Vitamin Shoppe's (VSI) CEO Anthony Truesdale on Q2 2014 Results - Earnings Call Transcript

Aug. 5.14 | About: Vitamin Shoppe, (VSI)

Vitamin Shoppe (NYSE:VSI)

Q2 2014 Earnings Call

August 05, 2014 8:30 am ET

Executives

Daniel Lamadrid - Former Chief Accounting Officer, Vice President and Controller

Anthony N. Truesdale - Chief Executive Officer and Director

Brenda M. Galgano - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Analysts

Charles X. Grom - Sterne Agee & Leach Inc., Research Division

Simeon Ari Gutman - Morgan Stanley, Research Division

Sean P. Naughton - Piper Jaffray Companies, Research Division

Stephen V. Tanal - Goldman Sachs Group Inc., Research Division

Chris Mandeville - Jefferies LLC, Research Division

Christopher Horvers - JP Morgan Chase & Co, Research Division

Karen F. Short - Deutsche Bank AG, Research Division

Mark R. Miller - William Blair & Company L.L.C., Research Division

Kate Wendt - Wells Fargo Securities, LLC, Research Division

Curtis Nagle - BofA Merrill Lynch, Research Division

Peter Sloan Benedict - Robert W. Baird & Co. Incorporated, Research Division

Andrew Kinder - Crédit Suisse AG, Research Division

Damian Witkowski - G. Research, Inc.

Philip Terpolilli - Longbow Research LLC

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Vitamin Shoppe's Second Quarter 2014 Results Call. [Operator Instructions] I would like to remind everyone that this conference is being recorded. I would now like to turn the conference over to Mr. Dan Lamadrid. Please go ahead.

Daniel Lamadrid

Thank you, and good morning, everyone. Earlier this morning, we released our financial results for second quarter 2014. 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 future 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 direct bearing on our operating results, our performance and our financial condition.

I will now turn over the call to Tony.

Anthony N. Truesdale

Thank you, Dan, and good morning, everyone. Thank you for joining us. Earlier this morning, we released our second quarter results. We also announced that our board authorized $100 million share repurchase plan to be carried out over the next 3 years. I will begin my discussion today with a brief overview of the quarter, and then Brenda will take you through the discussion of the second quarter financial results and provide our outlook for the year.

Our second quarter performance was generally consistent with our expectations. The Vitamin Shoppe business model, which is based on a broad portfolio of brands coupled with an attractive value proposition, continues to deliver consistent results. Our total comp, which included e-commerce, was 5.1% in the quarter. During the period, we generated total sales growth of 9.6% year-over-year, driven by positive comparable store sales, a double-digit increase in e-commerce sales, new store growth and a small contribution from our new manufacturing operations. We had a retail comp of 4% for the quarter. Similar to past quarters, the comp was primarily driven by traffic. This represents the 35th consecutive quarter of positive retail comp sales growth.

We opened 12 stores, bringing total store count at the end of the quarter to 678 stores. We are on track to open approximately 60 new stores this year. We plan for approximately 20 new stores in both the third and fourth quarters. The majority of the openings will skew towards the end of each quarter. On the international front, our second franchise store in Panama recently opened.

Moving on to our e-commerce business. Our marketing plan combines both retention strategies for current customers and acquisition strategies to ensure that we always have new customers. And during the quarter, we did see a significant number of new customers. This, in turn, resulted in our e-commerce sales increasing 14.9% in the quarter and represented our 12th consecutive quarter of double-digit growth. Our digital marketing efforts continue to play a key role in cultivating stronger and more personalized consumer connections. This, in turn, fuels loyalty and drives traffic to our brands across all shopping channels. During the past few conference calls, we have discussed the investments we had made to enhance our customers' online and retail shopping experience.

Last month, we made a significant change on the personnel side. Lou Weiss, our Chief Marketing Officer, was promoted and given the added responsibility for merchandising and product development. By creating a cohesive structure that integrates merchandising, product development and marketing into one group, we will be well positioned to continue to create unique products and compelling customer experiences.

The integration of Nutri-Force is progressing as planned. Brenda will take you through the financial impact of this transaction.

So in conclusion, our commitment to providing a broad product selection, coupled with our knowledgeable Health Enthusiasts and attractive value proposition, continue to drive traffic to our stores and website. And our solid financial position will enable us to fund growth initiatives and return cash to shareholders through our recently announced share repurchase program. We remain committed to being our customers' first choice for their health and wellness needs.

