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GNC Holdings (NYSE:GNC)

Q3 2013 Earnings Call

October 24, 2013 10:00 am ET

Executives

Dennis Magulick - Vice President of Treasury & Investor Relations

Joseph M. Fortunato - Chairperson, Chief Executive Officer and President

Michael M. Nuzzo - Chief Fianacial Officer and Executive Vice President

Analysts

Christopher Horvers - JP Morgan Chase & Co, Research Division

Kate Wendt - Wells Fargo Securities, LLC, Research Division

Mark Wiltamuth - Jefferies LLC, Research Division

Simeon Gutman - Crédit Suisse AG, Research Division

Karen F. Short - Deutsche Bank AG, Research Division

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

Meredith Adler - Barclays Capital, Research Division

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

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

Michael Weisberg

Kurt M. Frederick - Wedbush Securities Inc., Research Division

Operator

Good morning. My name is Samantha, and I will be your conference operator today. At this time, I would like to welcome everyone to the GNC Holdings third quarter earnings conference call. [Operator Instructions] Thank you.

I would now like to turn the call over to our host, Mr. Dennis Magulick, Vice President of Investor Relations. Sir, you may begin your conference.

Dennis Magulick

Thank you. Good morning, and welcome to the GNC Third Quarter 2013 Earnings Call. This morning, we released our third quarter financial results, which are available on our website. With me today are Joe Fortunato, Chairman, President and CEO; and Mike Nuzzo, Executive Vice President and Chief Financial Officer.

Today's call will be limited to 60 minutes. Following our prepared remarks, we will be available to take your questions. After I read the disclaimer, Joe will provide an overview of the business and an update on our key initiatives. Mike will then review financials, after which Joe will wrap up with some closing remarks.

Now for the disclaimer. This conference call contains forward-looking statements, which include information concerning our future results, trends and other information that is not historical information. All forward-looking statements included on this call are based on information available to us on the date of this call, current expectations and various assumptions. We believe there is a reasonable basis for our expectations and assumptions, but they are inherently uncertain and may not prove correct.

We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained throughout this call. For a list of important factors that could cause our actual results to differ materially from the forward-looking statements on this call, please refer to our public filings with the Securities and Exchange Commission and our earnings release this morning.

I will now turn the call over to Joe.

Joseph M. Fortunato

Thanks, Dennis, and good morning, everyone. We are encouraged by GNC's ability to once again generate growth across all channels, make progress on key strategic initiatives and deliver strong results. This quarter's performance is a testament to the strength of GNC's business model, whereby our brand, exclusive product offerings and a consumer demographic base which is aligned with the fastest-growing segments of the industry, and great execution provides a platform for consistent performance.

For instance, in the first quarter of our chain-wide Member Pricing Program, we are achieving our goals of driving consumers to the store on an incremental basis, capturing more complete shopping pattern data and generating a more balanced spread of sales over the month. We also continue to see favorable reaction to our consumer surveys, which reinforced improved awareness and overall preference for the new program, resulting in increased future purchases and renewal intentions. Member Pricing contributed to an 8.2% product-only comp, which accounts [ph] for the reduction in Gold Card sales we anticipated, following planned Gold Card giveaways during successful chain-wide launch in May and June. We expect Gold Card sales trends to improve as we move forward. In this plan, our investment and product margin moderated from approximately 200 basis points in the launch quarter to approximately 150 basis points this quarter.

We continue to learn and adjust as the Member Pricing program evolves. Among the most important aspects of this evolution is our ability to cultivate our approximately 8.5 million Gold Card members, including the approximately 5 -- 3 million that were acquired during the program's launch, utilizing the additional data we now have access to. We have partnered with dunnhumby, a leading customer relation management firm to maximize this opportunity. With them, we will elevate our direct marketing program, providing customers with an enhanced level of customization and targeting. We expect this program to launch in the first half of 2014. Our primary goals include sustained improvements in customer engagement, including more frequent visits, incremental purchases and retention.

Moving to product development. The 2013 vintage [ph] of new products continues to gain traction, with year-to-date sales from these products meaningfully ahead of last year. Importantly, the success is once again driven by exclusive premium products, including our AMP and Beyond RAW sub-brands, Vitapak and Total Lean.

Also in retail, new stores continue to exceed top and bottom line thresholds. We are confident in our ability to maintain domestic store growth of approximately 115 net new stores each year for the foreseeable future. This plan is supported by an updated market research assessment confirming the potential for approximately 5,000 total standalone GNC stores in the United States. And we are still very excited about the e-commerce landscape, where our businesses are succeeding across the pricing spectrum. GNC.com delivered a 31.7% comp this quarter, significantly exceeding industry growth rates, while also delivering solid flow-through and improved profitability.

Our exclusive branded product offering and dynamic call to action marketing are resonating with consumers, as evidenced by improved conversion and higher average ticket. Separately, LuckyVitamin.com delivered a 14.7% [ph] comp, driven by both an increase in visitors and better conversion. We are meeting our primary goals of growing the customer base and delivering top line growth, while also expanding operating margin rate through improved product margin and supply chain efficiencies.

Lastly, we are expanding our international presence. The acquisition of Discount Supplements provides entry into the world's second-largest sports nutrition supplement market, the United Kingdom, in the fastest-growing channel, e-commerce. Discount Supplements with its loyal and growing customer base is the leading multibrand sports nutrition retailer in this channel, offering a broad selection of competitively priced proprietary and third-party brand products. We expect the acquisition to be accretive beginning in 2014.

