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Edited Transcript of GNC earnings conference call or presentation 18-Apr-17 12:30pm GMT

Thomson Reuters StreetEvents

Q1 2017 GNC Holdings Inc Earnings Call

PITTSBURGH Apr 18, 2017 (Thomson StreetEvents) -- Edited Transcript of GNC Holdings Inc earnings conference call or presentation Tuesday, April 18, 2017 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Amy Greene

GNC Holdings, Inc. - VP of Investor & Government Relations

* Robert F. Moran

GNC Holdings, Inc. - Interim CEO and Director

* Tricia K. Tolivar

GNC Holdings, Inc. - CFO and EVP

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Conference Call Participants

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* Christopher Michael Horvers

JP Morgan Chase & Co, Research Division - Senior Analyst

* Curtis Smyser Nagle

BofA Merrill Lynch, Research Division - VP

* Damian Andrew Witkowski

G. Research, LLC - Research Analyst

* Joshua M. Siber

Morgan Stanley, Research Division - Research Associate

* Peter Sloan Benedict

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Robert William Summers

Macquarie Research - Analyst

* Sean Patrick Naughton

Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst

* Sean Stephen Kras

Barclays PLC, Research Division - Research Analyst

* Shane Paul Higgins

Deutsche Bank AG, Research Division - Research Analyst

* Stephen Vartan Tanal

Goldman Sachs Group Inc., Research Division - Equity Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to the GNC Holdings, Inc. First Quarter 2017 Earnings Call. (Operator Instructions) As a reminder, this call is being recorded today, April 18, 2017.

I would now like to turn the conference over to Amy Greene, VP, Investor and Government Relations. Please go ahead.

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Amy Greene, GNC Holdings, Inc. - VP of Investor & Government Relations [2]

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Good morning, everyone, and thanks for being with us. During the call today, we'll talk about the performance of the One New GNC during the first quarter of 2017 and how that shapes our view of the coming year. We'll walk you through financial results we released earlier this morning, and then open the call to your questions.

Before we begin, I must, as always, remind you that everything we cover during today's call, including questions and answers, is subject to forward-looking statements that are included in our 10-K.

Let me now turn it over to Bob Moran, our interim CEO.

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Robert F. Moran, GNC Holdings, Inc. - Interim CEO and Director [3]

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Thanks, Amy, and good morning, everyone. When we talked at this time last quarter, GNC had just opened its door as a new and fundamentally transformed business model, one that is designed around the customer, leverage our core strength and competitive advantages and is built to deliver meaningful profitable growth.

Looking at the first quarter results from the One New GNC. We are encouraged and excited by the progress of the business. Our goal was to bring consumers back to GNC with simplified competitive pricing, compelling loyalty programs, innovative and exclusive products and a dramatically improved customer experience. It's clear that customers are coming back to our stores. In the first quarter, transactions in our company-owned stores were up 9.3%, the strongest growth this company has seen in years. We were particularly encouraged by how transactions and customers' conversions ramped throughout the quarter. And while up across the board, the original pilot markets are continuing to outpace the rest of the chain that were converted at the end of December.

We're also pleased with our GNC.com business, which while down 7%, is a significant improvement compared to the down 49% that we experienced in the fourth quarter. We are encouraged with this performance and continue to aim for positive comps from this group in the back half of the year.

We believe that there were a few factors that helped to drive growth at GNC.com. First, our Amazon.com marketplace is outperforming our sales expectation and is leading with strong sales of GNC-branded products. Secondly, during the quarter we invested in an online marketing campaign that we believe generated a significant return on investment and helped to elevate our share of voice during the quarter. And lastly, the expanded assortment of products available online also helped drive sales.

But most encouraging is the performance of our new myGNC Rewards loyalty program, which puts us in a strong position as we head into the rest of 2017. We now have 5.4 million members enrolled in the new myGNC program. And in the first quarter, loyalty customers shopped more frequently. We are pleased that we are seeing former Gold Card member signing up for the new loyalty program, while also attracting large numbers of new members. On average, our members visited stores 1.5x this quarter. When you consider that a typical member of our old and outdated Gold Card visited just 4x in an entire year, and that myGNC Rewards members are tracking to come 6x a year, you see what the new program is capable of delivering.

We launched the PRO Access program in late March and already have almost 100,000 new members. The program, which combines traditional benefits like free shipping and points incentives with more premium offerings tailored to individual interests, purchase habits and needs, is resonating with our core and most profitable customer segment, the health enthusiasts.

But the true power of myGNC and PRO Access is capturing the e-mail addresses, which coupled with the customer data, makes customized marketing much more cost effective and efficient than it was for us in the past. Under our prior Gold Card program, while we have approximately 6 million members, we had only workable e-mail addresses for only 30% of them and customized communication with them through direct mail, which was much more expensive than targeted e-mail campaigns. Our new program requires e-mail address for each member, so that we can now communicate in a more cost-effective and timely manner. Now that we're using the rich data we get from our new loyalty programs to narrowly target offers, recommend regimens and solutions and incent behaviors based on customers' specific detailed shopping habits and patterns. In an industry where consumers are looking for trusted advice, something they just can't get online and map with -- map competitors, personalization matters and create significant opportunities for our business.

Let's talk about pricing, which is a foundational element of the One New GNC strategy. As you know, we moved from a multiple levels of pricing to a known value-added price strategy at the end of Q4. And we believe the change is helping fuel positive transaction trends. Today, we're sharply priced in categories that shape customers' perceptions, and we're able to take some margin in areas where they -- where there is much more flexibility.

