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GNC Holdings (NYSE:GNC)

Q1 2014 Earnings Conference Call

May 06, 2014 05:30 pm ET

Executives

Dennis Magulick - Vice President - Treasury & Investor Relations

Joe Fortunato - Chairman of the Board, President, Chief Executive Officer

Mike Nuzzo - Chief Financial Officer, Executive Vice President

Analysts

Chris Horvers - JPMorgan

Peter Benedict - Robert W. Baird

Shane Higgins - BMO Capital Markets

Mark Wiltamuth - Morgan Stanley

Stephen Tanal - Goldman Sachs

Meredith Adler - Barclays

Kurt Frederick - Wedbush Securities

Operator

Good afternoon. My name is Ian. I will be your conference operator today. At this time, I would like to welcome everyone to the GNC First Quarter 2014 Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

Mr. Dennis Magulick, Vice President, Treasurer and Investor Relations, you may begin your conference.

Dennis Magulick

Good morning, and welcome to the GNC first quarter 2014 earnings call. This morning, we released our first quarter financial results, which are available on our website. With me today are Joe Fortunato, Chairman, President and CEO; and Mike Nuzzo, Executive Vice President and Chief Financial Officer.

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

Now, for the disclaimer, this conference call contains forward-looking statements, which include information concerning our future results, trends and other information that is not historical information. All forward-looking statements included on this call are based on information available to us on the date of this call, current expectations and various assumptions. We believe there is a reasonable basis for our expectations and assumptions, but they are inherently uncertain and may not prove correct. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained throughout this call. For a list of important factors that could cause our actual results to differ materially from the forward-looking statements on this call, please refer to our public filings with the Securities and Exchange Commission and our earnings release this morning.

I will now turn the call over to Joe.

Joe Fortunato

Thanks, Dennis, and good morning everyone. When we issued our first quarter and full year 2014 outlook in mid-February, it was our belief that the severe weather patterns, which were negatively impacting our business would soon surprise and the core business will be back to our recent historical growth rates. However, as has been widely reported, the weather affect continued throughout the month of February.

In March, same-store sales were positive and exceeded the January-February period by several hundred basis points after adjusting for the Easter shift. At that point with the weather having cleared, we had better visibility into the underlying trends of our business. There are several categories performing exceptionally.

These are being driven by proprietary GNC product and include women's Vitapaks, Total Lean and GenetixHD. However, as we look at all the categories and the industry more broadly, in total we believe the combined effect of several factors has resolved in a growth rate that has currently moderated. These factors include the following. In the sports category, since workouts become more consistent as the weather changes, there has been a delay to the start of workouts season this year.

Although we have seen some normalization with better weather, we clearly lost some degree of peak shopping for beginning of year in spring break exercise regimen. Also in sports the pre-workout space has been weaker than expected, with GNC among the leading sellers of products containing DMAA, a contributing factor to the weakness in this category with the ongoing need for us to anniversary the combined DMAA and replacement product sales periods from 2013.

We expect this sales hurdle to continue to challenge us through the third quarter. Since the pre-workout customer also buys other high margin products, including Vitapaks, there are some collateral impacts to the vitamin category.

Moving to Vitamin, negative media that has significantly escalated since the middle 2013 has been more persistent and impactful than we had historically experienced. As a result, we have seen weakness in multivitamin sale coinciding with market trends more generally.

Similarly, fish oil has been declines in both, specialty and mass channels following studies published last year. Negative media thought the explosive growth of our proprietary Vitapaks over the last several years has been an important differentiator for us, but also gives us a harder challenge in this subcategory as we hurdle successful product introductions.

Third, although our proprietary diet business driven by Total Lean and GenetixHD continues to be strong, the rest of the diet category lacks a major third-party catalyst, which historically has enhanced the growth rate in this category. For example, Garcinia Cambogia is trending positively in 2014, and general offsets Raspberry Ketones and Green Coffee Bean (Inaudible) from last year, but is not generating incremental growth.

Combined these factors will pressure our same-store sales expectations for the next several quarters. Now that we continue to transactions and sales lift from the new pricing stores Member Pricing stores converted in May and June last year. The above factors are currently negatively impacting the potential lift in the second and third year in the older converted markets.

Nonetheless, the Member Pricing program has been the right strategic change for us and positions us with a strong pricing foundation for the future. The good news is that I do not view these factors as damaging to our long-term growth model, however what I do anticipate is that in the short-term, the industry will react to these and similar factors with more aggressive promotional effort.

We plan to address this situation in the following way, protecting our position in the marketplace by continuing to offer unique shopping experience, leveraging our core competency in product development and customer service to maintaining our level of differentiation by continuing to introduce new products that are more sophisticated and targeted than other products in the market.

In 2014, this includes expanding our successful Vitapaks franchise to create new sub-segment such as the women's Pro Performance, [program] which has been clinically studied and scientifically designed to boost performance in a manner that far exceeds other supplementation programs. This Vitapaks is driving double-digit growth in our women's business.