In addition to the core business, we are excited about the incremental opportunities Discount Supplements presents. For instance, we've entered -- introduced premium GNC subbrands such as AMP and Total Lean to the site as early as next year. Furthermore, our expertise and exclusive products in the wellness category will be used to complement their already extensive sports nutrition assortment. And finally, we see the potential for Discount Supplements to be a platform for future growth into additional European and Scandinavian geographies.

I will now turn the call over to Mike for details on our financial performance.

Michael M. Nuzzo

Thanks, Joe. Good morning, everyone. As Joe said, GNC once again delivered strong results in a challenging retail environment, while simultaneously making meaningful investments in the business. First, to the consolidated results.

Our third quarter consolidated revenue increased 8.7% to $675.6 million. Retail segment revenue increased 9.5%, franchise segment revenue increased 9.3% and manufacturing/wholesale segment revenue increased 2.4%.

Third quarter gross profit calculated after deducting product, warehousing, distribution and occupancy costs was 37.6% of revenue compared to 37.8% in Q3 2012. The decrease in gross profit rate was due primarily to planned investments in the Member Pricing rollout.

Third quarter consolidated SG&A expenses were 18.9% of revenue compared to last year's of 19.8%. Within consolidated SG&A, advertising and promotion expense was 2.5% of revenue, consistent with Q3 2012.

Q3 2013 net income was $73 million, a 15.6% increase from the prior year's adjusted net income. Diluted earnings per share were $0.76, a 24.6% increase over adjusted Q3 2012 results.

Now for information by segment. First to our Retail segment. Our Retail segment includes domestic and Canadian corporate-owned location and the domestic Internet businesses. Q3 Retail segment revenue grew 9.5% to $487.3 million, driven primarily by a 6.7% same-store sales increase in domestic company-owned stores and the addition of 148 net new GNC stores as compared to the end of Q3 2012.

Q3 retail operating income increased by 7.3% to $92.6 million and was 19% of segment revenue in Q3 2013 compared to 19.4% in Q3 2012. Operating income was negatively impacted by planned gross product margin investments related to the Member Pricing Program. In the quarter, we added 34 net new company-owned stores.

Next to our franchise segment. Revenue in franchising is generated primarily from wholesale sales to our franchisees, the collection of royalties on franchise retails sales and fees. Q3 franchise segment revenue grew 9.3% to $118.9 million. Domestic franchise revenue grew by 10.1% to $67.9 million with the same-store sales increase of 5.9%.

International revenue increased 8.2% to $51 million, driven by an 11.6% franchisee-reported local currency same-store sales result. Our portfolio of International franchisees continue to perform well with nearly all top-15 countries increasing wholesale purchases by more than 10% this year, with the primary exceptions of South Korea and Mexico. Specifically in Mexico, which was affected by regulatory changes, we expect wholesale purchases to return to more normalized levels by the end of 2013. Importantly, this business continues to report positive same-store sales trends.

In South Korea, our business continues to be pressured. However, we've anniversaried the start of last year's downturn with the business reporting strong positive same-store sales for the quarter. We're also working with our South Korea franchise partner to improve our economic model.

Q3 franchise operating income increased 14.6% to $41.6 million and was 35% of segment revenue in Q3 2013 compared to 33.4% in Q3 2012. The increase in operating income percentage was driven by higher gross profit margin.

In the quarter, we added 15 net new domestic franchise locations, 28 net new International franchise locations and 1 company-owned store in China.

And third, to our manufacturing/wholesale segment. Revenue in this segment is generated primarily by third-party sales at our manufacturing facility and product sales to Rite Aid, drugstore.com, PetSmart and Sam's Club. Q3 manufacturing/wholesale segment revenue increased 2.4% to $69.5 million. The year-over-year comparison was affected by the timing of our contract renewal with Sam's Club, which resulted in a new product set and associated channel fill in Q3 2012. On a year-to-date basis, segment revenue grew by 10.3%.

Q3 operating income increased 7.5% to $28.4 million and was 40.9% of segment revenue compared to 39% in Q3 2012. The increase in operating income percentage in the quarter was driven primarily by higher gross profit margin, mainly generated by operating efficiencies at our manufacturing facility. We opened 17 net new Rite Aid store within-a-store locations in the quarter.

Next to our balance sheet and cash flow. Through the first 9 months of 2013, we generated $215.4 million net cash from operating activities. We spent $33.6 million on capital expenditures, primarily for new stores, store maintenance, updates and remodels, corporate IT and other manufacturing facility expenditures. We generated $180.7 million in free cash flow. We paid $43.3 million in cash dividends on our common stock, and we repurchased $238.4 million in shares of common stock under our share repurchase program, resulting in $11.6 million remaining under the existing $250 million authorization. We anticipate completing this authorization in the fourth quarter of 2013, and view capital return to shareholders through ongoing consistent share buyback as a key element of our future financial plan.

As of September 30, 2013, we had cash balance of $77.7 million and long-term debt of $1.1 billion. We have an undrawn $80 million revolving credit facility with $1.1 million pledged as collateral for outstanding letters of credit. After quarter end, on October 2, we acquired Discount Supplements for GBP 21 million, inclusive of a GBP 3 million performance-based purchase price adjustment. Total consideration in US dollars was $34.1 million.