We're also significantly reducing the number of buy one and get one offers, which while they drove higher average ticket, also had potential to encourage pantry loading in favor of percent-off promotions that capture consumers' attention, drive traffic, frequency and promote trial. When we compare this year's first quarter to the prior year period, there are several marked differences. We had more than a 20% reduction in the average number of SKUs on promotion, a greater than 80% reduction in the average number of items on BOGO during the period and no all-store BOGOs during -- BOGO days compared to 10 in the prior year period.

Change at this level is never easy. And in the short term, we are feeling the impact from basket size into our margins due to the investments that we have made in price and promotions. Getting customers back in the store is the first critical step and is exactly what we are doing. From here, we have plenty of opportunities to increase average ticket. We continue to train associates in solution-based selling, supported by technology and in-store marketing, which should be on display by early May. We're building and promoting additional regimens. And we're adding new grab and grow product offerings to the assortment. These initiatives all have basket-building power, and we expect to gain traction on that front beginning in the back half of the year. We believe that the incremental training the pilot markets received help them transition the customers over to the new format, and that subsequent training will be beneficial to the entire chain.

We're also focused on reinvigorating private label innovation, which has historically been a competitive strength. This work includes developing new products and formulas that address unmet customer needs and expanding customer brands like Beyond RAW, Mega Men, Women's Ultra Mega and GNC probiotics. Innovation is the key to our product assortment, and we are working to optimize the assortment and have projects underway to improve product turns in stocks and right size inventories in stores, our DCs and manufacturing.

Before I turn it over to Tricia, I'd like to spend just a few minutes on marketing, and specifically on our Super Bowl strategy. Our plan was to launch the One New GNC using the Super Bowl, including not just the game day ad, but the ongoing campaign, social media outreach and PR that comes with it, FOX suddenly and inexplicitly pulled our campaign just days before the Super Bowl. We are currently assessing the extent of these damages and will then take appropriate action. As disappointed as we were, we continue to believe we're on the right track as we shift away from brand building and focus on customer acquisition and driving traffic. We're telling customers about the One New GNC and inviting them to come back. And as we saw in the first quarter, customers are responding. And while there is still a great deal of work to do, we feel good about the trends that we're seeing and believe we created a business model that can deliver results.

With that, I'll hand it over to Tricia, who will look at our first quarter numbers.

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [4]

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Good morning, everyone. During the first quarter, we saw continued strength in transaction, offset by softness in average basket due to both investments that we have made in price and the lapsing in promotions that occurred during the prior year period. Importantly, we believe that the positive transaction trends point to the consumers' receptiveness to the changes we've implemented as part of the One New GNC.

For the quarter, our consolidated revenue decreased 3.6% to $644.8 million. Revenue was down by 3.8% year-over-year in our U.S. and Canada segment during the first quarter and at 7% in our International segment, while manufacturing and wholesale revenue, excluding intersegment sales, decreased 8.6%.

Excluding gains on refranchising in both periods and the legal charge related to the outcome of litigation, adjusted EPS was $0.37 this quarter compared to $0.69 in the prior year period.

First quarter same-store sales, including GNC.com, decreased 3.9% in domestic company-owned stores with the biggest declines coming from protein, vitamins, weight management and food and drink, which is partially offset by strong performance from the health and beauty and performance supplement categories. As we defined in the earnings release, same-store sales exclude sales of all membership programs, so the Gold Card and PRO Access sales have no impact to comps. It's products only. We shared the previous 8 quarters in 2016 and 2015 under our revised definition in our earnings release.

Last quarter, we had a 49% decline in GNC.com sales, as we better aligned online and in-store pricing and promotions. With that work behind us and the added benefit of our launch, on the Amazon marketplace and our investment in an online marketing campaign, we saw a decrease of just 7.2% in the first quarter of 2017 and are encouraged by this performance. And as Bob said, we believe that this will help GNC.com achieve positive comps in the back half of the year.

In domestic franchise locations, same-store sales decreased 4.6% during the first quarter. For the quarter, transactions and average basket were up 4.2% and declined 8.4%, respectively.

Our international business grew during the first quarter with a 3.8% local currency same-store sales, helping drive a 7% increase in revenue and a 10.9% growth in operating income. We are beginning to see some improved business trends in Mexico, South Korea and Hong Kong.

Revenues in the manufacturing and wholesale business, excluding intersegment sales, declined 8.6% for the quarter. Third-party contract manufacturing continue to increase, up almost 1% for the first quarter. Sales to wholesale partners decreased 19.3% compared to the prior year period, due primarily to a rationalization of SKUs sold to a warehouse of a wholesale club partner. And intersegment sales decreased 2.7%, primarily due to lower GNC-branded product sales in the U.S. and Canada.

First quarter gross profit, as a percent of sales, was 33%. Compared to last year, we experienced softer gross margins in the first quarter driven by deleveraging and occupancy costs associated with negative same-store sales and by lower domestic retail product margins, partially offset by the recognition of the remaining $23 million in deferred revenue associated with the Gold Card program and prior-year deep discounts on excess vitamins. Backing out the benefit of Gold Card revenue, net of coupon redemptions, our gross margin for the quarter would have been 30.6%, which is significantly below where we believe our gross profit margin will be for the full year. We believe that a more normalized level for the remainder of 2017 is in the 31% to 33% range, improving as we move through the back half of the year and begin to see the benefit of margin-enhancing programs we have put in place that are designed to shift product mix and our cost.

