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Executives

Dan Lamadrid - CAO, VP & Controller

Tony Truesdale - CEO

Brenda Galgano - CFO

Analysts

Sean Naughton - Piper Jaffray

Stephen Tanal - Goldman Sachs

Charles Grom - Sterne Agee

Karen Short - Deutsche Bank

Kate Wendt - Wells Fargo Securities

Justin Klaver - Baird

Damian Witkowski - Gabelli & Company

The Vitamin Shoppe, Inc. (VSI) Q4 2013 Earnings Conference Call February 25, 2014 8:30 AM ET

Operator

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to The Vitamin Shoppe Fourth Quarter 2013 Earnings Results Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session and instructions will be provided at that time for you to queue up for questions.

I would now like to remind everyone that this conference is being recorded. I would now like to turn the call over to Dan Lamadrid. Please go ahead, sir.

Dan Lamadrid

Thank you, and good morning, everyone. Earlier this morning, we released our financial results for fourth quarter 2013. A copy of our earnings release and a recording of this call will be available on our website at vitaminshoppe.com in the Investor Relations section. Making presentations today will be Tony Truesdale, 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 about the company's results and plans. These are subject to risks and uncertainties that could cause the actual results and implementation of the company's plan to vary materially.

The words believe, expect, plan, intend, estimate or anticipate and similar expressions, as well as future or conditional verbs, 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 undertake 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.

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 our 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 over the call to Tony.

Tony Truesdale

Thank you, Dan, and good morning, everyone. Thank you for joining us. Before getting into the details for the quarter, I want to spend a minute discussing the past year. In fiscal 2013, we had several key accomplishments which I am quite proud of. We exceed the billion milestone in total net sales and our comparable store sales increased for the 20th consecutive year.

On the product development front, we introduced several sub-brands. We successfully integrated Super Supplements, the largest acquisition in the company's history and we opened a new distribution center to support long-term growth. All of these accomplishments would not have been possible without the dedication and superior execution of our team of health enthusiasts. I'd like to thank all of our health enthusiasts for another solid year.

To recap the fourth quarter headline, we increased total sales by 17% and delivered 4.6 retail store comp and 6.2% total comp. The momentum in our e-commerce business continued with 25% growth. The gross margin delevered primarily due to the distribution center product mix and channel mix shifts within the business, which Brenda will discuss in more detail during her presentation.

EPS was $0.38 in the quarter excluding $0.01 of integration cost. Retail cost of 4.6% represented the 33rd consecutive quarter of positive comp sales growth. This comp was driven by traffic. Sports Nutrition remained one of fastest growing categories. We saw solid comp levels in October, November, and early December. From mid-December onward our sales have been impacted by severe weather. Brenda will discuss our Q1 comp expectation when she discusses our outlook for the current quarter and full year.

Now on to the stores. We opened 19 stores during the quarter and 52 for the full year, slightly ahead of our guidance for 60 new stores. Total store count at the end of the quarter was 659, which includes 31 Super Supplements stores and our two Canadian stores. With strong returns on investment and a ample market opportunity, opening new stores continues to be an investment priority. We plan to open approximately 60 new stores this year. As of today, we have more than 90% of the site completed for the coming year. The majority of the new store openings are expected to be weighted towards the second half of the year.

Product development is the key initiative for us and I'm very pleased with the progress we have made. We have invested in label redesign, sub-brands, and increased formulation. In 2013 we launched more than 60 private label products more than any other year since I've been at The Vitamin Shoppe. These sub-brands include True Athlete, MyTrition, plnt, ProBioCare and the latest Next Step. Next Step is our most ambitious launch to-date. Next Step offers our customers a customizable weight management solution for wherever they are on their wellness journey. We have developed delicious meal replacement shakes and high quality supplements that help boost metabolizers the main control appetite. Next Step is about finding the right combination of healthy diet and exercise that works best free to our customers. Next Step is starting to arrive in the stores now and we're planning a marketing launch in the spring.

Moving on to our e-commerce business. Our customers responded positively to our marketing activity this quarter as evidenced by the 25.5% increase in e-commerce sales over the prior year. Excluding Super Supplements the increase was 20%. More specifically we adjusted our promotional cadence in the quarter, this coupled with the acceptance PayPal, easier checkout and improvements in our customer contact strategies are supporting continued double-digit e-commerce sales growth.

On the last call I discussed our omni-channel initiatives, as customers now have the ability to purchase the complete online assortment from their local Vitamin Shoppe stores. And the evolution continues as we've recently introduced a feature on our website where customers can check product availability at their nearest store.