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

Brenda M. Galgano

Thank you, Tony, and good morning, everyone. Thanks for joining us. Today, I will briefly highlight our second quarter results, provide an update on our recent acquisition and then discuss our outlook for the year.

To recap the numbers for the first quarter, we grew total sales 9.6% and delivered a 5.1% total company -- comp, including the impact of online sales growth. Our e-commerce business performed well, driving 14.9% comparable sales growth. Retail revenue grew 7.5% to $270 million. The store comp in the quarter was 4.0% and was driven by traffic.

Moving down the P&L. As a percentage of sales, gross profit in the second quarter decreased 120 basis points. Approximately 60 basis points of this decrease reflects costs associated with the new Virginia DC. This was slightly higher than expected due to a delay in receiving some added functionality to our warehouse management software, slowing down expected productivity gains. About 40 basis points were attributable to the acquisition of Nutri-Force. This is related to a purchase accounting adjustment for the step-up of inventory to market value. The overall value of the inventory step-up was $4.9 million. Of this amount, $1.2 million related to inventory sold through in the second quarter, which negatively impacted margins by $1.2 million. The remaining $3.7 million relates to inventory that is expected to sell through in the third quarter. Lastly, product margins were negatively impacted by faster growth in lower-margin product categories and higher growth in e-commerce sales. Also, as Tony mentioned, our marketing initiatives are driving new customers to our website. New customers, however, tend to have a negative impact on margins. This was partially offset by leverage on occupancy.

Looking ahead, for the third quarter, we expect the lower margin Nutri-Force business to negatively impact consolidated gross margins by approximately 80 basis points. This excludes the estimated $3.7 million purchase accounting charge previously noted. Additionally, we expect the year-over-year impact from the new DC to be approximately 40 basis points negative. As a reminder, the new DC opened in the second half of last year. Although the DC was operating during the third quarter of last year, the increase in expenses from the added fixed cost did not impact the P&L until the fourth quarter. This was because the expense that's flowed through the P&L when the inventory is ultimately sold, which is typically on a 3-month lag. Also, we continue to expect negative pressure in product margins from changes in category and channel mix for the reasons previously discussed. Overall, we expect a decline in gross margins of approximately 150 basis points in the third quarter. In the fourth quarter, we expect the gross margin decline to be approximately 100 basis points, primarily driven by the acquisition of Nutri-Force.

SG&A for the quarter was $75 million compared to $67 million in the prior year. Overall SG&A as a percentage of sales increased from 23.9% to 24.4%. Corporate costs, which are included in SG&A, increased 14% from $25.7 million to $29.3 million. This includes approximately $2.2 million of acquisition-related costs and an increase of $1.7 million in depreciation, mainly from the new DC and IT investments. Last year's corporate costs also include the acquisition and integration-related cost for Super Supplements, as well as an insurance recovery from Superstorm Sandy. After adjusting for these items in both years, corporate costs increased 6%.

For the third quarter, we expect SG&A to delever slightly due to higher depreciation, as well as an increase in advertising to continue to drive new customer growth in the e-commerce business.

Moving on to cash flow. We generated $17 million of operating cash flow in the quarter. CapEx totaled $10.5 million in the quarter and represents the build-out of new stores, IT investment and improvement to existing stores. Our business continues to generate strong cash flow, and our balance sheet is solid, providing the financial resources to fund our growth initiatives and initiate a stock buyback program. At quarter end, we held $15 million in cash and cash equivalents, down from $88 million at the end of the first quarter, which reflects the acquisition of Nutri-Force. We have no long-term debt and nothing drawn on our revolver, which has availability of $89 million.

Before opening the call for questions, let me quickly review our outlook for 2014. As outlined in the press release, our expectations for 2014 include: total comps, including e-commerce, of 4% to 5% for the year; to open approximately 60 new stores; depreciation and amortization of approximately $33 million; EBIT margin decline of approximately 100 basis points. This is on an adjusted basis excluding the nonoperating items from both years previously discussed; and capital expenditures of approximately $40 million.

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

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Charles Grom with Sterne Agee.

