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Edited Transcript of VSI earnings conference call or presentation 1-Mar-17 1:30pm GMT

Thomson Reuters StreetEvents

Q4 2016 Vitamin Shoppe Inc Earnings Call

NORTH BERGEN Mar 1, 2017 (Thomson StreetEvents) -- Edited Transcript of Vitamin Shoppe Inc earnings conference call or presentation Wednesday, March 1, 2017 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Kathleen Heaney

Vitamin Shoppe, Inc. - IR

* Colin Watts

Vitamin Shoppe, Inc. - CEO

* Brenda Galgano

Vitamin Shoppe, Inc. - CFO

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Conference Call Participants

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* Shane Higgins

Deutsche Bank - Analyst

* Sean Kras

Barclays Capital - Analyst

* Joshua Siber

Morgan Stanley - Analyst

* Damian Witkowski

Gabelli & Company - Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the Vitamin Shoppe fourth-quarter 2016 earnings results call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Kathleen Heaney.

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Kathleen Heaney, Vitamin Shoppe, Inc. - IR [2]

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Thank you. Good morning, everyone. Earlier this morning, we released financial results for fourth quarter 2016. A copy of the earnings release, as well as the PowerPoint presentation, can be found on the website at VitaminShoppe.com in the Investor Relations section.

Making presentations today will be Colin Watts, Chief Executive Officer, and Brenda Galgano, Chief Financial Officer.

Before we begin, I need to remind listeners that remarks made by management during the course of this call may contain forward-looking statements within the meaning of the Private Litigation Reform Act of 1995 about the Company's future results or plans, guidance, strategy, and process. These are subject to risks and uncertainties that can cause the actual results and implementation of the Company's strategic plan to differ materially.

The words believe, expect, plan, intend, estimate, or anticipate and similar expressions, as well as future or conditional verbs as such as should, would, and could, identify forward-looking statements. You should not place undue reliance on these forward-looking statements. And we expressly do not take any duty to update forward-looking statements. Whether as a result of new information, future events, or otherwise unless required to do so by law.

During the call, we may refer to non-GAAP figures. We have provided a reconciliation for these numbers in table 4 in the earnings press release. We refer all of you to our filings with the Securities and Exchange Commission, including our annual report on Form 10-K, as well as quarterly reports on Form 10-Q, for a more detailed discussion of the risks and uncertainties that may have a direct bearing on our operating results, our performance, and our financial condition.

I will now turn the call over to Colin.

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Colin Watts, Vitamin Shoppe, Inc. - CEO [3]

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Thank you, Kathleen. Good morning, everyone, and thank you for joining us.

On today's call I will start by providing my perspective on our fourth-quarter 2016 performance. Then give a more in-depth update on the progress we have made on our Company reinvention strategy. Giving some early indications of what we expect to see on key initiatives for 2017. And then I'll turn the call over to Brenda to provide financial details about the fourth quarter and guidance for 2017.

Our financial performance in the fourth quarter continued to be mixed. Total comps were negative 2.2% in the quarter with our retail comp negative 1.8%. By contrast, we delivered a positive 7% comp from our VitaminShoppe.com website. Largely driven by the re-platforming and Company focus on the website. While our overall direct business was down 5% as we move away from selling on third-party marketplaces.

While we continue to be disappointed with negative comp trends, similar to past quarters, over 2.5 points of our overall comp decline came from just three categories: sports and nutrition, weight management, and on-the-go nutrition. With the majority coming from the protein powder business. The balance of our portfolio experienced positive comps in the quarter led by vitamins, probiotics, and specialty supplement.

As we've indicated on prior calls our sports on the go and weight business has seen increased levels of pricing and promotional pressure that have led to ongoing weakness. I will speak about some of the steps in category management, private brands, pricing and promotional strategy that we are putting in place in the first half of 2017. Which we believe will help address overall comp, including a greater focus on these key categories.

Our biggest disappointment in Q4 was Nutri-Force. While we were pleased with how the insourcing and servicing of Vitamin Shoppe private brand SKUs is progressing. We continue to struggle with uneven performance from the third-party contract manufacturing business at Nutri-Force.

