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Edited Transcript of GNC earnings conference call or presentation 24-Oct-19 12:30pm GMT

Q3 2019 GNC Holdings Inc Earnings Call

PITTSBURGH Oct 27, 2019 (Thomson StreetEvents) -- Edited Transcript of GNC Holdings Inc earnings conference call or presentation Thursday, October 24, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Kenneth A. Martindale

GNC Holdings, Inc. - Chairman & CEO

* Matt Milanovich

GNC Holdings, Inc. - Senior Director of IR, Analysis & Strategy

* Tricia K. Tolivar

GNC Holdings, Inc. - Executive VP & CFO

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Conference Call Participants

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* Robert William Summers

The Buckingham Research Group Incorporated - Research Analyst

* Stephanie Marie Schiller Wissink

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the GNC Holdings, Inc. Third Quarter 2019 Earnings Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Matt Milanovich. Please go ahead, sir.

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Matt Milanovich, GNC Holdings, Inc. - Senior Director of IR, Analysis & Strategy [2]

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Good morning, and thank you for joining us for GNC's Third Quarter 2019 Conference Call. I would like to remind everyone that during this conference call, GNC management will make certain forward-looking statements about its outlook that involve risks and uncertainties. The forward-looking statements are generally preceded by words such as believe, plan, intend, expect, anticipate or similar expressions.

Forward-looking statements are protected by the safe harbor contained in the Private Securities Litigation Reform Act of 1995. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstance that are difficult to predict and many of which are outside of the company's control. Factors that could cause actual results to differ from expectations include, but are not limited to, those factors set forth in GNC's filings with the SEC. GNC is making these statements as of October 24, 2019, and assumes no obligation to publicly update or revise any forward-looking statements.

In addition to the GAAP results, GNC will provide certain non-GAAP financial measures. GNC's earnings press release for the third quarter of 2019 can be found under the News Release link on the Investor Relations page of the company's website at www.gnc.com. The tables attached to that earnings press release include reconciliations of the non-GAAP financial measures to the most directly comparable GAAP financial measures.

With that, I'll turn it over to our Chairman and CEO, Ken Martindale.

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Kenneth A. Martindale, GNC Holdings, Inc. - Chairman & CEO [3]

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Thanks, Matt. Good morning, everybody, and thanks for joining us. GNC is pursuing a focused strategy to transform our traditional specialty retail model into a true global brand, position our business to serve consumers' evolving needs and inspirations. This strategy includes continuing to stabilize our U.S. retail business and leveraging the strength of the GNC brand to drive digital growth, build our wholesale business and capitalize on opportunities in the attractive international market.

During the third quarter, we made good progress in U.S. retail and digital. And while we ran into some temporary headwinds on the international front, we continue to feel good about the power of the strategy to grow our global brand and improve our operating performance. I'll share the details of our third quarter progress and performance in just a few minutes, but first I want to give you a quick update on our capital structure.

In early 2018, we committed to a long-term process to reduce our leverage. Since that time, we've reduced debt by over $440 million and lowered our net total leverage ratio from 5x to 3.6x. As mentioned on last quarter's call, we recently conducted numerous meetings with current and potential debt and equity holders. These meetings have led to productive and ongoing discussions, and we believe that we are closing in on a longer-term resolution for our capital structure. Tricia will provide further details in a few minutes. Now let's turn to the third quarter.

We continue to focus on stabilizing and improving the core business and are starting to see results. Year-over-year operating income in the U.S. and Canada segment was up for the third consecutive quarter. And while comps were still a bit soft, the trend improved with domestic comps, including e-commerce, coming in at minus 2.8% versus a negative 4.6% last quarter. I should note that as customers increasingly shop across multiple channels, we believe a blended comp is the most appropriate way to measure domestic sales performance.