Charles X. Grom - Sterne Agee & Leach Inc., Research Division

Brenda, if we're going to take a step back and look at the 100 basis points of margin compression that you're expecting for 2013 -- or, sorry, 2014, could you speak to the buckets here? How much is from the new DC? It looks like it will be anywhere between 60 to 70 basis points. How much is going to be from Nutri-Force? How much is going to be from mix and e-commerce? How much is going to be the offset from occupancy? And I guess as a follow-up to that, when you look at these cost pressures that you've absorbed in 2014, how many of these go away in 2015? And what could the gross margin picture look like going forward after we get past these costs?

Brenda M. Galgano

Okay. So the 100 basis points is for the full year. So for warehouse and transportation, the impact there is -- for the year is probably in that approximately 20-basis-point range. Although we will -- we expect to continue to be negative year-over-year in the third quarter, we expect that, that will turn more positive in the fourth quarter. On the gross margin side, really, the biggest impact is the impact of the Nutri-Force acquisition. If you recall back when we announced the Nutri-Force acquisition, I discussed that contract manufacturing is a lower gross margin business, typically 15% to 20%. So when you combine Nutri-Force with DSI, the combined impact for this year is approximately 50 basis points. And then we also do have some slight deleverage in SG&A. We talked about the fact that we will be increasing our advertising rate a bit to continue to grow our new customers within the e-commerce business. Those are really the main drivers.

Charles X. Grom - Sterne Agee & Leach Inc., Research Division

Okay, okay. And then just on the fourth quarter, could you give us a little clarity on what your expectations are for SG&A? I think you gave the third quarter a slight deleverage. But what were you expecting for the fourth quarter?

Brenda M. Galgano

In the fourth quarter, I expect it to actually lever just slightly, a little bit of leverage there.

Charles X. Grom - Sterne Agee & Leach Inc., Research Division

Okay. And then, Tony, just with regards to traffic and gaining some new customers versus old customers, is there any way to break that out or quantify the new customer gains that you've been able to see?

Anthony N. Truesdale

Yes. I mean, typically, we haven't broken out where they come from. At retail, we had a nice improvement in traffic in the quarter. And then on the web, we've certainly had some good momentum in creating new customers. And some of the advertising we've been doing on the web has been effective. And therefore, we're increasing the advertising going forward. When you create new customers on the web, typically, the average basket size is a little bit smaller. You're spending the advertising money upfront to acquire that customer and then the shipping expense on that smaller order. So when you combine all that together, creating new customers faster puts a little bit of pressure on the P&L. But if you convert those customers into good customers long term, it's a good thing for the business.

Charles X. Grom - Sterne Agee & Leach Inc., Research Division

Right. And then any comment on the trend throughout the quarter and anything quarter-to-date here? You tweaked down the comp a little bit. Just any thoughts on that front?

Anthony N. Truesdale

No. I think it's consistent throughout the quarter.

Brenda M. Galgano

No. I would say our viewpoint on backlog quarter, we gave guidance mid-single digits for the year given that we're getting closer to the end of the year. What we aim to do was really refine the guidance a bit.

Operator

[Operator Instructions] And we'll take our next question from Simeon Gutman, Morgan Stanley.

Simeon Ari Gutman - Morgan Stanley, Research Division

So just first, a clarification on the numbers, Brenda, and then I have one for Tony. The third quarter, you mentioned the gross margin expectation, I think, down 150. And I think you said 80, Nutri-Force; 40, DC. And I think that leaves about 30-or-so from mix or other. Does that other piece include any leverage that you should get on the occupancy side? And then my second part of the financial question is, why does the Nutri-Force gross margin get worse in the fourth quarter? Is that a mix issue? Or is there something else?

Brenda M. Galgano

Yes. So, yes, the guidance does factor in some assumed leverage from occupancy. So the remaining 30 basis points or so is a combination of the mix of e-commerce, as well as some occupancy. And in terms of why do -- why does the impact get greater for Nutri-Force in the fourth quarter, it's primarily driven by seasonality. The Nutri-Force business tends to have their strongest quarter in the fourth quarter. If you think about our business, we're strongest in the first quarter, as is many in this industry. The manufacturers are preparing for that first quarter. So they tend to have their strongest builds during that quarter.

Simeon Ari Gutman - Morgan Stanley, Research Division

And the impact from mix, I guess, the 30 basis points that you said does include occupancy. Is that any different than the way your -- the way the business is experiencing currently? Is that a change? Or is that just a typical run rate and mix shift you've seen?