As a result, we engaged external consultants to perform a turnaround analysis, and will be undertaking a substantial restructuring of the Nutri-Force business that we will commence later this year. Brenda will give more details on Nutri-Force later on in this call.

Moving onto private brands, where we are continuing to see growth and profit improvement. The investments we've been making behind innovation in marketing are driving continued strong volume and increased penetration for our private brands.

During the quarter, comps were up 5.4%, and for the year increased a healthy 6.5%. Penetration increased more than 100 basis points for both the quarter and the year. We believe there is substantial upside to our private brand penetration in the coming years, which is also key to driving further margin improvement for the Vitamin Shoppe.

We are pleased with the substantial progress we have made behind our reinvention strategy. Last year, we made approximately $9 million of investment behind new programs, pilots, and capabilities, which are now driving to scale in 2017. Our early results would suggest that these scaled up initiatives will provide more stable top- and bottom-line results later in 2017, and return the Vitamin Shoppe to sustainable profitable growth thereafter.

As you can see in the PowerPoint presentation on page 8, that is online, our Vitamin Shoppe reinvention strategy has three priority levels. It has the first priority win level, differentiate level, and compete level. Our highest priority is to win our customers' share of wallet, via a substantial upgrade in our customer experience. Both in stores and online, to become the omni-channel retailer of choice for the health and wellness sector in which we compete.

Our second priority focuses on differentiating the Vitamin Shoppe on the basis of the unique product assortment we offer. Both partnering with key national brand, and significant growth and innovation through our own private brand portfolio.

Our final strategy area is to compete more effectively on value by fundamentally restructuring our cost basis, both from a cost of goods sold and an SG&A perspective. By renegotiating our supply agreements and creating deeper partnerships with our vendor community over the past few months, we have been able to secure better cost of goods arrangements, and mutually beneficial agreements to grow our combined business with our best vendors.

In addition, we have taken substantial overhead costs out of our retail business in headquarters to lower our overall cost of doing business.

Finally we just finished work on our pricing and promotion strategy, which we are confident will unlock additional profitability. While also allowing us to redirect investment behind sharper prices and more impactful promotions on our most important brands and key value items.

Before I review some of the proof points for these reinvention initiatives, I would like to emphasize that one of the most important editions to our strategy, over the past six months, was the introduction of a much more significant level of data analytics to help us better unlock value and focus on share of wallet for our customers. Working with external consultants, our team has developed new data capabilities focused on the profit performance of our assortment, our vendor community, our stores, and most recently an in-depth price and promotion analysis.

The Vitamin Shoppe has the unique advantage as our healthy awards loyalty program captures almost 90% of our total revenue. As a result, we were able to analyze over 3 billion transactions from the past 3 years, including an in-depth view of the 7 million loyal customers from the past 12 months.

We've already leveraged this deep analytical insight to negotiate terms with our top vendors based on clear performance criteria, make changes at the retail store level to drive efficiencies, and significant savings in payroll utilization. As Brenda will share, we see the profit and performance impact of these savings as we progress through 2017.

Now let me share a few highlights about milestones achieved over the past year with our reinvention strategy. In 2016, we took several steps to upgrade our customer experience. Our digital experience saw a major improvement through the re-platforming of our VitaminShoppe.com website, now more mobile friendly with stronger promotions, content, and easier navigation.

We relaunched the site in early Q4, and in addition to comp growth of 7% for the quarter, our overall visits to the site increased by 9%. Conversion improved by 14%, driven by mobile conversion, which improved by 34%. We are very pleased by the early and positive results we have seen since the relaunch.

We saw further growth in our buy online, pick up in-store capabilities, which now represent almost 8% of our online transactions and is a clear winner with our best customers. Additionally, the new website launch included a major upgrade to our auto-delivery capabilities. Now available across all our private brands, and also available and supported with greater promotional value by many of our top national brand partners.

While we are still in the early stages new auto-delivery subscriptions are up strong double-digits since the site relaunch in November. And we have plans to continue to promote this new value offering in the coming months.