Now I will provide an update to our 2013 outlook. We expect adjusted diluted earnings per share to be approximately $2.85 to $2.89, a 22% to 24% increase over 2012 adjusted EPS. This represents an increase over our previous outlook and is due to a reduction in the full-year diluted share count based on share repurchase activity through Q3 of this year to achieve a high single-digit increase in domestic retail same-store sales in the fourth quarter of 2013.

That completes the financial update. I will now turn the call back over to Joe to discuss our supply chain initiatives.

Joseph M. Fortunato

Thanks, Mike. The company is making supply-chain investments to provide more scalable and efficient operations, to maintain service levels to our stores, as we continue to expand and to allow for improved inventory management. The net effect of these initiatives is expected to be neutral to marginally accretive beginning in 2014. All financial elements of these initiatives are included in transportation and distribution costs, which are a part of cost of sales and therefore reported in net margin. We will begin to utilize our new distribution center in Indiana in early 2014 and expect to be fully operational in the back half of the year. We anticipate this capacity addition will serve our needs for the foreseeable future.

We also completed our transition to a more cost-effective third-party, pooled carrier transportation network, moving away from our existing private fleet. We expect this initiative to provide more than $5 million in pretax savings annually. This transition took effect in October and will result in a one-time pretax expense in the fourth quarter of 2013 of approximately $8.5 million for employee severance and early lease termination on transportation equipment. Our 2013 adjusted EPS outlook does not include this one-time expense.

In closing, the strength of our business model, which provides consistent profitable growth and generates substantial cash flow allows us to continually invest in initiatives that grow our business and positions GNC to gain market share. We are expanding our infrastructure, entering new geographies and substantially improving our direct marketing efforts to capitalize on our expanding customer base.

Now we are available to take your questions. [Operator Instructions] Thank you very much.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from the line of Chris Horvers with JPMorgan.

Christopher Horvers - JP Morgan Chase & Co, Research Division

If you could talk about what you're seeing from the consumer -- we've heard preannouncements from pet food retailers, DIY auto parts, so just curious what you're seeing, and if you think the Gold Card is just simply overwhelming that? And then in terms of the Gold Card pull forward, the comp, how should we think about the fourth quarter?

Joseph M. Fortunato

I'll start with the last question. I think the comp, as we indicated earlier in the year when we did this program or converted to the Member Price Program, is going to continue to decline. What we would think about for the fourth quarter? It came down from 200 basis points, I believe, last quarter to 150. I would see a trending down towards 100 and then continuing to trend down from there. And I don't think there'll be much impact as we move into next year. So we always thought it would phase out by the end of the year, the impact from the Gold Card, and I still think that's true. But you're still going to see some impact in the fourth quarter. In regards to the consumer, Chris?

Christopher Horvers - JP Morgan Chase & Co, Research Division

Yes.

Joseph M. Fortunato

In regards to the consumer, I think we're still seeing a good consumer base, and I would agree with you on the fact that because of this transfer to this program, we continue to deliver the expectations we thought we would under the program, which are are very strong. And hardly anything that we thought would happen is not happening, and we are seeing -- I just went through this morning actually and see a good return rate from our consumers that we gave the cards away from -- away to, in May and June. So in general, the consumer, I think, seems to be -- not as everybody else has indicated in retail. And if you go back in history -- I've always said this; this business, whether it's through economic downturns or through softer retail environments where the consumer is a little more hesitant or skeptical or whatever the reason is causing them to spend less, we rarely see that in this business and we really haven't seen that to date. But I think, overall, you looked at MBJ data -- I'll hit it now while -- probably going to be a question on it -- is that the forecast for MBJ data is still very strong, and actually stronger than they have forecasted into the next 5 years a year ago, but off from the growth rates that we've been seeing in '11 and '12. So with -- but at GNC right now, I can tell you, we're not seeing those same retail consumer trends that it seems that other people are seeing.

Christopher Horvers - JP Morgan Chase & Co, Research Division

On the MBJ data, do you think that that is -- is that -- is the industry expect to grow -- I think it was 7% last year. Is it more low to mid this year and then mid-single digit going forward?

Joseph M. Fortunato

No. Actually, it actually ended up in the 10% range in 2012, and it's forecasted to continue fairly strong especially in sports again, which is one of our core businesses' strengths. But the 7%-plus number is kind of the indicator for the next 4 or 5 years, and that is higher than they had projected for '14, '15, '16, '17 and '18 before, but it is down from the 10% -- the earlier gross rates that they had, but not significantly down. I mean, there's not a major change at all. I think the -- some of what you may be seeing as they're forecasting a slight decline is because they're not taking into account -- remember, they're giving you a total revenue growth, so they're not taking into account a lot of what has been sports pipeline fill into the mass market over the last couple of years, which is not going to continue. Obviously, pipeline fill goes away, and you're living off term.

Operator

Your next question comes from the line of Kate Wendt with Wells Fargo Securities.

Kate Wendt - Wells Fargo Securities, LLC, Research Division

Just want to start out with -- on retail revenue. It came in a bit lower than we expected, not really from the comp but from the contribution from new stores. Can you talk a little bit about the timing of new store openings in the quarter? Were they weighted towards the back half of the quarter?

Michael M. Nuzzo

Yes, Kate. You're spot on with that. So this quarter in particular, most of the stores that we opened in the quarter had an average of 1 month or less in sales. So that -- our indicators and our measurements on new store productivity are really strong. And obviously, we're -- well over 100 new stores opened so far this year. We'll easily hit the 150 net in openings in corporate, and we continue to see a nice pipeline go forward in 2014. So yes, it's more of an issue of the timing of the opening of those stores within the quarter.