Now a brief comment on the new DC. As you know, in September, we commenced shipping of product to the store from our new distribution facility in Ashland, Virginia. By year-end we were servicing 120 of our stores, and will continue to add more stores throughout the year. As a reminder, it is expected to take approximately 18 months for this facility to achieve its targeted productivity level.

So in conclusion we have an attractive business model with many growth opportunities ahead of us, including omni-channel, product development, e-commerce, and new store development. We will continue to make the investments that will enhance our customers overall experience in stores, online, and through mobile devices. We remain committed to being our customer's first choice for all their health and wellness needs.

I will now turn the call over to Brenda to discuss the financial results and the outlook. Brenda?

Brenda Galgano

Thank you, Tony, and good morning everyone. Thanks for joining us. You would likely have the opportunity to read the press release that lays out our financial results for the quarter. I would like to provide some additional color on the result. And then I will walk you through our current outlook for 2014.

During the quarter, we reported total sales growth of 17.2% with comparable retail sales growth of 4.6%. Retail revenue increased 16.4% to $226.4 million with the 31 Super Supplements stores contributing about $16.8 million.

As Tony mentioned, the complex driven by traffic in the fourth quarter we experienced slight retail deflation, which we expect will ease in the second half of the year.

Our newer stores in the comp phase continued to perform well and our mature stores continued to comp positively in the low-single-digit. E-commerce continues to drive significant growth for us increasing 25.5% in the quarter with Super Supplements contributing 5.5 percentage points to this growth. Going forward and beginning with the first quarter of 2014 we will be including our e-commerce sales with the comp figure as we migrate more to an omni-channel business as you heard Tony discuss. To give you an idea of what our pro forma fourth quarter comp would have looked like, on an organic basis, excluding Super Supplements, the contributions to comp from our e-commerce sales would have been approximately 160 basis points for total comp of 6.2%.

Moving down to P&L, reported fourth quarter gross profit as a percentage of sales was 33.4% compared to 34.9% in the same quarter of the prior year. This decrease reflects cost associated with the Ashland DC of approximately 70 basis points. Additionally overall product margins were down approximately 100 basis points due to faster growth in lower margin product category, higher growth in e-commerce sales, and the addition of the Super Supplements business. These impacts were partially offset by leverage on occupancy.

SG&A for the quarter was $67 million compared to $60 million in the prior year. The fourth quarter of 2013 SG&A cost include integration expenses of approximately $500,000 related to the Super Supplements acquisition.

Adjusted SG&A as a percentage of sales was 25.9%, compared to an adjusted 26.1% in the fourth quarter of 2012. The reduction was mainly due to lower incentive compensation expense. As a reminder, fourth quarter 2012 results were negatively impacted from Superstorm Sandy, the Super Supplements acquisition, and Canadian start-up costs.

Moving on to cash flow, we generated $28 million of operating cash flow in the quarter and $81 million for the year. CapEx totaled $10.4 million in the quarter and $42.8 million for the year and primarily represent investments for the new DC, build-out of new stores, improvement to existing stores, and the website.

At quarter end, we have $74 million in cash and cash equivalents, had no long-term debt and nothing drawn on our revolver. Inventory in the DC was down about $10 million in the fourth quarter, which was partially offset by store inventory.

Our business continues to generate strong cash flow and our balance sheet is solid, providing significant financial resources to fund our growth initiatives.

Now, I will address our expectations for the first quarter and full year of 2014. Starting with comp. Weather is negatively impacting customer traffic so far this year. More than three quarters of the store base has been impacted to varying degrees by severe weather. As a result, our expectation is that the total comp for the first quarter will be in the low-single-digit.

Sales in stores not impacted by weather combined with our current e-commerce growth supports our outlook for a mid-single-digit total comp for the full year.

Looking at gross margin, we expect that the first quarter gross margin rate could be approximately 100 basis points lower than last year. As previously disclosed, the combination of costs associated with the new DC and category and channel mix shifts will have a delivering impact on gross margin. In addition, gross margin will be further impacted by lower first quarter sales. When taking into account the lower first quarter estimate, we now expect the gross margin for the full year to be down slightly year-over-year.

For SG&A, with a lower projected total comp in the first quarter, we expect the SG&A rate as a percentage of sales to be approximately 50 basis points higher than the prior year.