Finally on the digital technology front, we launched a beta test for a new Vitamin Shoppe mobile app, and an in-store tablet experience that we call our V book. Both designed to make healthy awards loyalty information, as well as product information and purchase history, much easier to access by both our health enthusiasts and our customers.

The other major innovation in our upgraded customer experience was the launch in the back half of 2016 of our new brand defining store transformation. Which are not just a store remodel, but a bold step forward for the Vitamin Shoppe in redefining specialty retail in the wellness sector. There are now four of these new store formats open, with six more coming in the next couple months. While still early, we're excited about the results.

For example, overall store traffic, new customer visits, and comps have been above our expectations, both compared to pre-transformation and against control store comparison. We're seeing strong growth in new and expanded category offerings. Such as natural and organic personal care and beauty, refrigerated, frozen and healthy foods, as well as health and wellness products and specific categories designated to driving shopping frequency.

We also added a rotating nutritionist in each of the stores. We sponsor both one-on-one consultations and in the evenings, we hold our signature Spark workshops with multiple customers in attendance. Reported customer satisfaction, net promoter scores, and increased basket size for attendees of these new services has also been very strong.

Importantly, we've also been able to cost engineer these stores as we progress. So that our latest stores now cost well below half of our first flagship store. Giving us confidence that we will be able to demonstrate a strong positive IRR, once we have piloted the first 10 or so of these stores by mid-year.

Our goal is to expand these transformations, beginning no later than early 2018, to have a meaningful impact on customer acquisition, retention, and overall business growth for years to come. In turn, we will reduce our new store openings, with plans for only 15 new store openings in 2017, and further reductions expected in 2018.

Finally, I let Brenda update you on the work that the team delivered in cost savings and improved margin opportunities over the past few months, which will begin to be reflected in our profit performance later in 2017. This work not only will improve the overall margin profile for the Vitamin Shoppe in the future, but it has allowed us to make important investments in improving our value proposition to our customers.

12 months into our reinvention strategy, we've made very good progress to date. We are confident that our Company is well-positioned to grow profitably and to increase shareholder value by the back half of 2017.

I will now turn the call over to Brenda to take you through the financial details.

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Brenda Galgano, Vitamin Shoppe, Inc. - CFO [4]

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Thank you, Colin, and good morning, everyone, and thank you for taking the time to join us. Let me start with a quick overview of earnings.

On a GAAP basis, operating income and earnings per share were impacted by an impairment charge of $39.2 million for the Nutri-Force business, based on continued challenges with our third-party contract manufacturing business. Partially offsetting that was a lower-than-expected tax rate related to the write-off of our Canadian business. Reported EPS loss in the quarter was $0.49. But on an adjusted basis, we reported positive EPS of $0.36 per share in the quarter. The 53rd week contributed an estimated $0.08 to EPS.

Now on to sales, total revenue in the quarter increased 4% to $305 million, including the 53rd week. Total comp, excluding the 53rd week, were a negative 2.2%. Comprised of a negative 1.8% retail comp and a negative 5% direct comp. Private brand growth is outpacing overall sales growth, representing 20.2% of our total sales, up 110 basis points from the same period last year.

Nutri-Force was a disappointment as total sales decreased 8% in the quarter, driven by a 29% decline in third-party sales. On the positive side, sales to Vitamin Shoppe increased 36% in the quarter. Nutri-Force incurred operating loss of $2.2 million in the fourth quarter of 2016, as compared to a loss of $0.5 million in the fourth quarter of 2015.

As a result of this declining performance, driven by volatility in sales, loss of third-party customers, and difficulty in optimizing production, we updated our long-range projections and valuation analysis for Nutri-Force. Resulting in interment charges totaling $39.2 million for goodwill, and customer relationship and tangible assets. In light of this continuing decline of the Nutri-Force business, we recently engaged manufacturing turnaround consultant to perform an assessment of the alternative to improve results of this business.

This assessment spanned a complete business from product portfolio, manufacturing operations, and sourcing capabilities. Coming out of this assessment, we expect to have a detailed plan to improve performance, which will likely result in one-time cash and non-cash charges associated with activity to simplify the business and reduce costs. We expect to be able to provide a more detailed update on our next earnings call in early May.

