Vitamin Shoppe (VSI) Colin F. Watts on Q4 2015 Results - Earnings Call Transcript

| About: Vitamin Shoppe, (VSI)

Vitamin Shoppe, Inc. (NYSE:VSI)

Q4 2015 Earnings Call

February 23, 2016 8:30 am ET

Executives

Daniel Lamadrid - Chief Accounting Officer, VP & Controller

Colin F. Watts - Chief Executive Officer & Director

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

Analysts

Tami Zakaria - JPMorgan Securities LLC

Meredith Adler - Barclays Capital, Inc.

Simeon Ari Gutman - Morgan Stanley & Co. LLC

Sean P. Naughton - Piper Jaffray & Co (Broker)

Mark Gregory Wiltamuth - Jefferies LLC

Shane P. Higgins - Deutsche Bank Securities, Inc.

Joe Edelstein - Stephens, Inc.

Justin E. Kleber - Robert W. Baird & Co., Inc. (Broker)

Bob Summers - Macquarie Capital (NYSE:USA), Inc.

Operator

Good day, everyone, and welcome to the Vitamin Shoppe Fourth Quarter 2015 Earnings Results Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Dan Lamadrid, Senior Vice President and Chief Accounting Officer. Please go ahead, sir.

Daniel Lamadrid - Chief Accounting Officer, VP & Controller

Thank you, and good morning, everyone. Earlier this morning, we released financial results for fourth quarter 2015. 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. Today's call will be limited to one hour. 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, strategies or prospects. These are subject to risks and uncertainties that could cause the actual results and implementation of the company's plan to differ 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'll 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 Colin.

Colin F. Watts - Chief Executive Officer & Director

Thank you, Dan. Good morning, everyone, and thank you for joining us. We have a lot to cover this morning, including providing more specific details around our reinvention strategy, and as a result, Brenda and I are going to change up our discussion compared to past calls. First, I'll briefly touch on the highlights of the past quarter and year, and Brenda will discuss the financials in more detail. I will then talk about the company's customer experience reinvention strategy and Brenda will come back and discuss our current year guidance and longer-term outlook. We will then open the call to your questions. So, let's get started.

Our fourth quarter results were mixed, with disappointing total comps of negative 0.3%, as weaker store comps were partially offset by an improved performance from e-commerce, which increased about 4% in the quarter. We are still seeing weakness in key categories that had a negative impact on our comps. We were expecting recovery of the weight management category in the back half of 2015. And, although we are seeing the rate of decline moderating, there continues to be a drag on comps.

We also saw the level of competitive promotion in the sports nutrition category increase in Q4, which had a negative impact on our business. We expect this category will remain very competitive and we're in the midst of reviewing our promotion cadence for the remainder of the year. On the other side, we are seeing positive contribution to comps from categories such as: cleansing and detoxification, probiotics and our newly introduced Protein Pantry set in the Functional Foods category.

We believe that Functional and Fortified Foods area represents an exciting opportunity for growth going forward. Another highlight was the continued year-over-year penetration growth of our private brand business. This is a strategic area of focus for us and we put emphasis behind our private brands, which helped drive greater penetration. We tested giving more prominence to these products in the stores with end-cap displays, and we're pleased to see positive sales increases for these products in those test stores. As such, we will be implementing this program throughout stores in 2016.

I'm also encouraged by the success we are having with other new initiatives to drive sales. Our new loyalty program, which we began piloting with select customers in June 2015, featured quarterly point redemption versus the current program, which features annual redemption. This test is resonating with test customers, and we are seeing a lift to comp sales of approximately 1% with the test customers and even stronger results with our best customers. As a result, we began the marketing behind the program in first quarter of 2016 and expect to see a positive contribution to growth beginning in Q2.

Separately in fourth quarter 2015, we also tested health enthusiasts-led in-store consultation and evening workshops for customers across a broad range of topics, both contributed to increased sales in stores where they ran, and we are currently optimizing these programs for expansion later this year.

Now, let me give you a quick update on Nutri-Force. The results at Nutri-Force were mixed and the business is still not where we'd like it to be, although we are making progress with the new management team largely in place. In recent months, the business showed signs of stabilizing, and we're beginning to see increased interest from third parties, and the sales pipeline is ahead of the prior year. The transition of private brand production in house is moving ahead nicely and we are well ahead of our original acquisition model on those transfers.

Lastly, we continue to face challenges in the quarter from both regulatory agencies and the media, and we proactively have taken actions that we believe are in the best interest of our customers. For example, we decided to step away from selling USPlabs' products upon our learning of issues surrounding the company and several federal agencies' concerns with several of their products, which we promptly removed from our shelves. Although this action had a negative impact to our P&L, we believe this was in the best interest of our customers. We continue to cooperate with federal and state regulators, and are very active with the industry associations to continue to educate and earn trust with our customers around the products and brands we carry.

So stepping back, we accomplished a lot in 2015, as we work to pivot the company to be more relevant to our customers' evolving health and wellness needs, and I'm very pleased with the rapid progress we made with our reinvention strategy. Some of the actions we had to take were structural and we also had to make some tough calls to streamline our business, such as a reduction in force back in June, as well as closing our Seattle Distribution Center and our Canadian operations.

We also strengthened the senior management team as we changed roughly 50% of the senior positions and added new capability. Additionally, since my arrival, we've institutionalized the continuous focus on productivity improvement and opportunities for margin enhancement, of which we are already realizing the benefit.