Anthony N. Truesdale

Yes, it's similar to the mix shift that we've been seeing.

Simeon Ari Gutman - Morgan Stanley, Research Division

Okay. And then my follow-up on just the competitive environment. Tony, can you just talk about generically how do you -- can you characterize the promotional environment? Have you seen any changes lately? I am asking in light of some of the potential changes that GNC talked about with respect to their pricing strategy. I'm curious if there's anything you're picking up from promotions, whether you're seeing heavier or lighter cadence and some of the investments they've talked about.

Anthony N. Truesdale

When I look across the competitive environment, both retail and web, over the quarter, it was very similar to where it's been in past quarters. So we haven't seen a significant change over the second quarter versus the previous year. I would say very similar.

Simeon Ari Gutman - Morgan Stanley, Research Division

And if you saw anything in July, would you comment on it? Or it's too soon?

Anthony N. Truesdale

Yes, I wouldn't comment on the current quarter.

Operator

And we'll take our next question from Sean Naughton, Piper Jaffray.

Sean P. Naughton - Piper Jaffray Companies, Research Division

So when we think about inflation on cost of goods in some of your key categories, thinking about whey protein, can you talk about the consumer response to some of the higher prices that you saw in 2012 and then some of the deflation you saw in 2013? Have you done any adjustments in your pricing at retail today? And then maybe what the response was to previous price increases on the units that were sold through.

Anthony N. Truesdale

Yes. A couple of things, Sean. I mean, we wouldn't talk about pricing in general on the call. What I would say is that during the second quarter, we saw a slight price inflation, the first time, in probably 5 -- 4, 5 quarters that we've seen some slight price inflation. So that was interesting. In the past, when we've seen retail price inflation on protein, what we've typically seen is that passed on to the consumer across the marketplace. And the consumers adjusted, and the business kept going as normal.

Sean P. Naughton - Piper Jaffray Companies, Research Division

Okay. So not too much of an impact on the units, historically?

Anthony N. Truesdale

Yes.

Sean P. Naughton - Piper Jaffray Companies, Research Division

Okay. And then just a follow-up. Just when we think about the CapEx spending longer term here as we get through the acquisition and then the -- obviously -- so when we get through the acquisition here of the new manufacturing facility, how should we think about CapEx for your business moving forward now that you've got some of these incremental spending expenses on the maintenance CapEx for the manufacturing?

Brenda M. Galgano

Generally, on a run-rate basis, we would target CapEx at around 3% of sales.

Sean P. Naughton - Piper Jaffray Companies, Research Division

Okay. That's on the overall business or the manufacturing component?

Brenda M. Galgano

Yes, that's on the overall business. On the manufacturing, it's actually a little bit lower than that. So overall though, it's around that 3% range.

Anthony N. Truesdale

Sean, the way we think about capital allocation is you really have to have a return if you're going after that capital. So we would expect the manufacturing business to put forward a case that will justify significant capital investment in that versus other opportunities within the business.

Operator

And we'll take our next question from Steve Tanal, Goldman Sachs.

Stephen V. Tanal - Goldman Sachs Group Inc., Research Division

I'm sort of curious within the margins on the gross side, are you seeing any pressure at all on sort of core merchandise margin if you think about that at retail sort of x the mix shift?

Anthony N. Truesdale

Yes. I would say both on the direct side and the retail side, core merchandise margins are pretty stable and have been stable for some time.

Stephen V. Tanal - Goldman Sachs Group Inc., Research Division

Or sort of flattish year-on-year within the context of what's been happening also within your guidance?

Anthony N. Truesdale

Yes. I would just use the word stable. I think they've been fairly stable.

Stephen V. Tanal - Goldman Sachs Group Inc., Research Division

Got it, okay. And then in terms of inflation, I mean, certainly, the whey protein numbers would suggest that it seems like you're maybe picking up and potentially going to have a bigger impact in the back half of the year. Is that fair? Or is that sort of inconsistent with how you're thinking about it?

Anthony N. Truesdale

Well, I think Brenda has always said that we said that the inflation impact for the year would be about 1%. And we said it would be probably more weighted to the back half of the year than the front half of the year, and I think that's holding true based on what we saw in the second quarter.

Stephen V. Tanal - Goldman Sachs Group Inc., Research Division

Okay [indiscernible]. Okay. And just one last thing here. Super Supplements, they're in same-store sales at this point?