Moving down the P&L, on a reported basis, our gross profit margin rate for the quarter was 175 basis points higher than the fourth quarter 2015, and 88 basis points above the adjusted fourth-quarter 2015 rate. The factors driving gross margin performance are as follows.

Product margin improvement. We realized a year-over-year increase in product margins of approximately 15 basis points. The second consecutive quarter of improvement. Product margin improvement benefited from increased private brand penetration and favorable category ship, which is partially offset by a decline in the direct business where promotional activity continues to be stronger.

Supply chain and occupancy both leveraged by 36 and 55 basis points, respectively. This is mainly due to the 53rd week, which has no rent expense, as well as actions we took earlier in 2016 to streamline supply chain costs. Partially offsetting the increase in gross margin rate was the negative impact of Nutri-Force of approximately 18 basis points.

Reported SG&A expenses, including the Nutri-Force impairment charge of $39 million as already discussed, and excluding that charge increased 11% over adjusted third-quarter 2015 rates. Excluding certain costs for both years, SG&A as a percentage of sales delevered by 177 basis points. In line with the estimated 150 to 200 basis points of deleverage we had estimated on our last call. This deleverage is from a combination of store payroll, corporate, and Nutri-Force.

Included in corporate are investments associated with growth and profit-improving activities of approximately $2.5 million, including private brands, digital, merchandising, and advanced analytics. This deleverage was partially offset by benefits from cost-saving initiatives totaling approximately $1 million, mainly associated with store payroll. The reconciliation to GAAP for these items is presented in table 4 in our earnings press release, which can be found on our website.

We reported an operating loss in the quarter due to the Nutri-Force impairment. Adjusted operating income in the fourth quarter of 2016 was $16.5 million, compared to an adjusted $18.5 million in the same period of the prior year. With margins of 5.4% in the fourth quarter of 2016, compared to 6.3% in the fourth quarter of 2015. The estimated operating income benefit from the 53rd week is approximately $3 million.

The provision for income taxes continues to fluctuate as taxable events occur. In the fourth quarter, we reported a tax benefit of $3 million related to the write-down of the Canadian stores. The tax rate is expected to be closer to 40% for 2017.

I will now update you on the changes we are making to the business that are creating permanently lower cost structure. While we continue to invest in a number of important areas to drive top-line growth, given current market realities, we are continuing to sharpen our focus further on making the Vitamin Shoppe an even leaner company.

Before I get into the details, I want to refer you to the presentation on the homepage of the investor relations section of the website that will make it easier to follow the numbers I'm about to discuss. We understand all of these numbers can get a bit confusing to follow during a call, and the schedules we have provided should help.

On the last call, we had discussed that we had identified $22.5 million in total cumulative annualized savings from initiatives starting in the middle of 2015. Based on additional work that we have undertaken, including deep analytics around cost of goods sold, we have identified an additional $14 million of annualized savings, bringing the total savings to $36.5 million. These additional savings are mainly expected to be generated from the work we are doing around vendor partnership, and more efficient pricing and promotion.

As expected, the impact and benefits related to these efficiency initiatives was modest in 2016, as we invested approximately $9 million in the business tied to our reinvention plan. Of the total $36.5 million in total savings, more than $25 million relates to the cost of goods sold reduction. Most of which has not yet been realized in our P&L. These savings are expected to ramp up during 2017 as the inventory is sold through.

Overall we expect a year-over-year increase in cost reductions to be approximately $17 million. Which will help to bridge expected weaker top-line comps during the front half of 2017, and allow us to make investments to support longer-term growth. An additional approximate $10 million of savings is expected beyond 2017, as we realize a full annualized benefit from these initiatives. And we will continue to work to identify further opportunities.

This is a key focus for the company. We're pleased with the significant progress made, and you can expect to see these benefits in our results as the year progresses.

We are focused on a permanent (indiscernible) building a cost structure that improves our point of leverage, which has historically been at the 3.5% or more comp range. With actions we have taken, including all of our cost-efficiency initiatives and reduction in new store growth, we believe we can begin to leverage costs with a sales comp closer to 2.5%.

