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GNC Holdings (NYSE:GNC)

Q3 2012 Earnings Call

November 01, 2012 10:00 am ET

Executives

Dennis Magulick - Senior Director of Treasury & Investor Relations

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

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

Analysts

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Mark Wiltamuth - Morgan Stanley, Research Division

Christopher Horvers - JP Morgan Chase & Co, Research Division

Brian Wang - Barclays Capital, Research Division

Simeon Gutman - Crédit Suisse AG, Research Division

Kate Wendt - Wells Fargo Securities, LLC, Research Division

Damian Witkowski - Gabelli & Company, Inc.

Michael Weisberg

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

Operator

Good morning. My name is Heather, and I will be your conference operator today. At this time, I would like to welcome everyone to the GNC Third Quarter 2012 Earnings Release Conference Call. [Operator Instructions] After the speakers' remarks, there will be a question and answer session. [Operator Instructions] Mr. Dennis Magulick, Senior Director, Treasurer and Investor Relations, you may begin your conference.

Dennis Magulick

Good morning, and welcome to the GNC Third Quarter 2012 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 a brief overview of the business. 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 in this call, please refer to our public filings with the Securities and Exchange Commission and our earnings release this morning.

I'll now turn the call over to Joe.

Joseph M. Fortunato

Thanks, Dennis. The GNC brand is recognized by consumer globally for its quality, integrity, trust and innovation. We have been the leading brand in this industry for over 75 years. Our distinct ability to deliver world-class products, unique formulations and great customer service is a key differentiator that continues to drive our success. That position was established by dedicating the GNC brand, our organization and strategy to nurturing our loyal and elite healthy lifestyle customer base who trust the GNC experience.

First and foremost, differentiation is created through a unique in-store experience, which has, at its core, a premium product offering highlighted by proprietary flagship brands in each major health and wellness category. The assortment is delivered through collaboration between our merchant, field and product development teams, who are experts in the industry. They effectively anticipate market trends and the unique customization and future unmet needs of our lifestyle consumers. This product guides our product development efforts, resulting in a broad complementary assortment targeted to specific customer segments. Our new products are innovative, and create separation in the marketplace. Our expertise focuses on customization for our health and wellness consumers' needs, which builds tremendous brand loyalty.

These products and sub-brands drive the business. They also create equity with consumers that builds over time. Consequently, the successful launch of new flagship brands supports growth over multiple years, driven by increased customer acceptance and key product line extensions. This [indiscernible] effect contributes to sustained multiyear revenue growth. For example, Pro Performance has grown from a $50 million house brand to more than $275 million, the largest sports nutrition brand today. This growth was driven by sub-brand development such as Pro Performance AMP and product line extensions, the result of extensive research, merchandising, expertise and a deep understanding of our customer.

More recently, Beyond RAW was successfully launched in 2011. In 2012, we introduced 5 additional products. Through increased acceptance of the line and these recent product extensions, Beyond RAW's sales will increase by nearly 50% this year.

Similarly, Total Lean was repositioned about 3 years ago. We introduced very successful ready-to-drink offerings followed by new Lean Vitapak and snacks. This year, Total Lean sales will be more than 50% greater than in 2011.

With these product line, we have quickly established a leading position in the meal replacement category. And our Vitapak business continues to grow through increased customer acceptance and better segmentation. Since the launch of the current program about 4 years ago, sales have increased on average more than 25% annually. This unique combination of elite customers and the product development life cycle provide a sustained competitive advantage. Examples like these have contributed to our year-to-date 2-year comp up 22.3% and 3-year comp up 27.8%.

Second, GNC's in-store experience is further differentiated by a trusted team of store associates, credible and trained on helping customers find the right product for their needs. In addition, we allocate significant in-store shelf space to educating our customer, which, again, differentiates us from other retailers.

Third, we have been successful in our customer acquisition efforts. We now have 5.8 million active Gold Card members, nearly 20% more than 2010. And we've grown our email database to over 10 million names, 75% more than in 2010. We believe there is tremendous opportunity to drive additional business by effectively capitalizing on this data with improved direct marketing, and by proportionally allocating more resources to these efforts.

And fourth, I'm especially excited about a major effort to evolve the Gold Card program. As many of you know, we are changing Gold Card from a fixed 20% discount the first week of the month to an everyday variable discount member price model. Our goals are straightforward: Simplify pricing and promotions for our customers. Address our customers' #1 criticism of the Gold Card program by allowing all members to use the Gold Card every day of the month for added convenience. Drive incremental sales, traffic and margin dollars and capture complete customer purchasing habits, maximizing our direct marketing efforts and allowing for improved segmentation.

We started the evolution in August 2010 with one test market, Kansas City. At the beginning of 2012, we launched in Denver and Buffalo and converted 3 additional markets where we have been conducting other pricing tests. In each case, to help launch the program, we used Gold Card promotions and incremental marketing for the first 2 months. We also gradually managed the conversion to everyday member price levels to effectively appeal to both existing and new Gold Card members.

The results in test markets have been both extremely consistent and meaningfully positive. Using the rest of the chain as a control group, which has generated a 12.8% comparable store sales year-to-date, these markets have shown out-performance in the high single digits for both sales and transactions. That Kansas City market reflects the same out-performance relative to the control group over the cumulative 26-month period, showing a sustained 2-year trend.

Participation in the membership program is up significantly in every test market, providing visibility into customer purchasing behavior for 90% of our sales. Gross margin dollars and percentage are lower than control in the first 2 months of the period. But then as expected, gross margin dollars rebound to consistently outperform the control group as we moved beyond the initial phase.

In addition to the numbers, the feedback from store managers and customers is overwhelmingly positive. In October, we launched Member Pricing in New York, Chicago, St. Louis and Omaha markets as a significant next step. We are following the same formula as in the previous test markets. This includes investing gross margin and marketing dollars in the initial phase, which will impact Q4 due to the size of the New York and Chicago markets. With the addition of these recently converted markets, approximately 1/3 of the chain is now on Member Pricing program. Assuming continued success with the addition of these markets, we will plan to transition the majority or possibly the entire chain by the end of 2013. We look forward to continuing this effort. As you can anticipate, we are extremely optimistic about the results of these tests and see the program as a major long-term benefit for the business.