Excluding a legal charge related to a U.K. license agreement, SG&A in the first quarter was 24.6% of sales, that's up a bit from where we've been in the past due to increased marketing cost to support the media campaign around the One New GNC launch and online advertising.

During the first quarter, we saw a strong 3:1 return on the dollars we invested in online marketing and, as such, have continued to invest in the second quarter. If we continue to see the return, we may make the decision to allocate incremental dollars behind online marketing in the back half of 2017.

Let me take a few minutes to go through some of the changes that we're seeing in the business since the introduction of the One New GNC. As Bob told you, our pricing and promotional strategies are proving their worth in bringing customers back to GNC. We are pleased with the cadence of strengthening transactions at company-owned stores through the first quarter with January up 7.5%; February up 7.8%; and March up 11.7%. After several years of consistent transaction declines, largely self-inflicted due to the consumers' perception that we were overpriced and that the old pricing model was confusing, we are very pleased that the consumers are coming back to GNC.

If we look at the rollout of the pricing and segregate the stores by time of launch, there are 3 different groups of stores: the original 249 pilot stores launched in September; group 2, the 228 stores converted in October; and the rest of the chain at the end of December. For the first quarter, the original pilot group experienced a year-over-year 14.8% lift in transactions, offset by a 12.9% year-over-year decline in average basket, resulting in the flat same-store sales. In the second group of stores that converted to the One New GNC in October, for the first quarter we experienced a 13% increase in transactions year-over-year, a 10.1% year-over-year decline in average basket, resulting in a 1.7% increase in same-store sales. Lastly, in the rest of the chain, those stores that converted on December 29, 2016, for the first quarter we saw an 8.8% increase in transactions year-over-year and 11.8% drop in average basket, resulting in a same-store sales decline of 4.1%.

As we have discussed on prior calls, we made a conscious choice to invest in price and believe that it was fundamental to getting customers back into the stores and to remove the perception issues about the price value proposition that GNC offers. We are aware that it will take time to change perception and recover basket, but believe that we are on the right path and are encouraged by what we are seeing. We are pleased that the pilot stores continue to generate transaction results, which are better than the rest of the chain, continuing the trends that began at the launch of each pilot. All 3 groups saw a slowdown in basket recovery and transaction growth during February, as we lapped a particularly aggressive promotional cadence in the prior year period.

And Bob mentioned in his comments, the prior year quarter was fairly heavy with all-store BOGOs, 4 days in February and 6 days in March. The BOGO events tend to drive average basket size at the expense of future transactions and frequency. In the second and third quarters, there are several periods of all-store BOGOs that we have to anniversary. In the second quarter, there were 6 all-store BOGO days in May, 6 days in June and in the third quarter, there are also 6 days in September. We estimate that on average, each all-store BOGO to have approximately $700,000 in incremental sales per day.

As Bob mentioned, we're also very pleased with the improved customer conversion trends that we've been seeing. Prior to the December 29 launch, pilot stores in malls and strip centers, both saw conversion lift of 13% and 7%, respectively, since implementation of the new pricing. Both pilot market and the rest of chain stores are continuing to see improvements in conversion. As we stated in the first quarter, based on these trends and our focus on improving average ticket, we believe our same-store sales will sequentially strengthen over the course of fiscal 2017 and still expect them to turn positive in the back half of the year.

Looking at the balance sheet. We ended the first quarter with $46 million in net cash from operating activities. We invested $14 million in capital expenditures and generated $33.4 million in free cash flow. As we indicated last quarter, for fiscal 2017, we're still planning fewer new store openings and less spending on IT, and still expect CapEx to be approximately $34 million, a $25 million reduction from the prior year. Further, we expect 2017 free cash flow to be in excess of $250 million.

As we discussed last quarter, we plan to use cash that previously would have been allocated to our dividend, or in prior quarters to share repurchases, to lower our debt levels, focusing first on paying down our revolver. This is a sharp departure from our previous strategy, but we believe it's important to invest in the successful turnaround in the business. It's our intention to move towards a long-term adjusted leverage ratio of approximately 3x with rent capitalized at 5x and to take a disciplined approach to inventory management and capital expenditures. Working capital initiatives should drive incremental near-term debt reduction opportunity.

At the end of 2016, the vast majority, more than 95% of our stores, generate positive cash flow and are EBITDA positive. Like other retailers in the market, we will continue to reevaluate our real estate portfolio and make changes we feel are in the best interest of the company and our shareholders.

As we said last quarter, this is an entirely new business model. We're managing and modeling it completely differently than we have in the past. We're very excited about the progress that we have made in the short period of time. But with any new business, we believe that it's prudent to see additional results and trends before we give detailed guidance.

As we said last quarter, and continue to believe, we still expect to return to positive same-store sales and begin to see quarter-on-quarter margin rate and dollar benefit in the back half of the year. As we get through a full annual cycle, we should begin to see those improvements drop to the bottom line. As we've mentioned in the past, it takes a 2% same-store sales comp for us to see benefits of operating leverage.

With that, I'll turn it back to Bob for some quick closing comments.

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Robert F. Moran, GNC Holdings, Inc. - Interim CEO and Director [5]

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Thanks, Tricia. I think it's clear that with first quarter of performance from our new business model behind us, we're encouraged by the trends that we're seeing. We have changed this business in a fundamental way, and while there is still work to do and investments to make, we're confident that the One New GNC can and will deliver meaningful results for our shareholders.

Operator, let's open up the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) For the first question, we'll go to Sean Kras of Barclays.

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Sean Stephen Kras, Barclays PLC, Research Division - Research Analyst [2]

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Of the 5 million customers that joined the rewards program, how many were previously Gold Card members?