Turning to our balance sheet, cash and cash equivalents at December 31, 2016, were $2.8 million. At the end of the year, the Company had $11 million drawn on the revolving line of credit and a convertible note liability of $121 million. While we continue to review and prioritize our capital needs, we remain committed to making the required investments in our Company to help position us for long-term success. Our cash flow generation should allow us to continue to invest in our business and maintain our financial flexibility.

Now, I will cover some changes we plan to make for segment reporting in 2017. Beginning with the first quarter of 2017, we plan to change our segment reporting to better reflect the changes we are making in managing and evaluating the business. And we'll combine retail and direct segments to one retail channel in both our internal and public reporting.

We continue to move to a more customer-centric, omni-channel focused business, and have reorganized internally to support this important change. As part of this change, we will no longer evaluate our operating performance by purely retail and direct channels.

In addition, after benchmarking our classification of costs within segments with other retailers, we will reclassify some costs previously classified as corporate into the retail channel. Examples of these costs include store-level depreciation, and field-level personnel. We plan to reflect these changes in the 10-Q for the first quarter of 2017, and we'll restate prior year for comparative purposes.

As you think about what we've been able to accomplish over the past 18 months, it's important to focus on how we have restructured the business for both top- and bottom-line growth. We have permanently removed costs from the business. We have lowered the point of leverage, and we are continuing to invest for top-line growth.

For the current year, these actions will translate into the following. Comparable sales growth of flat to low single-digit negative. Full-year growth is expected to be impacted by a slower first quarter, mainly driven by changes in the loyalty program, then improve as the year progresses.

EPS of $1.95 to $2.20. This excludes any potential charges associated with the implementation of strategic initiatives to improve performance at Nutri-Force as previously discussed. Capital expenditures of $45 million, including build out of the distribution center in Arizona, IT investment, approximately 15 new stores, and 10 to 15 brand-defining store transformations in the first half of the year.

This guidance assumes the operating income margin is flat to slightly positive year over year, as the deleverage associated with lower sales growth is offset with cost reductions in cost of goods sold and SG&A, as previously discussed. The guidance also assumes that Nutri-Force remains generally consistent with 2016 performance for the full year, with a continuing decline in the first half, and improvement later in 2017.

It is also important to note that quarterly performance in 2017 will be impacted by a number of items as follows. The first quarter will be negatively impacted by the change in our loyalty program. Specifically, certificates issued to customers in the first quarter of 2016 were value based a year of sales as compared to one quarter sales in the first quarter of 2017, resulting in less certificates issued, and at a average lower value.

We estimate the impact of this to be approximately 3% to comp in the first quarter. Resulting in comps being down in the mid-single digits for the quarter. We expect this to be the low point for the year. In addition, the timing of the cost and benefits associated with the cost reduction work will impact the quarters. As we discussed, we continue to work with outside consultants to build a transaction and customer database, and are building more in-house analytical capabilities to power a much deeper look at our business.

First quarter is expected to include approximately $1.5 million of professional fees for this project, while the benefits are expected to ramp a little later during the year through inventory turn. Specifically, we expect improvements from cost of goods sold reductions and margin efficiencies to improve gross margins by over 100 basis points for the year. With the first quarter generating up to 50 basis points of improvement, and a build to close to 150 basis points by the fourth quarter.

All of these initiatives are expected to drive an additional 100 basis points improvement to operating margins in 2018 as we realize the full annualized benefit in the P&L.

This end our prepared remarks. We'd be happy to take your questions now. Operator, please open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Shane Higgins, Deutsche Bank.

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Shane Higgins, Deutsche Bank - Analyst [2]

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Good morning, thanks for taking the questions. Just wanted to get your thoughts on just the overall competitive environment during the quarter. And did you guys really see any significant difference in competitive intensity between the online channel versus brick-and-mortar?

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Colin Watts, Vitamin Shoppe, Inc. - CEO [3]

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Great. Thanks, Shane. Thanks for the question. Thanks for joining us.