The collective impact of all these initiatives is that GNC is gaining market share, and has sustained growth opportunities. I will talk more on our future opportunities later. But now, I'll turn the call over to Mike for additional detail on our financial performance.

Michael M. Nuzzo

Thanks, Joe. Good morning, everyone. As we indicated in the press release, in addition to presenting results in accordance with GAAP, we also provided adjusted results that exclude transaction related costs, sponsor obligation and executive severance. Where appropriate, I will speak to these adjusted results.

For our consolidated results, our third quarter consolidated revenue increased 15.5% to $621.6 million. Retail segment revenue increased 15.5%. Franchise segment revenue increased 19.7%, and manufacturing/wholesale segment revenue increased 9.5%. Third quarter gross profit margin calculated after deducting product, warehousing, distribution and occupancy costs was 37.8% compared to 36.2% in Q3 2011. The increase was primarily driven by retail gross margin gains and occupancy leverage.

Third quarter consolidated SG&A expenses excluding adjustments were 19.8% of revenue versus 20.7% last year. Within consolidated SG&A, advertising and promotion expense was 2.5% of revenue versus 2.3% last year. On a year-to-date basis, advertising and promotion expense was 2.4% of revenue versus 2.6% last year.

Q3 2012 consolidated adjusted EBITDA was $124.2 million, a 31.2% and 240 basis point increase over Q3 2011. Adjusted net income was $63.2 million, a 28.7% increase from the prior year's adjusted net income. Diluted earnings per share were $0.61, a 32.6% increase over Q3 2011.

Now for information by segment. First, to our retail segment, which includes domestic and Canadian corporate-owned locations and the Internet businesses. Q3 retail segment revenue grew by 15.5% to $445 million, driven primarily by a 9.8% domestic same store sales increase including 20.9% growth in GNC.com revenue, the addition of LuckyVitamin.com and 155 net new GNC stores from the end of Q3 2011. Q3 retail operating income increased by 38.8% to $86.3 million and was 19.4% of segment revenue in Q3 2012 compared to 16.1% in Q3 2011. The increase in operating income percentage was driven by higher gross margin and expense leverage on same store sales increase in occupancy and payroll. In the quarter, we added 37 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 retail sales and fees. Q3 franchise segment revenue grew 19.7% to $108.8 million. Domestic franchise revenue grew by 9.9% to $61.7 million with a same store sales increase of 14.3%. International revenue grew 35.6% to $47.1 million on a 6.2% franchisee reported local currency same store sales results. Q3 franchise operating income increased 13.5% to $36.3 million and was 33.4% of segment revenue in Q3 2012 compared to 35.2% in Q3 2011. The decline in operating income percentage was driven by a higher revenue contribution from wholesale products sales compared with higher margin fees and royalties. In the quarter, we added 2 net new domestic franchise locations and 60 net new international franchise locations.

And third, for our manufacturing/wholesale segment. Revenue in this segment was 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 grew 9.5% to $67.8 million, which includes a 3.7% increase in third-party manufacturing contract sales. Q3 operating income increased 13.1% to $26.5 million, and was 39% of segment revenue compared to 37.8% in Q3 2011. The increase in operating income percentage in the quarter was driven by an increase in proprietary product sales. In the quarter, we opened 11 net new Rite Aid store-within-a-store locations.

So to quickly summarize our total store data at September 30, 2012, GNC operated 3,151 company-owned stores in the U.S. and Canada at 935 domestic franchise locations, 2,168 Rite Aid store-within-a-store locations, 1,711 international franchise locations for a total of 7,965 locations globally.

Next, to our balance sheet and cash flow. Through the third quarter of 2012, we generated $142 million net cash from operations. We spent $29.9 million on capital expenditures primarily for new stores, store maintenance, updates and remodels, corporate IT and other manufacturing facility expenditures. We entered into a $200 million incremental term loan. We repurchased $360 million in shares of common stock under share repurchase programs, completing our existing authorization. And we paid $34.3 million in common stock dividends.

As of September 30, 2012, we had a cash balance of $96.8 million and long-term debt of $1.1 billion. We have an undrawn $80 million revolving credit facility with $1.2 million pledged as collateral for outstanding letters of credit. Subsequently in October, we repriced our term loan. In the current interest rate environment, our savings are 50 basis points annually. Lastly, as a continuation of our capital allocation efforts, the company's Board of Directors declared an $0.11 cash dividend for the fourth quarter.

Now I will provide an update to our 2012 outlook based on current expectations. We expect total company revenue of approximately $2.45 billion for the full year 2012, an 18% increase over 2011. This is based on achieving an increase of approximately 11.5% in domestic retail same store sales for the full year, including the impact of GNC.com. Full year 2012 adjusted diluted earnings per share to be approximately $2.29, a 50.7% increase over 2011 adjusted EPS of $1.52. This compares to our previous outlook of approximately $2.21. The current outlook includes an EPS impact up to approximately $0.03 associated with gross margin dollar investment and marketing spend in support of the Gold Card Member Pricing program expansion, and a diluted share count of approximately 105 million for the full year 2012.

That completes the financial update, and I will now turn the call back over to Joe.

Joseph M. Fortunato

Thanks, Mike. GNC has multiple unique assets, each providing sustainable market share and profitable growth opportunities. We are a leader in execution exhibited by the consistent performance in each of our segments. On a year-to-date basis, we delivered a 2-year domestic corporate comp sales increase of 22.3% and in domestic franchise locations, an increase of 21.9%. This year, each of our segments has contributed a 20% or more increase in operating income. And overall, we generated a 43% increase in adjusted EBITDA fueled by a 340 basis point impact in operating leverage.