Kate Wendt - Wells Fargo Securities, LLC, Research Division

Okay, great. That's good to hear. And then...

Operator

That question has been withdrawn. Your next question comes from Mark Wiltamuth with Jefferies.

Mark Wiltamuth - Jefferies LLC, Research Division

Will you give us a little trend on how the traffic is going from the third quarter into the third quarter? And if you can give us an indication on whether or not you think you're still on track for Gold Card accretion in the second half offsetting the dilution that occurred in the second quarter?

Joseph M. Fortunato

I'll start with traffic. Traffic is -- trends are strong still and continue to escalate, become a significant part of the comparable store sales growth that we're seeing. So that's all what we expected, and that's still occurring. Repeat the accretion question on Gold Card.

Joseph M. Fortunato

So the dilution for Gold Card was kind of $0.05 or $0.06 in the second quarter, and you'd indicated you thought it would turn accretive in the second half and kind of offset that initial dilution. Do you think you're still on track for that $0.05 or $0.06 of accretion in the second half?

Michael M. Nuzzo

Yes, Mark. And we sort of built -- as you can see, we built the guidance around that expectation.

Mark Wiltamuth - Jefferies LLC, Research Division

Okay. And did you turn accretive? Or do you think you're accretive right now here in the third quarter that was just reported?

Michael M. Nuzzo

Yes, and I think that we indicated that we would be moderately accretive, and then we would accelerate that into the fourth quarter.

Mark Wiltamuth - Jefferies LLC, Research Division

Okay. And just -- can you give us a little more detail on what you'll be doing with dunnhumby and just how broad the couponing or promotional efforts will be once you get started with them?

Joseph M. Fortunato

It's hard to give you a detail. I'll tell you, obviously, we hired them because they're one of the top firms in the nation in regards to consumer research marketing, and that we have this huge database now that we've set out and have accomplished, attracting almost 9 million Gold Card members at this point in time, and even more e-mail addresses. And in our minds, obviously, we feel that the database is so large right now. It needs to be customized more than generically approached with the direct mail process, our direct marketing process to get to these consumers most effectively and most efficiently. So that's what they're going to doing. We are now downloading data to them on all our consumers' purchasing habits over the past couple of years. And we are going to look -- going forward, they will understand and help us do the algorithms in regards to how we should be contacting our consumer, how we should be rotating messages and how many times we are attracting or sending notices to consumers and the couponing efforts. And some of them will be -- well some of what we're doing now, some of them will be much more customized. What we're looking for is the ability to go to the consumer and be able to customize [ph] as to what they bought before, how long it's been since they bought it, if they bought a Vitapak. It hasn't been 60 days since they've been back. Why have they not been back for a Vitapak? Provide them an offer for a discount off of Vitapak. I mean, there'll probably be 100, 200 different types of very customized direct marketing messages being sent to consumers on a regular basis.

Mark Wiltamuth - Jefferies LLC, Research Division

Will you be upping your marketing spend or just reallocating what you got today?

Joseph M. Fortunato

It will mostly be reallocation. I'm looking at some up in the marketing spend, but you got to remember last year, we spent an additional $6 million. A big part of that was direct marketing in regards to the new Member Pricing. So it will be down from the total spend, but it will be up from what the normal run rate spend would've been.

Operator

Your next question comes from the line of Simon Gutman.

Simeon Gutman - Crédit Suisse AG, Research Division

It's Simeon Gutman. So Joe, you touched on something on dunnhumby that I wanted to address as well, and it sounds like the secret sauce is retaining and then growing the wallet share with the new customers. So if you look backwards at some of the markets, and I realize it's a small percentage, but if you look at some of the markets where you've been in place for a while, does the data support that the retention and the share wallet is working? And then tied into that, can you talk about the genesis of using dunnhumby? Was that the intention of this plan all along? At what stage did they come into the process?

Joseph M. Fortunato

They came into the process right about the time we decided to do the program. So we felt that -- and clearly, that accelerated once we saw the success with attracting new names and new customers to the program, the need to be able to go external with this and get somebody that that's their core competency and one of the leading firms in regards to direct-to-consumer marketing. We felt that was necessary after we saw the success of the program. We thought about it and were very much along the lines of doing that anyway prior to the program. If you look at the -- the first part of the question was...

Michael M. Nuzzo

As far of the older markets...

Joseph M. Fortunato

Yes, the older markets. Here's what's kind of interesting, and I just looked at some of this this morning. So it's in the early stages. We are looking at the cards we gave away in May and June, those new -- 3 million new customers that we attracted through the giveaway program, and the repeat shopping where that customer has already come back is pretty significant. So I'm very pleased with that already, and I think anything we do at dunnhumby will certainly give us the opportunity to accelerate that repeat shopping pattern and attract those consumers back to the stores. So you look at 3 opportunities with dunnhumby, and they should -- always should be the direct marketing opportunities. One is get those people targeted on those 3 million names back into the store. Get them back regularly. Get them to spend more money. Keep our current Gold Card customer base so you don't get bleed off. So retention is critical, and then how do you manage your existing customer base that kind of makes up the real loyal component of your Gold Card database. That, I think, will be enhanced significantly. You got to remember, we've been doing this all manually, technically, manually, over the past number of years. So the need to go to this direction is critical and we knew it going into the program. The success of the program accelerated that thought.