I will now turn the call over to Brenda, who will take you through the financial results.

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

Thank you, Colin, and good morning, everyone. Thanks for joining us. As we communicated on the last call, we expected a challenging fourth quarter, which was characterized by lower revenue due to the ongoing industry headwinds, lack of product innovation and specific category weakness.

Later in the quarter, we saw an increase in promotional activity that largely impacted Sports Nutrition category sales. On the positive side, we continued to realize underlying product margin improvement and benefits from the cost cutting initiative. Total sales increased 1.2%, with total comps, including the impact of online sales, down 30 basis points in the period, which was lower than our expectations.

During the quarter, cost of goods sold was negatively impacted by inventory adjustments totaling $2.5 million. As Colin noted, we are closing the Seattle Distribution Center and more closely aligning the Super Supplements assortment with that of the Vitamin Shoppe stores. In addition, we are planning to exit the Canadian market where we currently have three stores. These actions are expected to be completed by the end of our first quarter and resulted in inventory charges of approximately $1.3 million, combined, in the fourth quarter. In addition, the removal of USPlabs products from the shelves resulted in $1.3 million charge in the quarter.

On a reported basis, our gross profit margin for the quarter was about 150 basis points lower than the fourth quarter of 2014. Excluding the impact of the inventory-related charges just described, the gross margin rate was 70 basis points lower than the same period of the prior year. Let me talk about some of the components. Occupancy delevered by 40 basis points, given lower retail sales. Product margin on the quarter was flat. However, excluding the impact of timing of new store allowances, product margins improved 40 basis points. This improvement is mainly driven by improved private brand penetration and favorable category mix shift.

Supply chain costs levered by approximately 20 basis points. And the year-over-year impact to gross margins from Nutri-Force was a decline of approximately 40 basis points, primarily related to inventory adjustment. SG&A for the quarter was up 7%. Included in SG&A were costs of approximately $5 million for the following: outside consulting fees associated with the company's reinvention strategy of $1.7 million; costs associated with the Seattle DC and Canada closures of $1.4 million; management realignment charges associated with the termination and recruitment of senior management of $1.2 million; and integration costs related to the acquisition of Nutri-Force of $500,000.

SG&A in the quarter last year included earn-out payments and integration costs of approximately $1.5 million. Excluding these costs for both years, SG&A as a percentage of sales increased approximately 40 basis points, primarily from de-leverage and store payroll and higher depreciation and amortization expense. This was partially offset by leverage and other corporate costs, benefiting from cost reduction initiatives and lower incentive costs.

Adjusted operating income was $18.5 million compared to an adjusted $21.1 million in the same period last year, with margins of 6.3% in the fourth quarter of 2015 compared to 7.3% in the same period last year. Moving down to P&L, we reported interest expense in the quarter of $600,000, which includes some expense related to the convertible debt transactions.

During the quarter, we completed a number of transactions to capitalize on our strong balance sheet and return value to shareholders. In early December, we issued $144 million of 2.25% five-year convertible senior notes with a conversion price of $39.74 per share. We used the proceeds to repurchase slightly over $100 million worth of common stock in the fourth quarter. In addition, a portion of the proceeds were used to fund the net cost of hedge and warrant transaction to effectively increase the conversion price to $52.99. The Board also authorized another $100 million share repurchase program, resulting in an aggregate total of $300 million share repurchase authorization in an 18-month period. As of the end of the year, there was $96.1 million remaining.

Accounting rules require the convertible notes to be bifurcated into debt and equity. The value of the debt is based on the present value of the debt, utilizing a market interest rate for similar term debt without the conversion feature. As a result, of the $144 million in convertible notes, only $115 million is initially classified as debt on the balance sheet. The remaining amount is classified within equity.

Over the five-year convert term, the debt balance of $115 million increases to the $144 million through interest accretion. As such, interest expense includes both the cash interest at the 2.25% rate, plus non-cash interest accretion. Total cash and non-cash interest expense, expected in 2016, is approximately $8 million. Our balance sheet continues to be solid, providing the financial resources to continue to fund our growth initiatives, as well as buy back shares.

At quarter's end, we held about $15.1 million in cash and cash equivalents and had $8 million drawn on our revolver.

I will now turn it back to Colin to provide more detail on our customer experience reinvention strategy.

Colin F. Watts - Chief Executive Officer & Director

Thank you, Brenda. I've previously discussed some of the initiatives we have undertaken to create demand and many of them are now a permanent part of our reinvention plan, which internally we have called Project Evolve. We have also alluded to other initiatives and I will be speaking about some of these today. As we undertook this work, we used two strong filters to help drive our approach to the overall project. The first was a deeper understanding of our market and our target customer segments than we've ever had in our history.

The second and equally important was improving returns on invested capital, as we thought about how to balance investing for growth with continuing to return excess cash to shareholders similar to what we've been able to do in the past year. The following four key ROIC goals underpin the development of our long-term strategy. Those were: increasing revenue growth, enhancing margins, improving our overall cost structure and efficient use of capital.

Assisted by Jackman Reinvents, a global firm with a successful track record of retail reinvention, we gained valuable insights about the market and our customers. We also gained insights into ways to best leverage our assets and what we might need to do new in order to stay relevant to our target customer in the new retail world.

We undertook the most in-depth customer research in our history encompassing over 4,000 consumers nationally to better understand their needs and what drives their purchase decisions. We now have clarity on critical customer segments and their key goals, and this would be where we will focus our efforts going forward.