In retail, our model presents profitable growth potential on an ongoing basis. Comp sales gains drive meaningful leverage on store expenses. And our multifaceted real estate portfolio is operating very profitably across all types of locations, including new stores which are exceeding our return targets. In international franchise, we are successfully executing our strategy to leverage capital-efficient growth opportunities by expanding units and wholesale revenue in existing geographies. In 2012, we've grown our franchise store base by more than 10%. And wholesale sales have increased more than 1/3, resulting from additional product sales through market growth and a more rapid pace of product innovation, which remains on the top of our biggest opportunities. Year-to-date, this business has delivered more than a 20.5% in EBITDA dollars.

Firmly, we continue to seek significant new country potential. We are focused on identifying appropriate partners and addressing product registration in each market.

Next, our multi-channels strategy continues to deliver profitable growth with existing partners. We have successfully expanded our arrangements with PetSmart and Sam's Club and are relative -- selectively assessing new mass market opportunities.

Lastly, we are committed to enhancing our brand position. We have once again partnered with Peter Arnell, who helped to elevate our brand through the very successful GNC Live Well campaign. We are excited about this partnership and in 2013, intend to reestablish brand continuity through an integrated campaign that includes new creative and a restructuring of all media efforts, including direct marketing, print, in-store and television. Our goal is to build upon GNC's leadership position by strengthening brand awareness and further expanding our customer base.

In conclusion, as I look at the business overall, I am enthusiastic that GNC can deliver sustainable top and bottom line growth. We drive into the future with a substantial momentum fueled by an expanding customer base and improved mental pricing program, a simplified pricing strategy and a comprehensive product development pipeline. All of this will be complemented by an overhauled marketing program and as always, the enthusiasm of our store associates.

Now we are available to take up your questions. Please limit yourself to 1 question so that we could speak with as many callers as possible. After everyone has had a chance, we'll be happy to take follow-up questions. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Matt Fassler with Goldman Sachs.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

How can -- I want to ask you a question about the Gold Card program. Can you talk about just the economics as they evolve, sort of, from launch through maturity? So, sort of, the move in particular in gross margin rate from the early part of the launch through when it ultimately kicks in. I know that traffic and ticket -- it sounds like traffic rather and transactions are up kind of from the get-go. Can you talk about what drives the initial hit to gross margin? And how the gross margin rate in the markets that are converted ultimately levels out relative to the pre-conversion level after the program really takes hold?

Joseph M. Fortunato

Matt, as you know, we have 10 markets on this program now, and we just rolled out 2 large markets, and 3 smaller markets on October 1. And consistently since the first market we launched 26 months ago in Kansas City, we've seen the same results in every market. And that is -- we went to a program the first couple of months where we do Gold Card promotion events, ramp up customers, and then we also market in those markets and we take some discount in across the chain where the benefit of the consumer -- and I'll highlight benefits first, and I think this is important. First, everybody sees that the biggest complaint we've had from Gold Card customers is you can't use a Gold Card every day. So that's been solved. If you go in and look at the simplified pricing strategy, one of the complexities of GNC has always been, we're very competitive with our pricing out the door. But nobody gives us credit for it because you have to have a calculator to get to the final cost. Now they're going to know on shelf pricing exactly what they get as a member, which will be extremely competitive in a marketplace, and continues to give brand upside 10%, 15% brand value upside to our strong brands that deserve the premium. Lastly, you start getting a customer database that now tracks every transaction that consumer does. So now we can utilize that with our expanded information and database of customers, email addresses, Gold Card names, et cetera, to capitalize on direct marketing efforts to those consumers. Just now from a segmentation standpoint, we truly know what that consumer buys all month long, not just what they buy the first 7 days of the month. So now we'll get into the economics of the program. The economics of the program, initially, you had to start a little deeper. Because you can't back up to 20% on all products because that's what consumers are used to getting when they come in the store that have a Gold Card. What you ended up doing afterwards is -- and takes about 200 basis points off the margin impact -- from a margin impact. Afterwards, you can start tweaking that pricing, and the key to this is a huge benefit to us. Before, we had to give 20% off every product in the store all the time. And when we're always giving away these peripheral products at 20% off where we're unnecessary to -- to tap the discount those products at 20% off. Now we have a pricing team here that starts tweaking that pricing. So that you get closer to 100 basis points down and maybe even closer than that, as we move forward. The important part is that sales and transactions, and you take the year-to-date right now, 12.8% comps for the chain. These stores are outperforming that by high single digits and most of that is coming from transactions. So if you look at the positive effect of all that gross margin dollars get up to a breakpoint in less than 3 months, and sometimes even faster. Gross margin percent eventually will get in within 100 basis points, maybe even to 50 basis points as we continue to focus and tweak the pricing and get more educated on tweaking that pricing as the programs go on. So that the economics of deal, and what you see is -- I mean, the significant upside is absolutely incredible. I mean, we are just excited, excited about this program as we compete and we've always wanted to fix the couple of problems that existed with Gold Card. And this fixes everything, gives us more data, gives us more consumers to market to, understand the consumers' buying habits and gives us tremendous upside in transactions and sales, and quickly recaptures gross margin dollars.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

So just recap briefly and make sure I get it. It sounds like the discount is not a bigger discount, maybe initially a little bit. Ultimately, it's a slightly smaller discount. More people take it. So the gross margin rate comes down, but the gross margin dollars are up a bunch?

Joseph M. Fortunato

Correct. That's correct. And then some of it is coming from Gold Card promotion the first 2 months. So after the first 2 months of that comes back really quick.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

And then just a final follow-up. You typically have charged people to get -- to join the program. I know that with launch, that has on occasion been waived. Does that -- does the upfront fee and the change in that fee as you launched this, have any contribution to the change in the numbers, sir?

Joseph M. Fortunato

Yes. That's 200 basis points that we're talking about, most of that is made up of giving free Gold Cards away for the first few days. And then once we ramp up the customer base, we get off of it, you start paying for the card like you always did. And we're seeing continual upside from there the same way. They ramp the program out of the gate.

Operator

Your next question comes from Mark Wiltamuth with Morgan Stanley.

Mark Wiltamuth - Morgan Stanley, Research Division

More on the Gold Card. What's been the member fee experience after you're off that promotion? Are people accepting the fee and is the renewal rate each month pretty strong? And how much has your membership base grown in the markets where you put the Gold Card in?