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Robert F. Moran, GNC Holdings, Inc. - Interim CEO and Director [3]

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Sean, this is Bob Moran. Actually, it's 5.4 million, so let's -- and incremental, so let's keep that going. And -- but it's about 30% was Gold Card members.

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [4]

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Identifiable Gold Card members.

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Robert F. Moran, GNC Holdings, Inc. - Interim CEO and Director [5]

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Identifiable Gold Card members.

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Sean Stephen Kras, Barclays PLC, Research Division - Research Analyst [6]

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Okay. And maybe can you tell us a little bit about what you've learned about the myGNC Rewards members that were not previously Gold Card members? What are these folks buying in the stores? And how frequently are they purchasing and things like that?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [7]

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Yes. So the Gold Card members -- excuse me, the new myGNC Reward members are coming into our stores and we actually talked about how their frequency is about 1.5x in the quarter alone. So that frequency, if you go back and look at the patterns of buying of our historical Gold Card members, they would only come 4x per year. So if we assume that the frequency levels that the new members in the myGNC Rewards program continue throughout the rest of 2017, we're on a trajectory to have consumers come 6x per year. And their spend, frankly, is higher than what the Gold Card customer was spending. So we're seeing very positive behaviors coming out of these new members.

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Sean Stephen Kras, Barclays PLC, Research Division - Research Analyst [8]

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And just a clarification on that. Are the folks who were previously Gold Card members, are they coming back in excess of 1.5x? Or are they also sort of in that range?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [9]

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I don't have that answer right in front of me. But my expectation is that they would be -- their frequency would be consistent with what we're seeing, but I don't have that specific data.

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Sean Stephen Kras, Barclays PLC, Research Division - Research Analyst [10]

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Okay. And then just one more for me, Tricia. You alluded to the opportunity to work with product partners to lower costs. I'm just wondering if you could give us a sense of maybe the size of that opportunity. And is this something we could start seeing like in the numbers this quarter?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [11]

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So we are in discussions with our partners. Their relationship is very important to us. And we'll continue to work those throughout the year. And I would expect to see improvements in our margins in the back half as those negotiations and dollars materialize in the results.

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Operator [12]

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And we'll move on to our next question, which will come from Chris Horvers of JPMorgan.

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Christopher Michael Horvers, JP Morgan Chase & Co, Research Division - Senior Analyst [13]

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A question. I'm trying to peel back the under -- the comp and see what the underlying trend is here. And clearly, you're showing very nice traffic and momentum during the quarter with the earliest conversion -- converted stores. Can you talk about the timing of the advertising campaign? Did that sort of coincide with that acceleration and traffic during the quarter? And how do you think about the sustainability of that? And then secondly, remind us of what -- if I was an existing Gold Card member and let's say I still had 6 months to go on my membership at the end of December, I got auto converted into new program. Did I get a coupon? And did that encourage me to come back? Or was that coupon used on that transaction the next time I came to the store? Just trying to get a sense of how much those 2 factors perhaps helped the overall comp in traffic.

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Robert F. Moran, GNC Holdings, Inc. - Interim CEO and Director [14]

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Chris, it's Bob. Let me kick off with the ad campaign. We started off in January with about 700 million marketing impressions, which obviously was to kick start the program. And then it was supposed to lead to the Super Bowl, which obviously we got kicked out about 6 days beforehand, which did have an impact on it. And if you think about the Super Bowl, it's one of the classic viewing sites where actually advertising and watching the commercials become sort of an art. So we missed out on that and we had to go to a plan B. So we didn't get -- we got marketing impressions, but not as strong as we would've gotten from the Super Bowl. And the momentum is -- it's still carrying through March. But that was really the big push, it's really the first quarter. The push now is really through our associates and the conversations that they're having with these -- with the customers as they come in the store. And we're continuing to do marketing, but not at the level of January and February. But on the -- you asked about a question about Gold Card members. Yes, we did give a coupon to Gold Card members: one, to recognize their value to us, and also to recognize how we could include them into the One New GNC. And so -- and I think that was well received by a lot of the Gold Card members. And I can't remember what the other question was.

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [15]

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Well -- so on that point on the Gold Card members, to give you some perspective, Chris, that we only had $1.4 million in redemptions -- coupon redemptions related to that campaign. And that was disclosed in the earnings release. So it's a very small part, although it's important to the launch to make sure we appease the Gold Card customer and thank them for their purchase and rewarded -- compensated them for that. It didn't have a significant impact on the transaction counts that you're seeing. And to the point -- go ahead.

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Christopher Michael Horvers, JP Morgan Chase & Co, Research Division - Senior Analyst [16]

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No, you finish what you're saying.

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [17]

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So one other thing. I just want to reinforce that our -- we did change our same-store sales reporting. So if you were to look apples-to-apples comparison how we reported in the past with Gold Card, same-store sales would've been down point -- down 6.5%. But we think it's critical to focus on products comps. And really, the reason behind our change is to match what we believe is important from a key performance indicator perspective. And we did a lot of research on how others are treating membership programs. And we modeled ourselves against Costco in our approach on how we're looking at comps and focusing on product comps going forward. But -- and Bob talked about this from a marketing perspective and how we can leverage going forward. We have this 5.4 million my free GNC reward members, and we're able to leverage their e-mails much more effectively through a CRM basis to drive the traffic going forward.