Adjusted operating income in our U.S. and Canada business grew to 7.3% of sales compared to 5.4% a year ago, driven by strong product margins, reduced costs and our footprint optimization initiative. As we first told you last fall, a key part of our U.S. and Canada strategy is our store optimization initiative, which includes a plan to close up to 900 GNC stores through 2021. We remain on pace to close approximately 300 stores in 2019 as planned, leaving us with between 500 and 600 targeted closures over the next 2 years. This strategic initiative is an important driver of the improvement in EBITDA, and we continue to transfer more than 30% of sales to nearby stores.

On the cost control front, we continue to track ahead of our $29 million cost reduction target for 2019 and are well on our way to $50 million in annualized savings by the end of 2020. We also believe our e-commerce business has turned a corner. We are seeing early results from our work to deliver an improved customer experience on gnc.com with more enhancements to come. And we are on track for an early 2020 launch of a new order management system that will help us transform how customers interact with GNC. The system will support the rollout of mobile in-store POS in 2020 and will make it possible for customers to buy products online and pick them up in a store or have what they need shipped from a GNC store directly to their home.

Online marketplaces also play an important role in engaging consumers with the GNC brand, and we continue to work with the Amazon team to expand sales and profit-driving initiatives. At the same time, we believe there are opportunities beyond Amazon, and we're excited about our recent launch on Walmart's online marketplace. Increasingly, customers want and expect to engage with brands anytime from anywhere. Our digital strategy is aimed at answering that demand. With over 9 million active numbers in myGNC Rewards and now more than 1 million customers enrolled in our PRO Access program, we are gathering rich data and insights that shape our digital advertising strategies, let us target information to specific types of customers, help us personalize the GNC offering and improve the overall experience. So far this year, our digital team has rolled out mobile push communications, e-receipts and a native wallet.

Customers are also responding to our Auto-Deliver & Save program, which makes getting products that are part of their daily regimen easy and convenient through a subscription. This growing service now fulfills more than 300,000 active subscriptions, which represents an increase of more than 200,000 subscriptions compared to the end of 2018. There is still significant opportunity for growth in Auto-Deliver & Save as we continue to strengthen the platform and improve the experience.

We are working hard to give customers new ways to connect with us. Customers know GNC. And beyond that, they trust our brand to give them innovative, quality products and expert advice. Our newly established global brand team is acutely focused on building upon that strength and making our products exceptionally relevant to the changing consumer.

For more than 80 years, GNC has helped people find products and build regimens that meet their specific needs. It's what customers have come to count on and what has always set us apart. Now we have the technology to bring this expertise beyond the 4 walls of the store and into the digital world.

Among our industry firsts were our prepackaged individual Vitapaks that were designed to target goals like energy or muscle growth. With this month's rollout of GNC4U, customers can now use online questionnaires to tell us about their health, lifestyle and individual goals and then receive highly personalized supplement packs delivered to their door every month along with tailored advice and education. This product is the next step in our journey to provide customers with truly customized nutritional supplement regimens. We believe the ability to deliver industry-leading personalization supported by our leading brands and quality standards sets us up to serve the changing needs of customers in ways others can't.

At GNC, product innovation is more than just new and better. It's about creating truly breakthrough, clinically proven formulas, such as our Slimvance weight loss product and TamaFlex for joint health. In early 2020, we will introduce another first-of-its-kind formula, [myotore]. This blend of herbal ingredients is clinically proven to improve upper and lower body strength, arm circumference, stamina and endurance. Myotore will be introduced in multiple existing GNC products, bringing much needed innovation to the protein category.

Energy drinks is another fast-growing category, and we are excited to launch Mad Pony, our first GNC branded energy drink during the fourth quarter. This lifestyle brand is targeted at young Millennials and Generation Z and gives us an opportunity to increase our reach with this important demographic.