Joseph M. Fortunato

Our membership base, I can tell you twofold. It's across -- you can -- you see significant upside in Gold Card sales even after you switch off the program because the pricing is much more apparent to the consumer instead of going through this very complex pricing strategy that we've had in the past. So Gold Cards continue to ramp. And you see in those markets where you've been selling 2-year Gold Card programs and we're seeing a lot of buying on the 2-year Gold Card program benefit. So that's also helping the future where customers will stay in the family of GNC. So I think if you look at this overall, the Gold Card -- I can tell you what the Gold Card ramp has been in the company, we gained 1 million Gold Card names in the last 1.5 years, which is 20% increase. And we haven't had that in 5 years.

Mark Wiltamuth - Morgan Stanley, Research Division

And do you think longer term, we're moving more towards like a Costco model, where you've got annuity value here on these fees just continuing to roll in?

Joseph M. Fortunato

I think we got 2 things going for us that will help offset some of the margin percent decline, the initial 2 months or so of expense to incur. And that is, one, that we are selling more Gold Cards and we will continue to sell more Gold Cards under that program. And two, we have deferred revenue that will continue to come into the system from the last year of Gold Card sales, which have been very strong. So that deferred revenue that will leak into the system over the next 12 months will help offset some of the costs as well. So the impact becomes less than anticipated as you continue to move further into the year with these tests.

Mark Wiltamuth - Morgan Stanley, Research Division

Okay.

Michael M. Nuzzo

Right. I do agree. I think this becomes an annuity contract or annuity payments. So much like it's -- it would be at a Costco or Sam's Club.

Mark Wiltamuth - Morgan Stanley, Research Division

How about -- just on the quarters of your -- what's your traffic versus ticket on the domestic comp?

Joseph M. Fortunato

I'll go this way. Traffic and ticket, I'll tell you that we have 20% 2-year comparable store sales growth. And I know this was a tough issue in the last call, and it was kind of frustrating, because we had a record quarter. And I think there was a lot of panic over how we promote to our consumers, and how we maximize the opportunity to get share wallet and at times, drive traffic. So I'll tell you this. We are doing 10% 2-year comparables -- 20% 2-year comparable store sales growth, 10% a quarter all year long. So obviously, we have the ability to drive growth from comp, and we continually do it quarter-after-quarter on strong comps from last year. And I don't know if any -- many retailers are doing 22% comparable store sales growth on a quarter-by-quarter basis throughout the year. In regards to traffic, I can tell you these things. We have 1 million more Gold Card names. We have 4 million or 40% -- actually 60% more email addresses. We have a 30% increase in unique consumers target in our email address. So we're very satisfied in how we are targeting growth -- comp growth in our stores through promotion either through traffic or average ticket. And without going into all the discussion points we had last time, which I think were -- not fruitful and uneventful and so, in some ways, but eventful some ways for you guys. I think you have to look at the comp and that we are very satisfied with the trends on transactions and average ticket as we move through the year.

Mark Wiltamuth - Morgan Stanley, Research Division

And since you're converting the whole system over to Gold Card eventually here, the ticket -- I'm sorry, the traffic number has been up in that same growth versus the control group, right? Your -- you just -- you got the good solid single-digit growth here in ticket and traffic?

Joseph M. Fortunato

I'm sorry, in the test markets?

Mark Wiltamuth - Morgan Stanley, Research Division

Yes, the test markets. You talk about your traffic trends in the test markets versus the base.

Joseph M. Fortunato

Yes. The ticket is pretty comparable to the base.

Michael M. Nuzzo

So the real differential is in the transaction growth to sales growth.

Operator

Your next question comes from the line of Chris Horvers with JPMorgan.

Christopher Horvers - JP Morgan Chase & Co, Research Division

A couple of follow-ups that focus in the Gold Card as well. Can you talk a little bit more about what the Kansas City out-performance was in year 2 and maybe, I don't know, how you want to talk about it, in absolute level or perhaps stacks? And can you talk about what the gross margin profile was in that market in year 2?

Joseph M. Fortunato

In year 2, the gross profile margin goes closer to 100 basis points from where we started the program. So it started out about 200 basis points below, start gearing towards 100 basis points. And I currently assigned 2 analysts just to handle Member Pricing now that it's expanding into other markets. I think we can get another 50 basis points just by tweaking the pricing more effectively. So my goal is to get it back to even but be very competitive where you need to be competitive. Get a premium for your brand when you can, and then don't discount these peripheral items as much as you've been discounting them because it's not necessary. The customers are going to buy them anyway. So the goal is back to about 100, but the goal for that should be to get closer to 0. And again, gross margin dollars breakeven very fast, I mean, quickly. All the expense is really tied up in the Gold Card for the most part.

Michael M. Nuzzo

Yes, Chris, and if you want to talk about a compounding effect, the performance in year 2 in Kansas City has been just as strong as the initial year. And so that's what's so -- and we've got lot of excitement about the program. But looking at that 2-year trend in Kansas City is just as exciting as looking at the market that we turned on at the beginning part of the year from all the metrics that we've been talking about.

Joseph M. Fortunato

Yes. And Mike's point's right. I mean if you think about -- one of the reasons we didn't roll out a lot more markets right away was we were waiting to get into year 2 with Kansas City because you never really know until you get into the second year how the continuity of that program is going to continue to evolve. And we are more than elated with how that program is evolving and continuing to substantially outperform the rest of the chain in sales and transactions and gross margin.

Christopher Horvers - JP Morgan Chase & Co, Research Division

So just to clarify, so that means that in year 2 in KC, you're still outperforming at a high-single digit pace?

Joseph M. Fortunato

Absolutely.

Christopher Horvers - JP Morgan Chase & Co, Research Division

And -- okay, understood. That's great. And then on the gross margin, essentially you have a 1Q dip here and then you get it back 1 year. You get down 200 in the market, and you can get 100 of it back a year later, and that's how it annualizes.