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Christopher Michael Horvers, JP Morgan Chase & Co, Research Division - Senior Analyst [18]

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Understood. And then just a clean-up question on the gross margin. The 20 -- should we think about the benefit of the gross margin? Is it the net $4 million? Or is it the gross $24 million as it relates to the -- for this quarter related to the membership change?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [19]

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So in the quarter, there is a benefit of $24 million that will not replicate in future quarters. And if you adjust the gross margin -- gross profit margin and exclude it, it would go from 33% to 30.6%.

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Christopher Michael Horvers, JP Morgan Chase & Co, Research Division - Senior Analyst [20]

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Okay. So it's not the net $4 million, it's the gross $20 million.

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [21]

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If you look year-over-year, it's a net $4 million impact. But that $24 million will not replicate in second, third or fourth quarter.

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Operator [22]

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And next, we'll go to Shane Higgins of Deutsche Bank.

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Shane Paul Higgins, Deutsche Bank AG, Research Division - Research Analyst [23]

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I first just wanted to drill down -- I think, Bob, you said you guys had about 100,000 PRO Access members so far. And can you just remind us when -- I believe you guys rolled that out at the very end of the quarter. So I guess that's for the first couple of weeks, how is that trending relative to your expectations? And what's kind of -- I don't know if you want to give the exact target for the year, but kind of what's your expectations in terms of the membership fees that could be generated from that program? And how much of the Gold Card membership fee income do you think that could replace?

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Robert F. Moran, GNC Holdings, Inc. - Interim CEO and Director [24]

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You're right, Shane. We did kick it off at the end of March. And we did that purposely because as we were layering in the new GNC and really going from the old GNC to the new GNC, we really didn't want to burden our sales associates with too many conversations. So one, we wanted to kick off the pricing. We wanted to kick off the myGNC free rewards. And then couple that with the PRO Access at the end of March. So 2 weeks prior, we went through extensive training. We were in progress that -- we have about 100,000 at this point in time. The target at the end of the year, we haven't disclosed. But it's go with ultimately down the road, and we think it's going to take a year. We'll end up getting to a point where we can match up to the revenues that we have from the Gold Card. And again, these are the customers that are really are health enthusiasts that spend more and visit us more. So we're very excited about adding that program on. The features that we have today, it's a dynamic program. It's meant to keep on adding features to it. And as we add features, obviously, we're going to have stronger conversations as we go through it. We're having a lot of success in about 50% of the stores. And obviously, right now, we're concentrating on the other 50% to help them understand the program better and go in and maybe change some of our conversations that we have to have with our consumers. But we feel that right now, we're very happy where we are today and where we're expecting to progress through the end of the year.

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Shane Paul Higgins, Deutsche Bank AG, Research Division - Research Analyst [25]

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Okay. I appreciate that color. And just switching gears real quick to the balance sheet, which I don't think, Tricia, you addressed this. But your net debt to EBITDA increased a bit. By my math, I think it was around 4.6x at the end of the quarter. Can you just provide an update on where you stand with respect to your covenants today and if you guys have had any discussions with your lenders about potentially extending your revolver or term loan just to maybe give you guys some additional headroom, while you execute your new strategy?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [26]

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Sure, Shane. So I believe we're at 4.7x. And we are closely monitoring our cash flows. And our projected cash flows are sufficient to meet our needs and don't give us any concern with our existing agreements. We're in compliance and anticipate that we will remain in compliance throughout 2017. But we certainly are monitoring the market. And we intend to approach the market with something in the near term to address our upcoming maturities.

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Shane Paul Higgins, Deutsche Bank AG, Research Division - Research Analyst [27]

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Okay. So just to be clear, you guys don't expect your financial covenants to impact your operating flexibility in any way over the next few quarters.

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [28]

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We do not.

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Operator [29]

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And we'll move to our next question, which will come from Peter Benedict of Robert W. Baird.

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Peter Sloan Benedict, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [30]

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First question just to Bob. Talk a little bit more about strategies to build basket. And obviously, the transactions are coming back. But are you -- is it more about training in stores? I think you alluded to some things around technology coming to stores in May. Maybe expand on that. And are there any adjacent categories that you're considering as you think about how the store might look going forward?

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Robert F. Moran, GNC Holdings, Inc. - Interim CEO and Director [31]

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Yes, that's a good question, Peter. Yes. Definitely, the opportunity we have, we want to utilize some of our competitive advantages, which is our backroom. And our backroom is about our science, our quality of products and our knowledge of the products. And then coupling that with what we consider to be optimum regimens is really key to our conversations with the consumer. And if you think about this with the myGNC and also the PRO Access, we have incredible insight to what the customer is buying, but then we can fit them into optimum regimens. And through that, we can incent through our CRM program how do you get one more item into or towards that optimum regimen or solutions that you're trying to do. Continue training is incredibly important. And that's something that is we're going to continue to do. And we found that in the past, our training was around how do we sell more Gold Card. Now our training is about how to be a trusted adviser, how do we give you solutions to your needs, be it running a marathon to not sleeping through the night or recovering from cancer treatments. These are things that we're trying to do. We're building bundles to support the regimens. We're also focusing on Grab & Go type of products that may -- basically at the register and they're basically $9.99 and very attractive as we do that. We're looking at our products and obviously, we've got new innovation coming in and new products coming in through the course of the year that will be very exciting. That will also drive conversations. And again, the key here is the conversation between our associate and our customer. And I've said before, and what we say here in the company, our very -- most valuable piece of real estate is the 3 feet between one of our associates and one of our consumers, so that we can actually have that conversation. We could become a trusted adviser and we can recommend solutions to their needs. And if you really think about our competition, when you go to the aisle, it's about self-selection. And self-selection is not the only thing our consumers are looking for. They're really looking for somebody that has experienced it or has seen somebody experience what we're -- what they're looking for and their change in their lifestyle. We think this is very exciting. And you can't do it overnight. When you're changing a culture that is selling Gold Cards or explaining a pricing proposition that's really difficult to understand, to now where we're talking about regimens and lifestyle changes, it takes a little bit of time. And you can see that in the pilot stores. We're picking up momentum in the pilot stores, not only more transactions, more frequency, but we're starting to work on that basket in those areas. And we're pretty excited about what we're seeing. So a lot of work to be done. A lot more to add. And this -- I mean, I hate to say it. The hardest part of this was will the consumers come back. And we're seeing that the consumers are coming back. Now we're back to retailing 101. How do we add one more item to the basket? Now I think we're very capable of doing that.