Brenda M. Galgano

Yes.

Anthony N. Truesdale

Yes, they're in same-store sales, yes.

Operator

And we'll take our next question from Mark Wiltamuth, Jefferies.

Chris Mandeville - Jefferies LLC, Research Division

It's actually Chris Mandeville on for Mark. Just a quick question. You can correct me if I'm wrong. I believe you guys ran a BOGO for the month of April. So if could maybe help quantify that for the quarter?

Anthony N. Truesdale

Yes. I mean, it's the same BOGO we've run for the last 10 years. So I mean, it's -- I'd say that I think in the last quarter that we improved the signage and the presentation in the store, and we think our execution in that BOGO was better than the year before. But it's very similar promotion to the one that we've normally run.

Chris Mandeville - Jefferies LLC, Research Division

Okay, great. And then just my follow-up would be related to kind of the product category. Was there anything throughout the quarter that had performed particularly well? And in addition, can you mention anything in terms of your progress in some of your new product categories, whether it be Tommie Copper or some of your electronic health devices?

Anthony N. Truesdale

Yes. I mean, a couple of things. Tommie Copper, we rolled to an incremental number of stores based on the sales that we were seeing in that particular category. It's early, early on the electronics. We've just got that out late at the second quarter. So I wouldn't want to talk at that. There's not enough data yet to talk about that. As far as general categories go, sports, on the go, which is bars and drink for us, natural bath and beauty and some of the supplement categories performed well during the quarter. And we saw -- although negative, we did see some improvement in fish oil during the quarter, which was nice to see.

Operator

And we'll take our next question from Chris Horvers, JPMorgan.

Christopher Horvers - JP Morgan Chase & Co, Research Division

So just stepping back. I mean, you started the EBIT guidance for the year down slightly. You made the Nutri-Force acquisition. You said down 50 to 100 and talked about uncertainty around gaining control over the business and the integration and the 100 basis points sort of being the conservative end of it. And now you're saying down 100. So in real simple terms, what's really changed since your last call that's causing the incremental because it doesn't sound like it's the sales line item?

Brenda M. Galgano

Yes. It's, I'm sure, a few smaller items that sort of add up. So we talked about higher advertising. We also talked about a greater impact from the mix of new customers in our e-commerce business, which has some impact on gross margin. Our warehousing transportation is a bit higher than expected because some of the functionality of the warehouse management software I previously discussed. And there's also a little bit of impact from the finalization of purchase accounting. So when you add all that up, it really gets up to that higher end of the range, the 100 basis points.

Christopher Horvers - JP Morgan Chase & Co, Research Division

So the step-up in advertising and the mix of new customers, you talked about core merchandise margins being stable in the direct business. So what's the -- but yes, there is an investment in advertising to go after new customers who are initially dilutive. So what's the thought process behind that? Is that you've seen the business going online at a faster rate and you're trying to gain mind share there? Or what's the opportunity and risks that you're seeing that's driving that decision?

Anthony N. Truesdale

Yes. I mean, I think, there's a couple of things. I'll let Brenda tag on to me. But at a high level on the business side, some of the advertising that we have also has an impact on our retail side of our business. So when we look at customer migration, we're not seeing an acceleration of customers to the web business. That's not the reason we're doing this. It's advertising for the whole business, but it happens to be web-centric. So it's a more omnichannel, thoughtful approach to how we're trying to look at customer acquisition going forward rather than the traditional advertising that has happened in the past with radio and print.

Brenda M. Galgano

And to address your question of -- we've talked about our product margins as you look at each of the categories being stable. Where we're really seeing the impact in e-commerce within the gross margin is on the cost of shipping. The average order value for new customers is lower. Therefore, when you look at the overall mix, your cost of shipping as a rate of sales is higher. And that's where we're seeing the negative impact in the e-commerce business.

Christopher Horvers - JP Morgan Chase & Co, Research Division

So just to restate -- so you're shifting advertising online. That's a more expensive business as you generate transactions online because the cost of ship, but the -- and there's a negative mix shift as well because the merchandise margins are lower online versus retail store as well?

Brenda M. Galgano

Yes, and that -- well, that mix shift, we've always had, the -- just overall lower gross margins for e-commerce. But what we're seeing really changing mainly is the increase in the shipping cost due to the growth of our new customers in the e-commerce business.