Joseph M. Fortunato

That's a perfect way to look at it. I mean you look at the first quarter, it's more about promotion through Gold Card, getting more members in the door. And then it normalizes almost to -- close to, like I said, 100, 150 basis points. Then you start tweaking the price, and you get all your margin dollars back with -- under 3 months and exceed your old margin dollars. So I look at it on a quarterly basis. It's exactly the right way to look at it.

Christopher Horvers - JP Morgan Chase & Co, Research Division

And so then when do you get the leverage? I mean when is EBIT rate actually start expanding in these markets?

Joseph M. Fortunato

It all depends on how you decide to roll out. If you decide to roll out more -- if we see continued success in New York, so far, already, in a couple of weeks, New York is showing the same trend as the other markets, obviously up until the storm has hit. But we're very pleased with that. And that just means that we could decide to continue to roll out so many markets each quarter or we could decide to ramp and do it all in one time, which you would have one quarter of hit to the system. But then after that, you'd be exceeding where you would have been before.

Christopher Horvers - JP Morgan Chase & Co, Research Division

But I'm just saying overall, in the first 2 months, you're getting gross margin. When do you get EBIT rate expansion in the market on rollout?

Joseph M. Fortunato

4 months in.

Christopher Horvers - JP Morgan Chase & Co, Research Division

4 months in. Okay, understood. And then -- okay, understood. And then as a final follow-up, perhaps you could just talk about Sandy and what the exposure is there. It sounds like you said New York's been a very nice lift as you've rolled out. But obviously, you have a lot of stores in the Northeast. And is that taken into account into the implied A comp for 4Q?

Joseph M. Fortunato

We have not taken that into account yet, and we're not sure what the impact is. I mean like everybody else, first, I hope everybody that's up there -- I know a lot of people in the call are from New Jersey, New York, et cetera, and I hope everybody's safe and sound up there at this point in time. But we have not -- I mean we've had a significant number of store closings, like any retailer would, and they are high-volume stores on the Northeast. And we probably will not know the full effect of that until Monday, as we're starting to see some stores come up over last day or so. But I don't think all the stores will be up and running until at least Saturday and maybe even until Monday. So we'll know then the full effect of the storm on the company.

Christopher Horvers - JP Morgan Chase & Co, Research Division

So looking back historically in other markets where you had a hurricane, does this consumer basically is a deferred purchase and the demand just makes up for itself over time?

Joseph M. Fortunato

Yes. You will find -- we know that we'll get some of those sales back. The guessing game all the time is how much. You can get 25% back and get 50% back. You'll never going to really recover them all.

Operator

Your next question comes from Brian Wang with Barclays.

Brian Wang - Barclays Capital, Research Division

If you would just mind talking about the cadence of sales trends throughout the quarter? And if you have any commentary on the quarter-to-date trend?

Michael M. Nuzzo

We don't really talk about either, Brian. I mean clearly from what Joe is talking about before and what you can see in the numbers, we've delivered very consistent comp store growth. And the framework for thinking about comp is a stacked 2-year 20% plus. And so we're getting contribution from all our product categories, and that's what you see in the numbers.

Joseph M. Fortunato

We're pretty easy to gauge. I mean we are very consistent. You can see last year, pretty much double-digit comps every quarter last year. And this year, we're doing the same thing. So if you look at the franchise system, a little invert from us, out-performance a little bit this year, underperformance is a little bit last year. But you can keep looking at that 22% same-store comparable store sales growth for 2 years, and that's pretty consistent across the months and across the quarters for our franchise and partner stores.

Brian Wang - Barclays Capital, Research Division

All right, great. And then just one follow-up on the Gold Card test. Obviously, you've gotten into a lot of detail about different aspects of it. But I guess, if you could just talk about -- I would think that you would be -- the stores will be more efficient by spreading out the sales throughout the month rather than having so concentrated in that first week of the month. Have you seen any kind of benefit from that?

Joseph M. Fortunato

Well, we may, long term. I mean right now, we don't want to do anything to interfere with customer service. It's been a great upside for us, a big differentiator for us in the market. Talking to our consumers, educating our consumers, cross-selling, UPTs have been up on a regular basis. That's a big, big selling culture change in the company in the last couple of years that we wouldn't want to affect. What we should see though by easing in our Gold Card week is probably less part-time hours that were utilized in Gold Card week that we can spread out either over the month more or actually just catch some savings in regards to part-time hours.

Brian Wang - Barclays Capital, Research Division

Great. And then just one last one. You mentioned the franchise comps obviously have been very strong. I guess if you could just talk about like how far along -- obviously, like some of the initiatives had been them adding new products especially on the private-label side or adopting the promotions more frequently. If you could just talk about how far along you think you are with those efforts.

Joseph M. Fortunato

Yes, our main -- well, there's 2 sides of it, right? Domestic sales have been very strong and comps have been very strong. We have 14% in the third quarter I believe and 16% year-to-date. So if you look at that, that story is more about them performing better because of the same thing we perform better for a good reason: Product launches, more line launches, Total Lean, Vitapak, Mega Men -- our Pro Performance, Pro Performance AMP, Beyond RAW. I mean those products are up anywhere from 25% to 50% this year. And obviously, what the franchise system has finally done is buy into these new product launches quicker domestically. So that has helped tremendously boost their sales. In addition, they are all, for the most part, in strip centers. So they do have some out-performance from us just in regards to strip centers are doing slightly better than the malls on a comparable store basis. So that gives them a little bit of leverage, about 200 points leverage from where we're at. On the international front, this goes to show you what I've been talking to you for a while about is product innovation, consumer packaged good capabilities this company has nobody can match. Because as we bring these brands to the international markets now, the Total Leans, the Pro Performance, the AMP, the Vitapak programs and the Genetix, the various things like that, that we've launched in the last 18 months, 24 months, 36 months, those stores are ramping up significantly. So if you saw the international sales, the comp was 6.5 or so, but -- and now, it's much higher. This is so far I've seen starting to ramp up. And their sales though, their wholesale sales, where $14 million in wholesale sales came from new product introductions into those countries. And we're only about 20% through the list of the opportunities that we could continue to bring new product into those countries. So significant, significant upside and then I've been saying is going to happen and is starting to happen, and you'll see the leverage. And we have 35% increase in wholesale sales from those new product introductions. And Canada's another prime example. Canada this year, third quarter's in almost 20% comparable store sales growth. Last year, it was lagging the whole year. And the one in the -- each quarter this year, it has elevated each quarter from somewhere around 7 to 12 to 19. And the reason is we brought Pro AMP into the market, we brought Total Lean into that market and we have Vitapaks in that market now. So these product introductions, as I keep saying over and over again, compounds your growth. And that's what happened in the United states as well. And now we're starting to bring that same compounding effect of our innovation technology to the international markets into Canada, and you're seeing the same effect. It's a rollover compounding effect.