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Peter Sloan Benedict, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [32]

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Now that's helpful. And I think you alluded to technology coming in May. I mean, can you expand on that?

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Robert F. Moran, GNC Holdings, Inc. - Interim CEO and Director [33]

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Yes. Well, we've invested in the stores with new registers and also tablets. And obviously, as we're working on putting content in to support our sales associates because it's impossible to know every single ingredient or every single benefit of every single product. And what we want to do is help them with the tablets with that type of content, so they can actually add value to the conversations that they have and use our backroom expertise, which I think is far superior than anybody else out there.

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [34]

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And part of what's coming in May is additional marketing collateral in-store to help support those discussions around solution-based selling and regimens. So there will be signage and other displays to help assist the associates in the selling process with the consumer.

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Peter Sloan Benedict, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [35]

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Okay, that's helpful. And then just my other follow-up question. Just around the competitive environment and any response that you've been seeing in the market to your new pricing posture. And I mean, how -- what comment can you give us around that?

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Robert F. Moran, GNC Holdings, Inc. - Interim CEO and Director [36]

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The only changes we've seen -- I mean, in the specialty area, we've seen competitors doing a lot more BOGOs, which we're shying away from because we felt that even though during the BOGO, the added value, the days before and the days after, they took value away. So when you kind of added the whole process, it didn't really add a lot of value. But I -- we're starting to see a little bit more promotional activity within the competitive landscape. But we intend to respond appropriately. And we're getting smarter with our promotions. Instead of doing a broad brush, we're looking at categories to actually drive traffic. And they're meaningful to the customer and especially with the pricing perception. I think that's critical as we go forward.

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Operator [37]

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And now we'll take a question from Simeon Gutman of Morgan Stanley.

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Joshua M. Siber, Morgan Stanley, Research Division - Research Associate [38]

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It's Joshua Siber on for Simeon. I'm curious what percent of the sales from Q1 came from new customers versus existing customers. And of the existing customers, are they buying the core products that you've always had or some of the newer products that you're just introducing?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [39]

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So there's a good balance between new and existing customers in our sales results. There's a little bit of an opportunity to assess the data more because we have 5.4 million members in our myGNC Rewards program, nearly as many members as we had in our Gold Card program historically and creating that connection to the myGNC Rewards members were they, in fact, truly Gold Card customers in the past. But what we're -- what we have seen with the data that we have is that there is a significant number of new customers, and there's a healthy balance of new and existing. And the existing customers appear to be spending in a similar way that they have in the past in similar categories.

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Joshua M. Siber, Morgan Stanley, Research Division - Research Associate [40]

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Are you still working with dunnhumby to mine the data?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [41]

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We are not working with dunnhumby, per se. But we are certainly using their methods in-house. So we've developed that expertise by partnering with dunnhumby for a number of years and have brought that in-house over the past several months and are leveraging it in a very similar way.

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Joshua M. Siber, Morgan Stanley, Research Division - Research Associate [42]

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Okay. My follow-up question relates to the Amazon storefront. I'm curious what your expectations are for online and store cannibalization? And what the product margins look like relative to the rest of the store?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [43]

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What we find with our omnichannel customers is we actually see that they spend more in-store when they're omnichannel. So it boosts both the brick-and-mortar experience and the online experience. So -- and specifically with Amazon, we're seeing a very high mix of GNC-branded products. The consumer shopping on Amazon is looking for GNC. And those products have very high margins, so we're able to leverage that on the storefront with Amazon.

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Joshua M. Siber, Morgan Stanley, Research Division - Research Associate [44]

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Are you seeing these customers buy on GNC.com as well in addition to the shopping on Amazon? Or are they exclusively on Amazon?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [45]

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It's too early to tell at this point, but we'll continue to monitor the data.

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Operator [46]

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And now we'll go to a question from Curtis Nagle of Bank of America Merrill Lynch.

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Curtis Smyser Nagle, BofA Merrill Lynch, Research Division - VP [47]

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Just a quick one on free cash flows, hoping to clarify the number. I think you said $250 million this year. And if that's the case, what are the primary drivers? It looks like that would imply a pretty significant acceleration.

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [48]

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So the free cash flow, I did say $250 million, is the combination of working capital improvements and operating results.

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Curtis Smyser Nagle, BofA Merrill Lynch, Research Division - VP [49]

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Could you be a little more specific in terms of, I guess, which buckets within working capital?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [50]

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So we do have an opportunity to rationalize our inventory levels. So our per -- inventory per store amounts are the highest they have been in years. In the second -- in the first quarter, we wanted to be very mindful of our in-stock, so we did accelerate inventory to make sure that we're meeting the demand that we were seeing from the transaction levels. But we do see opportunity to segment stores and reallocate inventory into the appropriate places, which result in reductions in average inventory per store and working capital improvement by the end of 2017.