Finally, let's turn to the International market. While we had several challenges in this business during the third quarter, we continue to see plenty of opportunity for long-term global growth. As with other brands with a large presence in Hong Kong, we are seeing substantial sales pressure in that market. And at this point, we're unsure as to when that situation will stabilize. Hong Kong is an important market for us in Asia, and we are actively exploring alternative ways to capture market share in that region. Our International partners in Saudi Arabia and South Korea also ran into headwinds during the quarter, but we expect these challenges to be more short term in nature and anticipate more normalized results as we move into 2020. Other International markets continue to perform to our expectations, and we experienced strong growth results in countries such as India, the Philippines and Guatemala during the period.

As we work to strengthen our core business, leverage our meaningful competitive advantages and increase the awareness of our powerful global brand, we feel good about the progress we are making. There are certainly hurdles that we still have to overcome, but we also have exciting opportunities in front of us, and we're confident that GNC is taking the appropriate steps today to position the company for long-term success.

I'll now turn the time over to Tricia.

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Tricia K. Tolivar, GNC Holdings, Inc. - Executive VP & CFO [4]

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Thanks, Dan, and good morning, everyone. Our quarterly adjusted EBITDA was $37 million, down $13 million from the third quarter of last year driven by the transfer of the Nutra Manufacturing facility to the newly formed joint venture and softer sales in the international segment partially offset by improvement in the U.S. and Canada segment.

For the third quarter in a row, operating income from our largest operating segment, the U.S. and Canada, increased compared with the corresponding period of 2018. Third quarter adjusted operating income in this segment was $33 million, up 26% over the third quarter of 2018, driven by lower occupancy costs and salaries and benefits as a result of our store optimization and cost-reduction initiatives. These initiatives helped drive improvements in adjusted operating income margin of 190 basis points in this key segment from 5.4% in 2018 to 7.3% in 2019.

Third quarter consolidated revenue was $499 million compared with $580 million in the prior year. The decrease is primarily attributed to the transfer of the Nutra Manufacturing and China businesses to the newly formed joint ventures, closure of company-owned stores from our store optimization initiatives, negative same-store sales in company-owned stores and lower International franchise revenue.

As Ken mentioned, third quarter same-store sales, including e-commerce, were down 2.8%. E-commerce sales increased to 8.6% of U.S. and Canada revenue in the current quarter compared with 7.2% in the prior year quarter. Revenue from our International business, excluding China, was down $9 million as a result of the International franchise challenges Ken discussed earlier. Separately, the transfer of the China business to the joint venture resulted in a $5 million expected decrease in revenue.

Manufacturing and wholesale revenues, excluding intersegment sales, decreased approximately $35 million primarily due to the asset transfer to the newly formed manufacturing JV as a result of the transaction with International Vitamin Corporation on March 1 of this year. Wholesale revenues declined approximately $4 million largely driven by an expected reduction in consignment revenue with Rite Aid. At the end of 2018, we renegotiated the contract with Rite Aid and eliminated the consignment portion of the prior contract, which created unique supply chain inefficiencies. As a result, the elimination of these sales does not have a material impact on profitability. In addition, we eliminated the radius restriction that prevented us from selling GNC products within a mile of Rite Aid stores. This change, which went into effect in January of 2019, freed us up to explore new strategic partnerships, some of which we highlighted on the last call, including DICK'S Sporting Goods, Hudson News and Albertsons.

Third quarter gross profit was 32.6% of sales compared with 31.8% in the prior year. The improvement was due to the transfer of the Nutra Manufacturing business to the manufacturing JV and lower occupancy expense as a result of the adoption of the new lease accounting standard, store closures and rent reductions associated with the store portfolio optimization strategy. We expect consolidated gross profit to range from 31.5% to 32.5% for Q4.

At 27% of sales, third quarter adjusted SG&A was up 180 basis points from last year, primarily driven by deleverage in salaries and benefits associated with the decrease in sales and to a lesser extent, an increase in consulting fees. SG&A dollars were down $11.2 million compared to the third quarter of 2018, primarily due to lower salaries and benefits associated with the store portfolio optimization as well as cost savings initiatives, cost reductions in connection with the nearly formed strategic joint ventures and lower consignment commissions as a result of the termination of the consignment agreement with Rite Aid. We expect SG&A to be down more than $35 million in 2019 driven by cost savings and store optimization initiatives. As a percentage of revenue, we expect SG&A to range from 27% to 28% in Q4.