Similarly, the newly developed a elite physique Vitapaks offered under our proprietary GenetixHD brands which leverages multiple clinical studies to provide an unparalleled level of performance is off to a great start.

We also launched GNC Puredge a full line of sports nutrition product that set the standard for whole food-based performance. These are just a few examples of the foundation GNC has built around premium, proprietary products and brands. Three, drive marketing to the next level with our Beat Average campaign, which launched last month in our direct marketing initiative with dunnhumby.

The proprietary goal of Beat Average is to introduce new customers to GNC. To achieve this goal, we will be more inclusive, targeting wellness achievers at all stages of their journey. The campaign uses humor, sarcasm and wit combined with a simple inclusive message ingredient of successful campaign just being in other industries.

Beat Average is integrated, national and across all medium showcasing our superior products and brand. The May 3rd TV launch featured network primetime placement on NBC, CBS and ABC. Additional highlights include expanded network partnerships, targeted cable and high-impact online video and display execution.

Beat Average will be aired in programming that includes ESPN's broadcast of the NFL draft, World Cup and online sports center. This campaign is designed to be longer-term in its evolution. It could be adapted over time to be focused on product and brand differentiators and is particularly applicable to social and digital media.

Moving to direct marketing, with the additional insights gained through our enhanced Gold Card database, which now provides a more comprehensive, quantifiable and actionable list of customer behaviors. We will drive customized strategies that reward loyalty and expand share of wallet.

Optimizing our direct marketing efforts will provide an improved total customer experience via more relevant offers that are designed to drive incremental business and increased spend. The customization efforts start with historical purchasing habits such as category, channel and promotion preference. It also factors product purchase affinity identified through rigorous database analysis, improvement techniques presented by dunnhumby.

The outcome is very detailed view of customer engagement from initial spend to tendencies for repeat purchases and seasonality patterns. Our customers will begin to see the enhanced level of segmentation over the next two months. Lastly, building on the success and flexibility of our member pricing program, we will use it as a vehicle for more dynamic pricing and promotions in response to the current market environment.

Strategically the transition to Member Pricing is providing benefits on many levels. Our customers have consistently told us they shop more with this program and the stores most recently converted once again generated incremental sales and transactions that compared to the rest of the chain.

Further, we continue to do the trade up potential or customers new to this program as the long-term growth opportunities. With this in mind, we will regularly seek different ways to engage with them.

For example, we are conducting a tiered approach to Gold Card renewals, in an effort to maximize the value of our customer acquisition efforts as we anniversary last year's Member Pricing launch. We believe these strategies positions GNC to secure a leadership position in the marketplace by providing a unique shopping experience to an expanding base of wellness achievers.

I will now turn the call over to Mike to provide details of our financial performance.

Mike Nuzzo

Thanks, Joe, and good afternoon everyone. First, the consolidated results, our first quarter consolidated revenue increased 1.9% to $677.3 million. Retail segment revenue increased 3.1% and our franchised and manufacturing wholesale segment revenue decreased 1.4% and 2.2%, respectively.

First-quarter gross profit calculated after deducting product, warehousing distribution and occupancy costs was 37.8% of revenue compared to 38.5% in Q1 2013. The decrease in gross profit rate was due primarily to lower Gold Card deferral revenue recognition related to the Member Pricing rollout, and occupancy de-leverage associated with retail same-store sales below our leverage point.

First quarter consolidated SG&A expenses were 19.9% of revenue compared to last year's of 19.8%. Within consolidated SG&A, advertising and promotion expense was 2.5% of revenue as compared to 3.1% in Q1 2013. In 2014, the company's Beat Average campaign launched in the second quarter, whereas in 2013 Respect Yourself campaign launched in the first quarter.

Q1 2014 net income $69.9 million, a 3.8% decrease from the prior year. Diluted earnings per share were $0.75, a 2.7% increase over 2013 results.

Now, for information by segment, first to the Retail segment, our retail segment includes domestic and Canadian corporate owned location and the Internet businesses including DiscountSupplements.com. Q1 Retail segment revenue grew 3.1% to $509 million, driven primarily by growth in our e-commerce businesses, $8.6 million from DiscountSupplements.com and the addition of 158 net new GNC stores as compared to the end of Q1 2013.

New store productivity continues to meet our expectations, delivering year one revenue at approximately two-third of our mature store model. These gains were partially offset by negative same-store sales at approximately $3 million due to the exchange rate trend of the Canadian dollar.

We continue to be pleased with the success of our e-commerce strategy and each of the businesses comprising it. GNC.com and Lucky Vitamin.com both, generated top-line gains that eclipsed market growth rates while also expanding operating margins and DiscountSupplements.com delivered a solid quarter, contributing $8.6 million in revenue and a solid operating margin.

Q1 retail operating income decreased by 4.5% to $94.1 million and was 18.5% of segment revenue in Q1 2014 compared to 20% in Q1 2013. Operating margin rate was negatively impacted by lower Gold Card revenue recognition related to the Member Pricing rollout in 2013 occupancy de-leverage and Canadian dollar exchange rate variance. In the quarter, we added 36 net new company-owned stores.