So I'd say that the competitive intensity that we see in the first quarter is roughly in line with what we saw last fourth quarter as well. There is, in this category, as you well know, a sharp increase in promotions that happens against broadly health and wellness for the month of January, tying into a lot of the seasonality that happens for things like weight, et cetera. We are aware of other players in the specialty channels that have increased a level of pricing and promotion approach. But substantially against our Business we haven't seen a significant change.

I will say that online intensity continues to be significant. We saw that in the fourth quarter. We continue to see that in first quarter, and certainly what we're trying to do is make sure we get the right balance of promotional intensity from our side, while also protecting margins to make sure that we deliver a reasonable return for the Business as we move forward.

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Shane Higgins, Deutsche Bank - Analyst [4]

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Okay. Thanks for that color, Colin.

Just as a follow-up, I wanted to get your thoughts on your decision to allocate CapEx to opening 15 stores this year, maybe versus spending a little bit more on the new -- I know you guys are still testing the new remodels, but just in general in terms of your thought process there between opening new stores versus spending capital on remodeling stores, especially your older stores.

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Colin Watts, Vitamin Shoppe, Inc. - CEO [5]

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Shane, as we mentioned on the call, we're definitely taking steps to tap the brake on new store openings. You saw us do it last year. You're seeing us increase it down this year. And you heard from my comments that we expect to go even further with that in 2018.

The reality is, we do have a pipeline against our real estate business. Some of the stores that we are opening in 2018 were ones that we contracted over 18 months ago, and in many cases, we'd have penalty if we pulled out of them.

We've done actually quite well. We're pleased with how our newer stores have been performing. But we do see a very, very significant opportunity, as you mentioned, with some of the new store transformations or remodels that we've done behind what we are calling our brand-defining store. And you're going to continue to see us shift CapEx towards those types of investments as we move forward, as we want to create better leverage against the current assets that we have, and get a better overall return on capital for the Company.

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Operator [6]

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Sean Kras, Barclays.

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Sean Kras, Barclays Capital - Analyst [7]

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Good morning, and thank you for taking my questions.

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Colin Watts, Vitamin Shoppe, Inc. - CEO [8]

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Sure, Sean.

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Sean Kras, Barclays Capital - Analyst [9]

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Colin, can you talk a little bit more about what you learned with your new data capabilities? You mentioned some interesting things on the assortment, pricing, and promotion.

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Colin Watts, Vitamin Shoppe, Inc. - CEO [10]

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Sean, what was really interesting about this analytics approach -- when I joined the Company a couple of years ago, I was kind of blown away by the penetration we have for our loyalty program, 90% of our transactions being captured against our loyalty program. But honestly, when I looked at the way we mined that information, one of the issues that we've had historically is, we've primarily used that information to go to market from an email marketing standpoint, sort of I'll call it a light CRM, customer relationship management, approach. What we've done over the last six months is we've built a fairly substantial data warehouse, which then allows us to take a look at baskets, price elasticity and inelasticity, and a better understanding also about what I'll call the customers' increasing loyalty and share of wallet to the Vitamin Shoppe, or in some cases decreasing loyalty.

So we've said this in earlier calls, Sean, but despite I think having a very strong history, and a very strong loyalty following, our average customer still only sees about 14% of their share of wallet with the Vitamin Shoppe. Some of our best customers see a much more significant share of wallet with the Vitamin Shoppe. One of the things that this analytics approach has helped us to unlock is the types of campaigns that we can use both in-store and online with our customers to get those customers to step up their share of wallet with us. We've shared some of that data with our vendors, and we've made some changes to our promotional cadence, and our approach to open up new capabilities that the vendors can also take advantage in those approach.

So I'll give you a really simple version just to bring it home, Sean. There is a clear interaction with most customers between their sports protein purchases and their sports supplement purchases, pre-workout/post-workout. As we looked into our database, and we did this work, we could see that there was a substantial number of our customers who are only purchasing sports supplements with us, but not buying sports protein or vice versa.