We ended the third quarter with $122 million in cash and an undrawn revolver. Year-to-date versus last year, free cash flow increased $45 million to $87 million. The increase was driven by favorable working capital changes primarily due to an increase in accounts payable as a result of our cash management efforts as well as the establishment of payables associated with the manufacturing joint venture. We continue to expect free cash flow for 2019 to range from $90 million to $100 million.

Finally, I'd like to take a moment to provide an update on the refinancing process. As I described in my remarks last quarter and noted in our press release earlier today, we are in the process of reviewing a range of refinancing options to further optimize our capital structure and enhance our financial flexibility. This work builds on the progress we made over the past year as we reduced our indebtedness by approximately $400 million. We are working with an independent committee of the Board supported by independent financial and legal advisers as we conduct our review and have had a series of discussions with financing sources in the United States and Asia. We are pleased with progress to date. And while there can be no assurances, we are on track to complete our process in the fourth quarter.

With that, James, let's open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We will now take our first question from Steph Wissink.

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Stephanie Marie Schiller Wissink, Jefferies LLC, Research Division - Equity Analyst [2]

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Real quick question is just to isolate the operating margin improvement you saw in your U.S. and Canada business. Wondering if you can give us 2 insights. One is any sort of actions you've taken that are somewhat unrelated to sales from a cost-reduction perspective in that unit specifically? So on the controllable side, what actions you have taken? What can we expect from you still going forward? And then secondly, any sort of thoughts around the promotional environment in the U.S. and Canada. Has that been an area where you've been able to pull back and see some improvements in the leverage?

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Tricia K. Tolivar, GNC Holdings, Inc. - Executive VP & CFO [3]

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Okay. Steph, regarding actions taken, we've certainly looked at occupancy and been quite aggressive in working with our landlords in negotiating rent reductions and also the store optimization program that we have in place is positively impacting operating margins as 30% of the sales are transferring from closed stores into the remaining stores, and we don't have to add an increase in fixed costs to help absorb those sales. In addition, we've been focused on salary and benefit cost in our store environment as well as our corporate office. But looking at U.S. and Canada, those -- that attention and those initiatives have helped drive improvements in our salary and benefit costs, which are driving improvements in our operating margins. Regarding our promotional environment, I would say we haven't seen significant changes nor have we changed our promotional strategy significantly over the past quarter and certainly outside of the holiday period don't anticipate significant changes going forward.

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Stephanie Marie Schiller Wissink, Jefferies LLC, Research Division - Equity Analyst [4]

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That's great. And then just a final question is on the relationship with Walmart online or on the marketplace and Amazon and the marketplace. Could you just remind us how the margin structures work when you're directing sales through those marketplace models versus when you're selling traditional wholesale to a retailer?

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Tricia K. Tolivar, GNC Holdings, Inc. - Executive VP & CFO [5]

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Yes, actually we're agnostic to whether the products are sold online or in our stores, because although participation with marketplaces generally has a toll, what we find is our experience on those marketplaces is we predominantly sell GNC-branded product, which has a higher margin, hence making it much easier to afford that additional toll associated with those partnerships.

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Operator [6]

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(Operator Instructions) We will now take our next question from Bob Summers from Buckingham Research.

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Robert William Summers, The Buckingham Research Group Incorporated - Research Analyst [7]

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So just I wanted to dig a little deeper into comp trends, just maybe talk about the cadence over the quarter or maybe where we are quarter-to-date. And then I think that there's a broader question on why the store closures and a 30% recapture aren't driving stronger comps in the company-owned stores. You've closed over 400 stores over the last 6 quarters and clearly, there's a lot more to come, but just wanted to work through that.

