Anastacia S. Knapper - Secretary, Senior Vice President & General Counsel Robert T. Wallstrom - President, Chief Executive Officer & Director Kevin J. Sierks - Chief Financial Officer & Executive Vice President Sue Fuller - Chief Merchandising Officer & Executive VP.

Edward J. Yruma - KeyBanc Capital Markets, Inc. Ike B. Boruchow - Sterne, Agee & Leach, Inc. Randal J. Konik - Jefferies LLC Courtney Willson - Cowen & Co. LLC Eric M. Beder - Wunderlich Securities, Inc. Dana L. Telsey - Telsey Advisory Group LLC Janet J. Kloppenburg - JJK Research Evren D. Kopelman - Wells Fargo Securities LLC.

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Vera Bradley Year-End 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for you to queue up for questions.

As a reminder, today's conference call is being recorded. I would now like to turn the call over to Stacy Knapper, Vera Bradley's Senior Vice President and General Counsel. Please go ahead..

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

Some of the statements made on today's call during our prepared remarks and in response (00:45-00:47) 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 February 1, 2014 filed with the SEC for a discussion of known risks and uncertainties.

Investors should not assume that the statements made during the call will remain operative at a later time. The company undertakes no obligation to update any information discussed on the call. I will now turn the call over to Vera Bradley's Chief Executive Officer, Rob Wallstrom..

Thank you, Stacy. Good morning, everyone, and thank you for joining us on today's call. With me today are Kevin Sierks, Chief Financial Officer; Sue Fuller, Chief Merchandising Officer; and Julia Bentley, VP of IR and Communications.

Even though our revenues were challenging and fell below our expectations, we were still able to deliver earnings per share for both the quarter and year within our guidance. Fiscal 2015 was certainly a year of transition for Vera Bradley.

And let me take just a minute to highlight the substantial progress that we made against our long-term strategic plan.

We strengthened the organization with the addition of high-caliber, experienced leadership, including Sue Fuller, EVP, Chief Merchandising Officer; Karen Peters, EVP of Retail and Wholesale; and Angel Ilagan, EVP, Chief Marketing Officer; as well as VPs in key areas including, global sourcing, store development, merchandise planning and wholesale.

We have a great blend of existing and new talent in the organization and the right team for the future of the business. Our balance sheet remained strong. We managed our inventories and ended the year with a very solid cash position. We accomplished a great deal related to products.

We innovated and began to modernize and elevate our product assortment through the introduction of laser-cut, faux leather and other products; the launch of our full coordinating collections including our smaller prints, and the expansion of our solid microfiber assortments.

All of these additions are diversifying our offering and lessening our dependence on our traditional cotton quilted signature patterns. We better focused our assortments by reducing the number of signature cotton quilted pattern launches and by eliminating underperforming SKUs to the assortment.

We majored in the majors making a bigger impact in the big volume drivers and classifications Vera Bradley is known for and what we do best, like travel, backpacks, bags, and accessories. We began exploring relevant brand extensions that will enhance our position as a lifestyle brand.

We entered into arrangements with two strategic jewelry partners to re-launch and expand our jewelry offering, elevating the aesthetic and increasing our customer reach, and conducted a successful test of this new collection in the fourth quarter.

We work to make our existing supply chain more efficient and cost effective, and began exploring lower cost manufacturing facilities in country. We shifted some production out of China and into Vietnam and reduced cost at our domestic manufacturing facility.

We also identified and implemented cost reductions in shipping, supplies and other overhead costs. On the distribution front, there are several accomplishments to note. We opened 13 full-line stores, bringing our total year-end to 96 and opened 14 factory outlet stores, bringing our count to 29.

We began work on our new prototype full-line store, which will be unveiled this year. We started the transition of our outlet stores to factory outlet stores with the introduction of approximately 20 factory-exclusive styles, which are generating higher sell-throughs and gross margin rates than our traditional outlet business.

We implemented our LOCATE system in both our full-line and factory outlet stores, which allows sales associates to find a product in another store and ship it directly to the customer if it is out of stock within the originating store.

We made key enhancements to verabradley.com including adding product recommendations, enhancing product descriptions, adding silhouettes for product scale, generating cart and site abandonment emails and gathering and analyzing customer feedback. We expanded our department store presence through new relationships with Macy's and Belk.

We are now in 100 Macy's stores, including a small Outpost in the Herald Square flagship store and began testing our products in three Belk stores, one of which is a prototype shop-in-shop in the Dallas Galleria. We work to stabilize the specialty gift channel.

We've began focusing on our largest accounts that represent our brand development and discontinuing unproductive accounts that did not represent the Vera Bradley brand well, leaving us with approximately 1,900 partners with approximately 27 new locations in this channel. It's down from a high of about 3,600 three years ago.

We made progress on balancing inventories and better tailoring and segmenting our product assortment by door. In addition, we reduced our team of field sales consultants that services this channel, better aligning the number of sales consultants with the current sales level.