We've never before really cross-campaigned to those types of customers as they come into our store or as we reach out to them online. And now with that understanding, and an understanding of which specific healthy rewards users have that propensity, we're in a much better shape to campaign them and increase their overall basket and their overall spend with us over the year. Does that make sense?

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Sean Kras, Barclays Capital - Analyst [11]

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Totally. That's actually very good color, appreciate that.

For my follow-up, Brenda, I guess this is probably more for you. Can you maybe talk a little bit about the additional cost-savings opportunities that you outlined, perhaps what's going on to get to the $36.5 million? And maybe also related to that, how much of that is going to be reinvested back into the Business?

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Brenda Galgano, Vitamin Shoppe, Inc. - CFO [12]

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Sure. I'll start with the second part of your question, first. In terms of reinvesting back to the Business, we view this as a net number. Colin did mention that we would be making some price investments as we evaluate the overall opportunity, and look at the benefit we see in cost of goods sold. The numbers that we are talking about would be the net number.

In terms of what are the incremental areas where we see the opportunity? Again, it's within cost of goods sold and it ties right back to the data analytics that Colin referenced. As we get much smarter about our customers and the transactions, we are able to share that information with our vendors, and partner with our vendors to, one, reduce our costs, but also help the vendors grow, and be much smarter about the types of investments that we make to grow the sales. So it's really around vendor partnership, and more efficient pricing and promotional activity.

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Colin Watts, Vitamin Shoppe, Inc. - CEO [13]

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This is where, Sean, we're seeing some real synergistic benefit between the reinvention, particularly what we're doing in stores and online, the analytics, and then working with vendor partners. Because basically we are demonstrating to them that we are making investments behind innovation of how we are setting up the Vitamin Shoppe to go to market. We are able to show the winners and losers, and which of our vendors really are best partners or have the opportunity to step up to be best partners. And then as we move forward we're in a much better position to start to build their business while building our Business at the same time.

And because the Vitamin Shoppe -- it's the benefit and the curse of only having 20% of our sales in private brands, it means 80% of our sales are our third-party business brands. That vendor community is very important to us, and we are very important to them, as we are now a clear number two or in some cases a number one vendor for them. We're taking advantage of using that a bit for leverage, and frankly, a lot of it is for partnering, to be able to set this Company up for growth and for profitable business for years to come.

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Sean Kras, Barclays Capital - Analyst [14]

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Okay. That's very helpful and great color. Thanks, guys.

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Operator [15]

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Simeon Gutman, Morgan Stanley.

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Joshua Siber, Morgan Stanley - Analyst [16]

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This is Joshua Siber on for Simeon. Just two questions, one clarifying. Did you say even margin would be flat to slightly up for the entire year? And then what was the gross margin outlook? Was it up 100 basis points?

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Brenda Galgano, Vitamin Shoppe, Inc. - CFO [17]

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Yes. So operating income, yes, we said we expect the guidance we provided, that operating income margin rate will be flat to slightly positive, and we do expect that will ramp up during the year. We expect deleverage in the Business. But as we start to really realize the benefits from the cost savings that will start to be realized in the P&L as we sell through inventory, we expect the margins to expand.

I didn't get into the details of the breakdown between cost of goods sold and SG&A margin. But the way to think about it is, given that the majority of the incremental savings is within cost of goods sold, what you should expect to see is quite significant expansion in the gross margin rate as we ramp during the year, offset by deleverage in SG&A from the comp.

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Joshua Siber, Morgan Stanley - Analyst [18]

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Okay.

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Brenda Galgano, Vitamin Shoppe, Inc. - CFO [19]

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I did also mention the 100 basis points of additional improvement would be in 2018, as we then realize the full annualized benefit of the $36.5 million.

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Joshua Siber, Morgan Stanley - Analyst [20]

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Okay. That's it for me. Thank you.

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Operator [21]

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(Operator Instructions)

We will take our next question from Stephen Tanal with Goldman Sachs. Stephen, please check your mute function; we are unable to hear you if you are on the line. Stephen with Goldman Sachs, please check your mute function.

Since we are getting no response, we will take our next question from Damian Witkowski with Gabelli & Company.