Looking at the full year, as I mentioned on the last call we are planning for approximately $2 million in expenses relating to our international growth initiatives including Canada. We are also investing in CRM and in an order management system. These expenses are expected to be offset by leverage from an estimated mid-single-digit total comp and synergies from Super Supplements. So when taking into account the lower performance in the first quarter, we are now expecting slight EBIT margin decline for the full year.

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

Question-and-Answer Session

Operator

(Operator Instructions) We'll go first to Sean Naughton, of Piper Jaffray.

Sean Naughton - Piper Jaffray

Yes, just a clarifying question may be on the operating margin. You talked about it's a slight EBIT margin decline now in 2014 versus 2013. Can you tell us what EBIT margin percentage your baseline is for 2013, given the fact that you've had some numbers that have been excluded or included given the acquisition series what the baseline is there? And then also does that include or exclude any integration costs associated with Super Supplements?

Brenda Galgano

Yes, I'll address that one. So that would be on an adjusted basis. So it would exclude integration cost and other costs that we have culled out. So when I look at that I am looking at the -- I am comparing a total EBIT margin rate for 2013 of 10.4% on an adjusted basis.

Sean Naughton - Piper Jaffray

Okay, that's very helpful. Thank you. And then secondly, may be just a question on the e-commerce. Obviously, you guys seem to be having very nice set there transitioning towards this omni-channel platform. Can you talk about some of the drivers that drove that uptick? Could you also may be just address a little bit about what you guys are doing with mobile and how you guys see that strategy evolving here in 2014? Thank you.

Tony Truesdale

Yes, Sean, this is Tony. On the mobile side, we've been very thoughtful about that last year. We brought the mobile site in-house and we're managing that in-house. We have a separate team that manages now the mobile and tablet part of our business and have their own metrics that they're measured against versus the base internet business.

So I think it's the combination of improvements that we've made there, improvements that we've made to the website. As you know we've been spending quite a bit of capital against the web business over the last couple of years and I think that's starting to pay dividend.

Operator

We'll go next to Stephen Tanal, Goldman Sachs.

Stephen Tanal - Goldman Sachs

Just in terms of margin expansion or lack thereof, I guess in the back half of the year in 4Q should we be expecting any sort of benefit from cycling the DC rollout here. And you guys talked about 18 months of full productivity, but when do you start to see some sort of year-on-year benefit from that?

Brenda Galgano

Yes. We expect to see year-on-year in the back half of the year so. In the first half of the year we expect to see year-over-year increase as a rate to sell but then as we cycle through the year we do expect to see improvement.

Tony Truesdale

Stephen, this is Tony. Probably just one clarifying point, so you have your fixed cost piece that you'll cycle through June of this year. So June of '14 you'll cycle through your fixed cost, and then the reason we say that it goes beyond that is the 18 month is really about the variable productivity piece of that. So you should bring the new DC up, your units per hour, your productivity within the building takes the period of time to ramp as well.

Stephen Tanal - Goldman Sachs

Sure. That makes sense. It sounds just like the -- obviously the big impact here is 70 basis points in 4Q. I mean should we be thinking about that as sort of one for one get back by 4Q '14 or is that too much to sort of assume that?

Brenda Galgano

No. You should expect a -- probably not quite the 70 but approaching that.

Stephen Tanal - Goldman Sachs

That makes a lot of sense. Just on the launch of plan, I mean, how has that been going obviously you guys have been stepping up sort of private label penetration and what is the number look like now and once you start an early rate on the plant launch?

Tony Truesdale

The launches that we've had have been met our expectations, the ones that we did last year. The Next Step is just rolling out now, so it's too early to talk about that. We continue to say that our private label penetration is kind of in the mid-20s. We've done some things in some other categories to expand those categories, so we're kind of in that 20 to 22 range per penetration.

Operator

We'll take our next question from Charles Grom at Sterne Agee.

Charles Grom - Sterne Agee

Can we talk a little bit about the margins not necessarily for 2014 but beyond it seems like there is obviously there's going to be some benefits coming from the DC as you cycled out. But at the same time you've got some mix shift issues going on and the higher penetration of e-commerce probably is only going to continue. So can we just talk about the puts and takes on margins in the next couple of years?

Brenda Galgano

Sure, I'll take that one. Long-term the way we think about margins is really there is three pieces of the product margin component, which we believe will continue to be pressured with the mix shift you described. And then we believe offsetting that is the occupancy leverage that we would expect to realize with the long-term expectation of mid-single-digit comp. So those two pretty much offset each other.

And then where we expect we would get some leverage over time is with the new DC, which is going to take us about 18 months, but after about 18 months we do expect that we would start to see some improvement, so that would be really where there is the opportunity to get some gross margin improvement.