Christopher Horvers - JP Morgan Chase & Co, Research Division

Understood. And one quick one, can -- what was the occupancy leverage in the quarter?

Brenda M. Galgano

It was approximately 20 basis points.

Operator

And we'll take our next question from Karen Short, Deutsche Bank.

Karen F. Short - Deutsche Bank AG, Research Division

A couple of questions just on your mature stores. Can you just give some color on how those mature stores are comping now? And then what is the composition of the comp traffic versus basket?

Brenda M. Galgano

Sure, Karen. Overall, our mature stores are comping positively in that low-single-digit range. And the comp is all traffic.

Karen F. Short - Deutsche Bank AG, Research Division

Okay. And then can we just get an update in terms of what to think about on the comp, what the right comp would be now to leverage occupancy? Is it still in the 3% range?

Brenda M. Galgano

3% retail comps.

Karen F. Short - Deutsche Bank AG, Research Division

Okay. And then just last question, in terms of the integration and acquisition costs at $2.2 million, that's all acquisition? Or was there a little bit of integration in that?

Brenda M. Galgano

$2 million of it would be the transaction cost, and approximately $200,000 represents integration cost.

Karen F. Short - Deutsche Bank AG, Research Division

Okay. And the integration cost expected for the third and the fourth quarter?

Brenda M. Galgano

I'm going to estimate an overall $1 million. So there's probably around $800,000 in that range for third and fourth quarters.

Karen F. Short - Deutsche Bank AG, Research Division

Okay. But no change on that?

Brenda M. Galgano

Correct.

Operator

We'll take our next question from Mark Miller, William Blair.

Mark R. Miller - William Blair & Company L.L.C., Research Division

So for the online business, Tony, can you highlight what your key initiatives are operationally? Obviously, you'd made an investment to improve search functionality because it seems like part of the key is to keep a strong rate of growth for returning customers. So more of the growth is coming because you've stepped up advertising. You're getting a bigger mix of new customers. What do you do as an organization to keep a higher rate of renewal amongst existing customers?

Anthony N. Truesdale

Yes, there -- I mean, there's a couple of CRM and marketing techniques that we use with new customers. So over the years -- last couple of years, we've developed a conversion program for new customers that allows us to take new customers and convert them. And we measure the conversion rate of new customers to kind of, what we call, mature customers or consistent customers who shop with us. So it's a cadence that I wouldn't talk about on the call, but that's how we think about it. Once we've got the new customers, then the marketing starts to convert them to a permanent -- what we call permanent customer along the way. We also -- we have a -- probably later this year, Mark, we'll highlight some redesigned elements to our website that should also improve customer acquisition and retention.

Mark R. Miller - William Blair & Company L.L.C., Research Division

Okay. And then just separately, can you sort of recap for us where you see long-term store development? And as you're moving into some smaller markets, is there any change in your thinking around long-term store expansion potential, domestically?

Anthony N. Truesdale

Yes. I mean, we still publicly said the 900. We're still looking at the small markets and analyzing that. And when we have a little bit more data, we'll come back to everybody and let you know what we're going to do with the small market; so far, so good.

Operator

And we'll take our next question from Kate Wendt, Wells Fargo Securities.

Kate Wendt - Wells Fargo Securities, LLC, Research Division

Yes. So I was just wondering whether things like your 20% off multivitamin or free shipping on any order promotion is part of what you did talk about in terms of an increased in online advertising. Is that really separate? And you're talking about things more likely paid search or Facebook promotions or other forms of online advertising.

Anthony N. Truesdale

Kate, the 20%, when I said earlier that I -- merchandise margins are pretty stable. That's all included in those types of promotions. It would be in that merchandising margin, which has been pretty stable year-over-year. That's just a change in cadence of what we think. We're just looking at some different things in different categories and trying some different promotions to see what the lift is. So it's kind of a test and control kind of environment with that. The real advertising is in paid search, PLAs that you get through Google and other places like that.

Kate Wendt - Wells Fargo Securities, LLC, Research Division

Okay, got it. That's helpful. And then I was wondering how the rollout of the Sterling Order Management system is progressing and how overall investments in omnichannel that you talked about earlier in the year are tracking versus your prior estimates?