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Damian Witkowski, Gabelli & Company - Analyst [22]

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Good morning. The pricing pressure that you mentioned in certain categories, and sports nutrition in particular, where is that coming from? Is it from a specific competitor or is it just in general?

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Colin Watts, Vitamin Shoppe, Inc. - CEO [23]

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Damian, it's coming pretty much significantly from online, as well as from I'd say mass, as opposed to in specialty channel itself. It's not something that's been brand new, frankly. But I think in the past year, particular to the sports business, which, as you know, is a relatively small percentage of our Business -- it's roughly 25% to 30% of our Business -- it's where we've seen a bit more competition, both in terms of some online retailers, but also what's happened across some of the mass retailers have started to increase their shelf space in this particular area.

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Damian Witkowski, Gabelli & Company - Analyst [24]

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For a long time, we talked about lack of innovation in various categories. Are we seeing any signs of improvement that give you hope going into the second half of 2017 that's going to change as far as third-party innovation?

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Colin Watts, Vitamin Shoppe, Inc. - CEO [25]

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Damian, it's funny; I get this question a lot. And I'm always a little careful, because the definition of innovation that I think is commonly used on these calls is a little different than the way I think about innovation within our Business. Do I see any new fish oil ingredients or some blockbuster ingredient showing up on the calendar over the next 12 months? I would say no.

On the other hand, what we are seeing is, we're seeing actually some very, very strong new ingredient -- or I'd call it, not new ingredient but new news against some of the products that are in the market, and some form innovation and packaging innovation that, through a lot of work that we've been doing in the last six months around category management, we're doing a much better job of starting to highlight, and really move into the front-and-center point of our promotions, both in-store and online.

One of the things that we are building the Vitamin Shoppe to be able to do is to be a better platform for any new news that's out in the marketplace. And what we're seeing, in particular with some of our vendor negotiation discussion, as well as what we're doing with our own private brands, is there is an understanding from the vendor community that Vitamin Shoppe happens to be a great place to launch and incubate new brands as you move forward.

I think you're going to continue to see us put those new brands, new incubated opportunities front and center as we move forward. And we know when we do, our customers tend to reward us.

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Damian Witkowski, Gabelli & Company - Analyst [26]

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Sorry, just maybe one more. The new stores, I know you're scaling back on how many you open. I think that makes a lot of sense. But if you look at the new store that you've opened up in the last couple of years, are they still ramping up the way you hoped they would, the way they have historically?

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Colin Watts, Vitamin Shoppe, Inc. - CEO [27]

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Yes, I think they definitely are performing the way they have been historically. We continue to find that we're picking some very good positions in the market. We have variability in each of our store classes as we launch them.

We have some that are like phenomenally successful versus our expectations. We have others that fall a little short. Often when they fall short, they fall short because we haven't hit our marketing right when we launched them, or sometimes it's because co-tenancies or other changes in some of the places where we have locations are doing well.

Damian, one of our biggest benefits for the Vitamin Shoppe overall in our close to 800 stores in our fleet at this point is we have very little mall exposure. And so that really helps us out a lot because we tend to pick pads for strip mall positions that are really Main on Main. And that helps us a ton from a traffic standpoint. It also has insulated us a lot from issues in terms of mall settings where we know other retailers have hit a little bit harder times in those areas.

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Damian Witkowski, Gabelli & Company - Analyst [28]

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Thanks.

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Operator [29]

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(Operator Instructions)

It appears we have no further questions in queue at this time. I would now like to turn the call back over to CEO Mr. Colin Watts for any additional or closing remarks.

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Colin Watts, Vitamin Shoppe, Inc. - CEO [30]

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Thank you. I really want to end today's call first with a huge thank you to our Vitamin Shoppe health enthusiasts, many of whom I know tend to listen in to this call. This is a very passion-driven and purpose-driven Organization, as well as a performance-driven Organization. And the dedication that we see from our health enthusiasts every single day will continue to contribute to our further success as we move forward. Thanks to everyone for joining us this morning on the call, and we look forward to continue to speak with you in the next quarter.

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Operator [31]

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This does conclude today's conference call. Thank you all for your participation, and you may now disconnect.