Next, to the Franchising segment. Revenue in franchising is generated primarily from wholesales sales to our franchisees, the collection of royalties on franchise retail sales and fee.

Q1 Franchise segment revenue declined 1.4% to $106.3 million. Domestic franchise revenue decreased by 2.2% to $64.8 million and was driven by lower wholesale product sales associated with a 3.2% same-store sales decreased.

International franchise revenue decreased 0.3% to $41.6 million; a 6% franchisee reported local currency same-store sales results was offset by lower wholesale product sales. Our portfolio of international franchisees has consistently delivered solid same-store sales and earnings growth over the last few years.

More recently, however, series of regulatory and geopolitical factors have negatively impacted results. For example, in 2014 Mexico will undergo their second regulatory challenge in the last three years related to product reformulation. Although we are adept to changing formulations, these initiatives require additional resources and time before they positively impact the business.

As discussed previously, we continue to face challenges in the South Korean market. Turkey, Venezuela and Australia are examples of other countries facing similar regulatory, geopolitical war heightened market pressure. Although, we continue to be excited about the long-term growth prospects for international expansion, these regulatory and other challenges are simply an aspect of the business that can cause short-term variability.

Q1 franchise operating income increased 4.6% to $40.2 million and was 37.8% of segment revenue in Q1 2014 compared to 35.6% in Q1 2013. The increase in operating income percentage was driven primarily by higher gross profit margin resulting from a higher mix of store fees. In the quarter, we added 14 net new domestic franchise locations and 27 net new international franchise locations.

Third, to our manufacturing wholesale segments, revenue in this segment is generated primarily by third-party sales at our manufacturing facility and product sales to Rite Aid, drugstore.com, PetSmart and Sam's Club.

Q1 manufacturing Whole segment revenue decreased 2.2% to $61.9 million. The decline was due primarily to timing of purchases by one of our wholesale partners. Q1 operating income increased 2.5% to $23.5 million, a 38% of segment revenue compared to 36.2% in Q1 2013.

The increase in operating a percentage in the quarter was driven primarily by a higher mix of proprietary product sales. We opened eight net new Rite Aid store within a store locations in the quarter.

Next, to our balance sheet and cash flow. For the first quarter of 2014, we generated $123.1 million net cash from operating activities. We spent $12.8 million on capital expenditures, primarily for new stores, store maintenance, updates and remodels, corporate IT and other manufacturing facility expenditures.

We generated $109.7 million in free cash flow, which we defined cash provided by operating activities, less cash used in investing activities excluding acquisitions. We paid $14.6 million in cash dividends on our common stock and we repurchased 150 million in shares of our common stock. The company now has 290.7 million remaining under its existing 500 million under its authorizations.

As of March 31, 2014 we had a cash balance of $172.7 million and long-term debt of $1.35 billion. We have an undrawn $130 million revolving credit facility with $1.1 million pledged as collateral for outstanding letters of credit.

Now, I will provide our current 2014 outlook. As outlined in our earnings release this afternoon, we expect diluted earnings per share to be approximately $3.05 to $3.10, a 7% to 9% increase over 2013 adjusted EPS. Key assumptions underlying EPS guidance are as follows.

One, a mid single-digit increase in consolidated revenue for 2014. This is based on achieving a domestic retail same-store sales results including GNC.com of flat rate low single-digit increase for the remainder of 2014.

The second and third quarter, this is on a product-only basis as compared to 2013. Two, modest full-year consolidated gross profit margin expansion as the benefit of anniversarying investments associated with launching the Member Pricing program in 2013, are partially offset by 2014 strategy to response an anticipated competitive marketplace trend in this challenging sales environment. Three continued regulatory and macroeconomic challenges in our international franchise business.

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

Joe Fortunato

Thanks Mike. As Mike said although the international business has its chairman, mainly on the regulatory side, which caused temporary business fluctuations and our addressable, we continue to see expansion opportunity in major markets like Europe and China.

In Europe last month, we require The Health Stores, a nine-store chain based in Dublin, Ireland. The Health Store generated revenue of approximately $13 million in 2013, representing the double-digit market share in the Irish health and wellness market. This acquisition complements our entry into Europe last year via DiscountSupplements.com and expands the foundation for establishing a meaningful presence there.

In closing, while we are not satisfied with recent industry trends, we believe our strategies in response to them will secure our leadership position. Our expectations for same-store sales of flat to a low single-digit increase for the remainder of the year reflect a conservative approach given the current challenging trends, including our vitamin category that is pressured by external factors and difficult transaction hurdles pre-workout and with the second and third quarter Member Pricing conversion last year.

As we move forward later in the year, we anticipate the combined effect of our marketing efforts meeting sales hurdles and an improved international regulatory situation will help to offset these meaningful challenges.

All-in-all, we continue to be very confident in the strength of our brand and the long-term strategic growth profile of our business and believe we have the right strategies in place to drive ongoing success.

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Chris Horvers. Your line is open.