Anthony N. Truesdale

Yes. We're tracking still for buy online, pickup in the store late fourth quarter, early first quarter, somewhere in that time frame. It's a pretty complex project tied to all these systems together. So, so far, so good on that. We did launch, early this year, the ability for the stores to access the web SKU list. So those stores now have 18,000 SKUs that they can choose from. We've looked at the order profile from those customers. And the majority of the sales that we're getting from the stores are actually coming from SKUs that aren't in the store. So the expanded aisle is actually working at the store level pretty well for us.

Kate Wendt - Wells Fargo Securities, LLC, Research Division

Interesting. That's great. And then just finally, somebody asked about category performance before. I was just curious if you could just talk about -- you mentioned fish oil, some improvement there, which is great to hear. Hopefully, some recent positive research helps with that as well. Anything on just overall trends in multivitamins in the diet category?

Anthony N. Truesdale

I think multis, you're going to see improvement. I think you cycle in December the negative press. So I would say early next year, we should see the cycle in multis. We are seeing some multi categories that have had improvement, like prenatal vitamins for women. Given what's going on in this country right now with birth rates, we're seeing some positive momentum in prenatal, which is good. But a couple of other categories are still pretty soft in multis.

Kate Wendt - Wells Fargo Securities, LLC, Research Division

And diet?

Anthony N. Truesdale

Diet, you're starting to see a little bit of a tail off in Garcinia, which was -- I think, I talked about in the last couple quarters, was pretty strong. But that's starting to tail off. That was a Dr. Oz product, I think last year, third or fourth quarter last year. So we're starting to see that tail off in diet.

Operator

We'll take our next question from Curtis Nagle, Bank of America.

Curtis Nagle - BofA Merrill Lynch, Research Division

I was wondering if you guys could just potentially comment on how we should figure the cadence of the buyback program. Will that be mostly weighted towards '15 or '16? Or do you expect to do any this year?

Anthony N. Truesdale

Yes, I think it's going to be -- we're still putting together the cadence of what we're going to do. I don't think we'd publicly just say when and exactly the timing of it. But we'll put something that's thoughtful in place and execute that over a period of time.

Curtis Nagle - BofA Merrill Lynch, Research Division

Okay, great. And then just as a follow-up. I guess just quickly going back to the product margins, I guess, how should we think about potentially when mix pressure should tail off? Or how should we look at that going forward?

Anthony N. Truesdale

Yes. I mean, I think there's a couple really -- I mean, in the fourth quarter, you really lap the distribution. So my perspective would be fourth quarter on when we start to see significant leverage in the distribution side of the business. You're going to cycle the Nutri-Force June of next year. So again, those are the 2 biggest things that I see putting pressure on the margins. So the first one is cycle in the fourth quarter. The next one is cycle in June. Then like-for-like, I think we'll be in good shape.

Brenda M. Galgano

And I would absolutely add on. For Nutri-Force, we'll not only cycle through that, but we'll also start to see improving margins for the Nutri-Force business as we ramp some manufacturing of our own branded products to Nutri-Force. As we said on the call when we had the acquisition, in 2 to 3 years, we expect that gross margins will actually be accretive from this transaction.

Operator

And we'll take our next question from Peter Benedict, Robert W. Baird.

Peter Sloan Benedict - Robert W. Baird & Co. Incorporated, Research Division

A couple of follow-ups just to make sure I understand it correctly. First of all, the down 100 plan, is that a GAAP number? Is that x items? What is the fiscal '13 base rate that we should be anchoring off of? And if you can give us a sense how much of the decline is attributable to Nutri-Force?

Brenda M. Galgano

The 100-basis-point decline is x items. And as I look at last year's x item operating income, I have 10.4%. And in terms of the impact from Nutri-Force overall, that would be probably in the 30 to 40 basis points range. Although there is some gross margin impact, there's a little bit of picked up leverage on SG&A.

Peter Sloan Benedict - Robert W. Baird & Co. Incorporated, Research Division

Okay, perfect. That's helpful. And then Tony, I guess, can you talk a little about the new store performance? How these stores have been doing in year 1? I mean, there is a lot going on in your business, but how has that been holding up versus kind of your historical model? And then the first year comp progression, any updates on how that's been going over the last year or so?