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Curtis Smyser Nagle, BofA Merrill Lynch, Research Division - VP [51]

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Understood. And then I guess, are there any opportunities on accounts payable?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [52]

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Certainly always looking for opportunities on accounts payable and that would be part of discussions with the vendors that are ongoing.

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Operator [53]

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(Operator Instructions) We will now go to Stephen Tanal of Goldman Sachs.

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Stephen Vartan Tanal, Goldman Sachs Group Inc., Research Division - Equity Analyst [54]

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I guess, just to follow up on that last one first. Other than elevated inventory in 1Q, is there anything else that you would sort of describe as sort of unusual with respect to kind of a run rate in cash generation? Obviously, $33 million and we're talking about $24 million of deferred Gold Card fee revenue. Like, is there something else I should be thinking about there that would imply kind of like a $9 million underlying operating figure?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [55]

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Well, there isn't anything else underlying. So certainly, as we sell more PRO Access memberships, those drive cash flows in the back half of the year and improvement in the business itself, in addition to the improvement in PRO Access sales. It's what drives the improved performance.

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Stephen Vartan Tanal, Goldman Sachs Group Inc., Research Division - Equity Analyst [56]

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Got it. And then just advertising at $12.3 million per quarter. Is that a fair run rate? Or is that a bit elevated given the relaunch? Where should we think about that going quarterly?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [57]

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So the advertising and the $12.3 million that we referred to is actually an increase in advertising over the prior year. And $6 million of that is related to the launch of the One New GNC, the combination of the Super Bowl investment that we've reallocated into other areas and around $6 million in an investment in online marketing that we mentioned that had a 3:1 return. So as we look at those results and what that means going forward, advertising historically has been around 2.5% to sales. I would say, our spend would be at least that on a go-forward basis. And as we learn more about online marketing and see those results, it's possible that, that could increase as we proceed through the second, third and fourth quarter. From an online marketing perspective, we heavily invested, as I mentioned, $6 million in the first quarter and we're pleased with the results. And we've elected to continue that investment in April. And we'll closely monitor and adjust the investment up or down based on the returns as we go into 2017.

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Stephen Vartan Tanal, Goldman Sachs Group Inc., Research Division - Equity Analyst [58]

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Got it. That's helpful. And just lastly, as we kind of look at the relaunch impact kind of by bucket of stores, which is great and helpful to think about, and the transactions are obviously great across the board, but it seems like the overall comp is pretty different by group of stores. And most recent set being the toughest, the first set a little softer than the second set. What do you make of that? How do you think about the ramp? And how would you characterize the different outcomes here by group of stores?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [59]

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So certainly, our most recent stores haven't had the benefit of more time on the program. So the pilots have an additional 2 to 3 months, at least, on the program. So their customers are coming more often. The transaction list in the pilot locations are 5 points or more above the rest of the chain. So you can see where there's momentum that continues to build. The other piece is, as we've said, there's a significant investment in basket. So as the stores -- back to what Bob said, as the stores continue to demonstrate retail 101 behaviors, we'll see that improve. So our expectation is the rest of the chain will model itself out with time, very similar to what the pilot stores were experiencing. Certainly, training will help that. But keep in mind that in February, the all-store BOGO in the prior year had an impact on all of our stores from a comp perspective, a basket perspective and a transaction perspective. And also keep in mind that there are two 6-day BOGOs, all-store BOGOs in the second quarter that we're anniversarying, too. So that will have an impact on our results as we move through Q2.

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Operator [60]

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

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Sean Patrick Naughton, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [61]

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Thanks for the breakout on the retail sales and the online data. It's helpful on the comp side. But just, I guess, when looking at that and I take a look at your kind of domestic retail business on a 2-year stack trend, it appears there's very small set of improvements from Q4, only about 30 basis points. And I would have expected some potentially higher numbers given the marketing campaign and maybe an extra selling day from Easter. So any explanation there? Am I looking at these correctly? Anything I should be thinking about as we think about modeling moving forward?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [62]

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I would really focus on transaction list. So the transaction -- Q1 transaction increase was 9.3% over the prior year. Those types of transaction lists are something we have not seen in years and years at GNC. So understanding that we made an investment in basket, but we have training and programs in place to help drive that in the back half. So that I would focus on the transactions and how that's changed dramatically from the fourth quarter. So we were down 6.5% in Q4 and up 9.3% in Q1, and then the opportunities that we have in basket to drive positive comps in the back half of the year.

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Sean Patrick Naughton, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [63]

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Okay. And then any clarification on whether or not Easter shifting out of Q1 into Q2 was a benefit for you guys?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [64]

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It certainly was some benefit to us. And it's less than 1 point, but it has an impact.

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Sean Patrick Naughton, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [65]

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And then any comment on how that impacted transactions for the month of March? You gave the numbers going from 7.5%, 7.8% then to 11.7%.

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [66]

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There is some impact, but it does not explain the increase that we see from 7.5% to 11%.

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Sean Patrick Naughton, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [67]

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Okay. And then I guess, you also provided some interesting details on the 249 stores that you rolled out in September for a flat comp in the first quarter. Any commentary on how those 249 stores performed in Q4?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [68]

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So those stores in Q4 had positive transaction growth amounts and declines in basket. They hadn't reached a net positive comp yet in Q4, but they were -- what we're seeing in the rest of the chain is very similar to what we saw in the pilot markets in the fourth quarter of 2016.