Our two top customer segments, what I'll refer to as the active segment and the focused segment, account together for about 33% of the overall population, but they also account for 60% of overall industry sales and over 70% of our Vitamin Shoppe sales.

Now that we have a deep understanding of our customer shopping patterns and their needs, we believe we can significantly increase our share of wallet with these customers. These target customers are on an ongoing wellness journey, with a strong holistic view on their health, a broad expectation for strong personalization and a quest to find other enthusiasts like themselves, who can provide help and a sense of community as they strive to achieve their best self.

From a financial perspective, by utilizing new tools in our database, we know that our active and focused customer segments in the top quartile spend significantly more than our target customers in the lower two quartiles. If we added one item to every fourth basket of these two customer segments, our total sales would increase by over 5%.

Our company history is that of a warehouse of brands with attractive prices and great customer service. While this strategy served us well for the past almost 40 years, it has become clear that it is time to move beyond being a solid retailer and a familiar name.

We are going to become a truly great brand, one with clear customer purpose, to be the trusted partner in our customers' health and wellness journey, and we will elevate that purpose to our overall customer experience, delivering this new experience consistently everywhere.

Now let me talk about how we are going to do that and bring it all together. First, we are going to get there by looking at every action through the lens of what we learned in our customer segmentation work. Starting with upgrading the customer experience, our research showed that our top target customers love learning about health and wellness and choose their retailer in large part based not just on price and access, but about the inspiring store environment and innovative product selections. Project Evolve is focused on delivering a bold new, 360-degree experience for the Vitamin Shoppe customer that includes all of our touch points. We will be adding a new platform for personalization in our stores and online, as well as introducing our first major mobile platform application later this year, which will enhance the overall customer experience.

As mentioned, we recently rolled out our new loyalty program. Major initial enhancements include quarterly redemptions and a more beneficial content distribution to our 5 million plus customers in our database. We expect our loyalty platform, linked to our proven CRM capabilities, be the basis of a much stronger relationship focus with our best customers going forward.

Moving on to our next major initiative, which is investing in our health enthusiasts. As confirmed with all the research, our store health enthusiasts are a key competitive and differentiating asset for the Vitamin Shoppe. We need to empower and incentivize them to drive stronger customer acquisition and conversion to bolster store performance. To do that, we have incorporated monthly store incentives based on areas like basket building, private brand sales and new customer acquisitions.

Moving forward in 2016, we will also be attracting new customers by taking it to the street. We recently provided a local marketing toolkit to all of our stores to enhance their ability to build affiliate relationships in their local markets and participate in local health fairs and sports competition. We will also be instituting new hiring and training practices to ensure we continue to attract and develop the best candidates to maintain and grow our strong reputation for store level health enthusiasts. We are adding supporting technology at the store level, including putting broadband Wi-Fi bandwidth into all our stores this year, and we will be launching pilot in the next few months to bring technology support such as tablets to our health enthusiasts to assist their engagements with our customers. Our target customer has a strong desire for more knowledge. And making digital assets or tools more readily accessible for our health enthusiasts is a key priority.

On the product solutions side, we are undertaking a major shift as to how we look at products and categories. We will shift from a warehouse of brands strategy to more aggressively deploy best retail practices in assortment optimization and demonstrate a mastery of category management. This strategy will take full advantage of our newly built omni-channel capability, so we can provide a more solution-oriented, store-level experience and a broader, more comprehensive assortment via our online and mobile channels.

Our core VMS products will be more focused or curated to better match the needs of our target customers. We will put a greater emphasis on key national brands and work more closely with them as we've discussed in prior calls. With respect to private brands, we are developing line extensions for some of our current private brands as well as launching all new lines.

We expect to have our first new private brands line in the market by the end of this year. As we drive growth within our new private brands, I would be disappointed if we don't achieve 25% penetration in the year 2018, which would translate to having our private brands grow at more than double the rate of our overall business over the next three years. We also see a significant opportunity in category expansion, a combination of our larger stores and our curation strategy will enable us to expand further into other exciting fast growing categories, such as Personal Care, Natural Beauty, Functional and Fortified Foods that are all on trend with customers' desires to seek their nutritional fortification from a broader array of sources and our natural adjacencies to our current vitamin/mineral supplement core business.

We have already seen early success with Protein Pantry and aromatherapy and we intend to expand on this success. Our top customer segments thrive on innovation and we intend to leverage our national brand partners, private brand entries and new category expansion, to satisfy their interests. All of these actions will further differentiate us from other retail competitors and the increase in private brand penetration will also be margin-accretive.

The last two components of our strategic plan are cost optimization and capital allocation. As we roll out these initiatives, we are mindful of the need to balance the investments required to do so, while at the same time judiciously managing our cost structure. As Brenda will discuss more, our plan is to balance the need to invest behind these new initiatives, with stronger cost savings in other parts of the business.

To end my presentation with how I began it, we are keenly focused on creating shareholder value. We believe the initiatives we've outlined for you today will do just that. Now, I will turn the call back to Brenda to discuss our current year guidance and the financial implications of our longer-term plan.

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

Thanks, Colin. I'll start by reviewing some of our expectations for full year 2016, a 53-week year. Total comp sales are expected to be flat-to-positive low single digits for 2016. We expect the first quarter to be the slowest quarter with negative, low single-digit comp, with comps improving throughout the year. Adjusted earnings per diluted share are expected to be in a range of $2.25 to $2.45 for the year. This assumes share repurchases account for approximately 3% to 5% of our market cap. We plan to open approximately 30 new stores and plan capital expenditures of approximately $40 million.