Charles Grom - Sterne Agee

So essentially you think you can offset the leverage -- offset the margin pressures with leverage over time?

Brenda Galgano

That's correct.

Charles Grom - Sterne Agee

And then just year-to-date here I was wondering if you have done the work in terms of comparing your good markets weather-wise versus your bad markets weather-wise. I'm just curious if you looked at what the spread is between the two?

Brenda Galgano

Oh, yes, we have spent a lot of time analyzing that. And as we look as I mentioned over 75% of our stores have been impacted by weather too in varying degrees. Overall when we look at the difference in comps between stores that have been impacted and stores that have not been impacted the -- this difference is close to 7% in comp.

Operator

We'll move next to Mark Wiltamuth at Jefferies.

Unidentified Analyst

Okay. Good morning. This is actually Chris (inaudible) for Mark. So actually just a quick question as it relate to kind of the Q1 guide, I know obviously weather was a meaningful impact. But looking at the latest Nielsen data and this is so indicative of kind of your account and in particular but I know clients do look at it units are down another 3% year-to-date. I was curious to know if you guys had seen anything in terms of a secular trend at all as it is relates to your business.

Tony Truesdale

Yes, this is Tony. We look at the Nielsen data on a regular basis and we kind of track our categories against their categories. We've got categories that are outperforming the Nielsen data and then we've got some that track with the Nielsen data. I would say that it is not always a great proxy for specialty retail. If you recall about 37%, 38% of the business is done in specialty. So it's a good proxy but I wouldn't take it one for one with what's going in specialty retail in Supplements.

Unidentified Analyst

And then, in terms of the e-commerce contribution to your comp was like the full year or even rather on kind of a quarterly basis, would a good rate be somewhat along the lines of a 1% to 1.50% contribution on a quarterly basis?

Brenda Galgano

Well, if you think about the fourth quarter, we have total growth of 20%, which contributed 160 basis points that's excluding the Supplements. And what we generally guided to on e-commerce growth is somewhere in the mid-teens, consistent with the projected industry growth. So if you do math on that you're probably looking at something a little over 100 basis points contribution going forward.

Operator

We'll go next to Karen Short at Deutsche Bank.

Karen Short - Deutsche Bank

Just a couple questions. Hey. Just a couple of questions on your new product introductions. I mean, as you point out, it does seem that you accelerated your new product introduction so far into this year. I guess I'm just wondering how do you think about the timing -- of the timing of the new product introductions that you've rolled out so far given kind of the dampening effect that the weather has had. I guess I'm wondering if the timing was right or if you may be lost some sales and it would have been -- would have a greater impact if the weather has been better?

Tony Truesdale

Yes, I mean -- Karen I remember I mean we spent an awful lot of efforts developing these brands and so we do it for the long-term not for the short-term impacted to the business. I think that if you look at Next Step, I mean that's a weight management kind of line. It is appropriately placed in the May spring time period where that's the heaviest season for weight management is kind of that April, May kind of timeframe. So I think we will be okay with that one. The other lines I do think long-term are positioned correctly in the marketplace as unique value propositions and formulation.

Karen Short - Deutsche Bank

And then, Brenda a couple of questions. I guess the first is on free cash flow and priorities for free cash flow and then I've one other follow-up?

Brenda Galgano

Yes. So we will continue to evaluate how we allocate free cash flow. As we've said in the past, we are focused on investments and we continue to have conversations with the board around capital allocation and right now our priority is investments for growth.

Karen Short - Deutsche Bank

And then, what should we look at in terms of corporate, the corporate growth rate, any color on that?

Brenda Galgano

Yes. Historically, I've guided to approximately 7% increase in corporate costs and I would continue to target that.

Operator

We'll go next to Kate Wendt at Wells Fargo Securities.

Kate Wendt - Wells Fargo Securities

So first of all, just on the -- hi -- on the Q1 guidance as a clarification, is your comp guidance where you are running now or does that assume a little bit pickup in March as the weather hopefully normalizes?

Tony Truesdale

Well, I think it really gives us a look back. We, March you don't know what's going to happen from a weather perspective yet. I mean, if the weather is good we would expect better, if the weather is like it's been in January and February we would expect it to perform more so. We're just waiting to see what Mother Nature does for us.

Kate Wendt - Wells Fargo Securities

And then, just -- Tony, you commented on spurring the e-commerce business that you have kind of up the promotional cadence that which we noticed. Do you think that can start to pull forward some sales from Q2 or does your guidance already anticipate maintaining a higher promotional cadence throughout the rest of the year?