Simeon Gutman - Crédit Suisse AG, Research Division

Okay, and then a quick follow-up is, the retention offers -- on the topic of retention, we've noticed that some of the offers in the New York market, which is about a year old now, they're coming in at a little bit of a promotional rate. Is that a targeted promotional rate to folks who either had a slower spending history? Or is every customer in those markets being targeted that way?

Joseph M. Fortunato

Yes. It's different. It's different but it's -- there's different messages that go out. So in other words, again, breaking it into those 3 buckets we look at, if a customer hasn't come back, we send them an offer. If that customer still don't respond to that offer, we enhance the offer. So the goal and objective is, no matter what, get them back. And if it has to get much more promotional, it does through a sequence of mail. The other initiative is, as soon as people join, they get a welcome mailer with a pretty fair promotional offer on it to come back to the store and shop. So the sophistication of that will rise tenfold, but what you're seeing in that market could be 3 different types of messaging depending on where you stand in the database of consumers at any one point in time. And again, what I've been happy with nationwide is we've seen -- I think we've talked about this on the last call. When they first come in and shop, those 3 million customers, they're not going to spend as much money. When they come back in, can we upsell them to the better products, which we're fantastic at? Can we get them to spend more and cross sell them? And so far, each time we've seen this consumers back to the store, their average ticket has gone up. So that's a huge success for us, if we can continue to do that and continue to drive them back into the store on a regular basis.

Operator

Your next question comes from the line of Karen Short with Deutsche Bank.

Karen F. Short - Deutsche Bank AG, Research Division

Just commenting -- back to the consumer for a second. Joe, in your opening, or in your actual prepared remarks in the press release, you comment on the pressures on the consumer. I don't know, I haven't seen that in the past. I was just wondering if there's any color there because your comments just earlier on -- to one of the first questions would not seem to indicate that you're seeing pressure on the customer.

Joseph M. Fortunato

So we're -- my comment there was more around the retail consumer in general. We've seen and you have seen a lot of comments in regards to some softness in the retail environment and reflecting back on the consumer spending habits slowing a little bit. And you've even heard it from some of the people in this industry that they're seeing some slowdown in regards to the spend levels of their consumer, and that's why it was addressed that way. Really, it wasn't an indicator of what's happening with us, but it was more a response of we're very happy to be delivering 8.2% product comps. And if you think about the discounting that's taking effect, another 150 bps, we're closing on almost 10% comparable store sales growth as we negate that pricing effect that we've had at -- discounted 200 bps, now about 150 bps and lower as we progress into 2014, as we told you. That effect right now though, if you netted up everything, you'd say, "This is almost a 9% to 10% comp rate." And -- so that wasn't geared towards what's happening with us. We're not seeing that with the customer, but it is geared towards what was happening, kind of what really happened with those results because they're in line with what we thought was going to happen. And more so, there is -- does appear to be among the retail community a softening of the consumer.

Karen F. Short - Deutsche Bank AG, Research Division

Right. That's very helpful. And then just on your CapEx for fiscal '14, the $20 million that you call out, is that incremental spend to your normalized run rate? Or is that -- we should we kind of expect next year's CapEx to still be kind of in line with what it's been historically?

Michael M. Nuzzo

Good question. It should be incremental. How much incremental I think we'll give some guidance on when we talk about the 2014 expectations. But the bulk of our CapEx today, the normal run rate CapEx, goes to new store development. And so clearly, we have all the expectations to continue that in 2014. So yes, it will be incremental. And as we talked about in the press release, I think it's for all the right reasons and it's to support growth in the business and we'll obviously plan it out very carefully.

Karen F. Short - Deutsche Bank AG, Research Division

Okay. So then, next year, as we're looking at free cash -- for free cash flow allocation, should I think [ph] mostly to share buybacks and dividends? Although it sounds like it may be a little bit less just given the incremental CapEx.

Joseph M. Fortunato

Well, you also got -- if the business continues as we intend it to go with growth rates, we'll be generating more cash.

Michael M. Nuzzo

Right.

Joseph M. Fortunato

But we intend to maintain the dividend program, obviously, and we'll decide what we're going to do with that as we move forward into next year. And the buyback program is on the top of our list and we've already have discussions with our board about it. So that will be something that we'll be addressing in the next month or so as well.

Operator

Your next question comes from the line of Mark Miller with William Blair.

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

Could you provide perspective how you're adjusting the discount for Member Price Program versus Gold Card? So it had been 20%. We're estimating a discount in a double-digit type range, low double-digit. Is that roughly the rate range? And then, are you testing different discounts in different markets? I guess, as you're seeing the data, I was wondering if you might want to adjust up or down that discount going forward.

Joseph M. Fortunato

We're always evaluating the Gold Card programs. And right now, the discount is -- part of going to Member Pricing was to get the opportunity to better manage our pricing schemes, be more competitive on a product-to-product basis in the off-brand products, get to premium for our brand as always, and be able to keep like a treasure hunt mentality where everything isn't 20% off. I never liked that we were giving everything in the store 20% off because of peripheral items. You don't have to. It's the key high-profile items that you have to stay in a certain range, but it doesn't have to be to 20% either. So the flexibility of this program gives us besides curing some of the price perception issues and some of the other matters with retention, or getting all the data from consumers, it provides us a tremendous amount of flexibility to price up and down as we want. So we can have 50% off a certain product this month, 25% off next month, 10% off, we can have 5% off, we can -- it's just a tremendous flexibility tool. So I look at the discounting and say, "Right now, we're still running in that range" -- because you can't shock the consumer. You're still running in that range of 18% to 22% for the most part. But as we move forward into next year, and the reason we'll go from 200 bps to 150 bps you currently see in the discounting down to probably less than 100 bps as we move through next year is we're going to start tweaking that pricing effectively to make sure we're maximizing our margin dollar opportunities and staying competitive where we need to be, but not giving away double discounting on certain things because of sale in Gold Card and giving away product on the peripheral and that you don't have to do it.