Our EPS guidance includes $10 million to $15 million of additional SG&A costs to support the many reinvention activities of the company. This includes adding both internal and external resources in the areas of private brand, digital and category management and investments at the store level with enhanced network, stronger incentives and improved training. We also expect some increases in the level of our marketing spend to support the growth of private brands and acquiring new customers. I should note that our guidance excludes certain charges relating to professional fees for the finalization of the reinvention plan and the closures of the Seattle DC and Canadian businesses, which are expected to be taken mainly in the first quarter.

While we believe it is important to invest in the reinvention, we are also very focused on identifying additional cost reduction initiatives and opportunities to help balance these investments. We are in the process of engaging a nationally recognized cost consultant firm to assist in this process. To-date, we have realized annualized savings of $5 million from cost reduction actions taken last year.

In addition, we have identified another $2 million to $3 million of annualized savings we expect to begin realizing in the second quarter of this year relating to the closure of the Seattle DC and exit of the Canadian business.

We also identified another $5 million of future annualized savings related to utilities and supply chain costs. By the end of 2016, we expect the total annualized savings identified to-date to be close to $10 million. And by the end of 2017, we expect the annualized run rate savings to be closer to $13 million.

We believe there are still more opportunities and will be working closely with outside help to quickly identify and capture additional savings. As we think about longer-term guidance, keep in mind that we are still in the early stages of the reinvention and many of the initiatives that Colin has spoken about will be tested and rolled out over the next three years. However, I will provide some high-level thoughts around our three-year expectation.

As we roll out the many growth initiatives starting this year and over the following two years, we expect comparable sales growth to increase back to industry growth rate, currently expected in the mid-single-digit range. We estimate the three-year CAGR for operating income to be in the high single-digit range and earnings per share CAGR in the mid-teens to high-teens. This assumes an acceleration of growth starting in late 2016. We believe that this level of growth will not require a significant increase in the rate of our CapEx spend, though we will likely be shifting some capital from new stores to remodels, and other higher return investments. Capital allocation decisions will be based on the objective of balancing high-return growth investments and continued return of capital to shareholders.

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

Question-and-Answer Session

Operator

Certainly. We'll go to Christopher Horvers with JPMorgan.

Tami Zakaria - JPMorgan Securities LLC

Hi, this is Tami Zakaria on behalf of Chris Horvers.

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

Hi Tami.

Tami Zakaria - JPMorgan Securities LLC

Hi. We have a question on weather. Did weather and the delayed tax refunds have an impact on sales of the fourth quarter?

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

Weather has a slight impact. And I'm sorry, what was the second part of the question?

Tami Zakaria - JPMorgan Securities LLC

Delayed tax refund.

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

No. We don't believe that that has had any sort of impact. Weather did have a slight impact, and I will also note that we also did have a minor impact from the testing of the new loyalty, which has some of negative impact in the first quarter.

Tami Zakaria - JPMorgan Securities LLC

Sure. And the follow-up question would be, what's going to drive the acceleration in comps as we go into 2016?

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

Sure. Well, it's a combination of things. First, as we said in the first quarter, there were some items that did have some impact to the first quarter. But mainly, as we roll out the initiatives that Colin discussed in detail, we believe that we will have – see some benefit in our comps. For example, Colin discussed the impact of the loyalty program. And we stated that in the test, we saw a lift of approximately 1%; that would be one example.

Tami Zakaria - JPMorgan Securities LLC

Sure. Thank you.

Operator

Our next question is from Meredith Adler with Barclays.

Meredith Adler - Barclays Capital, Inc.

Thanks for taking my question. You talked about going through a pretty comprehensive SKU rationalization or optimizing the assortment, do you think that means at some point that you're going to be able to operate with smaller stores? And are you uncomfortable with the size of stores that you have now?

Colin F. Watts - Chief Executive Officer & Director

Great question, Meredith. I – so, first of all, let me address the second, which is I don't think, we're uncomfortable with the size of the stores we have right now. In fact, I would say we think that there is a real strategic advantage to the size of stores. I mentioned the fact that one of the keys to this overall assortment strategy that we're putting into place is not just the notion of curating the assortment more aggressively, but frankly it's the opportunity for us to move into some really clear adjacencies that as we've done our research with our target customers. It's pretty clear that they're willing to let our brand stretch to start to bring them solutions that cut across some additional categories. And our larger store size allows us to provide those kinds of solutions right at the store level. I think, the first question, you asked about smaller store size, there is a possibility that we will see that there is an opportunity to fulfill customer needs through a smaller store set. We will certainly be piloting testing those opportunities as well as looking at the remodels against our current store size and depending on the results that we see as we go into those tests, we'll make some decisions about our real estate strategy moving forward.

Meredith Adler - Barclays Capital, Inc.

Great. And then I just do have another question about potential impacts on the business recently. Do you have a reason to believe that the bad publicity whether it's the Frontline report or anything else, was having an impact on your sales? And how do you think – I know, there is an industry consortium, how do you think it plays out to change the most negative people's view about the industry?

Colin F. Watts - Chief Executive Officer & Director

Yeah, so I think there's no question that there is a bit of a industry overhang that's occurring right now, and our research would bear out the fact that for the most committed and most, frankly the heavier users of our category, a lot of the negative publicity and some of the regulatory actions that have occurred aren't really having a substantial impact on their buying behavior. But I do think it's the folks that straddle the fence, folks that might consider buying their vitamin/mineral supplement through more mainstream retailers, they are probably at this point somewhat negatively impacted by what's occurring in terms of concerns that are being raised by the media.