Operator

Your next question comes from Simeon Gutman with Crédit Suisse.

Simeon Gutman - Crédit Suisse AG, Research Division

Maybe Mike or Joe, regarding expectations sort of markets that are being rolled out now to member pricing, is there any reason to expect a different, I guess, sales advantage given either market share issues or other things? Why these markets either do better or worse than this high-single digit above control group?

Joseph M. Fortunato

I can tell you this is probably simple as I can put it. The first few weeks, we've seen the same, same kind of momentum in those markets that we saw in the original test markets. So it's just the program. I think we are very confident that we have found a program that clarifies many, many positions for GNCs and gives us tremendous advantage in regard to consumer data, consistency of pricing, simplification of pricing to the consumer. They walk in and have to figure out our promotions and events and Gold Card discounts and everything. And everything is easily tagged in the store now, so people see the real price right away that we weren't getting credit for before. We were -- I'd always address people who said -- the feedback comes back with high price. Well, we're not. If you look at our out-the-door price, we're very competitive where we need to be. And on our brand, as we always have, we get a premium because they're specialty products that really can't be found in the marketplace. If you look now, people will note the out-the-door price and will get full credit for it. And I think that's what's driving some of the traffic back into the stores to rebuy because they know the price is great.

Simeon Gutman - Crédit Suisse AG, Research Division

Okay. And you mentioned 1/3 of the store base will be on member pricing. If you x out Kansas City and maybe the other 2 markets that you did early on, the new markets together, it appear that they represent about 25% of the base, something like that?

Joseph M. Fortunato

That's a little high. The new -- you mean just net of Kansas City?

Simeon Gutman - Crédit Suisse AG, Research Division

Yes.

Joseph M. Fortunato

Because Kansas City started 26 months ago. Three more markets started about a year ago almost. And then now, these recent ones, 5 more started. The 5 now represent about 18%, 19% of sales.

Simeon Gutman - Crédit Suisse AG, Research Division

Okay. And then on a follow-up, I wanted to ask about the marketing program. Because I guess from the outside, it seems to have been going well. It coincided with the momentum of the business accelerating, and it expanded the reach of the current company. And so the question is why recreate it now? What elements -- or what can be improved upon from -- what are we going to see that's going to be changed?

Joseph M. Fortunato

You'll see -- I mean if you're going to New York now, you'll see our window signs, which never would have done this before, just talking about the new member price. And it's very clear. It says exactly what I just said to you about the advantages to the member pricing program. We have sent a significantly higher number of direct mail pieces to those markets. So names that people had shopped and aren't shopping, again, names that we have in the market that we may not normally market to because they're not -- their spend isn't high enough, we're blitzing those markets with direct mail pieces. And that's part of the marketing spend obviously. And it is just promoting the program and would read, "Come to GNC. See the new pricing strategy. Use your Gold Card every day of the year," technically. And I could tell you, that has been the sore spot among our Gold Card customers that for 10 years -- 15, as I can remember. So that being solved is a very big positive for them because customers could shop when they want, as a convenience deal and they don't have to be forced to commit to wherever the city or wherever they're shopping the first 7 days of the month. So that's really what you see in these stores. And that's why -- and as you flood the stores with Gold Cards the first 2 months, you see a good repeat of that customer base coming back. And you see the Gold Cards, like in Kansas City, being renewed the following year on a better renewal basis than in other markets, which continues to drive traffic. It's again a compounding effect that should continue to roll over in these markets. And once again, we're not seeing anything different, although it's early in the first few weeks in Chicago or New York.

Simeon Gutman - Crédit Suisse AG, Research Division

And then my last question is your Live Well campaign, is that going to continue in its current form? And then the second part is the timing of product releases. I know last year, maybe they were pulled a little forward. Is the timing going to be about the same this year? Or do you do a little bit earlier into next year?

Joseph M. Fortunato

Yes, both good questions. The products -- we will be launching more products than we've ever launched going into a full year. And we'll be launching them -- some of them several months earlier. So almost all the new products that will hit the stores will be done in December. A couple are going to linger into January, February. That's not normally been the case. They've lingered all the way through March and April, and even into May at times. And there's more products hitting the market, hitting stores this year than there's ever been in the past. Second to that is, we have a pipeline already getting loaded up for 2013, which will keep us on very even keel with product launches throughout the year in 2013. So we're very satisfied with the pipeline of new product innovation and the continued compounding effect of these great brands and products that we've launched in 2011 and 2012, again, the Total Lean line expansions, Pro AMP, Beyond RAW, Genetix. They will all still be compounding at a high rate as we roll into 2013. I mean that's basically the model. It's almost like a new store model but with products. Oh, the Live Well campaign, yes. I can honestly tell you, I haven't been satisfied with our marketing efforts this year. I think we have a lot more access to customer data and customer names, and we haven't been going after it strong enough. I think we've got boring with our messaging and with our ads. So I got a chance to get Peter Arnell back, who I hired back in 2010, to launch the GNC Live Well campaign. It's been the most successful campaign we've ever had in the history of the company, and we've had positive transaction growth through that campaign on a regular basis since it launched. This group is coming back in again, Peter's been hired to help spearhead a new launch marketing campaign, branding campaign across all our media types. So again, we're going back on television. We will be on billboard. We will be on -- in print. We'll be -- our DM will be ramped up because now we're going to hit these 10 million email names, the additional 4 million, the extra million Gold Card members and these unique visitors that are visiting our website much more often than we've been in the past. So I'm thrilled about member pricing compounded with product innovation, compounded with a new marketing campaign. And I've already seen it. It's gotten underway. I'm in the middle of it now and very involved in it. And I'm telling you, I'm thrilled with it. And I think it's going to change, again, the image of GNC and grow and develop and evolve the image of GNC as we move forward, just like the 2010 campaign did.