We also entered into a five-year agreement with Mitsubishi Corporation Fashion Company and Look Inc. to import and distribute Vera Bradley products in Japan, moving us to a wholesale business model in this country. The first two stores will open in fall 2014 to positive customer response. We further developed our marketing initiatives.

We launched our first national ad campaign in September focused on leather and faux-leather. This campaign included a strategic combination of carefully-placed national ads, special event social media with a focus on Twitter and Instagram and creating buzz through bloggers and fashion influencers.

We also launched a November digital campaign and our Brightest Gifts Ever! holiday print and digital campaign. While we have made progress on our key initiatives, the overall business trends remained difficult. By this time, we had expected to regain momentum in the business, but this did not happen.

Our core customers are continuing to buy our products. However, our primary issue is that we have not attracted enough new customers to the brand, and therefore, both traffic and sales remained extremely challenging. We remain committed to our long-term strategic plan.

In fact, based on the challenges we are facing in traffic and sales trends, we are more convinced than ever that our strategies to innovate and modernize our products, distribution and marketing are the right ones for the future. In fiscal 2016, we are focusing on attracting new customers to the brand.

Specifically, we will continue to increase the relevance of our product by investing more in products and categories that are working such as leather, solid microfiber, our smaller coordinating prints and driving innovation and newness through new fabrications and styles.

We will continue to prudently grow our distribution, including adding select new full-line and factory outlet stores and expanding our department store partnerships. We will move much more aggressively on our marketing efforts.

We will allocate more dollars and resources to create and successfully implement a comprehensive, multi-faceted marketing campaign to drive brand and product awareness and target new customers. Sue and I will talk more about each of these in a few minutes.

As always, we expect to carefully manage our expenses but intend to redeploy any savings realized in areas such as marketing and e-commerce that will strengthen and grow the business for the long term.

For example, beginning in the fourth quarter of fiscal 2016, we expect to save approximately $12 million annually related to the closing of our domestic manufacturing facility, which will be reinvested in the aforementioned other areas of the business.

We continue to believe that we can reach $1 billion in sales and a high-teen operating margin in the future, but that it will take longer to achieve these sales than the five years we originally projected. I will now ask Kevin to give us a brief update on our results and outlook for fiscal 2016..

Thanks, Rob, and good morning. Before I begin, let me remind you that as a result of moving to a wholesale business model in Japan, we exited our Direct business during the first (9:48) quarter of fiscal 2015 and are accounting for it as a discontinued operation.

The income statement numbers I will reference reflect continuing operations, which is consistent with how we provided guidance. I won't go into a lot of detail on the historical numbers since all the information is contained in this morning's press release.

Net revenues totaled $152.6 million for the current year fourth quarter compared to $156.4 million last year and our guidance of $158 million to $163 million. Income from continuing operations totaled $17.3 million or $0.43 per diluted share for the current year fourth quarter compared to $19.9 million or $0.49 per diluted share last year.

Both quarters include certain charges that were outlined in the release. In our Direct segment, total revenues of $107.7 million were essentially flat with last year, reflecting new store growth, offset by a 14.4% comp sales decline.

Indirect segment revenues fell 8% to $44.9 million, primarily due to lower re-orders of our specialty retail account as well as the reduction in the number of specialty retail accounts.

Operating income totaled $25.9 million, or 17% of net revenues in the current year fourth quarter compared to $31.3 million or 20% of net revenues in the prior year fourth quarter.

By segment, Direct operating income was $29.4 million, or 27.3% of sales, which was consistent with last year, and Indirect operating income was $15.6 million or 34.8% of sales compared to $18.6 million, or 38.1% of sales in the prior year. Net revenues totaled $509 million for fiscal 2015 compared to $530.9 million last year.

Income from continuing operations totaled $40.8 million, or $1 per diluted share, for fiscal 2015 compared to $60.1 million, or $1.48 per diluted share for fiscal 2014. Both years included certain charges that were outlined in the release.

Direct segment revenues increased 4.5% for the year to $335.6 million, reflecting new store growth, offset by a 7.6% comparable sales decline. Indirect segment revenues decreased 17.4% to $173.4 million, primarily due to lower re-orders from our specialty retail account as well as a reduction in the number of specialty retail accounts.

Operating income totaled $64.1 million, or 12.6% of net revenues, in the current year compared to $95.8 million, or 18% of net revenues, in the prior year. By segment, Direct operating income was $74.1 million, or 22.1% of sales, compared to $81.2 million, or 25.3% of sales last year.

And Indirect operating income was $66.2 million, or 38.2% of sales, compared to $84.1 million, or 40.1% of sales in the prior year. Year-end cash totaled $112.3 million compared to $59.2 million last year. We had no debt outstanding at fiscal year-end.

