.

18 -------------------------------------------------------------------------------- Table of Contents Off-Balance-Sheet Arrangements We do not have any off-balance-sheet financing or unconsolidated special-purpose entities.

Critical Accounting Policies and Estimates The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses, as well as the related disclosures of contingent assets and liabilities at the date of the financial statements. A summary of the Company's significant accounting policies is included in Note 2 to the Company's consolidated financial statements in the Company's Annual Report on Form 10-K for the fiscal year ended February 1, 2014.

Certain accounting policies and estimates of the Company are considered critical, as these policies and estimates are the most important to the depiction of the Company's consolidated financial statements and require significant, difficult, or complex judgments, often about the effect of matters that are inherently uncertain. Such policies are summarized in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Annual Report on Form 10-K for the fiscal year ended February 1, 2014.

There was no significant change to any of the critical accounting policies and estimates described in the Annual Report.

Recently Issued Accounting Pronouncements In April 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. This guidance states that the disposal of a component of an entity is to be reported in discontinued operations only if the disposal represents a strategic shift that has (or will have) a major effect on an entity's operations and financial results. The pronouncement also requires additional disclosures regarding individually significant disposals of components that do not meet the criteria to be recognized as a discontinued operation as well as additional and expanded disclosures. The guidance is effective for all disposals (or classifications as held for sale) of components of an entity and all businesses or nonprofit activities that, on acquisition, are classified as held for sale that occur within annual periods beginning on or after December 15, 2014, and interim periods within annual periods beginning on or after December 15, 2015; it is applied prospectively. Early adoption is permitted, but only for disposals (or classifications as held for sale) that have not been reported in financial statements previously issued or available for issuance. The Company does not expect this standard to have a material impact on the Company's consolidated financial statements upon adoption.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, to clarify the principles used to recognize revenue for all entities. The new guidance is effective for annual and interim periods beginning after December 15, 2016, with no early adoption permitted. The Company is currently evaluating the impact, if any, the adoption of this guidance will have on its financial position, results of operations or cash flows.

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