We are actively participating with all of the major trade associations. We have taken on further steps in terms of improving quality and we are going to continue to look at ways that we can provide appropriate oversight. We take compliance very seriously. We also view the cooperation that we've been able to present with regulatory authorities as a real sign of the kind of trust we want to continue to build with customers, as well as with folks that are continuing to try to make sure our industry stays on the right side as we move forward.

Meredith Adler - Barclays Capital, Inc.

Okay. Great. Thank you very much.

Operator

We'll go next to Simeon Gutman with Morgan Stanley.

Simeon Ari Gutman - Morgan Stanley & Co. LLC

Thanks. Good morning. So, Colin, my first question is on just the business and the cadence in the fourth quarter, I don't know if you can provide any sales color, but you mentioned that things got more promotional, and I didn't know if the promotional comment was meant to say it just got more aggressive on price or is that when sales also slowed down when it got more promotional?

Colin F. Watts - Chief Executive Officer & Director

I'd say a little bit of both. I think that it's really not necessarily price at the level of promotional activity overall, particularly in the month of December it was fairly intense. And we therefore at the end of the quarter saw a bit of a slowdown, in terms of our business. I think – a scenario that we're looking at quite carefully, and as I mentioned, we're going to continue to look at our promotional cadence to make sure that we're appropriately responsive, but we're quite happy also with the discipline we've tried to show in terms of the way that we've managed the top line and the bottom line of our business.

Simeon Ari Gutman - Morgan Stanley & Co. LLC

Okay. And then on the strategic reinvention, if I got these buckets right, I think, you said the active and the focused customer.

Colin F. Watts - Chief Executive Officer & Director

Yeah.

Simeon Ari Gutman - Morgan Stanley & Co. LLC

Can you share with us what insights that you learned from this that you didn't already instinctively know, and can you tell us are these – do you know if these shoppers are shopping at competitors as well, are they shopping you in multichannel, and can you just remind us what does your average basket look like today, how many items, and at what price?

Colin F. Watts - Chief Executive Officer & Director

Sure. I'll cover the first two, and then I'll turn it over to Brenda to cover the basket size. So, Simeon, the two segments that we talk about, the active and the focused are certainly shopping across multiple retailers. We have a solid share of wallet, but we think we can have a growing share of wallet, and part of our growth premise is both growing the current share of wallet of those that we see, but also attracting more in those segments to the Vitamin Shoppe. We see a lot of expansion opportunity in that particular area.

Insights, I would say for me at least what was quite interesting to note was how engaged they were in this category. This is not a – it's not really a supplemental view from their standpoint. This is a lifestyle view and they purchase products in this category as part of their overall personal identity, high degree of personalization being sought, high degree of engagement, one of the reasons I think we do disproportionally well with these targets is because they really like our Health Enthusiasts, they like their product knowledge, they like the fact that they are people like them, and they are people they can engage with and get additional tips about ways to be able to be more successful on their health and wellness journey.

They are a bit younger than I would have expected. These are no longer – most of my career, I've been working on brands that have been driven by Baby Boomers. This category is no longer being driven by Baby Boomers. They still make up a sizable amount of the business done in the supplement category, but our research would suggest that now the dominant position in terms of driving category decisions is actually the Gen-Xs and Millennials, and with those two demographic segments, you get a large amount of focus on things like community-based, social-media based, technology-based solutions, and obviously we're going to take advantage of that learning to pivot a bit of our experience in that direction.

They are shopping us on a multichannel basis. We do get benefit from the fact that they're shopping us on multichannel basis. And we think that, continuing to look for ways to become more of an omni-channel retailer, as opposed to be a siloed e-commerce and store retailer is going to benefit the transactions and the relationship we have with these customers. I'll let Brenda identify the basket size and make-up for just a second.

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

Sure. So, on average for these two customer segments, the basket size is of little bit over $40. It's a little bit higher for the focused segment, and a little bit lower for the active. And for the focus, it's an average unit size of approximately three units per basket; and for the active, it's a little less than three.

Simeon Ari Gutman - Morgan Stanley & Co. LLC

Okay. Thanks for that.

Operator

We'll go next to Sean Naughton with Piper Jaffray.

Sean P. Naughton - Piper Jaffray & Co (Broker)

Hi. Thanks for taking the question. Just – and thanks for the detail on the strategic plan and I look forward to hearing more about it. But just curious if you could just give us a better understanding of kind of what you believe is the biggest impact, kind of on the business right now, is it mostly a lack of a product cycle, media, competition, maybe not the right product assortment, or is cannibalization starting to hurt you a little bit more? Just hoping we could hear a little bit more about what you think the biggest buckets are that are impacting it as down like the comps or beginning to turn here in the first quarter?

Colin F. Watts - Chief Executive Officer & Director

Yeah. I – Sean, I don't think this is a cannibalization story. I think, this is really a sector story. And I think the issue that we're facing in the sector overall is just, this is just a somewhat cyclical sector, and I'd seen it, and I've been involved in it for 25 years to 30 years in my career. You go through dips where you don't see a significant amount of new science or new products or new innovation come into the market. We're definitely in one of those lulls. And we're seeing basically a continued secular trend that everyone knows about, in terms of interest in wellness and focus in wellness. But I think, there has been a broader level of innovation in some of the adjacent categories around us, and I think, a little less innovation in the core categories that we represent.