Year-end inventory was $98.4 million, slightly below guidance of $100 million to $110 million and compared to $136.9 million last year. Inventories were below the prior year due to improved inventory management and below guidance due to receipt flow.

Net capital spending for the year totaled $37.1 million, slightly below guidance of $40 million due to the timing of certain expenditures related to the corporate campus consolidation. Now let's talk about the outlook for fiscal 2016.

Our guidance below is on a continuing operations basis and excludes estimated restructuring and other charges of $6 million to $7 million that will be recorded in the first quarter of fiscal 2016 related to the closing of our domestic manufacturing facility and other cost saving measures.

For the first quarter, we expect net revenues of $103 million to $109 million compared to prior year first quarter revenues of $112.2 million.

The first quarter revenue expectations reflect the timing of approximately $4 million in Indirect revenues related to the summer early order period, or EOP, for our specialty retailers that shifted from the first quarter last year to the second quarter this year.

We expect Direct segment net revenues to be flat to increase in a low single-digit percentage range with a comparable sales, including e-commerce, decrease in the mid-teen percentage. We believe our Indirect net revenues will decline in the low 20% range during the quarter.

The gross margin rate for the first quarter is expected to range from 53% to 53.5% compared to 53.3% in the prior year first quarter. SG&A as a percentage of sales is expected to range from 51.9% to 54.5% for the first quarter compared to 44.6% in the prior year first quarter.

The expected deleverage is primarily due to incremental investments in key areas like marketing, incentive compensation, and e-commerce on a lower sales base. We expect first quarter diluted EPS to be in the range of $0.00 to $0.03, based on diluted weighted average shares outstanding of 39.9 million and an effective tax rate of 39.3%.

Diluted EPS totaled $0.17 in the prior year first quarter. We expect inventory to be $100 million to $110 million at the end of the first quarter compared to $126.6 million at the end of last year's first quarter. This projected inventory level reflect the much better balance of current to retired inventory than a year ago.

For the full year, we expect net revenues of $510 million to $525 million compared to $509 million last year. Our revenue guidance includes Direct segment net revenue growth in the high single-digits to low double-digit range with a decline in comparable sales, including e-commerce, in the mid to high single-digit percentage range.

This guidance reflects our plans to reduce our promotional activity which Rob will discuss in further detail. Indirect net revenues are expected to decline in the low-teen percentage range. The gross margin rate for fiscal 2015 is expected to range from 55.7% to 56.2% compared to 52.9% last year.

This planned improvement reflects the leveraging of overhead costs, reduction in sourcing and product costs, primarily related to made-for-outlet product, and including the closure of our domestic manufacturing facility and reduced promotional activity.

SG&A as a percentage of sales is expected to range from 44.9% to 46.3% for fiscal 2016 compared to 41% last year.

The expected rate increase is primarily a result of the previously-discussed strategic investments in the business in fiscal 2016, such as incremental advertising expense of approximately $8 million, additional incentive compensation expense of approximately $7 million, and incremental e-commerce expenses, and the deleverage due to the soft sales projection.

We do have an active expense control program in place and we're focused on reducing expenses.

We have identified and are implementing several cost reductions, including the closing of our domestic manufacturing facility, negotiating lower prices with our fabric mills, right-sizing the support staff of our Indirect channels, and gaining staffing efficiencies in our stores.

Our expectations for diluted EPS is from $0.82 to $0.92 for fiscal 2016. On a comparable basis, diluted EPS totaled $1 last year.

We expect our net capital expenditures will total approximately $31 million for the full year, primarily related to new store openings, continued investments in our systems, and completion of our corporate campus consolidation.

As Sue will discuss, we intend (17:55) to make some targeted investments in inventory, so our inventory is projected to grow at a faster rate than sales this year. Let me turn the call over to Sue, who will give us an update on product.

Sue?.

bags, accessories, travel and backpack. Even though sales have continued to be challenging, we do know that our customers are responding to the newness, and our SKU productivity on these products is higher than on our traditional merchandise.

We are getting great feedback from our retail partners and consumers, and they tell us that our assortments have never looked better and been more trend right, and our offerings are getting better and better each season. I'm really excited about our summer, fall, and winter assortment.

At the end of fiscal 2015, about 30% of our Direct assortment is what we consider new merchandise. Let me go over a few of the specific actions we are taking. We are continuing to refine our internal innovation pipeline to keep fresh fabrication ideas coming, and we are implementing a fast-track process to more quickly react to market trends.

We are working to increase our market share of bags through the continued style and color expansion of leather, laser-cut and faux leather and the introduction of diversified and new-to-us fabrication.

We intend to grow our backpack market share by increasing and diversifying new assortment, expanding our very successful Lighten-Up fabrication and introducing new functionality. We will work to increase our travel market share through the addition of the Lighten-Up fabrication and new style.