Anthony N. Truesdale

Yes. I would say the new stores that we've opened, about 20 stores so far this year. And I've been pleased with the performance of those 20 stores as a class. So it gives me some confidence as the customer and the -- the customers relating to the business model well. And then when I look at last year's first quarter, we had some stores that came out particularly slow, and their comp in

Year 2 has been solid. So I also feel pretty good about last year's class of stores in total as well. So I don't have anything that would raise a red flag at this point around new store performance.

Peter Sloan Benedict - Robert W. Baird & Co. Incorporated, Research Division

Okay. And in terms of solid, I mean, that's, I think, historically something in the 20% to 30% range for that first year in comps that has been something you've spoken to. Is that -- so you're still seeing that?

Anthony N. Truesdale

That's right. That's right, yes.

Operator

[Operator Instructions] And we'll take our next question from Gary Balter, Crédit Suisse.

Andrew Kinder - Crédit Suisse AG, Research Division

It's actually Andrew on for Gary. One quick question. Could you give us an update on how you're thinking about pricing online? It seems GNC has dropped a couple of third-party brands, while Lucky Vitamin has got a little more aggressive on those items. Is there any response from you guys? Is the goal still to be priced aggressively on just 500 SKUs?

Anthony N. Truesdale

Yes. I mean, we continue to have a dynamic pricing model online. We continue to look at both competitors online and the retail and balance. Our pricing mechanism is based on what's going on in the market. So we spend a lot of time looking at this, and we'll continue to monitor and make changes that are prudent.

Operator

And we'll take our next question from Damian Witkowski, Gabelli & Company.

Damian Witkowski - G. Research, Inc.

Tony, any thoughts on just the general vitamin and supplements environment here in the U.S.? Obviously, you're doing well, benefiting from some of the things you put in place, as well your new stores maturing. But if you look at the overall environment, anything that's giving you a pause in terms of things you worry about and -- or positive as well? Or do think the long-term, the mid-single-digit growth that we've seen in the industry for the last decade is still sustainable?

Anthony N. Truesdale

Yes. I would -- overall, I would say that there certainly has been, if you look at the Nielsen data, some softening. I think that Vitamin Shoppe's model is well positioned. I think we'll continue to do well through the softness. And then as the business turns around, the market turns around, we'll benefit from that positive momentum. Like I said, 2 of the biggest categories had negative articles last year, fish oil in July and multivitamins in December. And I think you cycle those at the beginning of next year, and those 2 big categories should see some growth returned to them. And I think that will be good for the overall industry. So all -- both should rise as you cycle through those, and that will be good for the industry in total.

Damian Witkowski - G. Research, Inc.

Okay. And then if you look at your more mature customer, is there -- and I'm not sure what that really means, but someone that shops with you online exclusively for over a year now. Is their basket increasing? I mean, the number -- and is it driven by the number of items that they actually put in, in their basket?

Anthony N. Truesdale

Yes. Let me comment on it. So rather than older customers, I'll use heavy users. If you look at heavy users of supplements, people that are really committed to the category, when they get to the point that they're taking 8 to 10 supplements a day, it's really hard to get them to take the 11th or 12th. And one of the strategies that we've had is to think about our broad assortment. Because of the size of our stores, we've had the ability to leverage other categories that are adjacent to that customer's supplement needs, things like aromatherapy and natural bath and beauty, which are additive to that customer's basket. So when we get those categories right, like Tommie Copper, we have the chance to take our best customers increase their basket size with those incremental health and wellness purchases that are beyond just their supplement needs. So we continue to work at categories like that, utilize our square footage to take advantage of our best customers and hopefully provide products that appeal to them.

Operator

And we'll take our next question with Philip Terpolilli with Longbow Research.

Philip Terpolilli - Longbow Research LLC

Just one quick one on Canada. I don't think we touched on that, but if you could just kind of give us an update there of how it's performing versus your expectations, if the run rate for investments this year, you talked about last call, if that's still a good number to use.

Anthony N. Truesdale

Yes. I think, there are a couple of things. We're seeing some good positive sales growth in existing stores that we've got there. We've got 3 open. We open 1 more this year. We've got a merchant that's dedicated 100% to work in that business, and we continue to be positive about that business at this point in time. It's tracking on where we expected it to be for the year.

Operator

That concludes today's question-and-answer session. Mr. Truesdale, at this time, I'll turn the conference back to you for any additional or closing remarks.

Anthony N. Truesdale

Thanks for joining us this morning, and we look forward to updating you on the next quarter. Talk to you soon.

Operator

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

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