So, I think that's probably the number one softness driver that we're seeing in the business. We also think frankly for our own good that we can sharpen our gain. And I think that's why you're hearing us talk about focus on share of wallet, focus on customer acquisition, because frankly we think we can be a better retailer. And in this environment, where we're going to be fighting for getting the right customers and building share of wallet, we think it's going to be critical that our execution and our innovation is as strong as possible.

The final piece, I'd point to is our private brand business. We continue to view private brand on a lot of different levels as a real positive for us as a business. Most importantly, it's an opportunity for us to control our own destiny. We see a lot of headroom in terms of growing our percentage of sales that we realized from our private brands. And we think, we can use our private brands as a real source of innovation for our customers and a source of differentiation in the market as we move forward.

Sean P. Naughton - Piper Jaffray & Co (Broker)

Okay. That's helpful. And then, just two clarification points here, just two quick questions. Brenda, I think, you gave a longer term strategic plan kind of for the next three years. Can you talk about the store growth that you're expecting during that time, like how many additional units do you think you're kind of prepared to do that? And then just quickly on the share count at the end of the year. Those are the two quick questions.

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

Yeah. It would probably be a little too early to give you specifics around that. As Colin discussed, we will be testing different formats. We're going to be doing some new stores, with the elements of the reinvention in it, and then we'll also be remodeling stores, and we'll be closely evaluating how we get the best returns. We believe that it is likely that our rate of new store growth will slow down, as we invest more in remodels. So, it is likely that over the next few years, our rate of store growth will be less than the 50 to 60, we saw in the past few years. However, to get any more specific than that would be – it'd be a little bit early.

Sean P. Naughton - Piper Jaffray & Co (Broker)

Okay. That's fair. And then anything on the share count at year-end just to be helpful. Thank you.

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

Sure, share count, we ended the year, hold on. You know what? Let me pull that up, and then I'll answer that later.

Sean P. Naughton - Piper Jaffray & Co (Broker)

Thank you. Appreciate it.

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

Okay.

Operator

We'll next to Mark Wiltamuth with Jefferies.

Mark Gregory Wiltamuth - Jefferies LLC

Good morning. Wanted to dig in a little bit more on this idea of having a more curated offering. You've always had this broad assortment of SKUs, what's your SKU count today, and where do you think you could be in five years? And what does that have in terms of implications for working capital, and maybe cost savings over time?

Colin F. Watts - Chief Executive Officer & Director

So, Mark, it's premature to try to get into specific numbers of the numbers of SKUs, that we think we'll end up with. I believe, currently we're at about 8,000 SKUs per store. I believe online, we have roughly 20,000 SKUs. We see opportunities to curate the tail, if you will, depending on the categories that you're talking about, we've got 20 SKUs to 30 SKUs for various different forms of straight up vitamin Bs, vitamin Es, vitamin Cs. And one of the things that we will be doing is really asking ourselves the question, where do we get the highest level of productivity, where do we see the best uniqueness. What's the right balance, because we know variety is important in this category, and there are significant percentage of customers that are looking for very unique SKUs and looking for small detailed levels of differentiations. That being said, we think, we see some real opportunity to be more focused in the way, we move forward.

It's really important to understand though that part of the whole reason for this curation is to open up the opportunity to move into new categories. The last six months or so, as we've done the work on Protein Pantry, even though that's a relatively small segment in the grand scheme of thing, we've been rewarded by accretion in terms of overall comps, just from that category alone over the last few months. And we see other categories that fit our overall brand position that we think we can make available to our business, as we move forward.

I don't know, if Brenda you want to address any of the financial impact from an inventory, it's probably a little bit too premature to get into that.

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

Yes. Exactly, yeah.

Mark Gregory Wiltamuth - Jefferies LLC

And how about – could you give us some bigger picture comments on what you're doing on cost cutting. You talked about getting up to that $13 million run rate on cost cutting. How low can you go, how much fat do you think there is to cut out on cost?

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

Certainly would be early to start throwing numbers out there. As we're looking at cost cutting opportunities, we're really looking at it from an – a full enterprise perspective. So, beyond just, let's call it corporate cost, we believe that there is opportunity to look at our supply chain cost, including manufacturing, as well as looking at our overall cost of goods sold and how we negotiate with vendors.

Colin F. Watts - Chief Executive Officer & Director

Mark, the reality is that, this next phase of our cost efficiencies and cost reinvention really is going to require some process reengineering. And it's totally appropriate to do that at this time, because it fits within what we're doing in general in reinventing the enterprise. So, I – the notion that we've got a lot of fat to target unfortunately, I'd love to say we do, I don't think that's the case. On the other hand, there are several areas where we have not really looked at the process that we use for various different areas, we've vertically integrated over the last couple of years, there is opportunity to make sure we're getting forecast efficiencies, inventory efficiencies, a variety of different areas that we're going to take advantage of during this approach.

Mark Gregory Wiltamuth - Jefferies LLC

Okay. Thank you.

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

Just to – sorry. Just to go back and answer Sean's question. The shares outstanding as of the end of the year was 25.9 million.

Operator

We'll take another question. We'll go to Karen Short with Deutsche Bank.

Shane P. Higgins - Deutsche Bank Securities, Inc.