We want to be the go-to place for carry-on luggage for all styles. We will continue to expand our successful solid microfiber business by adding additional SKUs in our core color of black. This fall we will be adding Navy and Espresso to our core microfiber assortment and we will continue to add seasonal colors to the collection.

Solid, including leather and faux leather, represents nearly 25% of our Direct business at the end of fiscal 2015. And we have doubled our scarf selection. And mid-year, we will launch our updated and expanded jewelry collection in all full-line doors and on verabradley.com.

One important point I want to make is that by diversifying into a variety of new fabrics in each of our key classification, we believe we now are more effectively able to compete and are better positioned to take market share. By offering primarily cotton-quilted products, we were only able to compete in about 10% of the bag market.

Our expanded offerings will allow us to compete in approximately 90% of the market. We are focused on appropriate inventory management and assortment by channel, and we believe we now have the team, processes and systems in place to do just that.

Specifically, we've recently completed implementation of our new merchandise planning and allocation system. The new system, along with the talented team we now have in place, will allow us to manage our assortment by channel and optimize inventory quantities and improve our stock positions down to the store level.

We have improved our chase processes to maximize sales opportunity. We have expanded our LOCATE system online. If an item is out of stock in a particular store, LOCATE will allow the sales associate to find the product in another store online and ship it directly to the customer.

We are investing more dollars in inventory in key areas where we believe sales have been negatively impacted by low stock levels, particularly in our factory outlet stores. We are moving faster and adding more inventories of certain new products and categories, such as leather, faux-leather, and solid microfiber.

We are getting more strategic about product segmentation. Leather is distributed in our full-line stores on verabradley.com and in department stores. Faux leather will be segmented to the specialty channel.

In addition, we are creating other specific products for specific channels and, of course, our factory-exclusive products are an important piece of this segmentation. We remain optimistic that we are on the right track and that these product changes will lead to increased revenues, better sell-throughs, and higher gross margins over time.

We are also taking other actions that we believe will expand our future gross margin rate. For example, we are in the process of building a more flexible, efficient, and cost-effective supply chain through our vendor and country diversification. One piece of this is closing our domestic manufacturing facility in Fort Wayne.

This was an extremely difficult decision, but one that will save us approximately $12 million on an annual basis beginning in the fourth quarter of this year. We are currently manufacturing approximately 5% of our product in this facility.

And as Rob mentioned, we are broadening our base to countries outside of China to other countries with expertise in specific product classification. We have also aggressively renegotiating pricing with all of our mills due to lower cotton and petroleum cost and expect to save $3 million in cost of sale on an annualized basis beginning in fiscal 2017.

One last note on the West Coast port slowdown. Of course, we are all glad that the situation has been resolved. We have had and will continue to have some minor delivery impacts due to the situation. However, we were proactive and routed some of the deliveries through Canada and air-freighted other merchandise that was more time-sensitive.

I think that the team has been able to manage the situation very well.

Rob?.

Thanks, Sue. Our distribution strategy remains an important part of our long-term plan. We still believe there is ample opportunity for both full-line and factory outlet store growth. Of course, this growth is off a relatively small base. We have planned to open 15 full-line stores this year with five opening in the first quarter.

We continue to believe that we will have opportunities to add an average of around 20 new full-line stores per year going forward, equating to about 300 full-line stores over time. We are working hard on trying to create in-store excitement and give customers a reason to shop.

Over the holidays, we tested a monogram machine in one of our Michigan stores, which drove solid gains in traffic and sales. To further test the concept, we are rolling these machines out to a handful of additional stores this spring.

Harry Cunningham, our new Head of Store Development, is beginning to test more modern visual merchandising methods to attract new customers into our stores. He has been working on the new prototype store design, which we should have finalized midyear.

The first iteration of this new design will be rolled out to our new Kierland Commons store in Scottsdale, Arizona, which opens later this month. In our factory stores, we are on track with our made-for-factory product transition. Currently, about 25% of merchandise in our factory outlet stores is factory-exclusive.

And we are pleased with the performance. This percentage should grow to about 70% over the next couple of years. We have plans to open 10 factory outlet stores this year with five opening in the first quarter.

We still expect to open an average of about 10 stores per year and believe the opportunity exists to have over 100 factory outlet stores in the long term. This would leave us with a ratio of about three full-line stores to every factory outlet store. e-commerce is an integral component of our five-year plan.

We are in the early phase of our 18-month conversion to a new web technology platform.

Once fully implemented, this new platform will allow for a true omni-channel experience for our customers and will offer significantly enhanced search capabilities, personalization, and segmentation of customer experiences and offers, and better management of promotions.

Over time, this new platform should allow us to better focus on our brand and product story and to reduce promotional activity on our full-line sites.

This year, we will be strategically weaning ourselves off of our hyper promotional activity that is not sustainable and damaging to the brand, eliminating our deepest discount both on the website and in our full-line stores.