Operator

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

Kate Wendt - Wells Fargo Securities, LLC, Research Division

I was wondering whether you think the upside in sales and transactions is related to the fact that after the first week of the month, probably a lot of your customers were going elsewhere where they can get a better price, and that you're actually losing sales in the past because of this. And whether you think that's part of what's going on as you're recouping those transactions. And on the gross margin side, whether you think you might be a little offset some of the pressure from rolling out the new Gold Card program with the mix shift towards more higher-margin proprietary products, particularly as you accelerate the new product pipeline.

Joseph M. Fortunato

Yes, your first analysis is correct. I believe that we were getting people in weeks 2, 3 and 4 that would want to buy a product and they just wouldn't be as competitive at GNC in those weeks, so they go somewhere else and buy them. And we do know that customers in this industry shop 2, 3, 4 locations for various supplement needs they have. So I would say you are correct in that analysis. Some of it, some of that transaction increase is coming from that. In regards to the...

Michael M. Nuzzo

Yes, I think your second part of the question about -- or you're thinking about the mix shift to more proprietary, that certainly possible as you get into the program. I think what Joe was talking about before in how we can strategically manage the discounts. And again, we used to give 20% discount on everything, and there are clearly product lines that we don't have to do that. And so our ability to manage that much tighter I think is really where you're going to see the gross margin rebound as you get later into the stage of the program. So I hope that helps.

Kate Wendt - Wells Fargo Securities, LLC, Research Division

Great. And then just quickly also on margins. In terms of the whey protein prices, it looks like even though they've gone up a little bit recently, they've still come down pretty substantially from their peak. I was wondering if there could be any maybe stickiness here in terms of maybe you don't reduce retails as fast as input prices have declined.

Joseph M. Fortunato

I was just with the gentleman that supply almost our whey protein as they do our whey protein manufacturing for us. And the prices have not really come down. They have leveled off in the fourth quarter. WPC 80 still went up from where it was at in the third quarter. They expect them to level off completely in the first quarter of next year and start to climb in the second, third quarter of next year. Because new factories are coming aboard, they have -- Glanbia has built a factory in Ireland. And then there's another new factory just been built here in the United States, it would be coming aboard with whey protein production. So they have really not come down, they have leveled off. And we are going to maintain prices like everybody else that we're talking to at this point in time. And when they do come down, I think as always, you won't be giving it all back to the consumer. You'll be giving part of it back to the consumer, and it also depends with all the competitors. So -- and I would assume they'll all do the same thing as you see.

Operator

Your next question comes from Damian Witkowski.

Damian Witkowski - Gabelli & Company, Inc.

Can you talk about strengths, where are you seeing -- what categories are you seeing the -- are growing more than others? And then I think your overall are growing a lot faster than the supplement industry. Where do you think you are sourcing from?

Joseph M. Fortunato

I'll get the sourcing question next. I can tell you in all categories, all categories, we're outperforming the market and significantly outperforming the market in some categories. And for example, our vitamins business is up into the double-digits on a 2-year basis. That is what the market has been doing. On a 1-year basis, actually it is in double-digit. So that -- vitamins are growing 3% to 5% in the market in general. So we're gaining market share, and we're gaining market share in every category. Our diet business has been fairly strong and is being driven -- which just makes me happy, the meal replacement business, which is being driven by our brand of total lean products. So we continue to capture more and more of that critical meal replacement market, which has the customers transition away from the pill business and are going more for the meal replacement business. And our sports business is the same way. I mean on a 2-year basis and 3-year basis, we're over 30% growth on a 3-year basis in our sports business. So clearly, that's outperformed the market and we continue to take market share. And if you look at our Pro Performance brand in total between Pro AMP and Pro and Beyond RAW, we have 26% of the markets. Sports market right now is the largest brand in world. So we are gaining share just from the sheer number of looking at the categories and knowing what the growth is in the industry.

Damian Witkowski - Gabelli & Company, Inc.

And do you specifically -- I guess it doesn't matter. The -- in terms of again categories, is there any change in terms of what's growing faster, I think last time you mentioned that the probiotic category was sort of showing incremental growth faster than everything else. And more specifically, going back to the whole pre-workout category, it wasn't an issue last quarter. It seems like it's almost behind us now.

Joseph M. Fortunato

Yes, the pre-workout issue is behind us. We've had no more correspondence from anybody. We continue to move out products that we think may still cause a problem down the road. If somebody's decides to get back on that horse again. But that's diminished so much for us and we've replaced them. And we did a fantastic job of transitioning that business. We're not concerned about it at all. If you look at probiotics, the thing is they are growing fast. They're not as big a part of the business as other categories are, but they are growing fast. They are much faster than our normal growth rate and the story would be for those items. And obviously, they're growing very fast in the mass market as well.

Damian Witkowski - Gabelli & Company, Inc.

Okay. And lastly, can I just ask one clarification? Your comment about EBIT expansion in the markets where you have the new Gold Card program, you said it would be positive, EBIT will expand in 4 months into it. I'm assuming you're talking about dollars, not margins.

Joseph M. Fortunato

Correct, dollars.

Operator

Your next question comes from Michael Weisberg with Crestwood Capital.

Michael Weisberg

How much of an impact on the comps this year have you gotten from the Kansas City and the other markets' better comps? Can you give us a sense of how much positive impact that's been thus far this year? Or is it not that significant?

Joseph M. Fortunato

It's not that significant because those markets are all pretty small markets. So you're talking about more recently Pittsburgh and Orlando and prior to that, Kansas City and some of the smaller markets. So the impact will be pretty insignificant.

Michael Weisberg

Okay. As you go with -- I'm sorry, Joe, as you go into next year, I know you keep referencing a 2-year comp of 20% or 22%. Given the impact, do you think that kind of 2-year comp is -- would be sustainable in 2013?