Michael M. Nuzzo

And I think Mark, just to add, we've experimented with different pricing structures in different markets before. We'll probably still do a little bit of that. But again, I think we look to the Member Pricing program as a way to be more consistent across the chain and then build additional promotional events either through direct marketing on top of that. And those could be focused on particular markets.

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

Mike, you've had real good cost control. What have been the biggest drivers of that? Just how should we think about corporate expense going forward?

Michael M. Nuzzo

Yes, corporate expense was a little bit lower than the normal run rate this quarter. Incentives were a piece of that. Health insurance was a little lower. Lower legal cost, lower IT. I mean we always talk about sort of a normal run rate growth in low single-digits, and I think that's probably respectable going forward.

Operator

Your next question comes from the line of Meredith Adler with Barclays.

Meredith Adler - Barclays Capital, Research Division

Talk a little bit about -- you mentioned the potential for 5,000 domestic stores based on a new kind of market study. Could you talk a little bit about that study and what might have changed and given you the potential to open even more stores?

Joseph M. Fortunato

Well, I think all along, we've been -- probably for the last 2 years that we've thought there was at least 1,000-store upgrade from where we were at, we got very conservative and said, "Well, let's just talk about 500." The confirmation from Buxton at that time said there's probably 1,000. You can't always land all the leases, the right locations at the right timing and everything, so we felt the 500 was reasonable. You can see that the new store results are extremely strong. I mean, these stores are just performing, almost across-the-board without exception, extremely well and exactly or better than our expectation. So as long as that keeps happening, we're going to keep opening stores. To confirm that we are doing the right thing, and -- we went out and revisited Buxton again and had another survey done. And Mike, I think the results of all that and their feedback was we have another source to go [ph].

Michael M. Nuzzo

Right, and that's where the 5,000 comes in. And then yes, Joe's point, it's a combination of the fact that our stores, in particular new stores, have performed exceptionally well over the last couple of years, since we did the 2010 study. And then also, we've found that we're having success with new stores in smaller markets. So even rural markets where we would have 1 store or maybe 2 stores at the most, there seems to be a lot of white space remaining in the U.S. for additional store count in those markets. And we've always talked about the success of adding stores to even large markets like New York and Chicago. There's still, to some extent, that as well. So it's a good combination of growth that, at least from the external analysis, we're seeing.

Meredith Adler - Barclays Capital, Research Division

And would you -- I don't know, this is probably just speculative. But would you say that the reason you can open multiple stores in smaller markets is because the whole concept of healthy living, healthy eating is really becoming more mainstream? Or is there anything else?

Joseph M. Fortunato

I think if you look at the growth in the industry again and you go back over a period of time when we weren't opening many stores for a few years, and we wanted to see how the market and our stores were maturing and the opportunities, the general growth rate and our ability to continue to take market share and grow this business faster allows us to go into these markets and be more opportunistic than before. So it's certainly -- I think it may be kind of a guess on our part and your part, but the reality is I think you're right. The lifestyle change and people living a healthier lifestyle and the industry growth allows you to go out over a period of time -- if you look at the growth in the industry, what was 4 or 5 years ago in a market is no longer the same. So that gives you provided upside opportunity.

Meredith Adler - Barclays Capital, Research Division

And then, I'd just like to ask a question about the change in the way you're going to handle transportation. Obviously, that is -- there is a savings to that. That's a good reason to do it. I was just wondering what might have prompted you to consider making the decision? Was there something -- did you need to put more capital in transportation or just somebody told you you'd save money?

Joseph M. Fortunato

No. I actually have felt for a couple of years that we had become a little antiquated in regards to what's going on in the world of transportation, having your own fleet, having your own drivers. We had a pretty mature driver base, so our overhead production was pretty high. And when we brought in a new head of distribution and transportation recently, that was one of the initiatives we put him on immediately is to -- if we got rid of our own fleet and went with a full carrier system, or any option, how would that look? And it came out very favorable, which was no surprise, truthfully. It was probably a little more favorable than I expected, but it was certainly no surprise that we would most likely save money by going to this type of system. And it's a big change. I mean, it's a big move and we've done it successfully. We're happy so far with the transition. So another good thing where we're now able to make these kind of looks at the business, whether it's logistics changes, efficiencies, beyond what we were doing before to continue to add value to the bottom line.

Operator

Your next question comes from the line of Peter Benedict with Robert Baird.

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

Just thinking about the dunnhumby stuff, it sounds pretty exciting. As we think to next year, you think about your ad ratio, typically 2.5% or so in that range. With all that going on next year, I mean, do you see an opportunity to leverage that number next year? Or do you think it more stays stable?