We realize this is likely to have a negative impact on sales, but is the right action to take for the long-term health of the business and the brand. Department stores are key to growth in the Indirect segment. Department stores allow us to attract new customers to Vera Bradley and to showcase our elevated product assortments.

By May, we are planning to be in 250 Macy's stores, and are in the process of enhancing both our product assortment and store presentation. We are now in seven Belk stores and plan to add more in the future. And, of course, Dillard's remain a very special partner for us, where we have distribution in all of their doors.

We are getting interest from several other department stores, but we are taking a methodical and strategic approach to building a profitable department store business that best represents our brand. The indirect specialty gift channel remains an important and very profitable piece of our business.

We continue to focus on our largest accounts that represent our brand the best. Our last three EOPs, or early order periods, have generated solid results, and the retailers have responded to our new product selections. Now, switching gears to marketing, which is probably our most critical focus area this year.

We are allocating more dollars and resources to create and successfully implement a comprehensive marketing plan to modernize our brands and attract a wider breadth of customers. We plan to invest approximately $8 million in additional advertising this year, bringing our total annual marketing spend to approximately $40 million.

We are increasing digital and print advertising, social media and public relations, while paring back direct mail. Our most recent advertising has not been effective in attracting enough new customers to the brand.

We hired a new ad agency, and they have worked with us to develop a new advertising campaign called, I Am (29:49), which highlights the multi-faceted nature of our customers, connecting them and their lives to our brand and products.

During the testing phase, this campaign resonated with both existing and potential customers, as indicated by a significant increase in purchase intent. We will launch the new campaign in conjunction with Mother's Day. We are also partnering with a nationally known PR firm to drive exposure.

We are investing more in digital print, social media and key magazine advertising with the intent to increase our effective reach from 8 million to 85 million customers, particularly focusing on the 25 to 45 style-conscious demographic. We will broaden our magazine coverage and increase our TV and movie product placement.

On the digital front, we will focus on mobile geo-targeting, display banner ads and video advertisements.

To drive customer engagement, we will launch the Vera Bradley Club program this summer, develop Vera Bradley brand ambassadors such as Olympic gold medalist and Dancing with Stars winner, Meryl Davis, and partner with influential social media stylists and bloggers.

As I look back over the last year, I am very proud of the progress that the Vera Bradley team has made against our strategy. While we continued to face challenges in attracting new customers to the brand, I am more convinced than ever that we are taking the right steps to position Vera Bradley for the future.

It is taking time, more time and investment than expected, to turn this business around, but I remain optimistic about the future and the Vera Bradley brand. Operator, we will now open the call to questions..

Thank you. We'll pause for just a moment to allow everyone an opportunity to signal. Our first question comes from Ed Yruma with KeyBanc..

Hi. Good morning. Thanks for taking my question. I guess, first on gross margin, obviously, you've spoken about reducing promos. But if you could walk us through your guidance and kind of the different puts and takes we should think about to get to your gross margin guide that would be really helpful. Thanks..

Sure, Ed, and good morning. This is Kevin. With regards to gross margin, we exited the year at 52.9%. There's four major things that'll impact gross margin next year. The first one is the MFO, that's our manufactured-for-outlet product.

It's been a huge success for us this past year, and it'll be a higher percentage of our sales in our outlet stores this year. That's the single largest impact from a positive perspective on our margin this year. The second thing is we'll get volume efficiencies. So we managed inventory down significantly last year. You won't see that this year.

In the back half of the year, you actually see inventory start to grow. We want to make sure we're well positioned for our factory stores as well as for the holiday.

And so you'll start to see inventory grow in the back half of the year, and we'll get efficiencies there because we'll be able to spread our distribution cost among higher units coming in, which is a good thing. The third thing would be ATR. Unfortunately, we're eliminating our manufacturing here domestically.

It was a high cost to us, and eliminating that helps us beginning in Q4, and because that's our largest quarter, you get a little more of an impact from a gross margin perspective. And then, lastly, it's due to promotions. So we've started to test that selectively here in the fourth quarter.

We do believe there'll be an impact to margin from a positive perspective. Obviously, it's reflected in our sales guidance that might take down our sales a little bit. But those four things are the reasons for the improvement in margin this year..

Got it. And I know you've said that at least we're seeing higher velocity in some of the new product.

But I was wondering if you could quantify, maybe, the performance of new product versus the old, I don't know if it's core versus fashion and kind of what percentage of the assortment is kind of the new product being touched (34:07) versus what is the legacy piece of the business? Thank you..

Yeah, Ed, this is Sue. Thank you for the question. We are seeing about 30% of our assortment that we exited the year with. We are seeing that the productivity on that assortment is up anywhere from 2 times to 3 times our core product in terms of SKU productivity..

Great. Thanks, guys..

Thanks, Ed..

Our next question comes from Ike Boruchow with Sterne, Agee..

Hi. Good morning, everyone. Thanks for taking my question. Two. I guess, first for Kevin. Maybe I missed this.