Chris Horvers - JPMorgan

Thanks. Good evening. Can you talk about the rationale on guiding the second and third quarter the flat low single-digit on the product side? Remind us what the delta was last year end. On the Gold Card side, how much do you think that you'll actually get back from the giveaways?

Joe Fortunato

Great question, Chris. The main reason for guiding zero to low for the rest of the year is really based on the outperformance last year in Q2 and Q3 based because of the member pricing program implementation. We had a 6.8% product comp and we had a 8.2% product in Q3, so part of the concern we see is will we be able to get and I will fill you in later on if you want on what's going on with Member Price shifting and what's occurred with that consumer. It's been positive, but it has not had the same momentum that we saw in the past, but we are still confident and surely we did the right thing with the program.

The things that result for us, the ability to have that consumer all the time and I think it's important for us to understand that that created hurdles for us last year that are to going to be part of the difficulties for us to hurdle this year. That combined with DMAA, which has been a significant component of Q1 and I will explain that further as well and that continues all the way into Q2 and Q3.

I'll emphasize a little bit, where we were hurdle in Q, DMAA, with alternate products and DMAA last year in the third and into the quarter October, as we went up against bigger peak periods for the replacement product and DMAA before it was discontinued, which runs all the way out of September, we were unable to hurdle those as effectively and also that's about 250 basis points. Also that is a related baskets there where those consumers were buying other products and conservatively we looked at that and that's another 50 basis points to 75-plus basis points, so that's kind of what's led us to a more conservative guidance as we move into Q2 and Q3.

Chris Horvers - JPMorgan

Then in terms of the actual, I think on a reported time basis you'll have Gold Card in there, so we are going to get two numbers going for 2Q in 3Q in terms of product-only comp and then in overall comp is the rationale to make sure that people don't assume that Gold Card comp is actual revenue and the leverage side of it.

Mike Nuzzo

Yes. Chris, I think, maybe I said it different way. To be fair on the comp comparison for Q2 and Q3, we really would look at it on a product-only basis, because as you know with the giveaway and the lower sales, because of the giveaway in Q3, we are going obviously have sales again of the Gold Card, so we thought it was important to do the comparison based upon the numbers that Joe gave you that Q2 of 6.8% and Q3 of 8.2% for the product-only comp.

Joe Fortunato

I think that's critical, because after some discussion certainly it would be unfair that fell to 6.8% and 8.2% six in the two last year not compare against that this year.

Chris Horvers - JPMorgan

Understood. Then just one final point, how much did - you comp positively in March axe the Easter shift and can you describe the acceleration that you saw. Similarly, as you have seen the first five, six weeks of the quarter, can you talk about ex-Easter what your experience is so far?

Joe Fortunato

I'll give you kind of the summation on Q1. January, not a good month, we accelerated by 200 basis points in the February, but as we got off the call, I think it was in the middle February last time, weather continued to be horrific across the U.S. for the next two weeks, so February got better than January. March got significantly better than February.

Chris Horvers - JPMorgan

Then anything on April?

Joe Fortunato

I'll just say the same things and I can highlight some of those things for you. I know it's not part of your question, but some of the same issues with the business whether it's DMAA or those hurdles that are same things we are concerned about that we are seeing in April as we were seeing before.

Chris Horvers - JPMorgan

Understood. Thank you.

Operator

Your next question comes from the line of Peter Benedict. Your line is now open.

Peter Benedict - Robert W. Baird

Yes. Thanks guys for taking the question. I guess, my question is on the industry and then the competitive environment. I mean, you talked a lot, Joe, about how the industry had some challenges. How do you separate that from what's going on competitively and maybe you can talk to us about how you view the competitive set today versus even 12 month ago, how does it feel different if at all? Thank you.

Joe Fortunato

I would put it this way. I feel comfortable that GNC has been very well-positioned. Although we still have strength in our sports category. We are seeing is weakness in the third-party brands that in sports and diet in particular frankly offset by the private label brands strength we are seeing in Total Lean, which is still a phenomenal growth rate, which is offsetting the softness in the third-party products and diet. Sports, pretty similar, third-party brands have become softer. I don't know some of the concern over some of the scrutiny of the FDA, or negative media whatever the case might be and our brands have carried the [day], so good news for us is going off road, we still have these great brands and great (Inaudible) brands 56% of our sales in Q1 that will continue to differentiate us in the marketplace.

We have to get the third-party vendors in like we did in 2005-2006 which resulted in phenomenal growth to get them to get back to be more creative and innovative with their products and doing special deals with GNC like we have always done, so that part makes me comfortable.

The industry trends, obviously, you can see the vitamin trends probably the most concerned as anybody, whether it's the mass market ends here somewhat, we had negative media which we think impacted obviously the mass market there shows the impacted them significantly that also impacted us some. We are seeing some reversal. Usually what happens over time that's stuff wears off, you are seeing some positive media start to hit the market pretty prevalently in the last couple of weeks and that just fade as time moves on, but it's definitely had some impact in the vitamin business and fish oil business.

Peter Benedict - Robert W. Baird

That's helpful, and related to that, in your conversations with your third-party suppliers, do you get the idea that you guys are holding share in those categories or could those sales be going elsewhere?