Joseph M. Fortunato

I think you're going to see leverage in the first quarter, because the spend, as we're looking at right now, will not be as significant because of the transition period and everything. We're going to do kind of our standard spend. We had spent on TV last year in the first quarter, and since that campaign, I'd rather hold off on that campaign and do more of the standard marketing efforts in the first quarter. We are going to probably double, quadruple our spend on digital and mobile, as everybody else in the world is doing, if not more. But we also have a lot of one-time spends last year, whether it be billboards, some initial one quarter of TV spend, that we have abilities to utilize those monies in different ways. And so I don't see the percentage rate changing in the spend as a percent of retail. It's going to be pretty standard. It may be a little flipped from quarter-to-quarter next year versus what it was this year. And then obviously in a different arena. I mean, in different ways to spend the money; dunnhumby, digital, mobile, all the things I mentioned.

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

Sure, that makes sense. And then moving to the inflation front, I mean, is there anything going on in the business, any categories where you'd call out any kind of a notable change in inflation, either benefits or pressures year-over-year?

Joseph M. Fortunato

No. We're happy to see that -- we just have got some early indication of cost changes on the raw material side just this week, and that looks good. We don't see anything that looks like it's going to affect to the upside in cost. And whey proteins seem to have leveled off pretty well, and that expectation is that will continue because there's more supply coming online. And we just renewed our agreement with Glanbia, who you know is our major supplier of our whey proteins and owns the dairy farms and cheese factories in the United States, the Ireland company. And we're very favorable about some of the challenges we've had on that side and been able to absorb over the past year or 2 years in regards to the whey protein side of the business. Looks like it's leveling off, and all raw materials in general look like they're in pretty good shape.

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

Okay, great. And then just the last question. With the Gold Card program obviously spreading out the traffic more evenly across the month, can you talk about the labor efficiencies and the supply chain benefits that you're expecting to get from that? I would assume that there'd be something there.

Joseph M. Fortunato

Yes. We definitely expect to get some. We brought in another individual onboard that's going to help manage manufacturing distribution in some of International business for us. He has some strong supply chain and manufacturing background. We always thought that some of the fallout obviously to the upside would be that as we transitioned this program, 2 things happened. One is, it transitioned to a much leveler playing field very fast. So that $6 million that we spent on direct marketing really was impactful because I haven't seen us transition a program as effectively or quickly to get to a more even week-to-week type basis of business than I've seen this time. It usually takes a year to filter through. So now, it gives us the opportunity to go out and manage through these logistics issues. And to me, it should equate to an overall reduction in inventory because we don't have to do these massive uplifts we used to have to do for Gold Card week to make sure we manage enough inventory through 50% of our sales occurring in 1 week, and we are doing other things in the distribution side of the business. It gives us the ability to improve, I think, again, inventory levels and hopefully gain efficiencies on the distribution side, which you're seeing on the transportation already.

Operator

Your next question comes from the line of Matthew Fassler.

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

This is Steve Tanal and Matt Fassler here. We were wondering, just on the 4Q guidance for the comp, is that comparable to the 6.7 you guys did this quarter or more like the 8.2 if you add back the giveaway impact?

Michael M. Nuzzo

Well, I would say this. I would say that the range of high single-digit in Q4 should probably encompass both. So as Joe indicated, we'll still be impacted by the really successful Gold Card giveaway from Q2, but it will be less of an impact than in Q3. And everything else evolves with the momentum of the business. We feel comfortable with that range really for both. So that gap is only -- and -- with Gold Card sales.

Joseph M. Fortunato

Yes, that gap has started to obviously decline, as I indicated earlier. So what you're seeing in the comp includes that, but it is definitely narrowing to probably 1% or less.

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

Got it. Okay, and did September -- how did September progress? It seemed to us as though things were maybe a bit stronger when we heard you guys last at our conference. Just curious how the quarter ended.

Joseph M. Fortunato

It's really hard for us to gauge, but the quarter ended fine. I think we were satisfied in general with the quarter. And September didn't indicate anything different to us than we have been seeing. So I think we were very satisfied. The harder part for us these days is when you knew after Gold Card week where your business was going to be because you had 50% of your sales done already, now it's -- we have to kind of work our way through. So when you saw us, we hadn't gone through the month yet, so it's a much -- a little bit more of a guessing game until we get a little more season in regards to how these sales transition through the month.

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

Understood. And last one just on gross margin --

Joseph M. Fortunato

An educated guessing game.

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

I'm sorry?

Joseph M. Fortunato

An educated guessing game, obviously.

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

Yes, of course. Of course. Understood. And just the last one here, on gross margins. You guys beat us handily. We were wondering if you're sort of dialing back member discounting maybe faster than you thought you could at this point in time.

Joseph M. Fortunato

No. And I can tell you on the net margin front, it came in pretty consistent with our expectations. That we would invest -- in this case, the 150 basis points in the pricing and that we would get leverage and occupancy. We had better margins, as we were anticipating with some of the other businesses, franchise and wholesale. So it definitely met our expectations, and the leverage dynamic played out as we expected, really.

Operator

Your next question comes from the line of Michael Weisberg.

Michael Weisberg

A few things. I noticed -- someone asked the question about smoothing of revenues across the quarter. Salary and benefit is going up at a really low rate. I think it was up 1% year-over-year in the quarter and about that for the 9 months. Is that a sustainable number? Why is that happening? And is it because you can manage your labor better, since you have a more smooth retail sales across the month? Is that the reason?

Michael M. Nuzzo

No, Michael. We historically do a really good job of managing labor expenses. But the real issue here is -- it has to do with the incentives both in the field and in the home office. But -- and obviously, there was a little bit of growth in the rate. But I think we are getting a little bit of benefit in some of the larger stores that use more part-time hours. They're able to space out their allocation a little bit more. But as you know, we've got a really good fixed cost structure in our stores with labor, and that doesn't tend to fluctuate too much.