The comp guidance for Q1, can you breakdown what that implies for store comps and then e-com? And then, Rob, when we think about new customer, is there a way for us to think about maybe the penetration of new customers you saw this year and what you're trying to grow that penetration to for 2015? Is there any other numerical way we can kind of think about that?.

Yes. First, I'll start with comps, Ike. We expect Q1 to be down in the mid-teens and that's the consolidated comps so that includes the web. We do expect the web to perform better than the stores in Q1. We're not separating that guidance but we expect the web to perform better.

But as we reduce promotions, especially on the web, we expect that to be part of the impact on why the web is going to be down in Q1..

And then, regarding customers, few comments. First of all, one thing has been encouraging through last year is that a retained customer has been holding up both from a customer count standpoint as well as a sales standpoint. The issue that we've been facing is really attracting the new customer. And we believe there's been a couple of reasons for that.

One, we have underinvested for the last few years in marketing. And two, our Indirect channel used to be a primary marketing arm for us. And as we reduced the Indirect channel, the marketing that they were doing for us also obviously became less.

So, we needed to spend more money in marketing and really improve our reach, which that is really what Angel has been working since he joined the team. And as we spoke about, we're going to go ahead and invest close to $10 million more in advertising alone to attract the new customer in and improving our reach from 8 million to 85 million next year.

So, we do believe that that's really the critical nature. The next piece to getting the comps driven is just get the new customer back in our store.

And we also believe that the distribution growth with the department stores is also critical to get a new customer because they have a different customer that's going through their stores and we believe this relationship, for example, with Macy's expanding up to 250 stores really gives us an opportunity to bring a new customer into the brand..

Got it. Thank you..

Our next question comes from Randy Konik with Jefferies..

Hey. Great. Thanks a lot. Can we just, I guess, kind of elaborate on the distribution strategy, if you will? I think in previous calls we've had more of a discussion that we have committed to our openings for 2015.

And then on the call this morning, I believe we talked about more of a further commitment longer term to continue to open stores yet the comps are getting worse. And it sounds in contrast that the department store business actually – or Indirect business sounds better and you're getting traction on, I guess, some of these factory outlet stores.

So, kind of – I guess what I'm curious in how do – what's the kind of the pull point where you're like you're going to say to yourself, we're not going to open more stores because these stores are hurting us rather than helping us, and to think about potentially more wholesale or Indirect channel distribution? And how does the factory play into how you're thinking about taking the brand more, I guess, a little more up market versus down market? Thanks..

Thanks, Randy. A couple of things.

So, first of all, from a store standpoint, our Direct store standpoint, as we talked about that we did have the stores committed for this year, as we look into the next fiscal year, as we're beginning to look at the real estate, we definitely are taking a more conservative approach next year until we see a turnaround.

So we do expect a slowdown in new store growth next year. But in terms of long-term guidance, we still believe there is really an opportunity to grow our stores. If we look at our stores, the first thing we started to do from analysis end was were our new stores cannibalizing our existing stores, and we did not see that as a major impact.

We saw that the major impact was really that influx of new customers and getting new customers into our store was really the critical piece. So, we are slowing it down as we go into next year, but we still believe long-term there's an opportunity for the store count and that's what you heard in our forward-looking discussion.

And in terms of department stores, we do believe that department stores are still a key growth for us. We're looking at continuing to expand our relationship with Macy's. We have other department stores that have come forward and spoken with us about distribution.

We're just making sure that we're prudent in how we're doing that and we're really trying to work to maximize the business in both Dillard's and Macy's through in-store presentation, improving the visual presentation in-store and really maximizing the business there.

In terms of the Indirect channel, we continue to believe that that is a core foundation for us. But, again, we expect that we wanted to try to stabilize the store count there. We don't expect this dramatic change in store count this year as you've seen over the last couple of years.

And we are looking for unique opportunities to potentially open, but we will continue to prune stores that don't represent the brand as well as we would want. So that's really what we're looking at from a distribution standpoint..

Great. And then, just if I could follow up real quick.

Are you seeing different types of SKU velocity across the different channels, meaning are there certain products selling on the wholesale side of things versus – that aren't selling in the retail side of things or vice versa? I'm just trying to get curious – like just very curious about what is the difference in the patterns of these different channels of distribution and why there's – it seems like there's such a disconnect there?.

Yes. So, as you know, we really started our channel segmentation. It's still in the very preliminary stages. One of the consistent piece that we are seeing across the channels is that solids are starting to take off across all channels of distribution. There are nuances within the fabrications themselves.

A good example of that is we are seeing the velocity, for example, of leather in our Direct business, trending a bit faster than, for example, what we had put out in some of our very select specialty accounts.

But the good news is that a fabrication such as microfiber, which was a major investment, a major strategy for us this year, were actually seeing check in all channels.

