After GNC reported quarter earnings that missed analysts’ expectations by a significant margin, the price of the company’s shares dropped by more than 28% in a single day’s trading on Thursday. The shares have rebounded slightly today, inching up over $29 per share.
GNC CEO Mike Archbold has been on the job for only about a year. He was brought in with a mandate to turn around a company that, after years of solid growth, has stumbled into a miasma of stagnant earnings and a plethora of expensive, unprofitable promotions. The old formula of frequent turnover of products on the shelf, heavy promotional activity and a frenetic pace of new store openings that was the legacy of previous CEO Joe Fortunato seemed to have run its course. This is the second quarter in a row when the effects of this turnaround effort have depressed the company’s earnings.
GNC, which sells a wide array of vitamin and mineral supplements, weight management products, sports nutrition formulations and personal care offerings, has been the subject of unprecedented scrutiny by state attorneys general. The well-known saga began earlier this year with the first investigation launched by New York Attorney General Eric Schneiderman that targeted GNC along with Target, Walgreens and Walmart. Even though industry experts complained that Schneiderman’s effort was based on an improperly applied DNA testing methodology and therefore came to false conclusions, GNC rapidly came to an agreement with Schneiderman to use DNA barcoding technology in its quality control systems and to report test findings to the NY AG.
Following that, the company was sued by Oregon Attorney General Ellen Rosenblum alleging breach of that state’s consumer protection laws. Rosenblum’s action was based on the presence of the ingredients picamilon and BMPEA (alternately labeled as Acacia rigidula) in third-party products sold by GNC. Rosenblum alleged, according to information garnered from FDA warning letters (in the case of BMPEA) or in the form a declaration on picamilon that was provided by FDA directly, that neither of these ingredients is a legal dietary ingredient.
Who's responsible? Retailer, or manufacturer?
Archbold took the unusual step of addressing directly these concerns during a conference call yesterday with analysts that was posted in transcript form on the site seekingalpha.com. He took issue with Rosenblum’s holding GNC responsible for products made by third parties.
“One of the issues at the heart of the allegation is whether GNC has the same rights as other retailers. That is the right to rely upon the guarantee of a third party vendor, a right that is firmly established in the FTC Act and in the FDA’s regulations. Under Oregon’s theory, any retailer that sells a third party product is responsible for ensuring that product’s lawful status and is not entitled to contractual guarantees, which is inconsistent with the FTC Act and the FDA’s regs,” Archbold said.
Archbold also bridled at the singling out of picamilon and BMPEA. In the time period covered by lawsuit, FDA had had nothing to say about either picamilon or BMPEA, he said. And in any case, Archbold said this is a matter of Federal law and should not be the subject of state-by-state negotiations.
“Second, while GNC was selling those products, the FDA had not taken a position, either formal or informal, regarding these ingredients. When they did, even informally, we promptly removed from sale all products containing those ingredients,” he said.
“Lastly, the whole purpose of a Federal regulatory framework is to avoid a patchwork of ad hoc regulations in 50 states. Consequently, as part of efforts by GNC and other industry leaders, we are building a coalition. The goals of the coalition include the establishment of raw material GMPs for the industry, including traceability standards, creating a new quality field to identify products and companies that comply with new minimum standards and annual facility certifications,” he said.
Shareholder and class action lawsuits
The company’s strategy of rapidly settling with Schneiderman, while decried at the time in the wider industry, seems to have paid off in restricting its subsequent liability. Archbold said the company has worked to have dropped or dismissed a number of class-action lawsuits that cropped up after the NY AG news broke. Archbold said progress has been made on that front. Of the original 22 suits, eight have been dropped and GNC was removed as a party in the remaining suits which have been consolidated in Federal district court in Illinois.
As for yesterday’s abrupt stock plunge, as could expected a number of shareholder lawsuits have been filed. As of this writing three had been filed on Thursday afternoon or Friday morning and more are possible.
Earnings details
GNC reported revenue of $672.2 million in the quarter. Analysts had been expecting something more along the lines of $685 million. The adjusted earnings per share came in at 76 cents, well analysts’ expectations of 84 cents.