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Sean Patrick Naughton, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [69]

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So if I -- to just summarize that, so the group 1 stores improved in comp from Q1 from Q4.

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [70]

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That is correct.

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Sean Patrick Naughton, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [71]

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Okay. And then just last question on the online segment. Obviously, a very nice improvement from Q4 into Q1. How much of that overall improvement was just driven by the Amazon marketplace? And then I think somebody else asked about the contribution margin from that business relative to the overall business. But how -- is that better than your own GNC.com business?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [72]

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Well, the Amazon marketplace business is very new. So we launched the site in January and it is contributing to closing the gap and the declines in GNC.com. But we've also done a number of other things with our GNC.com program. We've added an expanded assortment. So there is 3,000 or more SKUs have been added. We've invested in online marketing, which both benefit dot-com and the brick-and-mortar locations. And as you mentioned, we introduced our marketplace and FBA on Amazon, so we're prime eligible in February. And all of those together are helping us close the gap and give us the belief that in the back half of the year, as we mentioned in the call, we'll return to positive comps in the GNC.com business. Regarding margins on Amazon, I mentioned earlier we have a high penetration of GNC-branded sales, so that yields quite high margins on our Amazon business. It certainly proves to make very good economics, despite the toll there is associated with participating on Amazon.

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Operator [73]

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And now we'll take a question from Bob Summers of Macquarie.

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Robert William Summers, Macquarie Research - Analyst [74]

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Just to dig a little more into the comp buckets. So clearly, as a group -- the pilot stores are comping positive with the second group more productive than the first. I guess, is it fair to say that you've learned something in the first set of stores that made the second better? And then second with the -- with respect to the remaining stores, as you look about -- look at the progression, how does it compare to that second set? Is the path similar? Or is there anything in the dispersion of performance that will give you any concern?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [75]

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So I'll start with your last question. There's nothing in the performance that we're seeing that gives us any concern. The rest of the chain that launched on December 29 is performing similarly to the pilot locations. And while there are variances and differences between the 2 launches, September and October, we haven't identified anything in particular that's causing one to differ from the other. While there are differences, they are not significantly different. And what the rest of the chain needs is just the benefit of more time that those pilot locations have. So continued improvement in momentum in the transaction comps, and that's expected as we move through 2017.

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Robert William Summers, Macquarie Research - Analyst [76]

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Okay. And then on the -- you talked about the success of Amazon marketplace. Are there any metrics that you can put around that or maybe frame it as to how you're executing against both what you think are the near and longer-term opportunities?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [77]

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There aren't any other specific metrics that we'll share at this time, except to say that we're exceeding our expectations and we're pleased with the opportunity and what it'll be able to do for us in the back half of 2017 and beyond.

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Operator [78]

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And we have time for one last question, and that will come from Damian Witkowski of Gabelli.

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Damian Andrew Witkowski, G. Research, LLC - Research Analyst [79]

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Question on the retention or conversion rate. The 30% is identifiable from the paid Gold Card to the free Gold Card. And where does that rank in terms of what you were thinking initially? I mean, that seems pretty low. What are you doing to kind of get it to a higher number? And what do you think that number ultimately may be?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [80]

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So the 30% conversion is tracking where we expected. Certainly, we'll have the benefit of time to see that improve. But what we are very pleased with is this frequency of the people that are coming. And in the past, they came 4x per year. Our new members are on a path to come 6x per year. And while we have specifically identified a conversion of 30% of our existing Gold Card members, there is a possibility that there are my free GNC reward members that were old Gold Card members, but we have yet to link that data.

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Damian Andrew Witkowski, G. Research, LLC - Research Analyst [81]

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Okay. And then you mentioned the environment getting more competitive. Just curious, a, what do you think is driving that? I mean, is it that the overall market is slowing and everyone is trying to grab a bigger pie -- a bigger share of the shrinking pie? Or -- and more importantly, where is it coming from? Is it coming from the specialty independence? Or is it coming more from the bigger arrivals?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [82]

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So where we're seeing the more competitiveness is in the specialty area. They're really watching our price and reacting in a very promotional way. We're not finding that the -- our space in general is becoming tighter. So all of our estimates indicate that we've got mid to -- mid-, low-single-digit growth of 5% to 6% growth in the industry as we move forward. And in the specialty space, it's 6% or more and projected to be that through 2020.

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Damian Andrew Witkowski, G. Research, LLC - Research Analyst [83]

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Okay. And then just lastly, can you talk about mall locations versus your other locations on a same-store sales basis, just performance, how it compares to overall?

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Tricia K. Tolivar, GNC Holdings, Inc. - CFO and EVP [84]

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So the transaction list we're seeing in the malls and the strips are very similar. So -- and the conversion rate in the mall locations is actually higher than in the strip locations. So we're seeing good momentum from all real estate types.

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Operator [85]

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And this does conclude today's question-and-answer session. I'd like to turn the conference back to CEO Bob Moran, for any additional or closing comments.

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Robert F. Moran, GNC Holdings, Inc. - Interim CEO and Director [86]

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I just want to thank you for your time. We're very excited with what we have accomplished and actually even more excited for what we think is going to happen in the back half. We'll continue making investments in our associates, especially in our training in our conversations, but looking forward, 90 days from now, to look at our Q2 results and be able to talk a little bit more about all the things that are transpiring for the back half of the year. Thank you very much.

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Operator [87]

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Ladies and gentlemen, this concludes the GNC Holdings, Inc. First Quarter 2017 Earnings Call. You may now disconnect. Thank you for using AT&T TeleConference.