And then in terms of faux-leather, the good news there is that we saw that actually check in our own stores, but also it really significantly, from a velocity perspective, we did see a pickup in our specialty businesses.

We also think that as we move forward this is why it's a major strategy for us to continue to really – seek to understand what those consumers are valuing in each channel of business and that's why we are moving forward with the product segmentation strategy really starting this year, in fiscal year 2016..

One more thing, Randy, I did not fully answer your question on factory. And I did want to address that as we talk about becoming more of a full-price business. The number one area that we're focused on is reducing what we call the hyper-promotional activity online.

That we do believe that running a off-price business online and marketing that aggressively can damage the full price validity of the brand. So, the number one area we look to take it down to off-price activity is going to be online as we go through this year and next year. We believe that that is a critical, critical step that we need to take..

That's helpful. Thank you..

We'll go next to Oliver Chen with Cowen & Company..

Hi. This is Courtney in for Oliver today. Thanks for taking our question. Could you just comment on your free cash flow profile and working capital profile and also maybe what types of leverage do you have that you can pull to kind of protect cash flows and margins going forward? Thanks very much..

Sure. If you look at operating cash flow, it's fairly high this year at over $100 million, and that was primarily – that's operating cash flow, so $102.8 million. That was primarily due to managing inventory as well as we did. If you look at the prior year, we're about $88 million.

There was a couple reasons for that, managing accounts payable and some other things impacted that. Historically, from an operating cash flow, they're around $50 million, so we trended up the last two years which has been nice to see.

If you look at cash flow over the last two years, this year was about $37 million, so that puts about $66 million of free cash flow this year. Last year, relatively consistent. We had about $23 million in CapEx, or $65 million from a free cash flow perspective.

If you look at fiscal 2016, we do plan on growing inventory some and you obviously saw our earnings guidance, so you would expect some of those numbers to start to come down.

However, we don't give guidance on our cash flow number for the current year, but you could probably do the math based on their earnings and based on the CapEx and based on where we think inventories are going to trend up. There's four things that we can manage.

We're definitely looking at a lot of things to be able to manage from a sourcing perspective in terms of working with suppliers on lowering cost. We're also negotiating with vendors, and we're looking at a whole host of cost containment measures that we can use.

That being said, a lot of what we'll find in terms of savings, we believe, we'll reinvest in marketing in the web to be able to attract new customers..

Okay. Thanks very much. Good luck..

Thanks, Courtney..

We'll go next to Eric Beder with Wunderlich..

Good morning..

Good morning..

Can you talk about – when you look at your department store channel, could you talk about where you want that to be in the longer term in terms of maybe the amount of different department stores and kind of the amount of doors you wanted to be in terms of importance? And how are you going to judge whether this new strategy in terms of marketing such as going to be a success in terms of driving traffic? Is it traffic? Is it conversion? How should we start to think about when the turn is going to start to come?.

So, from a department store channel, a couple of things I would talk about there is that, one, we have not put a specific store count on the department store channel. But what we have spoken about is that we do believe there's an opportunity to be in multiple department stores.

We are really focusing on kind of that near, that mid-tier to Macy's tier in terms of the primary targets and above. We're not looking at going into the Penney's, Kohl's level, but we're staying at the Macy's level on up. And we do believe there's opportunity to continue to expand and two ways to expand.

One is to expand within the doors we're currently in. So if you add the Dillard stores and the Macy's stores together, particularly when we target that250 doors we'll be in in Macy's, we'll be over 500 doors in the department store channel. We want to increase our volume within those doors.

And we believe by enhancing the digital presentation and the initiatives we have in place and building our marketing initiatives with those key partners, that we will expand our business inside those existing doors as well as continue to look for other opportunities.

In terms of the second question, in terms of marketing, the key for us in marketing, the key measurement that we're looking at is driving new customers through our doors. That's the number one thing that we're looking at. When you build an impression campaign and you have a marketing campaign, it definitely builds out over the quarters.

And it's important to keep those impressions building upon each other. But we expect to see traffic being driven into our stores, particularly as we get towards the middle to back half of this year..

Great. Thank you..

We'll go next to Dana Telsey with Telsey Advisory Group..

Good morning, everyone. As you think about distribution, the margin equation from the department stores, how do you see that developing and adding to the total? And lastly, with the domestic facility closing, how does that adjust your ability to chase trends, be flexible, how do you see the whole sourcing chain? Thank you..

Good question. From a margin perspective, we've been fortunate that our department store margin has been pretty close to the Indirect segment margin, so we haven't seen a degradation in margin from department stores.

And as we look at that segment and look out the years, we don't expect a ton of growth from that segment, so we don't expect the margin to erode due to department stores. We actually expect it to be relatively flat within that segment..

And then from – this is Sue – from the ability to chase trends, we had been proactively working on this over the last 12 months with our vendor community.