Joseph M. Fortunato

You mean to do another 10% on top of 10% on top of 10%? Look, I think anything potentially is sustainable. I think it depends on the rate of success of our new product launches. And as -- about your question is pointed out, we are against stronger numbers and into the third year in a row. So we would expect it to normalize a little bit, but we still think we're going to be able to outperform the market.

Michael Weisberg

Okay. And then one more on that if I could. You've set the launch in the Tri-State area, it cost you $0.03 this year. If you do a launch all during 2013, what do you think the effect on earnings would be? Would it be a moderate negative next year in terms of earnings per share?

Joseph M. Fortunato

We have no thought process right now. There are several options to it as how we would rollout the program. And what you can see is 1 or 2 options. Come April, we're very happy with the program in New York and Chicago, and we decided to roll out the rest of the country quicker. Or we just continue to roll out pieces of the business for each quarter, so that the ramp from the previous rollout offset the decline in the new rollout period, then you keep doing that throughout the quarter. By the end of the year, you sustained little impact on your overall business because your markets did the transitions, and already you're up. And once you’re transitioning, you're down for a short period of time. And if you rolled it all at one time, you'll see less effect than you're seeing in New York and Chicago because they are huge markets that require a lot more expense to roll out. So that 300 basis points that you're seeing in regards to marketing and Gold Card promotion, giveaways and basically margin would be less across the chain, be probably more in the less-than-2% range. And as tweak pricing, it would recover quicker. But we have looked at the whole thing on rolling it out all at one time, and it would still be accretive to the business.

Michael Weisberg

Okay. Can I just -- 2 quick numbers. Did you mention what the international franchise comps were for the quarter?

Joseph M. Fortunato

They were 6.2 or...

Michael M. Nuzzo

They were 6.2, Michael. On a 2-year basis, that would be 24.7%, which is pretty comparable with Q1 and a little higher than Q2.

Joseph M. Fortunato

Yes. And a lot of that came from an impact in South Korea, which changed their regulatory environment and we are catching up with them now. So I looked at comps in the previous month and they're back up in the double-digits. So we found solutions around the South Korea problem, which was a huge market doing very strong comps last year. And they kind of leveled off this year, and that caused a little lower than expected comp in that business.

Michael Weisberg

I see. And what were the LuckyVitamin sales?

Joseph M. Fortunato

LuckyVitamin sales?

Michael M. Nuzzo

LuckyVitamin sales were around $14 million.

Michael Weisberg

$14 million, got it. And maybe one more if I could. The gnc.com growth was still okay at 20, but it's decelerated at the last couple of quarters. Any comment on that? Because it was like 27 last quarter on a year-to-year basis.

Joseph M. Fortunato

Yes, but if you look at it on -- I always look at everything on 2-year basis because last year, they're against very strong numbers. And I mean that business, if we look at that business, it's growing 60% over the last 2 years on a compounded basis. So we're not concerned about it, and we're also seeing it ramp back up again pretty quickly. It just depends again how you promote to that consumer versus how you're promoting to the store consumer. You want to do multi-channels. Those who want to do multi-channel, it's a very complicated promotional strategy that can drive one business beyond the other or drive all businesses then. Some of them drive all businesses and some of them favor stores and some of them favor the Web.

Operator

Your next question comes from Mark Miller with William Blair.

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

Concerned that the wholesale products sales to the franchisees could be affected by product diversion. I just asked because we have seen some GNC product sold by third parties on the Web. And in the future, is there a way to track individual product sales and potentially curtail that practice?

Joseph M. Fortunato

Yes, look, we see franchisees selling anything on the Web. It's so miniscule. It barely gets our attention. But if we see it or we hear about it, we stop it because they're not allowed to do it.

Michael M. Nuzzo

And basically, Mark, the quantities are so small and fleeting, you won't see products that sustain on any of those sites, that it ends up not being an issue for us.

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

All right. And then Mike, the payables were down relative to the inventory. Is there a reason for paying suppliers quicker? Is there a quirk of timing in this quarter that should change going forward?

Michael M. Nuzzo

Well, we actually -- and this has been a thing that we've focused on all year. We've actually gotten this incremental discount dollars from making payments on time or a little early. And obviously, we are in a great cash position, so we have the luxury to be able to do that. We weren't taking full advantage of it in previous years, we are this year. And so that's why you see the payables down a little bit.

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

All right. And then I hate to follow up with this question, but Joe, can you clarify, is the traffic down on a comp basis? Because I think that's maybe the impression people walk away with. Or is it up just up modestly? If you can clarify, that'd be great.

Joseph M. Fortunato

I think this is something that is we've kind of beaten to death. And like I said, I wasn't so pleased with the overreaction the last quarter again as we delivered a world-class quarter and again, this quarter. I can tell you that traffic and ticket are what we would expect to drive our comp. And we're satisfied that we're promoting the right way to reach new consumers and get them into the store. And I can tell you the same data I gave you, Gold Cards are up 20%, email addresses are up 60%, customer traffic to the Web is up 33% to 35%. So we're not getting into the details of transactions in comp and what makes up average ticket, what mix is up. Because I probably will not be giving that going forward even though it will be a substantial number if these member markets that continue to roll out. Because I think it is very confusing for everyone on the phone and our other participants as to how we manage our business and how we decide to drive traffic or drive share of wallet from our existing consumers. And sometimes, we do both. And I could tell you -- I'll reiterate again, we are very satisfied that driving that 10% comp year-over-year for 8 quarters or 7 quarters in a row right now or better has been managed very effectively. And we're very happy with the results of how we're driving traffic to this business.

Operator

And I would now like to turn the call back over to Mr. Fortunato.

Joseph M. Fortunato

Well, thanks, everybody, for joining us. We know there's a lot going on up in New York, New Jersey area. And we certainly appreciate the efforts you made to get on the phone. And we hope everybody is safe and healthy and things get back and close up there as quickly as possible. So thank you, appreciate it, and we'll talk to you next quarter.

Operator

Thank you for your participation. This does conclude today's conference. You may now disconnect.

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