Joe Fortunato

We know a number of the third-party vendors have gotten very weak. We also know a couple that we are very close to and are working side-by-side with us, have already given us a couple of exclusives and have been one of our main partners over the year, except for a period where they had some issues to deal with on their own. They are very much, let's embedded with us and we are very excited about products they are bringing to the marketplace and they should help drive that third-party business alone, but we also have to get more diligence with some of the other third-party vendors and they are shrinking somewhat.

I mean, the prominent third-party vendors, which gives us an edge again are shrinking, so we are going to keep paying more attention to our product innovation. It's been the best innovation we have done in years. It's showing the biggest quantity of sales and volume of sales in the early months and we are really happy with it. It's just the key to keep doing what's always been successful.

Then, we are going to make some alterations as necessary to our retail model to make sure we do a couple of things. We are not going to lose customers, we are not going to lose market share. We don't feel we are and believe me that will be the last thing that is acceptable here and we will make sure we do everything to offset that and we have got a lot of things in the pipeline.

As you know dunnhumby has shown some early results already just in the first month of being involved with the business. Again, on our direct mail pieces, and our marketing launch the other day, Beat Average, has been phenomenal, has gotten phenomenal feedback. I mean, 5 million impressions about 99% of the views have been very positive. I mean, we are really excited about that launch and the leg that it has for the future this is a multiyear campaign that is very flexible and will allow us to alter the product, alter it to large - it's really conducive to social media. People are involved.

I was at a convention show here in town for the marathon the other day, people are getting deeply involved in the Beat Average campaign and they understand it and it's got a tremendous amount of merit, so I am really excited by that.

Peter Benedict - Robert W. Baird

Great. Thanks very much for your comments.

Operator

Your next question comes from the line of Karen Short. Your line is now open.

Shane Higgins - Deutsche Bank

Good evening. It's actually Shane Higgins on for Karen. Thanks for taking the question. Joe, just wanted to hear some of your thoughts on dunnhumby and maybe what they are doing to target the 3 million new Gold Card members just in terms of maybe forming a new strategy on pricing and renewal for these members?

Joe Fortunato

Yes. I am excited about because - I will give you the 3 million breakdown a little bit, which is kind of interesting. I mean, two-thirds of those cardholders shop two, three or four times since we gave the cards. That's pretty positive. We have had very little response from about a third of them.

Dunnhumby, beside their main efforts of really enhancing our direct mail process, which has been very stagnant over the past three or four years, same thesis, same people, same audiences all the time. This is very customized with offers certainly not which you thought last time. Product suggestions as to what else you should be buying, they did one test already and it showed significant upside to what they are doing, so few people love customization thing. They want to feel special and that's what dunnhumby should help us do and we also think that where the market kind of interrupted our momentum with the member pricing customers that we obtained, this should help get us back on track, the industry and the market and whether hurt the moment of that program, but we expect to get it accelerated again and we are really focused.

Mike Nuzzo

Shane, just one more point, I think you mentioned it on the renewals, dunnhumby is also helping us. I know we have talked about doing tiered strategy for renewals and they have been really helpful in educating us about how to think about customers that have come back only once, two times, three times or haven't come back at all, so we are using their help and assistance to target those customers in the renewal process which we are in the process of doing right now to maximize the impact of that, because at the end of the day the focus for us is to keep the person as a member.

If we haven't seen them since they got a free card, we want them back in the store, so that's I think where they can also add a significant amount of value over the next couple of months.

Joe Fortunato

Then one last pivot to that is, part of this program of giving various offers out to various people in regards to renewing them, we had a two-year card out there that is selling the best of anything, so that gives us access to these people for two years out (Inaudible) and marketing to them and all that, so I think we are going to very effectively hurdle the 8 million-plus Gold Card members we have and 10 million plus email.

Shane Higgins - Deutsche Bank

Great. Thanks. If I could just squeeze one more in, guys, you obviously bought back a lot of stock in the first quarter. What are your thoughts on perhaps accelerating the 290 million or a big chunk of that maybe into the first half of this year?

Joe Fortunato

Good question. Mike, and I just had that discussion probably 20 minutes before this call. Our mindset is, we like the attractiveness of our ability to go out and market right now. We have been fairly aggressive and we are doing that for reason and we are going to continue to be aggressive and if we have to accelerate the I think we have done around 220 million something like that.

Mike Nuzzo

210 on the…

Joe Fortunato

We will go well beyond the 40 million number, we will go much further than that if we have to.

Mike Nuzzo

Just to be clear, the guidance has the 250 in it. Again, we generated as you saw 110 million in free cash flow, so clearly we are going to have the ability to do that. I always keep close to my best the timing et cetera, but certainly yes. That's top of the line.

Shane Higgins - Deutsche Bank

Okay. Thanks, guys.

Operator

Your next question comes from the line of Mark Wiltamuth. Your line is now open.

Mark Wiltamuth - Morgan Stanley

Thank you. On the Goal Card renewals that you are going through right now, what percent are renewing and what's that rate versus the prior year and how many of them are getting a free Gold Card given to them, because I would think whatever number you are collecting actual fees from right now would be an increase member fees you were collecting last year when you were giving them out?