Yes. Good morning. This is Shane Higgins on for Karen. Thanks for taking my questions. Firstly just on the, what's the broader strategy here for Nutri-Force. You seem to be looking at everything with fresh eyes, and it seems to have been a disappointing acquisition. So, why not look at this with little bit more scrutiny?

Colin F. Watts - Chief Executive Officer & Director

Sure. I am not sure, I would call it a disappointing acquisition. I would say, it's a disappointing integration. I think, we are very confident that over the next couple years, we're going to look back and say that buying Nutri-Force was one of the best things we could do for the company.

The strategy in terms of getting value out of the Nutri-Force acquisition is pretty much the same strategy we had in acquisitions on, that is we see an opportunity both in terms of bringing a large percentage of our SKUs for our private brands to Nutri-Force to capture the manufacturing margin, in addition to the overall private brand margin. We also believe in Nutri-Force because it is truly a very strong operation, can be a very successful contract manufacturer onto its own, and we're seeing that just in the last several months, under my period of leadership as we're seeing new customers come to us and we're seeing some of our older customers renew their contracts with us as we move forward. The challenge really has been in the integration, I think, it's fair to say that in our first year or so of acquiring the business, there are bunch of things that we've learned some important lessons about, around S&OP processes, around overall forecasting, around getting the right leadership in place down at the plant and being in a position where we can link with them a little better as we move forward.

We've got a lot of those process controls in place at this point, and we're expecting a better 2016 and then even better 2017, as we move forward.

Shane P. Higgins - Deutsche Bank Securities, Inc.

Okay. Thanks for that. And just a quick question on the international franchise business and your recent move into Honduras, any color there as to how that kind of fits into your longer term strategy?

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

Yeah. We have not moved into Honduras, we moved into Guatemala, just a clarification.

Shane P. Higgins - Deutsche Bank Securities, Inc.

Sorry.

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

No problem. As we continue to evaluate opportunities, we do think that and we're having several conversations with partners, globally about other opportunities. And we are really looking for partnerships with businesses that have experience in the space or in franchising and that can open more than just a few stores. We're looking for partners that can really expand in a full country.

Colin F. Watts - Chief Executive Officer & Director

We're hopeful that we're going to see some more announcements later this year. I mean, this continues to be an important area for us. I mean, I wouldn't call it our top strategic area, but we continue to see that the Vitamin Shoppe brand resonate, as we take it overseas. And we're going to – as we move up in private brands, and we move up in our overall customer experience, that will just increase the differentiation of the asset base, to make it even more attractive to franchise partners ex-U.S.

Shane P. Higgins - Deutsche Bank Securities, Inc.

Great. Thanks.

Operator

We'll go next to Joe Edelstein with Stephens.

Joe Edelstein - Stephens, Inc.

Hi. Good morning.

Colin F. Watts - Chief Executive Officer & Director

Good morning.

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

Good morning.

Joe Edelstein - Stephens, Inc.

Colin, you spoke a little bit about the need to reengineer the process on the cost controls. And I'm curious, what the approach has been like really so far and at least identifying the savings that you've outlined. Maybe you can just talk to the amount of benchmarking that you've done against other retailers, other channels and then couple into that question, Brenda. I'm curious if you actually feel like, you might be able to go faster, you outlined the cost savings really all the way out to 2017. So, maybe you could talk about the risk that you see to potentially going faster than what you've outlined for us this morning?

Colin F. Watts - Chief Executive Officer & Director

So, I'll start, Joe, and I'll throw it over to Brenda to follow-up. I think, our plan to-date, in terms of cost savings has been fairly straight forward. There has been some benchmarking in certain areas that we've done. But I think the other questions with after sales is really looking across the overall enterprise from a return on invested capital standpoint. And we identified a variety of different areas that we could not truly say were critically strategic from our growth standpoint nor were they returning to the level that we felt was appropriate internally.

So, we as I mentioned on this call, we had to make some tough calls and it's not easy to do that but we thought, given what we think are some really dynamite prospects for growth in other parts of our business, we thought it was appropriate for us to make some of those tougher calls, get ourselves to a healthier core, so we can start to build the business moving forward.

I think our plan moving forward, as I mentioned is going to require a high degree of sophistication, the reason that we've decided to bring in a national consulting firm to work with us because a lot of this is going to be very data driven, highly focused on benchmarks, and also some process reengineering that we're going to need to do in order to get the full kind of cost benefits that we see on the business, and we expect this is going to take a bit of time for us to be able to make sure we do it thoroughly and we continue to keep the core of our business healthy as we reinvent for growth moving forward. Brenda, anything you'd want to add?

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

Sure. In terms of addressing the question of can we go faster? I'll tell you, we ask ourselves that every day. We're very focused on moving quickly. Some of these savings that I referred to that we'll see later in 2017, is really because it requires some investment and some process changes associated with that. So for example, we are working on putting in LED lighting in all of our stores. That doesn't happen overnight and it takes a little bit of capital investment and it takes some time to get that done.

In addition, we are working on adding some new WMS capabilities in our DCs and things like that will then yield savings, but it doesn't happen overnight.

Joe Edelstein - Stephens, Inc.

Okay. Thanks for addressing that. Then I was hoping just to come back to one of the questions earlier. I know that it sounds like you're going to test different formats within the stores, what the reinvention ultimately looks like, it sounds like it's still yet to be determined. But given all of the assortment changes, et cetera, but how confident are you in some of the longer-term goals that you've talked to in the past. In terms of the store opportunity, I think 900 stores was a number that comes to mind there, is that something that still holds in your view?