Joseph M. Fortunato

And we were able to reduce that a little bit it as we went through the quarter last quarter, just because of what Mike said. When you're spreading out the business, you can manage your labor force much more effectively.

Michael Weisberg

Right. Because I mean, you always talked about maybe low single-digit increases there, or maybe a little bit more, but you're running way below that pretty consistently this year.

Michael M. Nuzzo

Yes. I wouldn't expect that to continue.

Joseph M. Fortunato

I think it will still be low single-digits, Mike.

Michael Weisberg

Okay, that's great. What is the gnc.com impact on comps?

Michael M. Nuzzo

140 basis points, same it was in Q2, I believe.

Michael Weisberg

140 basis points? Okay, great. And what was -- what were constant currency in -- the franchisee -- International franchisee constant currency number?

Michael M. Nuzzo

11.6%.

Michael Weisberg

Okay, that's a good number.

Joseph M. Fortunato

Because those markets continue to be extremely strong. I mean, on a 2-year basis, 18% or so, and all year, over 10%.

Michael Weisberg

That's great. Yes, and then maybe one more quickie, if I can. Typically, I think the incremental comps you get for -- on the new Gold Card stores versus the control group tends to accelerate as you move through the month. Now we're sort of in month -- you were in month 3, 4, 5 at the end of the third quarter. Have we seen the full impact of that sort of steady increase? Are we sort of at full-bore now? Or can we expect some incremental to the comp just as this program gets more mature?

Michael M. Nuzzo

Well, I think we've always thought that we'd be seeing some, and you've seen it so far all year. Second quarter escalated some into the third quarter. But I mean, if you look at the business in general, I think you have a consumer that hopefully continues to visit the store at a better rate. I would look more on the compares. I mean, we were against the strongest quarter in the history of the company in the third quarter and the strongest quarter certainly last year at a 9% comp. So when you start looking at the softening of the comp last year and your compares, you should be able to generate a reasonably strong comp in the fourth quarter and especially if you get some acceleration in that consumer base. I think we'll basically benefit the most from that consumer base when we get dunnhumby all -- completely up and running, which looks like it's going to be around the April 1 of next year. In the meantime, we're going to do every effort we can to keep that consumer base accelerated and motivated. And so far, their return to the stores has been good and their spend uplift has been good.

Operator

Your next question comes from the line of Kurt Frederick with Wedbush.

Kurt M. Frederick - Wedbush Securities Inc., Research Division

I want to touch on just the online business for a second. With the recent acquisition, it looks like it's going to be pushing close to 10% of sales now. Over the last couple of quarters, there's been an acceleration in both the gnc.com site as well as the Lucky site, although the GNC site's seems to have a much higher growth rate. So I wonder if you can address that, and then just kind of with the International strategy or plans, just longer term, what your expectations there are.

Joseph M. Fortunato

I think the GNC has always -- has been strong certainly for the last few years. But I mean, when you're doing the comp, the 30% comp, I mean, that's pretty darn strong. And even above -- I mean, we looked at the e-commerce industry growth rates, they're running probably close to 15%. I mean, we are doubling that performance, which is outstanding. I still equate what happens on gnc.com to twofold. One is that the -- it reinforces the value of our brand because a lot of sales on there are obviously branded. And the second thing is that we are getting more sophisticated in nurturing an e-commerce online consumer compared to how we were. I mean, remember, we were still in the infancy of the e-commerce business a couple years ago. So as we move forward, we're getting much better at how we go after, attack offers and generate business to that site, and then conversion. So that's just a maturing of, I think, our in-house knowledge and ability to continue to nurture that consumer base. Overall -- and I think on the International front -- I'm sorry. On the International front, when you look at Discount Supplements, we're really, really happy with that acquisition. Just like we did with Lucky, it got us into a different kind of business than we were in before. With third-party distribution of products more in the discount channel, this even gives us broader opportunity. I think they are a -- basically a sports nutrition business, again, fitness nutrition business, which right is in our sweet spot. We have the ability to bring our product lines, our subbrands into that market in U.K. and our full branded product line into the rest of Europe through that channel. And we're looking at expansion into Scandinavia and Europe once we get the plan of attack completely outlined and how we're going to utilize and uplift that discount sports nutrition business in general. The other benefit to it is they do very little in supplements right now. And we have, obviously as you know, tremendous lines of products that would feed extremely well into that market, the GNC type product lines, Mega Men, Women's Ultra Mega, Vitapaks, various things like that. So the ability to expand on that business is probably much better than even the ability was there to expand on LuckyVitamins.

Operator

Your next question comes from the line of Kate Wendt with Wells Fargo Securities. Okay, and that question has been withdrawn.

And at this time we have reached our allotted time for questions. I would like to turn the call back over to Mr. Fortunato for closing remarks.

Joseph M. Fortunato

Well, I just appreciate everybody joining us again today. I appreciate all your questions and inquiries, and I think we're -- again, I'll highlight how happy we are with the continued trends of the business and the ability to -- I keep highlighting with everybody, this business is consistency, consistency, consistency. And I think we show that quarter after quarter on how we deliver on all segments of the business. So I appreciate your time again and look forward to talking to you next quarter.

Operator

Thank you for participating in today's conference call. You may now disconnect.

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