Joe Fortunato

We're giving a, what I would call, a fairly small quantity to our customers to ensure we don't lose or lead any of those customers out of the business, so that's undergoing now. In addition, we have got as Mike and I have indicated are very tiered program that goes all the way up to $15, $10, $5, that is really targeted at the customer and depending on when you last shop and did you get a card free last year, did you shop before that or you are a member or you are shopping in off Gold Card. Those kind of things, so yes we intend to make sure that we retain the customers, because we think we have a lot of vehicles that will help us drive these customers much more effectively. Remember, we have a 3% better lift from those customers than we have in the other markets from when we launched the program.

Mike Nuzzo

Yes. I think, Mark, we will be in a better position with the Q2 call to give you some insight on that, because we are really in the midst of it right now and obviously getting to members and to lead new cardholders, so I think we will have better visibility to that on the next call. Certainly, we were happy with the renewal effort that we did in New York and Chicago, this past anniversary in Q4, so the hope would be to try to do better than that.

Mark Wiltamuth - Morgan Stanley

Okay. Then in the tough markets you were saying high single-digit lift and now it is kind of 3, but that's part partially impacted by the margin a little bit too. Is that fair?

Joe Fortunato

Yes. That's what we think. We think we got interrupted a little bit soft retail environment in December and obviously January and February, with the severity and more than that severity was the broadness of the weather impact across the country. We tracked it regularly. I mean, there were very few states that weren't impacted to some extent many states were impacted significantly, so that interruption in our relationship with those consumers and ability to get them to the stores, I think will be reignited as we go after them more aggressively with card renewals and with dunnhumby.

Mike Nuzzo

Yes. The other thing we anticipated when we rolled this out that the average ticket is slightly lower, because these are new members and they haven't been developed as customer so to speak, so that detracts a little bit. The transaction growth is pretty similar to the expectations. It's just we have had a little bit of a drag, because of the average ticket for these customers as you could probably imagine.

Joe Fortunato

The more you get them into the store, obviously our sales force is excellent at up-selling customers. That's why we always had maintained a very strong average ticket.

Mark Wiltamuth - Morgan Stanley

Okay. Just looking at these year ago hurdles that you talked about are comparison problems. It sounds like the DMAA and pre-workout areas are the biggest issues, where are the biggest year ago comparison issues by quarter?

Joe Fortunato

By quarter, you would have obviously we kind of done a discount it's 2 and 3 again. DMAA is going to carry us all the way from - I mean, impact is a little bit early in the year, March, but it's certainly going to impact all the way up through August to September.

Obviously, unless we can get more product in those markets to attract that pre-workout consumer or get them other things to buy, but we have a lot of products in the market and pre-workout that we probably don't carry. The obvious is that as both of those categories or as you call the same category pre-workout, but the replacement brands plus DMAA peaked at very strong numbers in March, April, May, June, July, August and then obviously DMAA fades and you go on from there.

Mark Wiltamuth - Morgan Stanley

Okay. Really the last gas of the DMAA inventory and the replacement of DMAA products.

Joe Fortunato

Yes. I can say we did a great job replacing the product as I told you in the last second and third quarter last year and we were effectively hurdling the combination rate of the DMAA products Oxy and Jack mostly, but as you got further into this year, because we did a good job through replacement product, we were still against very strong peak numbers from those products and against strong numbers from the replacement products.

Mark Wiltamuth - Morgan Stanley

Okay. Thanks you very much.

Operator

(Operator Instructions) Your next question comes from the line Stephen Tanal.

Stephen Tanal - Goldman Sachs

Hi, guys. Thanks for taking the question. How are you guys?

Joe Fortunato

Good.

Stephen Tanal - Goldman Sachs

If I heard it correctly, then so I think the Gold Card lift is closer to 33%. Did I hear that right?

Joe Fortunato

Yes.

Stephen Tanal - Goldman Sachs

Is it fair to sort of say the underlying comp trend is sort of negative then as we think about the rest of this year and is that sort of an industry problem that you would call out?

Joe Fortunato

You have to say it's 3% from the other market. Remember, a significant of big markets were already convert, so when you look at the lift, would you say it was 3% in comp, no, but it was 3% above what we were seeing in the other markets that had either already converted and there were good number in, New York, Chicago and you had Denver, you had Kansas City, a good number of other always convert, so I would say no and I don't want to guess, but I would say it's probably more close to half of that.

Stephen Tanal - Goldman Sachs

Understood, so 3% is sort of the year one lift then is the right way to think about it?

Joe Fortunato

Exactly.

Stephen Tanal - Goldman Sachs

Perfect. Okay. Then just to be clear on the Member Fee stuff, there's a lot going on there in terms of the price you charge stores and it's hard to do the math around it, so it's sort of giving out just to understand what it is. Are you expecting sort of member fee revenue to be up or down versus the all program now that you have more members?

Joe Fortunato

Tough question and we understand why you are having a hard time figure it out, but Mike, do you want to?