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

Yeah. So I would say, it's fair to say that we view the opportunity to be at least 900 stores as we test different formats, as we test smaller formats, we believe that if we're successful and through this tests that would increase the opportunity beyond the 900 stores.

Joe Edelstein - Stephens, Inc.

Okay, great. Thanks for taking the questions and good luck.

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

Thank you.

Operator

Our next question is from Peter Benedict with Robert W. Baird.

Justin E. Kleber - Robert W. Baird & Co., Inc. (Broker)

Yeah. Hey, guys, it's actually Justin Kleber on for Pete. Thanks for taking the question. I wanted to first ask about EBIT margins. The three-year plan you outlined calls for EBIT margin expansion, but can you talk about the outlook embedded within your 2016 guidance and maybe how we should think about the complexion between gross margin and SG&A?

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

Sure. I can give you some high level thoughts. Overall, we expect that the EBIT margin rate will be lower overall, year-over-year. As we get later into the year in the fourth quarter, we do expect that trend to turn. And as we look at the breakdown between gross margins and SG&A, we do expect that gross margins will improve overall. We talked about the underlying product margin improvement in the fourth quarter. And as we look at the first quarter and beyond, we certainly continue to expect to see that ongoing improvement due to mix shift as well as private brand penetration.

And then, we do expect to see some improvement in gross margins from Nutri-Force, those would really be the two main drivers of the improvement within gross margin. SG&A, we do expect we'll de-lever. We talked about the investment of $10 million to $15 million, that being the biggest driver. Of course we're going to continue to look for opportunities to also reduce costs, but overall we do expect SG&A will de-lever.

Justin E. Kleber - Robert W. Baird & Co., Inc. (Broker)

Okay. Thanks for that color. And then just two other real quick ones here. Was there any headwind to comps in the fourth quarter from no longer selling the USPlabs products? And then secondly, just what does your guidance assume for the extra week impact on maybe revenues or EPS?

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

So, the first question, yes, there was some impact to the fourth quarter. I would estimate that to be probably in the 30 basis point range or so. And then second question regarding the 53rd week, we are estimating a benefit to EPS of approximately $0.07 a share, and a benefit to revenues of close to $20 million. That of course, the $20 million is not included in our comp guidance, but the overall $0.07 is included in the EPS guidance.

Justin E. Kleber - Robert W. Baird & Co., Inc. (Broker)

All right. Thanks so much, guys.

Operator

We'll take our final question from Bob Summers with Macquarie.

Bob Summers - Macquarie Capital (USA), Inc.

Hey. Good morning. Just a couple of questions. When you think about brand stretch how much of the comp is being driven by categories that you're going to stretch the brand into? And then, sort of related to that, as you look at improving your share of wallet with your active and focused customers, you gave sort of the statistic of one item for every fourth sale adding 5%, and so it seems like you're talking about adding a $13 sale to $160 basket for the entire 70% of that customer base. And so related to that, how much of your comp expectation either on a one-year or three-year basis is predicated on achieving that?

Brenda M. Galgano - Chief Financial Officer & Executive Vice President

So, I'll start with the second part of the question. So, if you do the math, the two customer segment represents approximately 70% of the business and we're talking about adding approximately $14 or $15, which is our average item value to every fourth basket of 70%. And remember the basket size is approximately $40.

Bob Summers - Macquarie Capital (USA), Inc.

Okay.

Colin F. Watts - Chief Executive Officer & Director

I'll jump-in on the first, the reality is that a lot of the higher growth categories that we're looking at right now in the store, I mentioned, particular areas like functional and fortified food, areas like personal care, areas that may five years or seven years ago not have been seen as traditional categories for a company called Vitamin Shoppe like aromatherapy, have actually been some of our fastest growing and most hotly (57:34) rewarded areas.

So, our plan will be to continue to look at those particular areas, and you'll see us over the course of this year move into market with some fairly aggressive tests that will take advantage of some of these higher growth markets and we believe ultimately set ourselves up for stronger growth as we move forward.

Bob Summers - Macquarie Capital (USA), Inc.

Okay. And then I guess related, as you think about driving share of wallet and then stretching the brand, have you compensated for any potential competitive response?

Colin F. Watts - Chief Executive Officer & Director

Yeah. We expect that there will be some competitive response. We're in a very competitive segment coming from lots of different directions. So, I think we have full expectation that this will not be an area that we will be going in exclusively, we're prepared to compete as appropriate.

Bob Summers - Macquarie Capital (USA), Inc.

Okay. Thank you.

Operator

That does conclude our question-and-answer session. I would like to turn the call back over to Mr. Colin Watts for any additional or closing comments.

Colin F. Watts - Chief Executive Officer & Director

Yeah. So summing up everything we've discussed this morning, I just want to reiterate. I think our strategy is pretty simple as we move forward. So I had to break it down into the three critical areas in priority order. We're going to win by providing inspiring experiences to engage our customers across all touch points with our health enthusiasts being the key focal point. We're going to differentiate our business through a curated product assortment that will be solution-based and personalized for our target customers and put ourselves in a position to highlight growth in our private brand business, as well as expand into new categories.

And finally, we're going to compete on the fundamentals of our business which has really been about price value, convenience and consistent operational excellence, all-in pursuit of our new Vitamin Shoppe brand mantra, we're going to inspire and nourish our customers, so they can thrive every day.

And with that, I'm going to thank you for joining us this morning, and we look forward to speaking with you next quarter.

Operator

That does conclude today's conference. Thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!