And we have set up chase lines in order to make sure that we are able to capitalize on those items that are working for Vera Bradley and to make sure that we have separate lines set up so that we can make sure that the items that are working are flowing through at a faster rate..

Thank you..

Yes..

Our next question comes from Janet Kloppenburg with JJK Research..

Good morning, everyone. Rob, it sounds like you're having some success in the department store channel. And I'm wondering if that is coming largely from the core more traditional product line or if it's coming from a combination of that and the new silhouettes.

And I'm wondering what learnings you can derive from that channel to perhaps expand into your own stores to drive higher productivity there. Thanks so much..

Thank you, Janet. A couple things from the department store. What we are seeing is that the newness, particularly like our solid microfiber business, in the department stores is performing very well.

If anything, some of the performance in our department store is, well, say, it's following ours – we're actually further ahead in penetrating our new categories into our assortment in our Direct stores. But the department stores are seeing the same type of performance. So we feel really good about how the department stores are growing.

We do believe that the opportunity for the department stores now is for us to even focus on the merchandise presentation, particularly in Macy's, and we're really making stronger branded presentations within the department store space..

So is it just the fact that the traffic there is so much more pronounced than in your own stores that's fueling better results there than in the directly operated stores?.

You're exactly right. So in the department store world, their traffic is holding up much better than what we're seeing in our own Direct stores.

And so that's part of what gives us the confidence too is we market and get customers into our store and get more feet going through our store that we believe we will get the business turned around sand back on track because we are seeing with the department store partners that since they have traffic that they're having a better overall performance..

Okay. And it sounds like the Indirect channel is stabilizing.

Is that how you're looking at it with the gift channel? How should I be thinking about that?.

I would say we're beginning to see encouraging signs based upon our early order period, so there is a lot of excitement from that channel in terms of the new product direction. What they're seeing in the product, what they're hearing from their consumer, they're excited about the future and we're seeing that in the early order period.

At the same time, what we've heard from that channel is that they've been telling us that it's taking them some time just to get the customer back in and excited. So we have not seen a stabilization yet in re-orders..

Okay..

So we still are seeing some challenges in that business, but the future in terms of the forward-looking is much stronger and, as Sue commented earlier, a lot of excitement from them. And they continue to tell us they're very excited about the newness.

We've asked them, do they want us to focus more on core and they've really said, no continue to focus on what's new. We're very excited about where you're going. And we believe that's going to be a much brighter future. It's just taken us a little bit of time to get customers used to new look..

Okay. Great. And lots of luck..

Thank you..

Our next question comes from Evren Kopelman with Wells Fargo..

Great. Good morning. My question is about....

Good morning..

...e-commerce, can you discuss the dynamics in that business a little bit more? It sounds like you're seeing maybe a little pressure from the lower promotions or moving the sale items off of the initial site people get to.

But what's the trend maybe excluding that, and when would you lap that? And also, are margins improving with the new strategy? Thanks..

So a couple of comments, Evren, regarding e-commerce. You're right that as we've been pulling down the promotional activities at the very end of last year. Really as we got into January, we have seen a negative impact to our e-commerce business. Part of what we've seen also, though, in e-commerce is less clearance inventory available for sale.

As we cleaned up our inventory levels and pulled our inventory levels down, we've had less liquidation and hyper-promotional inventory available to sell on our website, and that's what's really been hurting us.

Traffic overall on our website has been holding up much better, but because there's been less clearance inventory, it definitely impacted the sales on e-commerce.

So we're definitely having to rebalance our e-commerce platform to become much more focused on regular priced product as we go forward and really enhancing that customer experience, which is part of the reason that we also have this transformation underway on e-commerce in working through new search, site design, and platform over the next 18 months, because we have to really move that business from an off-price business, which it historically has been to a full-price business.

And that is definitely one of the major undertakings that is underway..

And then Evren, with regards to – you asked about gross margin, we do expect a pickup in gross margin due to that. So less promotions, better gross margin.

Also if you think about the mix on the web, just to remind you, typically we're about 65% to 70% of what we sell on the web is retired products – you can think about that as being a factory store – and then the remainder is full-price, so it's still a larger store from a factory perspective the full-price..

Would that percentage you just gave, I think you said 65% to 70%, where would you like to see that and kind of maybe the timing of that in terms of the mix of full-price versus, I guess, not?.

I think it's a good question. We do expect it to gain a little more. Our focus is to grow the full-price part of the business on the web faster over time anyway than the retired product, but we don't have any goal set out there to express to you externally anyway over the next couple of years.

But we do expect to grow the full-price business faster than the retired business..

Okay. Thank you..

It appears there are no further questions at this time. I'd like to turn the conference back to management for any additional or closing remarks..

Great. Thank you. I just want to thank everybody for your interest and time and patience. We are very excited about the future. We're excited about the progress we're making against the long-term plan. Thank you, again, for joining us..

This concludes today's conference. Thank you for your participation..