Mike Nuzzo

Yes. Again, I think, we would expect it to be up. The sales of Gold Cards have trended up since we converted the rest of the markets, so that's obviously a positive thing. Renewals should be better than our historic renewal rate, so that will be another positive. Again, keep in mind as far as a comparison to last year from amortization perspective, Q2 is a hurdle. We got a big benefit in the Gold Card amortization in Q2, but then after Q2 the anniversary gets easier on the amortization side, so I know that wasn't what you asked, but I wanted to make sure we communicated that as well, so yes. I think that's certainly the expectation and that's what we think.

Stephen Tanal - Goldman Sachs

Yes. That's helpful. My next question was sort of on the amortization piece. I mean, you mention of the two-year cards are selling better. I think that right now I see it doesn't start $15 which is in about 750 a year, so assuming that occurs over the two-year period delay, a 12-month card, I mean, you would expect that headwind to sort of stop coming into revenue pretty soon if I am thinking about that right.

Joe Fortunato

Yes. At some point, I mean, we are also selling two-year cards at $25 before the special offer period and they were doing very well, so I look at it and say as long as we get the uplift on the two-year cards that we maintain a very healthy revenue stream as we move through the deferral period.

Stephen Tanal - Goldman Sachs

Got it, and this is a promotion then that expires. I would assume, I think ended June is that right?

Joe Fortunato

That's correct.

Stephen Tanal - Goldman Sachs

Got it. Then just very last one for me. In the guidance, you mentioned that you sort of anticipate gross margin impact to responses as to I guess competitive marketplace trends that I guess are yet to develop. Correct me if I stated that wrong, but does that mean that if the market does not get more competitive, we could see better flow through on grosses?

Joe Fortunato

Yes. I think, again going back to our themes, we are not going to give up market share, we are not going to give up customer base, we are accelerating all efforts within the company to make sure that we are putting more resources. We have hired additional resources, we are going after social media, we are going after everything digital, everything that will drive certainly the marketing campaign, but we are going to stay promotional as we need to, to make sure that we are not to lose market share. I don't think that is going to cost us significant margin, but I think that we were potentially commenting on some upside margin that we may not see the last year. This quarter reflects margin was pretty effective based on a couple of things that affect the market that Mike and I outlined for you.

Stephen Tanal - Goldman Sachs

Got it. No. That's very helpful. I follow-up offline. Thanks a lot, guys.

Joe Fortunato

All right. Thank you.

Operator

Your next question comes from the line of Meredith Adler. Your line is now open.

Meredith Adler - Barclays

Thanks for taking my question. I heard, Joe, what you just said about. You are not going to give up market share or customers and that's certainly a message you want to your competitors, but I guess it's a little concerning. Is there a point in which you say the value of the sales and the customers is not very high, if you are very promotional or spending a tremendous amount of money on marketing. Is there a point when you say enough is enough?

Joe Fortunato

I think, there is always a point when you say enough is enough. I think that we will do it in a, what we think is very strategic way. Obviously, we are planning on some of the vehicles that just planning to - we have talked our economy and a new Beat Average campaign. We continue to count on our brands that differentiate us in the marketplace, so we are really - talking about third-party brand, or we have to accelerate the promotional component of that, we will. I mean, we looked at January and February, you could see our dot com business was extremely strong. in all three of our dot com business, but especially GNC.com, because we got more promotional making sure that didn't lose that customer going during January and February, because they because they couldn't get to the stores because of the weather situations, so we do that very intelligently. We target and kind of back - where our end objectives are and end goals and we again can demand a premium on our brands, which is going to be a bigger and bigger piece and strategically we plan on making it a bigger and bigger piece of the business, because that again becomes the differentiator against the rest of the market, so you'll see some things getting more promotional against third-party brands with our competitors are getting more competitive, but if not, we will back off and we will do what we need to do and take advantage of our brands and so forth.

Meredith Adler - Barclays

All right. I guess, that makes sense. You are going to balance things is what I hear you saying.

Joe Fortunato

That's a good, I wish you were to answer it for me.

Meredith Adler - Barclays

My next question is just kind of a little bit about the industry maybe starting with DMAA or pre-workout products. Obviously, for whatever reason people bought ahead I think is the right way to think of it. That's what happened last year, but is there any reason to believe that sort of category is fading and I think you said vitamins are coming back, but do you believe that there has been any fundamental change in the way consumers think about supplementation for managing health?

Mike Nuzzo

I think, everything you read, see an indications from customers are, they are still very focused on health and wellness. I think that's why you are seeing a lot of companies that want to get into the business, they want to participate. The question is do they really know how to participate in the business - in a number of mergers and acquisitions. I really think that the market is still very strong.

I think in the pre-workout market, I have always been most confident that's why we are seeing our sports fitness business still up even in spite of the whether implications in January-February and accelerated significantly in March, because that consumer is the one that is most loyal, would not go away and they are not going to stop pre-workout.