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Tricia K. Tolivar, GNC Holdings, Inc. - Executive VP & CFO [8]

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Sure, Bob. We typically don't talk about cadence of comps, but let me give you a little bit of color. What we're seeing is that our strip center comps are pretty stable, just slightly negative and our mall comps continue to decline and certainly are worse than they were last quarter. As we mentioned before, we're focused on those mall locations and either improving the comps or exiting those stores opportunistically as those leases expire, and we'll continue to do that. So it's really just a result of the mix of stores that's driving the comp that we're seeing. In addition to that, regarding your question about sales transfer, while there have been about 400 stores that have closed, what we see is that from a corporate -- from a company-owned store perspective, there's about a 1 point impact -- favorable impact in comp as a result of those transfers. And frankly, the franchise locations are seeing a more positive impact closer to 2 points on the franchise side because there's a smaller base of stores that's benefiting from the same number of stores that are closing. So there -- that really sort of sums up where we are from a comp perspective.

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Robert William Summers, The Buckingham Research Group Incorporated - Research Analyst [9]

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Okay. And then just on U.S., Canada EBIT, clearly the improvement year-over-year or actually this quarter was pretty impressive, but we haven't had a clean fourth quarter in quite a while. So any help you can give on what that overall rate should look like compared to maybe the third quarter and given some seasonality issues?

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Tricia K. Tolivar, GNC Holdings, Inc. - Executive VP & CFO [10]

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Yes. So definitely seasonality plays a factor. The fourth quarter is our lowest sales quarter of the year. And therefore, you tend to see deleverage in both gross profit and in SG&A. And I would continue to expect that going into fourth quarter. I'm not aware nor at this point do we expect any unusual items hitting the fourth quarter. So I think the guidance we gave regarding ranges on SG&A as well as gross profit will help inform how that U.S. and Canada segment will perform. We still continue to expect that the U.S. and Canada will continue to show improvement versus the prior year as we go into the fourth quarter.

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Robert William Summers, The Buckingham Research Group Incorporated - Research Analyst [11]

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Okay. And then just on the -- when you think about Amazon and Walmart, can you just update us on what type of information you get on the end consumer in this arrangement? And how you can -- I would argue you're probably accessing new customers, but how do you better leverage that going forward?

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Tricia K. Tolivar, GNC Holdings, Inc. - Executive VP & CFO [12]

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We don't get a lot of information, as you can expect Amazon is pretty protective of that. Certainly, there's some insight on Seller Fulfilled Prime as we understand the consumers, their e-mail addresses and their physical addresses of where they're going, and we'll continue to partner to try to find out as much as we can, but there's certainly a limited amount of information.

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Robert William Summers, The Buckingham Research Group Incorporated - Research Analyst [13]

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Okay. And then last one. I think a lot of us thought you might have something done on a new credit arrangement by now. Clearly, you think something will be done in the fourth quarter. If you could just maybe comment on the confidence interval around that. And maybe at this point, what some of the key considerations are that are either in play or stalling the process from our perspective or from my perspective?

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Tricia K. Tolivar, GNC Holdings, Inc. - Executive VP & CFO [14]

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Yes, Bob, I guess I would say it was -- we spent a good part of the third quarter talking to dozens of different financing options. And now we're in the stage, we're being very prudent working with independent committee to evaluate those options and select the best one in the interest of the shareholders that'll drive the most value. So from a confidence perspective, we're doing all that we can to get this closed as quickly as possible. We want to be prudent through that process as we do so.

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Operator [15]

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Just as a reminder -- we have no more questions in the queue. I'll now turn the call back over for any closing remarks.

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Kenneth A. Martindale, GNC Holdings, Inc. - Chairman & CEO [16]

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Terrific. Thank you, James. Well, thank you, everybody, for your time this morning. We really appreciate your continued interest in GNC. We look forward to talking to you again next quarter. Have a great day.

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Operator [17]

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Ladies and gentlemen, this concludes our conference call for today. Thank you very much for your participation, and you may now disconnect.