Tony Truesdale

I don't think we really changed dramatically the promotional cadence. We changed the types of promotions that we're running. And I think the types of promotions we're in the fourth quarter were more effective than we did the year before. So I don't anticipate any pull forward from anything that we did from the promotions on the web.

Kate Wendt - Wells Fargo Securities

And then, just finally, any update on when we can expect to see any changes in terms of test through a Loyalty Program?

Tony Truesdale

Nothing to talk about at this point in time.

Operator

We will take our next question from Peter Benedict at Baird.

Justin Klaver - Baird

Hey, guys. It's actually Justin Klaver on for Pete.

Tony Truesdale

Hey, Justin.

Justin Klaver - Baird

Thanks for taking the question. Just wanted to follow-up on Charles question first, just to make sure I understood your answer Brenda. You guys are saying that you can offset gross margin pressure from the mix shift with occupancy and warehouse leverage. I'm assuming you're also going to get the leverage on the corporate cost. So do you guys use your consolidated operating margins still moving higher kind of post-2014?

Brenda Galgano

That's correct. So I was specifically referring to gross margin. Beyond that I would expect that operating income would improve with leverage from SG&A with that mid-single-digit comp I would expect leverage and SG&A.

Justin Klaver - Baird

And then, question on the gross margin profile. Can you may be just clarify what's going on within the category mix shifts that are impacting the margin, it seems as if sports nutrition continues to outpace the rest of the category. So what's specifically changing in the category mix working against you on the product margin line?

Tony Truesdale

Yes, this is Tony. I think we have had some categories. Certainly sports has been a good growth category for a number of years now. And then we've had some success with the aroma therapy rollout and some of the natural bath and beauty things that we have done, which has impacted mix a little bit. So we have had a bunch of different categories.

And then you're seeing some softness in the last year and I think I talked about in the last call in fish oil, which was a high growth by margin category the year before, which is much softer than we anticipated. So when you think those different category pieces together you are seeing some higher margin category slow a little bit some lower margin growth categories grow a little bit faster and that's kind of what's happening. It's not really price investment; it's really mix shift.

Justin Klaver - Baird

Thanks for that color, Tony, and last one just a housekeeping question. Are you guys going to report retail and direct revenues as a separate line item going forward or are you just going to consolidate revenues into one line item? Thanks.

Brenda Galgano

We will report separately. So the direct business will continue to be a sound segment. The only thing that we will combine will be the comp, given that mix channel shift that we're migrating.

Tony Truesdale

Yes, Justin, if you look at, I mean we rolled out the ability for the stores to access all the items online and you can go into a store and buy any of the items that we sell online that are not in the assortment in the store. And so that begins to blur the boundaries a little bit. Later this year I think we will roll out buy online pick up in the store. So by the end of this year, we're using the web now to show in stock by store. So if you go to the website and you look at an item and you click on find an inventory in the store it will show you whether it is in stock and which store you should go to. So as we go through this year, we are going to see a lot of blurring between the different channels and we thought this was the appropriate time that kind of show total comp.

Operator

(Operator Instructions) We will go next to Damian Witkowski at Gabelli & Company.

Damian Witkowski - Gabelli & Company

Just a question on private label, and can you just remind me the effect it has on your gross margins as in like next step, I mean, is it actually margin accretive, gross margin accretive?

Tony Truesdale

Yes, I think what we have said in the past is its 50% higher and usually margin accretive.

Damian Witkowski - Gabelli & Company

And then in terms of just cadence for same store sales you said that October, November were much higher than December. Can you tell us what those numbers were?

Tony Truesdale

No, we don't typically give those out.

Damian Witkowski - Gabelli & Company

And how should we think about just the 60 new stores you said it was second half way to -- I mean, 20 in the first half, 40 in the second half, how should we model that?

Tony Truesdale

Yes.

Brenda Galgano

Yes, that's about right.

Tony Truesdale

That's about right.

Operator

And we'll go next to Stephen Tanal at Goldman Sachs.

Stephen Tanal - Goldman Sachs

Hey, guys, actually that was an error on our part. My questions have been answered. Thank you.

Tony Truesdale

All right, thanks, Stephen.

Operator

And that concludes today's question-and-answer session. At this time, I will turn the conference back over to Mr. Truesdale for any closing remarks.

Tony Truesdale

Well, thank you for joining us this morning, and we look forward to updating you next quarter. Talk to you soon.

Operator

This does conclude today's conference. Again, thank you for your participation.

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