Pre-workout is just a situation of going against maximum sales both, levels DMAA and non-DMAA-related products as they are at the peak period of the year. We can't forget with the slow start to the kind of workout season and things like that DMAA could have picked up steam in January and February if we had more activity in the stores, but that's been delayed.

Maybe we are still optimistic, maybe it will, but I can assure that customers is not going anywhere. That customer will be loyal. It will coming in. That's the customer you know at the heart of the business will always be there again (Inaudible) for us.

Mike Nuzzo

Can I answer one other thing?

Meredith Adler - Barclays

Yes.

Mike Nuzzo

You also got to remember that because we were so strong with the pre-workout category and that impacted by DMAA, you got hurt the most, so we have done a good job of replacing it and trying to offset those trends, but we were probably stronger than anybody in marketplace with selling DMAA-type products.

Meredith Adler - Barclays

Right. I guess, my final question will be about international. I would say prices it seemed it's been relatively stable. I won't put the numbers Venezuela in that category, but maybe Turkey. Have become much less stable, does that make you want to rethink anything about how do international growth?

Joe Fortunato

Look we are over in 54 countries, we have spent few weeks ago a couple of days in strategy sessions and obviously international was a big focus. International last year as you know was impacted significantly from some of the regulatory environment changes and some of the what I'll call [cost] and various things like that there has been political and things like that. This year that is accelerating. I mean, Mexico, now a good number of product have been registered as drugs, doable, fortunate we have the infrastructure that cover that extremely well, but it's time consuming. The registered drug in Mexico takes six months, so you will see the same thing more prevalent in South Korea.

Venezuela is just a straight uprising one out of - there political issue that it's going to take months to work through. Our franchisees amazingly is comparable store sales are fairly very strong in that market, but the government is controlling monies in and out of Venezuela, so it makes the life difficult. We have been through this before and it will run its course. The question is when.

You have got Brazil, which we just had a transaction occurred from a franchise of ours in Brazil, hopefully to a stronger company which will even accelerate growth further. We have some great positive areas too. I mean, Singapore, Malaysia, Hong Kong. Those areas performed very well, so getting back to will get through the hurdles. It's just the time period again on getting products registered, getting them reformed, getting them to May and getting them out to the market, so that is another four to six months gap in some areas and that require that kind of time.

The other thing you see is we have shifted a lot of focus not to doing that, obviously to make sure that we keep our 54 franchise in tact in loyalties, but focusing in Europe and in China, and I don't want to talk yet above.

By the way, Russia is on track to open you probably July 1st, so products are registered. I know some of these answers are - something I saw that people were concerned that Russia would not happen. We had a our franchisee in there last week. I also saw with the [conference] they are staying aggressive. They have got a good team together and they are on track.

I think if we can get a growth vehicle in China, which is a major focus for us. I mean, major focus. We have been in China for a while. I think we have dap it a little too long and we need to get more aggressive puppy smart, but I think we have learned enough that it's time to make a move and you will be seeing that in Europe between discussion on whether it's M&A activity distribution models or retail models or ecommerce models while we thought yes you are going to see an acceleration in both of those areas much more quickly.

Meredith Adler - Barclays

Great. Thank you. Very helpful.

Operator

Your next question comes from the line of Kurt Frederick. Your line is open.

Kurt Frederick - Wedbush Securities

Thanks. Just want to talk a little bit on the operating expenses. One is on marketing you have the new campaign that's coming out what sort of investment big increase in market that in Q2 here. Then on the compensation line tick a couple of bit in a quarter, wondering if there's any impact from any law changes or are there something else that's going to run through there throughout the course of the year?

Mike Nuzzo

Yes, Kurt. On the marketing question, we will be spending - so we didn't spend as much in Q1 versus last year, because the Respect Yourself campaign launched in Q1 versus our new campaign the Beat Average campaign which is going to launch in Q2, if you look at it over the course of the of the total year, with our comp guidance the marketing percentage will probably be a little higher than it was last year.

I think last year it was 2.6% of revenue, they will probably tick up 20 basis points 30 basis points, because obviously we are committed to the spending. We think the Beat Average campaign is obviously off to a great start, so we are not going to take any of the fuel away from that, so that I think is the framework on marketing.

As far as compensation and benefits go, really nothing significant to speak of. A lot of that's driven by new stores. We always have minimum wage issues that tick up, but nothing of nothing of note or nothing standing out.

We had slightly higher healthcare expenses. We pay the Obama Care tax. We had some more use of healthcare, but again nothing significantly. I think the comp and benefits number was up 3.5%, so not significant in the grand scheme of things.

Kurt Frederick - Wedbush Securities

Okay. All right. Thank you.

Operator

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

Joe Fortunato

I thank everybody for joining us and thus certainly look forward to talking to you at any time, so if you have follow-up questions and various things like that, Mike and Dennis will be available and myself as well. I think, we have a few conferences we are going to be attending shortly. Hopefully we'll see you there.

Thank you. Appreciate it.

Operator

This concludes today's conference call. You may now disconnect.

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Source: GNC Holdings' (GNC) CEO Joe Fortunato on Q1 2014 Results - Earnings Call Transcript
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